LANCASTER UNIVERSITY

JANUARY 2014 EXAMINATIONS

EXAMINATIONS FOR THE DIPLOMA, MASTER OF RESEARCH AND MASTER OF
SCIENCE IN ACCOUNTING AND FINANCIAL MANAGEMENT AND DIPLOMA,
MASTER OF RESEARCH AND MASTER OF SCIENCE IN FINANCE, AND MASTER
OF SCIENCE IN FINANCIAL ANALYSIS
AcF 503

PRINCIPLES OF FINANCIAL REPORTING

Time: 2 hours
(+ 15 minutes reading time)

Section A
No choice. Answer all parts of all five questions (Total marks 40)

1. a) Ball, Robin & Wu (2003, J. Accounting & Economics, Vol. 36, 235-270) examine the properties of
earnings numbers produced by firms in Hong Kong, Malaysia, Singapore, and Thailand in which
Generally Accepted Accounting Principles (GAAP) is heavily influenced by common-law
practices and International Accounting Standards (IAS). They find that earnings in these
countries do not attain common-law levels of transparency, despite the influence of common-law
standards in the region. Discuss underlying reasons for their finding and its implications with
respect to IFRS adoption.
(5 marks)
b) Provide one example that shows that International Accounting Standard Boards (IASB) is issuing
standards that contravene its own Conceptual Framework.
(2 marks)

(TOTAL 7 MARKS)

2. a) Opponents of fair value accounting believe that fair value accounting focuses too much on
providing useful information to predict future cash flows but does not fulfill a variety of other roles
of financial statements. Discuss two potential roles of financial statements for which fair value
accounting is less useful.
(4 marks)
b) Explain the valuation hierarchy described in IFRS 13 Fair Value Measurement and provide an
example for each level.
(6 marks)

(TOTAL 10 MARKS)

3. a) Explain two reasons why International Financial Reporting Standards (IFRS) adoption may
reduce accounting quality.
(4 marks)
b) Company Alice purchased a building at 1 million in 1970 and still records the building at 1
million on its balance sheet. Using this case, analyse a trade-off between two appropriate
qualitative characteristics in IASBs Conceptual Framework (2010).
(4 marks)

(TOTAL 8 MARKS)

4. a) Discuss the role of disclosure in facilitating the detection of earnings management.

(4 marks)
b) Discuss managers possible earnings management incentives regarding the following statement.
In July Apples share price fell sharply after the companys quarterly earnings disappointed
investors, even though its net profit rose by 21%, to 8.8 billion.
(2 marks)

(TOTAL 6 MARKS)

5. a) Managers often argue that reporting non-GAAP measures help them to convey relevant
information about performance. However, some critics claim that non-GAAP earnings represents
managements attempt to present a more favourable impression of performance. Provide three
reasons to support this claim of critics.

(6 marks)
b) What are the two alternative classification bases for the disclosure of expenses in a statement of
comprehensive income and what factors should be take into account when selecting between
these two alternative presentation formats?
(3 marks)
(TOTAL 9 MARKS)

Section B
Answer three questions only (Total marks 60)
6. a) Hillier Construction plc commenced the construction of a building on 1 July 2013. It has a fixedprice contract for total revenues of 45 million. The expected completion date is 30 June 2016.
The expected total cost to Hillier Construction at the beginning of the project is 35 million. The
following information relates only to the construction of this building:
For the year ending 30 June
Costs for the year
Costs incurred to date
Estimated costs to complete
Progress billings during the year
Cash collected during the year

2014 (000)
12,500
12,500
23,000
10,000
10,000

2015 (000)
15,000
27,500
8,500
12,000
11,000

2016 (000)
10,000
37,500
23,000
24,000

Hillier Construction uses the percentage-of-completion method based on cost to account for its
construction contracts. What is the gross profit to be recognised for the year ending 30 June
2014, 2015, and 2016, respectively (rounded to the nearest 000)?
(8 marks)
b) An entity sells 3500 products for 55 each. Sales are made for cash, rather than on credit terms.
The entitys customary business practice is to allow a customer to return any unused product
within 30 days and receive a full refund. The cost of each product is 10. To determine the
transaction price, the entity decides that the approach that is most predictive of the amount of
consideration to which the entity will be entitled is the most likely amount. Using the most likely
amount, the entity estimates that 55 products will be returned. The entitys experience is
predictive of the amount of consideration to which the entity will be entitled. The entity estimates
that the costs of recovering the products will be immaterial and expects that the returned
products can be resold at a profit.
Provide the accounting entries to record the sale (and cost of goods sold), and the subsequent
return of the assets, assuming that the returns occur in accordance with expectations.
(8 marks)
c) Werribee Direct plc is a mail order company that allows its customers to order online and return
the goods without obligations during specified period. Werribee Direct plc had started this
business recently and experienced a high ratio of returned merchandise from online sales. What
is the appropriate accounting treatment for this sale that is in accordance with IASB (2011)
Revenue?
(2 marks)
d) Company Zumba delivers goods to Customer Yuppie on 1 January 2011. The agreement
between the two parties states that Customer Yuppie pays for the goods in two instalments, the
first (10,000) being paid on delivery and the second (5,000) being paid one year from the
delivery date. The goods are transferred to the control of Customer Yuppie at the date of
delivery. (Assume that Company Zumba determines that the discount rate for imputing interest to
the transaction is 10%.) What is the amount of revenue that Company Zumba recognises for the
year to 31 March 2011?
(2 marks)

(TOTAL 20 MARKS)

7. a) Analyse managements incentives to revalue (or not to revalue) depreciable assets where
management's bonuses are tied to profit (i.e. net income)-based performance measures. Provide
the reasons for the incentives. Assume that fair value of the asset is higher than its cost.
(5 marks)

b) Seagull Marinas plc owns land that was purchased for 300,000 to be used as the future site of a
boat shed. Due to the development of a resort in the vicinity, the land's fair market value had
risen to 480,000 and was revalued on 30 June 2009 accordingly. On 30 June 2012, the land
was revalued to 150,000.
What are the journal entries required to record the revaluations on 30 June 2009 and 30 June
2012? What is the impact of the journal entries on net income and total comprehensive income
for the year ending 30 June 2012?
(5 marks)
c) Kensington plc, an Irish Company, is an importer and retailer of Danish made glass crystals. For
the year ended 30 June 2012, Kensington plc holds 30 units of an item originally purchased for
10,000 each and having at that date a net realisable value of 8,000 each. On 1 June 2013 the
TV show Home Improvement featured a similar item prompting an increase in demand for this
glass crystal. Management believes that the net realisable value of this item is 15,000 each on
30 June 2013. All 30 items remain unsold on 30 June 2013.
What is the impact on profit of holding this inventory for the years ended 30 June 2012 and
2013?
(4 marks)
d) Lancaster Company sells pumps for commercial use. The inventory data are shown below.

Commercial pumps
Inventory at 28 Feb
Purchases:
3 March
12 March
21 March
Sales:
18 March
29 March
Inventory at 31 March

units

Price per unit ()

Total ()

600

800

480,000

600
300
500

900
950
1000

540,000
285,000
500,000

900
600
500

1080
1140

972,000
684,000

Assuming Lancaster uses a periodic inventory system, determine (1) the cost of inventory on
hand at 31 March (2) the cost of goods sold for March and (3) gross profit, under FIFO.
(6 marks)

(TOTAL 20 MARKS)

8. a) Weil (2004) argues that operating leases often plump up earnings through, among other things,
lower depreciation expenses (p. 2). Comment on this statement in relation with Figure 2 of
Imhoff et al. (1991), which is reproduced below.

.
(6 marks)
b) Discuss the impact of lease capitalisation of operating leases on current return on assets (ROA)
and debt-to-equity ratios and its implications for managers incentives in choosing between
operating and finance leases.
(5 marks)
c) Deliveries plc leased a truck from a truck dealer, City Vans plc. City Vans plc acquired the truck
at a cost of 180,000. Deliveries plc plans to keep the truck after the lease but has not made any
commitment to the lessor to purchase it. The terms of the lease are as follows:
Date of entering lease: 1 July 2015
Duration of lease: 4 years
Life of leased asset: five years, after which it will have no residual value.
Lease payment: 100,000 at the end of each year (e.g. 30 June 2016, 2017).
Interest rate implicit in the lease: 10 percent
Unguaranteed residual value: 50,000
Fair value of truck at inception of the lease 351,140

(i) Prepare the journal entries to account for the lease transaction in the books of the lessor,
City Vans plc, at 1 July 2015 and 30 June 2016.
(5 marks)
(ii) Prepare the journal entries to account for the lease transaction in the books of the lessee,
Deliveries plc, at 30 June 2016.
(4 marks)
(TOTAL 20 MARKS)

9. a) Banshee plc issues 12 million (par value) in 8-year, 8%, semi-annual coupon debentures. The
rate of return required by the market is 12%. What is the journal entry to record the first payment
of interest assuming that Banshee uses the effective-interest method to amortise any discount or
premium (round to the nearest pound)?
(5 marks)
b) In accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, differentiate
provisions from accruals and provide one example for each type of liability.
(5 marks)
c) A whisky blending company, Wright whisky, has several years worth of maturing whisky in
stock. It contracts to sell a certain quantity of the whisky to a bank for 5 million, and agrees to
buy it back one year later for 5.5 million. The whisky remains on Wright whiskys premises.
Analyse the possible accounting treatments. State which is the most appropriate treatment and
explain why this is so.
(4 marks)
d) The following diagram illustrates how to distinguish between provisions and contingent liabilities.
What are the appropriate actions for (A), (B), and (C) in the following diagram? Also provide one
example for each action.

(A)

(B)

(C)
(6 marks)

(TOTAL 20 MARKS)

END OF EXAM
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