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TUITION
CIMA
CLASS NOTES
F1
FINANCIAL OPERATIONS
F1 FINANCIAL OPERATIONS
- 3-
CONTENTS PAGE
F1 FINANCIAL OPERATIONS
- 4-
F1 FINANCIAL OPERATIONS
- 5-
- 6-
PAPER INFORMATION
F1 FINANCIAL OPERATIONS
- 7-
HOW TO PASS
F1 FINANCIAL OPERATIONS
(a)
Commissions (IOSCO);
explain the meaning of given features or parts of the IASBs Framework for the
Presentation and Preparation of Financial Statements;
describe the process leading to the promulgation of an IFRS;
describe ways in which IFRSs can interact with local regulatory
frameworks;
explain in general terms, the role of the external auditor, the elements of the
audit report and types of qualification
of that report.
11
(a) apply the accounting rules contained in IFRSs and IASs dealing eith
reporting performance, non-current assets, including their
impairment, inventories, disclosure of related parties to a business,
construction contracts (and related financing costs), post-balance
sheet events, provisions,
contingencies and leases (lessee only);
(b) explain the accounting rules contained
in IFRSs and IASs governing share capital transactions.
2. Apply international standards delaing with a range of matters and
items.
(a)
12
Reporting 60%
C Financial Accounting and
F1 Financial Operations
13
OVERVIEW
F1 Financial Operations
14
IASS
F1 Financial Operations
15
the
entitys financial statements of previous periods and with the financial
of
The objective of this Standard is to outline the basis for presentation
IAS 1 PRESENTATION OF FINANCIAL STATEMENTS
F1 Financial Operations
16
Standards change; or
The nature of the entitys operations changes it is more appropriate
to
? follow a different presentation or classification
?Going
Concern
Financial statements shall be prepared on a going concern basis
unless management either intends to liquidate the entity or cease
trading, or has no realistic alternative but to do so.
When financial statements are not prepared on a going concern basis,
it should
be
disclosed,
together
withthe
basis
on which
the
financial statements are prepared
and the reason why the entity is not regarded as a going concern.
Accruals
basis
accounting
of
Accounting
in
Changes
Policies,
Accounting
8
IAS
Follow
?
F1 Financial Operations
17
financial
the
in
reported
amounts
all
for
period
previous
the
disclosed for
statements.
Materiality and aggregation
Each material class of similar items should be presented separately in
the financial statements.
Immaterial items should be aggregated with similar items of the face of
the statement or in the notes.
Offsetting
Assets and liabilities, and income and expenses, should not be offset
unless required or permitted by a standard (see IAS 11).
Comparative information
Unless a Standard requires otherwise, comparative information should
be
F1 Financial Operations
18
X
X
Other comprehensive income:
Available
for sale
financial assets
Gains on property
revaluations
Income tax relating to components of other comprehensive income
X (X)
X (X)
(X)
Distribution costs
Administrative expenses
Gross profit
Revenue
Cost of sales
$
X (X)
X
Two formats of Statement of Comprehensive Income are provided by
IAS 1 but we shall consider the most likely to be examined.
Classification of expenses by function
19
is
it
but
IAS1
in
operations
from
profit
* There is no requirement to show often beneficial for you to do so.
F1 Financial Operations
CR
Sales
Purchases
45200
83200
Inventory
1 January 2009
Distribution at
costs
26000
12000
Administrative expenses
Bad debts written off
Hire of Machinery
Production wages
Loan
Interest
(loan repayable 2009)
Dividends
received
10000
1200
1000
800
2100
Motor
Cost Vehicles:
2000
1800
1000
3400
1
Depreciation is to be provided for on a straight line basis as
follows:
- Motor Vehicles 25 %
-
Machinery 10%
20
F1 Financial Operations
Required:
Prepare Creighton Ltds Statement of Comprehensive Income for the year
ended 31 December 2009 in a form suitable for publication.
21
F1 Financial Operations
22
23
WORKING PAPER
F1 Financial Operations
24
Total assets
Current assets
X
XX
X
Inventories
Trade receivables
Other
current
assets
Cash and
cash equivalents
X
X
XXX
Non-current assets
Property, plant and equipment
Goodwill
Other intangible assets
Available-for-sale
investments
$
$
ASSETS
Statement of Financial Position as at 31 December 2009
THE STATEMENT OF FINANCIAL POSITION
F1 Financial Operations
25
X
XXXX
Current liabilities
Trade and other payables
Short-term borrowings
Current portion of long term borrowings
Current tax payable
Short-term
provisions
X
Non-current liabilities
Long-term borrowings
Deferred tax
Long-term
Total equityprovisions
X
XX
X
X
XX
26
Balance at 31 December
2009
X
X
X
(X)
X
X
(X)
(X)
X
X
X
Restated balance
Changes in equity for
2009
Total comprehensive income for the period Dividends
Issue of share capital Transfer to Retained earnings
X
(X)
(X)
Balance at 31 December
2008
Changes in accounting policy
$
X
$
X
$
X
$
X
Revaln
reserve
Tota
l
Retain
ed earnin gs
$
X
Share
premi um
Share
capit al
The statement of changes in equity provides a comprehensive
summary of all movements in the share capital and reserves during the
year.
Statement of Changes in Equity for the year ended 31 December
2009
STATEMENT OF CHANGES IN EQUITY
F1 Financial Operations
27
the
in
applied
necessarily
is
that
policy
Each specific accounting
financial
statements
?
The measurement basis used in preparing the financial statements e.g.
Historic Cost; and
?
It is unlikely full sets of notes would be requested. It is more likely that
specific notes would be requested. Many disclosures are laid out in the
standard itself e.g. IAS 16
Accounting policies note;
NOTES TO THE FINANCIAL STATEMENTS
F1 Financial Operations
The company prepares its accounts annually to 31 December and its trial
balance for the year ended 31 December 2009, before final adjustments, is as
follows:
DR
$
CR
$
7500
200 000
76000
Plant and equipment
Cost
Additions in year
75000
10000
100000
140000
80000
30000
160000
90000
2500
12000
717500
717500
The following should be taken into account:
1 The plant disposed if originally cost $16 000 and depreciation was
cost;
Plant and equipment 20% reducing balance method
28
F1 Financial Operations
th
30
31
WORKING PAPER
F1 Financial Operations
32
33
(X)
Net cash used in investing activities
(X)
(X) X X
X
(X)
Cash flows from investing activities
Purchases of property, plant and equipment Proceeds of sale of
property, plant and equipment Purchase of intangibles
Purchase of investments
Interest received
Investment
income received
X
X (X) (X) X
Adjustments for:
Interest expense Investment income Depreciation
Amortisation Profit/loss on disposal Increase/Decrease in provisions
X
Cash flows from operating activities
Net profit before tax
$
$
Statement of Cash Flow for the year ended 31 December 2009
F1 Financial Operations
34
Short-term investments
X
Cash on hand and balances with banks (inc overdrafts)
2005
$
31 December
2006
$
* Allowed alternative presentation
Analysis of cash and cash equivalents
Cash and cash equivalents at end of period
(X)
XX
35
(X)
X (X) (X)
Investment income
Interest expense
Increase in inventories
and employees
suppliers
to
payments
Cash
Profit before taxation
Depreciation
Cash received from customers
$000
XX
$000
XX
Indirect method
Direct method
IAS 7 allows the cash flow to be prepared using either of the two
methods
below. It is important to note that both methods should give the same
overall outcome.
DIRECT VERSUS INDIRECT METHOD
F1 Financial Operations
36
or
managed
well
being
isnt
may not be the case if the working capital
unusual
transactions
haveoperating
taken place.
In general
net cash from
activities should be higher than
profit
from operations due to the effect of the adjustment for depreciation.
This
A cash flow alone cannot give enough information to enable a user to
know
if the entitys funds are being managed efficiently. Reviewing the
yearend Statement of Financial Position and considering the
relationship between components of working capital and financing
would be advisable.
Cash balances can also be distorted in the short term by holding back
payments to suppliers by a matter of days at the yearend, delaying
buying inventories or offering settlement discounts for prompt
payments.
Most businesses would not survive a prolonged period of net cash
outflows.
Whilst others who have too much tied up in liquid resources
have shareholders who would benefit from a cash outflow for example
investing in non-current assets or paying a dividend.
Ideally the cash flow should show a net increase in cash during a
period but
itINTERPRET
is obviouslyAnot
as OF
cut CASH
and dryFLOWS
as that within a business.
TION
F1 Financial Operations
Question 3 - Bean
Beans Statement of Comprehensive Income for the year
ended
31
December 2009 and Statement of Financial Positions at 31
December 2008 and 31 December 2009 were as follows:
360
82
59
9
150
Profit
tax
Incomebefore
tax expense
210
14
196
62
134
31
2009
$000
2008
$000
$000
$000
Non-current assets
Cost
Depreciation
798
159
780
112
639
668
Current
Inventoryassets
Trade receivables
Bank
12
10
34
24
26
28
70
64
709
732
Share capital
180
170
Share premium
Accumulated profits
18
343
12
245
541
427
Non-current liabilities
Income tax
100
250
21
47
15
68
40
709
732
During the year, the company paid $45,000 for a new piece of machinery
and a dividend of $36,000
38
F1 Financial Operations
55
Required:
Prepare a Statement of Cash Flow for Bean for the year ended 31
December 2009 in accordance with the requirements of IAS 7.
39
F1 Financial Operations
40
31 DECEMBER 2009
QUESTION 3 BEAN ANSWER
F1 Financial Operations
41
WORKING PAPER
F1 Financial Operations
Question 4 - Penny
10,050
Cost of sales
(6,040)
Gross profit
4,010
Operating expenses
(2,300)
1,710
Finance costs
(150)
1,560
1,060
42
F1 Financial Operations
$000
Non-current assets
$000
$000
6,400
1
8,500
Current assets
Inventories
1,200
1,400
Trade receivables
1,500
1,400
200
300
Cash at bank
2,900
3,100
9,300
11,600
Capital and reserves
Called up share capital
2,000
2,200
2,340
2,540
Revaluation reserve
Retained earnings
1,000
2,400
2,960
6,740
8,700
3
Current liabilities
Trade payables
800
700
Taxation
Bank overdraft
400
360
500
200
1,560
1,400
9,300
11,600
43
1,500
1,000
Non-current liabilities
F1 Financial Operations
NOTES
(1) Movements in fixed assets:
Cost or valuation
At 1 September
2008
Additions
Land
Buildings
$000
$000
2,000
3,000
Plant and
Total
equipment
$000
3,400
8,400
2,500
2,500
Disposals
(1,000)
(1,000) Revaluation 1,000
1,000
At 31 August 2009
3,000
Accum
ulated
deprec
iation
At 1 September
2008
Provision for year
Disposals
$000
3,000
4,900
10,900
400
1,600
2,000
60
1,140
(800)
1,200
1,940
2,400
Net book value
3,000
2,540
2,960
8,500
2008
At 31st August
2009
2,000
2,600
1,800
6,400
At 1 September
F1 Financial Operations
4
4
45
F1 Financial Operations
31 AUGUST 2009
F1 Financial Operations
Q
U
E
S
TI
O
N
1
Steve purchases a printing machine that had a list price of
$100,000 but was offered a trade discount of 10%. If Steve pays
for the machine within the next twenty days he can take
advantage of a further 5% settlement discount.
In addition to the list price Steve also incurred the
following charges:
$
Shipping & handling charges
2,500
Pre
production
testing
10,000
Maintenance contract for three years
18,000
Site
preparation
costs:
10,000
5,000
7,000
5
2
,
5
0
0
company
paid
after
eighteen days.
R
e
q
u
i
r
e
d
:
What initial cost should be recorded for the machine in the Statement of
Financi
al
Positio
n?
47
F1 Financial Operations
48
QUESTION 1 ANSWER
F1 Financial Operations
49
50
Reducing balance
NBV x selected % = falling depreciation charge
Methods of depreciation
IAS 16 only offers guidance the depreciation method used shall
reflect the pattern in which the assets future economic benefits are
expected to be consumed by the entity.
Straight line
(Cost residual value)/ useful life of the asset = constant
depreciation charge
the period over which an asset is expected to be available for use by
an
entity; or
the number of production or similar units expected to be obtained from the asset
by the entity
QU
EST
ION
2
Gamel purchased a refrigeration unit for $80,000 on 1 January
2004 when its useful life was estimated to be ten years with a
residual value of $10,000. A straight line depreciation policy was
selected.
On 31 January 2009 the Gamel reviewed the useful life of the asset
and found that it had a remaining life of eight years.
R
e
q
u
ir
e
d
:
What will the depreciation charge be for the year ended 31
December 2009?
51
52
QUESTION 2 ANSWER
F1 Financial Operations
QUE
STIO
N3
A lorry was purchased for $80,000 on 1 January 2004 when its
useful life was estimated to be ten years with a residual value of
$10,000. The depreciation policy of 20% reducing balance was
selected.
On 1 January 2009 the directors have now decided that to give a
fair presentation a depreciation policy of straight line over the useful
economic life should be followed. There has been no change in the
estimated useful economic life of the asset as a result.
R
eq
ui
re
d:
What would be the depreciation charge for the year ended 31
December
2
0
0
9
?
53
54
QUESTION 3 - ANSWER
F1 Financial Operations
55
equipment
whose fair value can be measured reliably can be carried at a revalued
amount
REVALUATION MODEL
After initial recognition of the asset, an item of property, plant and
equipment
should be carried at its cost less any accumulated depreciation
and accumulated impairment losses.
COST MODEL
Carrying amount the amount at which an asset is recognised
after
deducting any accumulated depreciations and accumulated
impairment losses.
An entity can choose either the cost model or the revaluation model as
its
accounting policy applied consistently to each class of property, plant
and equipment. The resulting carrying amount will be held under noncurrent
assets.
MEASUREMENT AFTER RECOGNITION
F1 Financial Operations
56
Dr Revaluation surplus
Cr
Retained
earnings
Each
year the
extra depreciation charged as a result of the revaluation
should be transferred from the revaluation surplus to retained
earnings.
ANNUAL RESERVE TRANSFER
Revaluation surplus = Revalued amount NBV at date of revaluation
The figure posted to the revaluation surplus can be calculated quickly
as
follows:
Cr
Revaluation surplus
The resulting balance is posted to a revaluation surplus
Accumulated depreciation
Dr
The accumulated depreciation on the asset is eliminated
Non-current assets cost/valuation
Dr
When revaluing an asset the first step is to increase the cost account
up to
the
revalued amount.
ACCOUNTING
FOR A REVALUATION
F1 Financial Operations
QU
ES
TIO
N4
Charlie bought an industrial oven on 1 January 2005 for $50,000.
The oven had an estimated useful economic life of five years with
no residual value. A straight line method of depreciation was
adopted.
On 1 January 2007 Charlie decided to revalue all non- current
assets in line with IAS 16. The oven was revalued at $60000. The
useful economic life is unchanged.
R
e
q
u
i
r
e
d
:
Show how the revaluation would be accounted for and the
subsequent depreciation calculation following the revaluation.
57
F1 Financial Operations
58
QUESTION 4 - ANSWER
F1 Financial Operations
QUESTION 5
Continuing from Question 4 above.
On 1 January 2009 Charlie decided to sell the oven. It realised
$25,000
Required:
Show the accounting entries to dispose of the item of plant and
the final reserve transfer?
59
Dr Revaluation surplus
Cr Retained earnings
surplus
journal to complete. Should any balance remain in the revaluation
for this asset it should be transferred to retained earnings.
When a revalued asset is sold the basic accounting is the same for an
asset
held at depreciated historic cost. However, there is potentially an
additional
DISPOSAL OF A PREVIOUSLY REVALUED ASSET
F1 Financial Operations
60
QUESTION 5 - ANSWER
F1 Financial Operations
61
X
X (X) (X)
X (X) (X)
X
X (X) (X)
Accumulated depreciation:
At
1 January
Charge
for year2009
Disposal Revaluation
At 31 December 2009
X
X (X) X
X
X (X) X
X
X (X) X
X
X (X) X
Cost or valuation:
At
1 January 2009
Additions Disposals Revaluation
Total
$000
Plant
$000
Motor
Vehicles
$000
Land and
buildings
$000
The main disclosure required for property, plant and equipment is
shown
below:
DISCLOSURES
F1 Financial Operations
62
63
If this is not possible then the intangible becomes part of the overall
goodwill
obtained
theIFRS3
business
combination.
Accordingin to
Business
Combinations, if an intangible asset
is
acquired in a business combination, the cost of that intangible asset is
its fair value at the acquisition date. Assuming a fair value can be
allocated to the intangible asset.
As part of a business combination
? Purchase price, import duties and non-refundable purchase taxes
less
any trade discounts
? Any directly attributable costs of preparing the asset for its intended
use eg professional fees, testing
This cost should comprise;
This usually means that the cost of the intangible asset is automatically
measured
reliably
i.e.entity
what to
you
paid.
The price paid
by an
separately
acquire an intangible asset
usually
reflects the expectations about the probability of obtaining the
future economic benefit generated by the intangible asset.
SEPARATE ACQUISITION
An intangible asset shall be measured initially at cost.
An intangible asset is recognised if, and only if;
? It is probable that the expected future economic benefits that
are attributable to the asset will flow to the entity; and
cost of the asset
measured reliably
? The
INITIAL
RECOGNITION
OFcan
ANbe
INTANGIBLE
ASSET
F1 Financial Operations
64
Q
U
E
S
T
I
O
N
7
Barry has the following research and development costs for the
year ended
31
Decem
ber
2009:
P
r
o
j
e
c
t
A
Expected total revenues $5,000,000, starting in early 2009. Expected total
costs will be $3,000,000. Costs incurred to date, all in 2009, are
$2,000,000.
P
r
o
j
e
c
t
B
Expected total revenues $4,000,000. Costs incurred to date are
$1,500,000. Expected total costs are $2,500,000. The commencement of
commercial sales is uncertain due to problems in raising funds to cover the
final development costs.
P
r
o
j
e
c
t
C
Expected total revenues $1,500,000 with $300,000 of revenue
already earned in 2008. Total development costs incurred, all in
2009, were
$
1
,
8
0
0
,
0
0
0
.
P
r
o
j
e
c
t
D
Research projects incurred total costs spent in 2009 were
$500,000.
R
e
q
u
i
r
e
d
:
Explain how each of costs incurred for projects A-D above should be
66
68
amount.
IDENTIFYING AN ASSET IS IMPAIRED
F1 Financial Operations
QUE
STIO
N9
A plate making machine was acquired on 1 January 2005 at a cost
of
$50,000 and has a useful economic life of
eight years.
At 31 December 2009 an impairment review was performed. The fair value of
the machine less selling costs was established to be $15,000. The expected
future cash flows are $5,000 per annum for the next five years. The current cost
of capital is 10%. An annuity factor for this rate over this period is 3.791
Is the machine
impaired?
QU
EST
ION
10
Continuing from the question 9. How would the
impairment
loss
be accounted for if
the machine had been revalued and its depreciated historical
cost was $17,000?
70
is
amount
Once the impairment has been accounted for the recoverable
then depreciated over the remaining useful economic life.
Depreciated historic cost recoverable amount written off to the
Statement
of
Comprehensive
Carrying
amount Income
depreciated historic cost reduces revaluation
surplus
Any write down in the carrying value of a previously revalued asset
should
first be treated as revaluation decrease and then any balance written
off to the Statement of Comprehensive Income immediately.
F1 Financial Operations
71
recoverable
its
below
reduced
be
should
CGU
the
in
asset
NB: No single
amount.
? Firstly, goodwill allocated to the CGU
? Secondly, other assets in the unit on a pro rata basis of the carrying
amount of each asset in the unit
The impairment loss should be allocated in the following order:
ALLOCATION OF IMPAIRMENT LOSSES TO A CASH
GENERATING
UNIT
The impairment review is conducted in the same way as an individual
asset,
with impairment again being identified where carrying value of the
CGU is higher than the recoverable amount.
A cash generating unit is the smallest identifiable group of assets that
cash
flows can be allocated to. This could include intangible assets like
goodwill as well as tangible and other assets.
It is not always possible to allocate cash flows to an individual asset.
To
overcome
this problem
a cash generating unit can be used.
CASH GENER
ATING UNITS
F1 Financial Operations
QUE
STI
ON
11
Siobhan owns a company called Harry. Extracts from Siobhans
Statement of Financial Position relating to Harry:
$
0
0
0
Goodwill
80,000
Franchise
50,000
Restored
costs
furniture
(at
cost)
90,000
Buildings
100,000
Other
net
assets
50,000
3
7
0
,
0
0
0
The restored furniture has an estimated realisable value of $115 million. The
franchise agreement contains a sell back clause, which allows Harry to
relinquish the franchise and gain a repayment of $30 million from the
franchisor. An impairment review at 31 March 2009 has estimated that the
value of Harry as a going concern is only $240 million.
R
e
q
u
i
r
e
d
:
Show how the impairment would be dealt
with.
72
F1 Financial Operations
73
QUESTION 11 - ANSWER
F1 Financial Operations
F1 Financial Operations
QUESTION 1
At 31 December 2008 Ava estimates that its current tax liability
for the year will be $150,000. In August 2009 Ava pays its tax
liability for the year ended
31 December 2008 at $147,000.
At 31 December 2009 Ava again estimates its income tax liability,
this time at $155,000.
Required:
Show Statement of Comprehensive Income and Statement of
Financial
Position extracts to reflect the above for the two years ended 31
December.
75
X
Total tax charge for the year
Income tax expense:
X
X/(X)
Current
taxprovision
chargefrom
for the
yearyear
Under/over
previous
as
charge
tax
years
This balance will then be incorporated to the current
you
cannot
go backisand
lastamount
years figures.
Often
this estimate
notrestate
the exact
that is actually paid
resulting in
an
over ortax
under
provision
Income
expense
(IS) for income taxes.
Income
tax liability (BS)
Dr
Cr
At the end of the financial year a company will estimate the amount of
tax
payable on profits for the period. This amount is charged to the
Statement of
Comprehensive Income and shown as a current liability in the
Statement
of
Financial Position.
CURRENT TAX
F1 Financial Operations
QU
ES
TI
ON
2
Becky purchased a boat on 1 January 2007 for $4 million. It was
estimated that the boat had a useful economic life of 5 years but
according to the tax authority had a 50% tax allowance in its first
year and 20% reducing balance there after.
Becky made an accounting profit of $3m for the year. This is
expected to continue for the next two years at least.
Income
tax
rate
30%
R
e
q
u
i
r
e
d
:
Ignoring deferred tax calculate the profits for Becky for each of the
three years ending 31 December 2007-2009.
76
Items that would have been used in calculating accounting profit but
would
NOT be used in calculating taxable profit e.g. some entertaining
expenses
Permanent differences
The reasons for this can be split into two categories:
Accounting profit Taxable profit
Deferred tax arises because;
Deferred TAX
F1 Financial Operations
77
QUESTION 2 - ANSWER
F1 Financial Operations
78
Opening provision
$000
X (X)
In subsequent years the provision should be recalculated as above
and the
closing
provisiontocompared
to the opening
provision
This is referred
as the Statement
of Financial
Position Liability
Method or
full
provision.
Income
tax expense
Deferred tax provision
Dr
Cr
This is recorded as;
X% x temporary difference = closing deferred tax provision
Then multiply the temporary difference by the income tax rate.
X
Temporary difference
(X)
Tax base (cost tax allowance)
X
NBV
To calculate the deferred tax provision you must first calculate the
temporary
difference.
$
0
0
CALCULATING DEFERRED TAX 0
F1 Financial Operations
QUESTION 3
Using the information in question 3 above. Calculate the
profits for Becky for the same years but this time accounting
for deferred tax.
Use this proforma to help
NBV
2007
$000
2008
$000
2009
$000
QU
ES
TIO
N4
Jane purchased an airplane for $5,000,000 on 1 October 2005. It
had an estimated life of eight years and an estimated residual value
of $800,000. The airplane is depreciated on a straight-line basis. The
tax authorities do not allow depreciation as a deductible expense.
Instead a tax allowance of 40% of the cost of this type of asset can
be claimed against income tax in the year of purchase and 20% per
annum (on a reducing balance basis) of its tax base thereafter. The
rate of income tax can be taken as 30% and the current tax estimate
for the year 2008 is $2m.
R
e
q
u
i
r
e
d
:
In respect of the airplane, calculate the deferred tax charge/credit in
Janes Statement of Comprehensive Income for the year to 30
September 2008 and the deferred tax balance in the balance sheet
at 30 September 2007 and
2
0
0
8
.
note: work to the
nearest $000.
80
F1 Financial Operations
QUEST
ION 5
The accountant of Tropical Ltd is in the process of calculating the
deferred tax for the year ended 31 October 2008. The deferred
taxation account had a credit balance of $1.5 million at 31 October
2007. All of these amounts arose in respect of the difference
between depreciation and capital allowances.
During the year ended 31 October 2008, the company charged
$18.0 million in depreciation and claimed $20.8 million in capital
allowances.
The income tax current charge for the year is $4.7m. There was an
over
Assume an income tax rate of 30%
throughout.
Req
uire
d:
Explain the purpose of deferred
taxation.
Prepare Statement of Comprehensive Income and Statement of
Financial
Position extracts for taxation in accordance with IAS 12 income
taxes.
81
st
82
QUESTION 6
430
10
75
15
14
60
14
12
7
10
37
60
450
280
40
160
100
23
139
7
62
140
100
343
1,294
1,294
=====
=====
83
F1 Financial Operations
The balance on the income tax account comprises the under provision
for income tax brought forward from the year ended 30 September
2009.
(e)
(f)
The directors have estimated that income tax of $57,000 will be paid on
the profits of the year.
Required:
Prepare an Statement of Comprehensive Income for New for the year ended
85
QUESTION 6 ANSWER
STATEMENT OF COMPREHENSIVE INCOME
F1 Financial Operations
86
F1 Financial Operations
QUESTION 6 ANSWER
STATEMENT OF FINANCIAL POSITION
87
F1 Financial Operations
QUESTION 6 ANSWER
STATEMENT OF CHANGES IN EQUITY
88
F1 Financial Operations
QUESTION 6 ANSWER
WORKING PAPER
89
QUESION 1
Should each of the following be treated as an adjusting or nonadjusting event?
(i)
(ii)
a legal action had brought against the company for breach of contract
prior to the year end. The outcome was decided shortly after the
Statement of Financial Position date, and as a result the company will
have to pay costs and damages totaling $80,000. No provision has
currently been made for this event.
(iii)
inventory included in the accounts at the year end at cost $30,000 was
subsequently sold for $10,000.
(iv)
90
F1 Financial Operations
91
?
?
an entity has a resent obligation, legal or constructive, as a result of a
past event;
?
A provision shall be recognised when;
RECOGNITION OF PROVISION
An event that creates a legal or constructive obligation that results in
an
entity
having noEVENT
realistic alternative to settling that obligation.
OBLIGATING
is
A present obligation arising from past events, the settlement of which
expected to result in an outflow or economic benefits.
LIABILITY
A liability of uncertain timing and amount.
DEFINITIONS
PROVISION
ASSETS
IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND
CONTINGENT
Learning Outcome:
F1 Financial Operations
Q
u
e
st
io
n
2
After a wedding in the summer of 2008 ten people died as a result
of food poisoning from eating food manufactured by Future. At 31
December 2008 the company was advised that there was probably
no liability and the matter was disclosed as a contingent liability at
that date.
As the result of developments in the case, which is still not settled,
the company was advised that it is now probable, as at 31 March
2009 that the company will be found liable.
Some directors consider that the matter should remain a contingent
liability until the court case decides the matter, while others
consider that provision should be made for it in the financial
statements for the year ended 31
Ma
rch
20
09.
What
do
you think?
a contract
legislation
other operation of law
?
?
?An obligation that derives from;
Legal obligation
the
of
estimate
best
The amount recognised as a provision should be the
expenditure
required to settle the present obligation.
Measurement
F1 Financial Operations
QUE
STI
ON
3
During the year Bebob acquired a gold mine at a cost of $5 million.
In addition, when all the ore has been extracted (estimated in 10
years time) the company will face estimated costs for landscaping
the area affected by the mining that have a present value of $2
million. These costs would still have to be incurred even if no further
ore was extracted. The directors have proposed that an accrual of
$200,000 per year for the next ten years should be made for the
landscaping.
R
e
q
ui
r
e
d
:
Discuss whether you think the Directors are right in their chosen
treatment.
93
of
part
as a result, the entity has created a valid expectation on the
those
other parties that it will discharge those responsibilities.
?
by an established pattern of past practice, published policies or a
sufficiently specific current statement, the entity has indicated to other
parties that it will accept certain responsibilities; and
?
An obligation that derives from an entitys actions where;
CONSTRUCTIVE OBLIGATION
F1 Financial Operations
94
95
A contingent asset is a possible asset that arises from past events and
whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the
control of the
entity.
CONTINGENT ASSETS
ii
it is not probable that an outflow of resources will be required to
settle
the obligation
the amount of the obligation cannot be measures with sufficient reliability
i
A contingent liability is:
? a possible obligation that arises from past events and whose
existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly
within the control of the entity
? a present obligation that arises from past events but is not
recognised because;
CONTINGENT LIABILITIES
F1 Financial Operations
96
QU
ES
TI
ON
1
Neil paid $3 per unit for the raw materials of its products. To
complete each unit incurred $2 per unit in direct labour.
Production overheads for the year based on normal output of
12,000 units was $72,000.
Due to industrial action only 10,000 units were produced and
1,000 units were in inventory at the end of the year.
As a result of the industrial action some units were badly stored
and became damaged. Its is estimated that 200 of the units will
now only be sold for $12 each after minor repairs of $2 each
R
e
q
u
i
r
e
d
:
What figure for closing inventory would be shown in the
Statement of
Financia
l
Position
97?
X
X
Finished goods
Raw materials
Work
in progress
$
XX
DISCLOSURES
estimate
the
of
based on the most reliable evidence available at the time
less
any costs
related
to selling
inventories.
The amount
at directly
which the
inventories
arethe
expected
to realise should be
Exclusions: abnormal costs, storage costs, administration costs and
selling
expenses.
NET REALISABLE VALUE
F1 Financial Operations
98
99
and Matching
F1 Financial Operations
100
balancing
a
becomes
sales
of
and
done
work
on
based
calculated
figure.
be included are both
profit to
and
cost
completed.
The amount of revenue
The recognition of contract profit is usually based on the percentage of
work
PROFITABLE CONTRACTS
? Proportion of work done either verified by professional surveyor or
by comparing costs incurred to date to total contract costs
? By identifying specific points in the contract where the work
completed has separately ascertainable values.
There is no set rule on how to calculate this but two main methods
exist:
CONTRACT REVENUE
F1 Financial Operations
QUESTION 2
Tarkwin has a contract which commenced in 2009. The following
is details from the year ended 31 December 2009.
$
m
Total contract value
Costs incurred to date
Estimated
costs
to completion
Work certified
as completed
in the year
40.0
25.0
3.5
12.0
Stage of completion
80% Profit recognised to date
5.5
Required:
Show
how this
Statement
contract
of
would
be
dealt
with
in
the
QUESTION 3
Tarkwin has a second contract which commenced in 2009
and will be completed in 2010. The following is details from
the year ended 31
December 2009.
$
m
Total contract value
Costs incurred to date
Estimated costs to completion
Stage of completion
35.0
20.0
19.5
50%
Required:
Show how this contract would be accounted for in the Statement of
103
X
Gross amounts due (to)/from
customers
Costs incurred
X
X (X)
(X)
Recognised profits
Recognised
Amounts billedlosses
current
a
as
balance
the
in
IAS 11 requires this amount to be disclosed
asset or liability depending on the outcome.
Gross amounts due to/from customers$
ACCOUNTING TREATMENT STATEMENT OF FINANCIAL
POSITION
F1 Financial Operations
Q
U
E
S
T
I
O
N
4
Jenny has a three year contract which commenced on 1 April
2008. At 31
March 2009, Jenny had the following balances in its ledger
relating to the contract:
$000
$000 total contract value
120,000 cost incurred up to 31 March 2009:
attributable to work completed
42,000 inventory purchased for use
in 2008/9
6,000
4
8,000
progress
payments
received
R
e
q
u
i
r
e
d
:
Prepare the Statement of Comprehensive Income and
Statement
of Financial Position extracts
showing the balances relating to this contract, as required by
IAS 11 long-term contracts.
104
F1 Financial Operations
QUESTION 5
Winnie designs and builds schools. During the year ended 31
December
2009 Winnie had two contracts start with the following details. All
outcomes can be estimated with reasonable certainty:
Tigger
Piglet
$m
Contract price
Total costs to date
$m
70
55
45
40
49
27
customers)
Estimated future costs to completion
10
16
Payments on account
Completion
50
70%
34
60%
Required:
Calculate figures for the Statement of Comprehensive Income and
106
Q
U
E
S
T
I
O
N
6
Christopher Robin constructed a Hospital at a cost of $100
million over eight Christopher Robin took out an $80 million 10%
loan on 1 January. The loan year.
R
e
q
u
i
r
e
d
:
Calculate the initial cost valuation of
the hospital.
107
following
the
until
open
not
did
hospital
The
December.
31
on
repaid
was
to finance the project
months from 1 January to 31 August. In order
F1 Financial Operations
108
109
110
?
?
?
?
The lease transfer ownership of the asset to the lessee by the end of
the lease term
The lessee has the option to purchase the asset at a price expected to be
sufficiently lower than fair value at the date the option is available and it is likely
that the option will be taken up
The lease term is for the major part of the life of the asset even if legal
title isnt transferred
At the start of the lease the present value of the minimum lease payments is
substantially all of the fair value of the leased asset
The leased assets are of such a specialised nature that only the lessee can use
them without major modifications
?
Examples of situations that individually or in combination would
normally
lead
to a lease
classified
Indications
of being
a finance
leaseas a finance lease are;
If not its an operating lease.
This reflects the concept of substance. Even though legal title does not
initially
the asset
treated
its owned.
A leasepass
is classified
asisa being
finance
lease as
if itiftransfers
substantially all the
risks
and
rewardsAincidental
ownership.
CLASSIFIC
TION OF to
LEASES
Not a finance lease!
OPERATING LEASE
F1 Financial Operations
EX
A
MP
LE
4
Danny has taken out an operating lease on its photocopier paying
a non- refundable deposit of $3,000. The lease is or three years
with annual payments of $5,000 after which the photocopier goes
back to the lessor. The photocopier has a useful economic life of
five years.
R
e
q
u
i
r
e
d
:
Show how the photocopier will be accounted for in the
Statement of
Financial
Position
and
Comprehensive Income.
Statement
of
111
Following substance legal title has not transferred but the asset
being
treated
as if its
owned
so theassets
accounting must reflect that.
Non-current
assets
leased
Lease
liability
Dr
Cr
The leased asset is firstly recognised at its fair value (cash price) or if
lower
the present value of the minimum lease payments. The opposite side
of the entry is to establish the lease liability
FINANCE LEASE
being
is
asset
the
and
transferred
Following substance legal title has not
treated
anotheras if its being hired not owned.
expense on a straight line basis over the lease term unless
systematic basis is more appropriate for the way the asset is used.
OPERATING LEASE
Lease payments under an operating lease shall be recognised as
an
ACCOUNTING FOR LEASES
F1 Financial Operations
112
liability
the
on
interest
of
allocation
an
be
must
there
Also each year
outstanding.
Depreciation expense
Accumulated
depreciation
Dr
Cr
The accounting for depreciation is in line with IAS 16;
depreciated
be
life of the asset would be used. Otherwise the asset would
over
shorter
of the
term and theusing
useful
life.
Eachthe
year
the asset
is lease
then depreciated
a systematic
basis. If it
is
likely that the lessee will obtain legal title at the end of the lease the
useful
F1 Financial Operations
113
Total interest
X
total interest x 1/6
3
X
total interest x 2/6
2
X
total interest x 3/6
1
Instalment
The total interest is then systematically allocated using the sum of the
digits,
i.e.
X
Total interest
X
Total payments
(X)
Cash
price/fair
value
The total
interest
needs to be calculated
2
= 6
3(3+1)
2
e.g.
lease
was paid
over 3 instalments
whereifnthe
is the
number
of instalments
paid.
n(n+1)
Use the following formula to initially work out the sum of the digits.
Sum of the digits
Each instalment must be split between interest and capital
repayment.
Interest should be allocated to each period during the lease term do as
to produce a constant periodic rate of interest on the remaining
balance of the
liability.
METHODS OF ALLOCATING INTEREST
F1 Financial Operations
LEASE PAYMENTS
BFWD
INTEREST
BFWD
INSTALMENT
AB
(X) (X) (X)
XXX
XXX
1
2
3
CFWD
PAID
INTEREST
BFWD
INSTALMENT
114
Payments in arrears
Using a three year lease again.
as
digits
the
the digits method. Work out the interest charges using sum of
above
andway
then
thefigures
interestfor
amounts
to the table.
The best
to slot
workinout
the Statement
of Financial Position
liability is to use the table above. This would be used automatically if using
the
method
but ison
just
as easy made
to useinif arrears.
you re following the sum of
Theactuarial
above table
is based
payments
CALCULATING THE LEASE LIABILITY FOR THE STATEMENT OF FINANCIAL
POSITION
This method uses actuarial tables or interest tables to allocate the interest
charges to particular periods. it also has reducing charges for interest but is more
accurate than the above sum of the digits method.
To be able to apply the actuarial method in a question you would need to be given an
implicit rate of interest.
ACTUARIAL METHOD
F1 Financial Operations
EXAMPLE 5
Danny also starts a finance lease on 1 January 2009 acquiring a camera
which has a fair value of $10,000.
The lease requires a deposit of $575
followed by seven annual instalments of $2,000 payable in arrears. The
implicit interest rate in the lease is 11%.
Required:
Show how the finance lease would be treated in the Statement of
Comprehensive Income and Statement of Financial Position for the year
ended 31 December 2009.
XX
BX
x
AC
X
(X) (X)
(X)
XX
X
1
2
3
= CFWD
+ INTEREST
=
CAPITAL
- PAID
BFWD
INSTALMENT
115
(A B)
Current liability
Finance lease
When payments
B
Non-current liability
Finance lease
F1 Financial Operations
Payments in advance
x
interesting
E
X
A
M
P
L
E
6
A lease rental of $20,000 was paid on 1 April 2008. It is the first of
five annual payments in advance for the rental of an item of
equipment that has a cash purchase price of $80,000.The implicit
interest rate in the lease as
12% per annum. Leased assets should be depreciated on a
straight-line basis over the life of the lease.
R
E
Q
UI
R
E
D
:
Show how the finance lease would be treated in the
Statement of Comprehensive Income and Statement of
Financial Position for the year ended 31 March 2009.
116
117
?
Definition of a related party
A party is related to an entity if the party:
IAS 24 RELATED PARTY DISCLOSURES
LEARNING OUTCOME:
F1 Financial Operations
118
119
distinguish.
whether a shares are one of the more difficult instruments to
Preference
The terms of each share should be considered to identify contractual
obligation exists (financial liability) or not (equity).
contractual
entity after deducting all of its liabilities ie have no
obligation
Equity any contract that evidences a residual interest in the assets of an
Financial liabilities any liability that is a contractual obligation to make one
or more
payments
in the
future
their true substance
rather
than what
entities
may want to show them as. It
distinguishes
between liabilities (debt) and equity.
on
based
IAS 32 helps to ensure that financial instruments are recognised
PRESENTATION
IAS 32 FINANCIAL INSTRUMENTS DISCLOSURES AND
TYPES OF SHARE
LEARNING OUTCOME:
F1 Financial Operations
QUESTION 1
Required:
Should the following be classified as equity or financial
liability? Ordinary shares
Non redeemable cumulative preference shares
Redeemable Preference shares
Non redeemable preference shares
Loan notes & bonds
121
QUE
STIO
N2
Gamel decides to make a bonus issue on the basis of one new
share for every four owned by its existing shareholders. The capital
and reserves immediately before the issue were:
$
0
0
0
Ordinary
$1
shares
1,000
Share
500
Retained
premium
earnings
4,350
Re
qu
ire
d:
Show how capital and reserves would change after the issue.
122
use
otherwise
used,
be
would
premium
share
Ideally
Financial Position.
retained
earnings.
The choice
of reserve will be dependent on what exists in the
Statement of
Dr Reserves
Cr shares
Share are
capital
The
given to existing shareholders for no consideration.
BONUS ISSUE
Cash
Share capital nominal value only
Share
premium - balance
Dr
Cr
Cr
ISSUE AT A PREMIUM
F1 Financial Operations
QUES
TION
3
Consider Gamel again who this time instead of the bonus issue
makes a rights issue on the basis of one new share for every four
owned by its existing shareholders. The issue price is $2 and the
issue is fully taken up. The capital and reserves immediately before
the issue were:
$
0
0
0
Ordinary
$1
shares
1,000
Share
500
Retained
premium
earnings
4,350
The market price of a Gamel share before the issue was $5
Req
uire
d:
Show how capital and reserves would change after the issue.
123
Cash
Share capital nominal value only
Share
premium balance
Dr
Cr
Cr
The shares are given to existing shareholders for a price lower than
market
price.
RIGHTS ISSUE
F1 Financial Operations
124
When an entity acquires its own equity shares, and at the Statement of
Financial Position date has not cancelled them, they are referred to as
treasury shares.
TREASURY SHARES
The value of the equity element is the difference between the fair value
of
the
overall instrument
and thealldebt
element.
To calculate
the debt portion
future
payments capital and interest
are
discounted
present
value.
If a financialtoliability
has
an option to convert to equity it is most likely a
compound instrument part debt, part equity. It must be accounted for
accordingly.
CONVERTIBLE DEBT
The issue of shares from announcement to application and allotment
can be
found
in Chapter
17the
pages
361 of
- 366
Payments
made to
holders
financial liabilities, even if described
as
dividends will be taken to finance costs in the Statement of
Comprehensive
Income
Payments made to equity holders will be treated as dividends and
taken to
the
Statement
of Changes
in Equity
DIVIDENDS
AND
INTEREST
IAS 32 requires share issue costs to be taken directly to equity not the
Statement
of Comprehensive
Income.
SHARE ISSUE
COSTS
F1 Financial Operations
125
126
The
This retrospective
change should be applied retrospectively. This
restatement
opening balances and comparatives.
Policies may of
also
changing the policy would result in fairer presentation.
need
where changes
in standards
take
place. consistently
Once amending
chosen accounting
policies
should be
applied
unless
Changing accounting policies
Faithful representation
Reflect the substance Neutral, free from bias Prudent
Complete
?
?
?
?
?Reliable
Relevant to the economic decision making needs of users; and
In all other situations policies should be selected so as to result
in
information
that
andaccounting
reliable in line
with the Framework.
requirements
of is
therelevant
applicable
standards.
entity must firstly consider the
an
accounting policies
In selecting
Selecting accounting policies
by
applied
The specific principles, bases, conventions, rules and practices
an
entity in preparing and presenting the financial statements.
DEFINITION
Accounting policies
ESTIMATES AND ERRORS
IAS 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING
LEARNING OUTCOME:
F1 Financial Operations
Q
U
E
S
T
I
O
N
1
SPC Construction incurs considerable finance costs on its
financing for the construction of superstores. Its chosen
accounting policy to date has been expense the finance costs
as incurred. The final accounts for the year ended
31 December 2007, and the 2008 draft accounts, reflect this
policy and show the following.
$000
$000
6,200
4,450
(1,900)
(1,400)
2007
8,700
6,200
(2,500)
(1,750)
Finance costs
Profit
2008
brought
4,300
3,050
26,050
30,350
======
26,050
======
On the advice of the auditors the directors have now decided to change
the accounting policy to one of capitalisation of finance costs to give a
fairer presentation. SPC incurs no finance costs other than those related
At the beginning and end of 2008 SPC had the following balances:
Ordinary
share capital
Share premium
$
,
0
0
0
5,000
3,000
SPC paid a dividend of $1m during the year ended 31 December 2008.
Required:
Show how the change in accounting policy will be reflected in the financial
statements for the year ended 31 December 2008.
QUESTION 2
Required:
Would the following be a change in accounting policy or
revision of an estimate?
If a company decides to change its method of depreciation from
straight line method to reducing balance method.
If a company decides to change from capitalising finance costs to
immediate write off.
128
Errors
Any fundamental errors or omissions would be dealt with in the same
way as the change in accountings policy.
Changes in estimates are adjusted prospectively in the current
years
Statement of Comprehensive Income but not retrospectively as with
changes in accounting policy.
As a result of inherent uncertainties in a business many estimates will
be
made.
As estimates
revisions
will obviously need to be made.
Changes
in accounting
estimates
F1 Financial Operations
Q
U
E
S
T
I
O
N
3
On 1 January 2007 Scrunchie Ltd bought an item of plant for
$200,000.
It has an expected useful life of 10 years but will realise nothing
on final disposal. On 31 December 2009, after three years of
using the asset, it was decided to sell the plant.
A plan was put in place and instructions given to locate a
buyer. The plant is in great demand so Scrunchie Ltd is
confident that the machine will be sold promptly. Its current
market value is $130,000. As the item of plant is a considerable
size dismantling costs to make it available for sale will be
incurred at $1,000.
R
e
q
u
i
r
e
d
:
Show how the asset should be presented in the Statement of
Financial
Position for the year ended 31
December 2009.
129
The asset should be held at the lower of its carrying value and fair
value less
costs to sell.
Accounting
130
?
?
?
The revenue, expenses and pre-tax profit or loss of discontinued
operations
?
(b)An analysis of this single amount must be presented into
PRESENTATION IN THE STATEMENT OF COMPREHENSIVE
INCOME
(a) An enterprise must disclose a single amount on the face of the
Statement of Comprehensive Income, comprising the total of:
? the post-tax profit or loss of discontinued operations; and
? the post-tax gain or loss recognised on the measurement
to fair value less costs to sell, or on the disposal, of the
assets constituting the discontinued operation.
? Represents a separate major line of business or geographical area
of
operations,
? Is part of a single co-ordinated plan to dispose of a separate major
line of business or geographical area of operations
A component of an entity that either has been disposed of or is
classified as
held
for sale and; OPERATION
DISCONTINUED
DEFINITION
F1 Financial Operations
131
132
Revenue from the sale of goods can be recognised when all the
following
conditions have been met:
? transfer of significant risks and rewards of ownership to the buyer
? sellers no longer retains any managerial involvement or control
over
the goods
? the amount of revenue can be measured reliably
? it is probable economic benefits from the transaction will be
received
? the costs incurred can be measured reliably
REVENUE FROM SALE OF GOODS
IAS 18 considers when revenue should be recognised in the Statement
of
Comprehensive Income. Revenue could arise from;
? the sales of goods
? the rendering of services
? the use by others of entities assets yielding interest,
royalties or dividends
RECOGNITION
REV
ENU
E
The gross inflow of economic benefits during the period arising in the
course of the ordinary activities of an entity when those inflows result in
increases in equity, other than increases relating to contributions from
shareholders.
DEFINITION
IAS 18 REVENUE
F1 Financial Operations
133
?
the accounting policies adopted for the recognition of revenue
the amount of each significant category of revenue (sale of goods,
rendering of services, interest, royalties and dividends) recognised
during the period
the amount of revenue arising from exchanges of goods or services
included in each significant category of revenue.
?
?
An enterprise should disclose:
Revenue should be measured at the fair value of the consideration
received
or receivable.
Disclosure requirements
MEASUREMENT
Revenue from interest, royalties and dividends may be recognised
when it is
probable that the benefits of the transaction will flow to the entity, and
the amount of the revenue can be measured reliably.
INTEREST ROYALTIES AND DIVIDENDS
?
?
the amount of revenue can be measured reliably
it is probable that economic benefits associated with the transaction
will be received
the stage of completion of the transaction at the Statement of Financial
Position date can be measured reliably
the costs incurred can be measured reliably
?
?
Revenue from services may be recognised only when certain
conditions have
been met relating to:
REVENUE FROM SERVICES
F1 Financial Operations
134
?
the nature of the regulatory environment (banking, insurance, etc.).
the methods used to distribute the products or services;
?
?
the type of customer for the products or services;
the nature of the production process;
?
the nature of the products or services;
l
Operating segments can be aggregated where they have similar
economic
characteristics
similar
in each ofofthe
transactionsand
withare
other
components
thefollowing:
same entity);
(b) whose operating results are regularly reviewed by the entitys
chief
operating decision maker to make decisions about resources to be
allocated to the segment and assess its performance; and
(c) for which discrete financial information is available.
to
expenses relating
and
revenues
(including
expenses
incur
The only definition given in IFRS 8 is that of an operating segment. An
operating segment is a component of an entity:
(a) that engages in business activities from which it may earn revenues and
135
the
of
75%
least
at
identified, even if they do not meet the 10% tests, until
revenue
is in fact included
the segmental
The segmental
analysis inmust
cover at analysis.
least 75% of the total
consolidated or
enterprise revenue. If the reportable segments total less than this it
may be possible the segments which do not meet the 10% test should
be combined with similar segments. If this is not feasible, additional
segments have to be
total sales revenue, including sales to other segments; or
total profits of all profit-making segments; or total losses
of all loss-making segments; or total assets.
?
?
?
?
An operating segment is a reportable segment if the operation
contributes at
least
10 per centSEGMENTS
of:
REPORTABLE
F1 Financial Operations
F1 Financial Operations
137
138
140
(W4)
(W3)
x
x
share capital
reserves (eg
RE,SP)
$
xx
statement of
$xx
financial position
Acquisition
(W2)
Net assets of subsidiary
S
100%
P
(W1) GROUP STRUCTURE
WORKINGS REQUIRED
by
subsidiaries
the
of
acquisition
position/income statement illustrating the
the
parent. We need a plan!
financial
of
statement
group
a
form
to
companies
individual
from
141
X x (x)
142
XXX
X
Share Capital (Parent only)
Reserves (W5)
Non-current liabilities (100% P + S) Current liabilities (100% P + S)
X
X
XX
Current Assets
Inventory (100% P + S) Receivables (100% P + S)
X
X
Non Current Assets
Goodwill (W3)
Tangible (100% P + S)
$000
Consolidated Statement of Financial Position at 31 December
2009
F1 Financial Operations
Question 1
Summarised statements of financial position
for the year to 31 December 2009
James
Neil
$
1000
500
600
- Current
Assets
800
600
2400
1100
Share Capital
500
200
Retained earnings
800
400
Current liabilities
1100
500
2400
1100
1) James purchased 100% of Neil for $600 two years ago when
Neils
retained earnings showed a balance of $100
Required:
Prepare the consolidated statement of financial position for the
James Group for the year to 31 December 2009.
144
If, for example, a parent sells to a subsidiary and the subsidiary has
not sold
on the goods by the year end an extra adjustment is required to
remove the
profit
on the are
transaction.
When goods
sold by one company in a group to another in the
same
group a cancellation would be required to remove, in accordance with
IAS
27s single entity concept, the receivable/payable amount on the
group statement of financial position.
Unrealised Profit - Inventory
NO! Therefore these balances are not true outstanding balances from
a
group point of view and need to be cancelled or receivables and
payables would be overstated. The same is true for any balance
between parent and subsidiary.
If this is the case, ask yourself this will the parent receive cash from
outside the groups? And, will the subsidiary pay cash outside the
group?
Elimination of intra group balances
IAS 27 requires all transaction and balances between group
companies to be eliminated on consolidation. Consolidated financial
statements treat the two companies as if they are one. If the parent
has sold goods to the subsidiary there could be receivable and
payable balances between them at the end of the year.
F1 Financial Operations
145
is
100 is the unsold inventory x mark-up of 25% over 100 plus the markup.
The 20 is an artificial profit that doesnt exist as far as the outside
world
concerned. It, therefore, needs to be removed at the consolidation
stage.
125
100 ??
25
? 20
(CSFP)
?Profit
(W4 GRE)
S
?Inventory
sells to
IF
P
(CSFP)
?Profit
Make the adjustment
STEP 2
100 ? Mark ? up
unsold inventory ?
Mark ? up
Question 2
Summarised statements of financial position for the year to
31 December 2009
James
Molly
$
900
Investment in Molly
500
800
- Current Assets
700
600
2400
1100
Share Capital
500
200
Retained earnings
800
400
1100
500
Current liabilities
2400
1100
146
F1 Financial Operations
1) James purchased 100% of Molly for $800 two years ago when
Mollys
reserves showed a balance
of $200.
2) James and Molly traded with each other and at the year end Molly owed
James $150. This is included in both sets of individual company figures.
Also included in the inventory of James was $30 of goods purchased
from Molly at mark up on cost of 25%.
1) Goodwill arising on acquisition of Molly has been impaired by $200.
Required:
Prepare the consolidated statement of financial position for the James
QUESTION 3
Summarised statements of financial position
for the year to 31 December 2009
Jack
Cate
2,000
900
800
-
Current Assets
Inventory
250
180
Receivables
300
200
Bank
90
50
3,540
1,230
1,000
200
Retained earnings
900
350
Non-current
500
100
Share Capital
liabilities
Current liabilities
148
F1 Financial Operations
1,140
580
3,540
1,230
1) Jack purchased 100% of Cate for $900 two years ago when
Cates
reserves showed a balance of
$100.
2) Jack and Cate traded with each other and at the year end Cate owed
Jack $50. This is included in both sets of individual company figures.
Also included in the inventory of Cate is goods bought from Jack for $50
at a mark up on cost of 25%
150
Question 4
Summarised statements of financial position for the year to 31
May 2009
Pam
Sam
$000
$000
10,000
6,000
6,000
Inventory
6,000
1,000
Receivables
5,000
6,000
Bank
1,000
2,000
28,000
15,000
Share Capital
12,000
4,000
Retained earnings
13,000
8,000
3,000
3,000
28,000
15,000
Current Assets
Current liabilities
151
F1 Financial Operations
1)
These tangibles
2)
3)
$150,000.
4)
During the year Sam sold $1m goods to Pam at a mark- up of 25%
on cost. Three quarters of these goods had been sold by Pam by
the year end.
Required:
Prepare the consolidated statement of financial position for the year to 31 May
2009.
152
F1 Financial Operations
Question 5
Summarised statements of financial position for the year to
31 March 2009
Jenny
Becky
$
$ Non
Current
Assets
Tangibles
Investment in
10,000
5,000
7,000
- Becky
Current Assets
Inventory
8,000
3,000
Receivables
6,000
2,000
Bank
5,500
1,000
36,500
11,000
Share Capital
Share premium
Reserves
Current liabilities
16,000
3,000
2,000
1,000
14,000
5,500
4,500
1,500
36,500
11,000
153
F1 Financial Operations
QUESTION 1
Statement of comprehensive income for the year ended 30
September 2009
Revenue
Cost of sales
BILL
$000
100,000
(50,000)
BEN
$000
80,000
Gross profit
(30,000)
50,000
Admin expenses
Profit from operations
50,000
(20,000)
30,000
(35,000)
15,000
Investment
income
Profit before tax
10,000
40,000
15,000
Income
taxyear
expense
Profit for the
(10,000)
30,000
(5,000)
10,000
1)
2)
3)
4)
Required:
Prepare the consolidated Statement of comprehensive income for
the year to 30 September 2009.
156
F1 Financial Operations
Question 2
income statement for the year ended 30 September
2009
Jo
$m
100
Revenue
80 cost of sales
(30)
50
50
(20)
30
15 investment
10
40
15 income tax
(10)
(5)
30
10 retained
50
30
(50)
gross profit
Admin expenses
Profit from operations
income
profit before tax
expense
profit for the year
earnings bfwd
Jo
acquired
Steve
$m
80
100%
of
(35)
40
Steve
on
October
2008.
At acquisition Steves plant had a fair value of $2m more than their
carrying value and are being depreciated over 5 years on a straight
line basis.
3)
REQUIRED:
158
in
This means it is treated as an associate and equity is accounted for
accordance with IAS 28 (no line by line consolidation).
A shareholding of between 20% and 50% is assumed to give the
investing
company
significant
influence TECHNICAL
over its investment.
PROVISION
OF ESSENTIAL
INFORMATION
If the investing company acquires less than 51% of the ordinary share
capital of another company, then control is not achieved and no
consolidation will occur.
?
?
?
?
representation on the board of directors;
participation in policy-making processes;
material transactions between the investor and the entity;
interchange of managerial personnel;
The key concept in the definition is significant influence. IAS 28
explains
that significant influence is the power to participate in the financial and
operating policy decisions of the entity but is not control over those
policies. The existence of significant influence by an investor is usually
evidenced in one or more of the following ways:
IAS 28 INVESTMENT IN ASSOCIATES
If an investor holds, directly or indirectly, 20 per cent of the voting
rights of an entity then it is normally considered an associated entity
and is accounted for in accordance with IAS 28 investment in
associates. IAS 28
states that there is a presumption that the investor has significant
influence over the entity, unless it can be clearly demonstrated that this
is not the case.
F1 Financial Operations
159
and
is calculated
as follows:
calculation
is needed.
Group reserves are required as normal.
No minority interest
the same way as they would be for a subsidiary.
Group structure, net assets and goodwill calculations are all calculated
in
Group Statement of financial position
The Mechanics of Equity Accounting
F1 Financial Operations
160
Taxation
Group (100% P and S)
Profit after tax
Revenue (100% of P and S), less inter-company
sales
Cost of sales (100% of P and S), less inter- company purchases , add unrealised
profit in inventory
Gross profit
Administrative expenses (100% of P and S) Distribution costs (100% of P
and S) Operating profit
Share of profits of associates(30% of Assoc
$00
0
$000
F1 Financial Operations
EXAMPLE 1
161
52,000
51,000
76,000
25,000
17,000
10,000
10,000
13,000
28,000
30,000
21,000
25,000
Share Capital
Reserves
Current liabilities
52,000
51,000
76,000
7,000
11,000
12,000
9,000
13,000
9,000
11,000
5,000
7,000
Current Assets
Inventory
Receivables
Bank
22,000
20,000
25,000
28,000
Tangibles
Investment
Jacob
Samuel
$000
$000
31 December
to
the year
for
Summarised Financial Statements
2009
162
During the year Oliver sold goods to Jacob to the value of $10m at
a mark-up of 25% on cost. Oliver also sold goods to Samuel to the
value of $15m at the same mark-up. All of the goods sold to Jacob
were still in Inventory at the year end but Samuel had sold
half of his inventory by the year end.
3)
two years ago
by $1,350,000
Oliver
also purchased 25% of Samuel for $13m
when reserves were $6m. Goodwill was impaired of which $250,000
relates to this year.
2)
by $750,000.
Goodwill has been impaired during the
Reserves
at acquisition were $5m.
2009.
January
on 1
year
of
Jacob for $15m
Oliver purchased 100%
1)
12,000
15,000
16,000
Profit After Tax
29,000
(17,000)
32,000
(17,000)
29,000
(13,000)
Profit Before Tax
Taxation
29,000
32,000
17,000
12,000
59,000
(30,000)
68,000
(36,000)
52,000
(35,000)
Gross Profit
Operating Expenses
Operating Profit
Investment Income
Revenue
Cost of Sales
Samuel
$000
125,000 (66,000)
Jacob
$000
160,000 (92,000)
Oliver
$000
133,000 (81,000)
Income Statements
F1 Financial Operations
Required:
Prepare both the group statement of financial position and income
statement for the year to 31 December 2009.
163
PRACTICE QUESTION
164
104
102
152
50
34
20
20
26
56
60
42
50
Share Capital
Reserves
Current liabilities
104
102
152
14
22
24
18
26
18
22
10
14
Current Assets
Inventory
Receivables
44
40
50
Bank
56
Non Current Assets
Tangibles
Investment
NOTE 1)
Dick
Harry
$m
$m
Tom
$m
Summarised Financial Statements for the year to 31 December 2009
Statement of financial positions
F1 Financial Operations
165
During the year Dick sold goods to tom to the value of $8m at a
mark-up of 25% on cost. All of the goods sold to tom were still in
inventory at the year end. There was an outstanding balance
between the two companies at the end of the year of $3m as a
result of this transaction.
3)
Tom also purchased 30% of harry for $26m two years ago when
reserves were $5m. Goodwill was impaired by $500,000 of which
$150,000 relates to this year. The other 70% of Harrys shares are
owned by a number of small investors who hold no more than 2%
each.
2)
year by $1,000,000.
Goodwill has been impaired during the
Reserves
at acquisition were $6m.
2009.
on 1 January
of Dick for $30m
100%
Tom purchased
1)
24
30
32
Profit After Tax
58
(34)
64
(34)
58
(26)
24
Investment Income
Profit Before Tax
Taxation
58
64
34
118
(51)
136
(59)
104
(70)
Gross Profit
Operating Expenses
Operating Profit
Revenue
Cost of Sales
Harry
$m
Dick
250 (132)
$m
Tom
320 (184)
$m
Income Statements
F1 Financial Operations
266 (162)
REQUIRED:
Prepare both the group statement of financial position and income
statement for the year to 31 December 2009.
166
F1 Financial Operations
accounting
accounting
in financial statements prepared in conformity with
standards
? provide
those who
about its
are interested in
the work
of the information
approach
to the formulation
of standards.
standards and in dealing with topics that do not form the subject of
an
accounting standard
accounting
applying
in
statements
financial
of
preparers
? assist
number of
?accounting
assist the IASB by providing a basis for reducing the
alternative accounting treatments permitted by law and standards
presentation of financial statements for external users.
In detail, the intended role of the framework is to:
? assist the IASB in its development of future accounting standards
and in its review of existing accounting standards
and
preparation
the
underlying
concepts
the
out
sets
statements
The IASBs framework for the preparation and presentation of
financial
OF FINANCIAL STATEMENTS
IASBS FRAMEWORK FOR THE PRESENTATION AND
PREPARATION
Learning Outcome:
F1 Financial Operations
168
main
169
Equity is the residual amount found by deducting all liabilities of the entity
Income is increases in economic benefits during the accounting period in the form
of inflows or enhancements of assets or decreases in liabilities that result in
increases in equity, other than those relating to contributions from equity
participants.
Expenses are decreases in economic benefits during the accounting period in the
form of outflows or depletions of assets or incurrences of liabilities that result in
decreases in equity, other than those relating to distributions to equity participants.
170
of
concept
financial
capital:
of
The Framework refers to two concepts
capital and physical concept of capital.
Concepts of capital and capital maintenance.
7
The Framework does not state which of the four should be used
F1 Financial Operations
171
These are secondary reporting duties which means that you only see
them
referred to in an audit opinion if they are not being done or are wrong.
Director transactions with company (if missing from FS)
Where Directors Report is inconsistent with FS
Where all Info and explanations were not received
Where Proper accounting records have not been kept
Where Accounting records are inconsistent with the FS
Where Returns not received from all branches of the company
? To report on other areas, dependent on national law, e.g. (for UK):
The above are primary reporting duties.
? To report on proper preparation of FS
? To report on truth and fairness of FS
Auditors Duties
Learning Outcome:
F1 Financial Operations
Independent Auditors
Financial Statements
Report
on
the
Group
To
the
Members
of Z plc
We have audited the group financial statements for the year ended 30 sep
2006 which comprise
of
the
consolidated
Statement
of
Comprehensive Income, consolidated balance sheet,
consolidated
statements of recognised income
and
expense, consolidated cash flow statement and the
related notes 1 to 27. These group financial statements have been
prepared under the accounting policies set out therein.
We have reported separately on the Parent Company financial statements
of Z plc for the year ended 30 Sep 2006 and on the information in the
Report on Directors remuneration that is described as having been
audited.
This report is made solely to the Companys members, as a body, in
accordance with Section 235 of the Companies Act 1985. Our audit work
has been undertaken so that we might state to the Companys members
those matters we are required to state to them in an auditors report and
for no other purpose. To the fullest extent permitted by law, we do not
accept or assume responsibility to anyone other than the Company and
the Companys members as a body, for our audit work, for this report, or
for the opinions we have formed.
172
clear that directors are responsible for producing the Accounts, whilst
auditors are responsible for forming opinions on them
3.
Introduction identifying what has been audited. Accounts are often
published as part of a larger Annual Report, not all of which is subject
to audit
2.
Title addressing the report (usually the shareholders)
1.
Basic Elements of an Audit Report
F1 Financial Operations
174
F1 Financial Operations
LIMITATION ON SCOPE
DISCLAIMER
DISAGREEMENT ADVERSE
LIMITATION ON SCOPE
EXCEPT FOR
DISAGREEMENT EXCEPT FOR
175
176
usually goes before the opinion, refers to the note prepared by the
directors
that is in the financial statement and states that the opinion is not
qualified in this respect.
This
by including an emphasis of matter paragraph in the audit report.
However, this event is important so the external auditor needs to
highlight it
statements. This will mean that there is no grounds for qualifying the
audit
opinion
no disagreement
or limitation
on the
scope).
If so, the(i.e.
directors
should disclose
this matter
in the
financial
outcome.
No-one will know the outcome of this event until much later.
is no
There
missing evidence it is just the passing of time that will determine the
final
Sometimes an event occurs before the end of the year that will not be
resolved
until after
the date that the audit
Fundamental
Uncertainty/Emphasis
of report
Matterwill be signed.
2)
F1 Financial Operations
177
178
Financial
International
the
by
interpretations
of
approval
Seven of the full-time members of staff are responsible for liaising
with
national standard-setters in order to promote the convergence of
accounting standards.
The IASB has complete responsibility for all IASC technical
matters,
including the preparation and publication of international financial
reporting standards (IFRS) and exposure drafts; withdrawal of
IFRSs and final
whom are full-time employees.
based on their having sufficient has the experience to tackle the
The IASB has 14 members, 12 of
Appointment of members is primarily technical expertise to ensure
the IASB
relevant business and economic issues.
The International Accounting Standards Board(IASB)
F1 Financial Operations
179
?
?
IASB and national standard-setters co-ordinating their work plans, so
that they can be reviewing an issue at the same time enabling each
party to play a full part in developing international consensus. National
standard-setters could consider this international consensus when
voting on their own national standards, although they would not be
required to vote for the IASBs preferred solution.
IASB and national bodies would continue to issue their own
exposure drafts, but may consider issuing them at the same time and
invite comments on any significant differences in proposed accounting
treatments.
?
IASB is currently exploring ways in which it can integrate its standardsetting
process more closely with those of national standard-setters. The
Board is currently investigating the following:
Many countries in this position have been working for many years to
narrow
the gap between their local standards and IFRSs. This usually takes
the form of all new or revised standards being developed to take
account of
international standards and comply with them in all material
respects. Although most of the standards now comply with IFRSs, they
are often
different in some way. Examples include Brazil, India, Japan and
Australia.
Countries with a track record in setting accounting standards already
had
standards in place before the original IASC was formed. As these
standards pre-dated IFRSs, they often did not conform with them.
F1 Financial Operations
180
INTEGRITY
A professional accountant should be straightforward and honest in all
professional and business relationships.
Integrity
Objectivity
Professional competence and due care
Confidentiality
(A)
(B) (C) (D)
FUNDAMENTAL PRINCIPLES OF THE CODE
A professional accountant is required to comply with the following
fundamental principles:
Learning Outcome
F1 Financial Operations
181
CONFIDENTIALITY
A professional accountant should respect the confidentiality of
information acquired as a result of professional and business
relationships and should not disclose any such information to third
parties without proper and specific
authority unless there is a legal or professional right or duty to
disclose.
PROFESSIONAL COMPETENCE AND DUE CARE
A professional accountant has a continuing duty to maintain
professional knowledge and skill at the level required to ensure that a
client or employer receives competent professional service based on
current developments in practice, legislation and techniques. A
professional accountant should act diligently and in accordance with
applicable technical and professional standards when providing
professional services.
The principle of professional competence and due care
imposes the following obligations on
Professional accountants:
(a) to maintain professional knowledge and skill at the level required
to ensure that clients or Employers receive competent professional
service;
and
(b) to act diligently in accordance with applicable technical and
professional standards when Providing professional services.
A professional accountant may be exposed to situations that may
impair
objectivity. It is Impracticable to define and prescribe all such
situations. Relationships that bias or unduly influence the professional
judgment of the professional accountant should be avoided.
OBJECTIVITY
A professional accountant should not allow bias, conflict of interest or
undue influence of others to override professional or business
judgments.
The principle of objectivity imposes an obligation on all
professional accountants not to
Compromise their professional or business judgment because of bias,
conflict of interest or the undue influence of others.
F1 Financial Operations
182
183
may also
in business
accountant
section 140 of the code. The professional
wish to seek legal advice or resign.
Where it is not possible to reduce the threat to an acceptable level, a
professional accountant in business should refuse to remain
associated with information they consider is or may be misleading.
Should the professional
accountant in business be aware that the issuance of misleading
information is either significant or persistent, the professional
accountant in business should consider informing appropriate
authorities in line with the guidance in
The significance of such threats will depend on factors such as the
source
of the pressure and the degree to which the information is, or may be,
misleading. The significance of the threats should be evaluated and, if
they are other than clearly insignificant, safeguards should be
considered and applied as necessary to eliminate them or reduce them
to an acceptable level. Such safeguards may include consultation with
superiors within the employing organization, for example, the audit
committee or other body responsible for governance, or with a relevant
professional body.
Threats to compliance with the fundamental principles, for example
selfinterest or intimidation threats to objectivity or professional
competence and due care, may be created where a professional
accountant in business may
be pressured (either externally or by the possibility of personal gain) to
become associated with misleading information or to become
associated with misleading information through the actions of others.
F1 Financial Operations
(A)
F1 Financial Operations
185
Indirect Taxes
An indirect tax is one that is levied on one part of the economy with the
intention that it will be passed on to another e.g. VAT in the UK.
Direct Taxes
These are taxes which fall directly on the person or entity who is
expected to pay it e.g. corporation tax.
Basic Tax Terminology
cost
Efficiency it should be administered efficiently and
effectively
iv.)
and
Convenient it should be convenient in terms of timing
payment
iii.)
Certainty it should be certain (i.e. not forever changing)
ii.)
Equity it should be fair, reflecting an ability to pay
i.)
An ideal tax system is clearly as close to perfection as any tax system
can
get. Adam Smith suggested that an ideal tax system should
incorporate the following characteristics:
No tax system is perfect everyone has some complaint about any tax
system.
Principles of Taxation
F1 Financial Operations
186
Withholding
Responsibilities
Sometimes a person or business paying a particular type of income to
persons or entities are required by law to deduct tax from the payment
before it is made. For example, UK Banks and Building Societies
deduct tax at 20% on interest paid to individuals prior to the payment.
This tax withheld is called withholding tax, which is then paid over
for the relevant tax authority.
designated for the UK state pension scheme.
originally
were
contributions
Insurance
National
e.g.
expenditure
of
Hypothecation
This means that the revenue from certain taxes is devoted to specific
types
Competent
Jurisdiction
The tax authority must have the legal power to assess and collect
taxes. In the UK, as with many other countries, this is done both
centrally (e.g. Corporation Tax) and locally (e.g. Council Tax). Either
way both authorities have the legal power to set and collect the
relevant tax(es).
business entity or an individual (obviously different taxes for each type
of
taxable person!).
It could be a
Taxable Person
This is the person accountable for the payment of a tax.
ii.)
Formal incidence the person or business having direct contact
with the tax authorities.
Effective (or actual) incidence the person or business which
actually ends up bearing the cost of the tax.
i.)
Incidence
The incidence of tax refers to the distribution of the tax burden and can
be divided into two elements
F1 Financial Operations
187
188
Sources of tax
rules
The nature of tax rules vary considerably from one country to another;
however, it is possible to categorise the sources and influences on
those rules. Within any country the balance between each source will
be different, but in most countries the same elements will be present to
a greater or lesser extent. The main sources of tax rules in a country
are usually as follows:
All tax systems are based on domestic primary legislation either
at the central government level or at the local authority level or both.
In some countries the legislation is very detailed and specific, setting
out every possible item of income and expense. In other countries
the legislation is less detailed and is supplemented by court rulings or
case law.
The practice of the relevant taxing authority will create
precedents which will be followed in the future. Tax authorities
sometimes issue guidelines or interpretations which are aimed at
clarifying the taxation legislation.
Supranational bodies may issue directives which the government
of a country has to include in the legislation, for example, European
Union (EU) directives on VAT.
International tax treaties signed with other states are also a
source of tax rules as the agreements often vary from the
countrys own tax regulations.
Learning Outcome
F1 Financial Operations
QUESTION 1
Which of the following is not one of Adam Smiths characteristics of
good
tax?
(A)
Equity
(B)
(C)
(D)
Certainty
Simplicity
Efficiency
(2 marks)
QUESTION 2
An indirect tax is a tax that:
(A)
(B)
(C)
is
based
on earnings
an individual
is paid
indirectly
to the taxofauthorities
(D)
QUESTION 3
List the three main tax bases used in developed countries.
(2 marks)
189
F1 Financial Operations
QUESTION 4
With reference to an entity paying tax, which of the following is the
best
definition of competent jurisdiction:
(A)
The country whose laws apply to the
entity (B)
Any country where the entity has
operations (C)
Any country where the
entity has an office (D)
Any country where
the entity has employees
(2 marks)
QUESTION 5
BM has a taxable profit of 30,000 and receives a tax
assessment of
$3,000.
(D)
a proportional tax
190
F1 Financial Operations
(2 marks)
In most countries all of the income and gains of a business are liable
to
In some countries (UK and USA particularly) there are large
differences
between accounting profit and taxable profits. Where as in Germany
and
France
is not
closely
linked
to accounting
profit.countries.
rules ontaxable
what isprofit
and is
taxable
differ
widely between
Precise
Profits from trade and other activities
iii.)
192
X
Taxable trading profit
X
(X)
allowable for tax purposes)**
Adjusted Trading Profit
Less capital allowances
X
not
just
or
non-trading
(either
expenditure
Add: disallowable
X
(X)
accounting profit that isnt trading
income*
in
included
income
Less
X
Accounting profit
Profits from a Trade of a
Company
In this category we are only interested in the trade of the company and
the resulting profits. Income and expenses for non-trading activities
therefore are ignored.
Because a company will produce accounts for reporting purposes, it is
necessary (certainly in the UK) to adjust accounting profit to get to the
profits from the trade. This is done as follows:
193
QUESTION 6
Rainbow Limited commenced business, making soft toys, on 1
June 2003. The company has prepared its first set of accounts
for the year to 31 May
2004. Rainbow Limited made the following purchases and
sales of fixed assets:
Purchases
2007
$
Industrial Building
260,000
June
2009
1
June
Stitching
(plant)
machine
1
June
31
Machine
47,000
58,000
Sales
2009
bought
on
9,500
May
June 2003
In your exam if a capital allowance computation arises the relevant
rates will
be
given.sizes of a company.
different
Capital allowances are statutorily set at different rates for
trading profits.
Instead a company can claim capital allowances as a deduction in
taxable
Depreciation and Capital Allowances
Any depreciation and amortisation is a disallowable trading expense
due to the many methods by which such depreciation can be
calculated.
F1 Financial Operations
1
9
4
196
197
where an asset has been owned for a substantial period of times its
value
would have increased as a result of inflation. In the UK the rise in the
value of the asset as a result of inflation can be deducted in calculating
the taxable capital gain, by way of indexation.
However,
This is essentially the sale proceeds less the cost.
the asset.
The basic idea of a capital gain is to work out the profit on the disposal
of
Gifts to charities of land, buildings and certain works of art
Gifts
i.) of any type of asset to government institutions and museums
ii.)
Some disposals are also exempt from tax.
Private motor cars
Qualifying corporate bonds
Chattels
bought and sold for less than 6,000
Wasting chattels (tangible moveable property with a life expectance of less than 50
years e.g. a horse)
i.)
ii.) iii.) iv.)
Most assets or investments being disposed of are chargeable
assets,
however,
some gains
key exemptions
exist.
Taxable capital
of a company
are subject to corporation tax in
the UK.
A capital gain is the taxable profit on the disposal of an asset or
investment.
Capital Gains
F1 Financial Operations
QUESTION 7
Radiance Limited bought a warehouse which cost $10,000 in
February
1988. It was sold in April 2009 for $20,000. Retail price indices were:
February 1988
103.7
April 2009
180.0
Required:
Calculate the chargeable gain on the sale of the warehouse for Radiance
Limited.
198
F1 Financial Operations
199
In the UK, this relief is commonly known as rollover relief and allows
the
company to roll the gain arising on the sale against the base cost
of the replacement asset. The effect is that when the replacement
asset is
sold in the future, a larger gain will arise at that time, resulting in
more tax payable in the future, effectively deferring the tax due
on the 1st gain.
In addition to indexation allowance, most countries allow for capital
gains
arising to be deferred where an item has been sold and
subsequently replaced. In these circumstances, businesses
often re-use the cash
realized on the sale of an asset to buy the replacement, leaving no
cash
available
to paygains
any tax liability.
Relief
from capital
F1 Financial Operations
$1 to $10,000 at 0%;
$10,001 to $25,000 at 15%;
$25,001 and over at 25%.
O
O
O
? Tax
entertaining expenses;
taxes paid to other public bodies;
accounting depreciation of non-current assets.
80,000
Distribution costs
20,000
35,850
Finance cost
1,900 profit before tax
33,950
Required:
Calculate DBs corporate income tax due for the year 2009.
F1 Financial Operations
2
0
0
201
i.)
Trading Losses
If a business makes a trading loss instead of a trading profit, it is
allowed to offset that loss using trading loss relief. The methods of
loss relief include:
Treatment of Losses
F1 Financial Operations
QUESTION 8
Country ABB has the following tax regulations:
? Taxable profits are subject to tax at 25%.
? Capital gains are added to profits from trading to give taxable
profits.
?
?
Hazel Limited began to trade in 2007 and has the following profits/losses:
(loss)
$000
Capital
profit/
$000
2007
(300)
400
2008
550
2009
700
(150)
203
QUESTION 9
A schedular system of corporate income tax means:
(A) A method used to calculate the corporate income tax
payable
(B) A system that has a number of schedules which set
out how different types of incomes should be taxed
(C) A system that has a number of schedules which set out when
tax
(D)
A system that has a number of schedules which set out the various
tax rates
204
F1 Financial Operations
(2 marks)
QUESTION 10
KM commenced business on 1 June 2007, making up the first
accounts for the year to 31 May 2008.
The entitys purchases and sales of fixed assets were as follows:
Purchases
2007
2009
1 June
Industrial Building
300,000
1 June
Plant
40,000
1 June
Plant
60,000
31 May
Plant bought on 1
12,000
Sales
2009
J
u
n
e
2
0
0
7
205
F1 Financial Operations
Calculate KMs tax depreciation for the year ended 31 May 2009.
(4 marks)
QUESTION 11
Rollover relief:
(A)
QUESTION 12
Country W has the following tax regulations:
? Taxable profits are subject to
tax at 25%
? Capital gains are added to profits from trading to give taxable
profits
? Trading losses can be carried forward indefinitely but cannot be
carried back to previous years
? Capital gains/losses cannot be offset against trading gains/losses or
visa versa
Capital
$000
$000
2007
(350)
2008
200
2009
700
(150)
profit/(loss)
Required:
Calculate the amount of tax due for 2009.
(3 marks)
207
F1 Financial Operations
208
the
Partial imputation system
Only part of the underlying corporation tax is passed to
shareholder by way of a tax credit.
iii.)
company is taxed on the dividends but the shareholder is not.
In other words
corporation tax on the distributed income.
the
the
Imputation
system
The shareholder receives a tax credit to the sum of
ii.)
causes the potential double taxation of dividends.
This system is easy to understand but it
dividends received.
Classical system
The business is responsible for corporation tax on all its taxable
income and gains. The shareholder is liable to income tax on
i.)
There are four main systems for taxing the profits of a business (hence
dealing
with the
above
anomaly):
If a company
pays
a dividend
to an individual, it is paid out of post tax
profits. The individual then includes that dividend as part of his/her
taxable income upon which income tax is paid.
This results in the
dividend being taxed twice.
System
The Interaction of the Corporate Tax System with the Personal
Tax
Learning Outcome
F1 Financial Operations
209
Wealth Tax
In some countries a wealth tax is imposed on the total wealth of an
individual and/or entity. In countries where a wealth tax exists for
entities, an entitys wealth, i.e. a measure of their asset value, will be
taxed each year.
3)
Property Tax
This is a tax usually on land and buildings, based upon the capital
value of the property.
2)
To discourage the excessive consumption of a product
To alter the distribution of income by taxing luxuries
To
a) help pay for increased costs of e.g. healthcare for smokers
b)
c)
Excise Duties
These are specific taxes on certain commodities e.g. tobacco,
motor vehicles and fuel. Excise duties are levied in order to:
1)
Indirect taxes paid by the entity fall into three main categories:
Indirect taxes and Employee Taxation
Split ratio system
These systems distinguish between distributed profit and retained
profits and charge a lower rate of corporation tax on distributed profits
to avoid the double taxation of dividends.
iv.)
F1 Financial Operations
210
to
passed
usually
is
burden
tax
system the
purchases. In this
the
b) end consumer.
A cumulative or cascade tax which does not allow credit for
taxes paid on transfers between levels meaning that tax paid at each
stage is treated as a business cost.
VAT and similar systems where credit is allowed for tax paid on
a)
Multi-stage taxes
This is a tax each time a product or its components is sold. There are
two types of multi-stage taxes.
2)
Single-stage taxes
These apply at one level of the production/distribution chain e.g. at the
retail level. Few countries use single-stage taxes although the USA
uses a single stage retail sales tax at the local state level rather than
the federal level.
1)
The two types of
These are taxes levied on the consumption of goods.
consumption
are:
Consumptiontax
Taxes
F1 Financial Operations
Q
U
E
ST
IO
N
13
A manufacturer, M makes microwave ovens.
These
are
sold first to a wholesaler, W, who sells in turn to a retailer, R.
Finally R sells to the ultimate consumer,
C.
The prices at which these transactions
take place (excluding sales tax) are as follows:
? M sells to W for $100
? W sells to R for $160
? R sells to C for $300
The country levies a multi-stage cumulative tax at the rate of 5% each time
a sale is made.
R
e
q
u
i
r
e
d
:
Calculate the sales tax due by each entity and in
total.
211
F1 Financial Operations
212
VAT and therefore reclaim input VAT incurred relating to those supplies. If an
entity makes wholly exempt supplies it cannot register for VAT and therefore
cannot reclaim input VAT incurred relating to the exempt supplies.
QUE
STIO
N 14
Country XYZ has a VAT system which allows organizations to
reclaim input tax paid. Vat is at 15% of selling price.
B manufactures ladies clothes and sells them to C, a wholesaler. C
resells them to D a retailer.
D
eventually sells them to E for $120.
The
prices at which transactions take place (excluding VAT) are as
follows:
? B sells to C for $50
? C sells to D for $80
R
e
q
u
ir
e
d
:
Calculate the VAT due from B, C
and D.
(3 marks)
213
The
214
cars
fuel for cars beneficial loans
private medical expenses
round-sum
expense allowances
Some benefits in the UK are taxable on Directors and employee
earning at
least
8,500 per year and include:
living accommodation that is not job-related
cash
Somevouchers
benefits are taxable on all employees in the UK and include:
employer contributions into a pension scheme
provision of job related living accommodation
In
Some benefits are exempt and are therefore not included in the tax
base.
the
UK exempt
benefits include:
Benefits
in Kind
These are non cash benefits given to an employee as part of a
remuneration package.
Professional subscriptions
Donations to charity through a payroll giving scheme
Contributions
into an occupational pension scheme.
1)
2)
3)
Deductible Expenses
Some expense are deductible in calculating earnings from
employment. The key ones are as follows:
F1 Financial Operations
Q
U
E
S
T
I
O
N
1
5
Jim is a 38 year old Finance Director earning
$80,000 per annum.
During the tax year Jim received a 10% profit share bonus and
benefited from the use of a company car for which the
assessable benefit valuation was $5,090.
Jim pays $1000 per year membership to the Institute of
Accountants and
$750 for gym club
membership.
R
e
q
u
i
r
e
d
:
Calculate Jims income tax computation assuming the
following:
a) his personal allowance is $6475; and
b) the tax rates are 20% on the first $38,000 and 40%
thereafter.
215
contribution
for
employers.
Employers
also have to pay social security
contribution per month.
The employee pays a percentage of earnings usually up to a maximum
from
Social Security Contributions
These contributions are assessed on individuals and deducted
earnings in the same way was employee taxation is deduction.
F1 Financial Operations
QUE
STIO
N 16
Country HG has a duty that is levied on all drinks of an alcoholic
nature where the alcohol is above 20% by volume. This levy is $4
per 2 litre bottle. This duty could be said to be:
(A) Ad
valorem tax
(B)
Specific unit
tax (C)
Direct
tax
(D)
(2 marks)
QUESTION 17
List three advantages of requiring employers to deduct employee
tax from employees pay each month.
(3 marks)
216
QUESTION 18
An entity purchases products from a foreign entity. These
products cost $21 each and on import are subject to an excise
duty of $4 per item and VAT at
20%. If the entity imports 100 items, how much do they
pay the tax authorities?
(
A
)
$
4
0
0
(
B
)
$
4
2
0
(
C
)
$
5
0
0
(
D
)
$
9
0
0
(2 marks)
QUESTION 19
If a product is exempt for VAT purposes it means that an entity:
(A)
218
219
1)
2)
3)
4)
5)
In addition to this
Payments
Deadlines are set by tax authorities, to ensure that taxpayers submit tax returns
and pay outstanding tax on time.
220
administration.
tax
friendly
customer
and
equitable
honest,
an
developing
avoidance by
and
towards evasion
Changing social attitudes
4)
Reducing the overall gain by regularly reviewing the penalty structure.
3)
Increasing the perceived risk by auditing tax returns and payments.
2)
Reducing the opportunity by deducting tax at source and simplifying
the
1) tax structure.
Anti-Avoidance Provisions
As well as legislating, tax authorities use other administration methods
to minimise evasion and avoidance.
Tax Avoidance
Tax avoidance is tax planning to minimise the tax liability. It is strictly
legal but usually exploits loopholes in legislation.
Tax Evasion
Tax evasion is the illegal manipulation of the tax system to avoid
paying tax and can include falsifying tax returns and claiming fictitious
expenses.
Tax Evasion and Avoidance
Learning outcome
F1 Financial Operations
QUESTION 20
Which of the following taxes is an entity unlikely to need to keep
additional detailed records for:
(A)
(B)
(C)
(D)
VAT
Employee
Property tax tax deducted from salaries
(2 marks)
QUESTION 21
Requirements:
(i)
Outline the difference between tax avoidance and tax
evasion.
(2 marks)
(ii)
221
F1 Financial Operations
222
possible that an entity has income taxed in the country it was earned
and
also
It is in a different company where the company is resident.
than one country which will lead to the problem of double taxation.
It is therefore possible for an entity to be resident for tax purposes in
more
An entity
use both bases to establish residency for tax purposes.
would
becontrol
resident
if itplace
meets
of the above
criteria.
Place of
and
of either
incorporation
some
countries (e.g. UK)
3)
Place of incorporation if a country uses this as a basis any entity
registered in that country will be deemed to be resident for tax
purposes.
2)
Place of control and central management the country from where
control of the group is exercised is deemed to be the country of
residence for tax purposes.
1)
Concept
of
Corporate
Residence
Corporate income tax is usually residence based. The test for
establishing residence of an entity varies from one country to another.
The main types of test are as follows:
International Taxation
Learning Outcome
F1 Financial Operations
QUEST
ION 22
H owns 30% of the equity shares in S, an entity resident in a foreign
country. H receives a dividend of $36,000 from S, the amount
received is after deduction of withholding tax of 20%. S had before
tax profits for the year of $400,000 and paid corporate income tax of
$100,000.
Re
qui
red
:
Calculate the underlying tax that H can claim for double
taxation relief.
223
QUESTION 23
Which of the following could NOT be used to indicate an
organisation is resident in a country?
(A)
(B)
(C)
(D)
224
(2 marks)
A place of management
A
Anbranch
office
A
factory
A workshop
A mine, oil or gas well
A
1)building or construction site
2)
3)
4)
5)
6)
7)
apparent.
is
establishment
be taxed in a country where permanent
Permanent establishment includes:
The OECD model suggests that business profits of an enterprise can
only
The OECD Model Tax Convention
The OECD has suggested a model tax convention which states can
adopt in their dealings with each other for tax purposes.
Double taxation relief exists to reduce the incidence of tax being paid
twice.
Often the taxpayer is allowed to deduct form its total tax liability, an
amount equal to the tax already paid overseas, thus eliminating tax
being paid twice.
Double Taxation Treaties
F1 Financial Operations
QUESTION 24
Which of the following would NOT normally be subject to a
withholding tax?
(A)
(B)
Rents
Divide
nds
(C)
Interes
t (D)
Profits
(2 marks)
QUESTION 25
The OECD model tax convention defines a permanent
establishment to include a number of different types of
establishments:
(i)
Which
A place of management
(ii)
(iii)
(iv)
A warehouse
A
workshop
A quarry
(v)
of the above
permanent
are
included
in the
OECDs
list
of
establishments?
(A)
(i), (ii) and
(iii) only (B)
(i),
(iii) and (iv) only (C)
(ii), (iii) and
(iv) only (D)
(iii),
(iv) and (v) only
( 2 marks)
225
F1 Financial Operations