CHARTERED ACCOUNTANTS EXAMINATIONS

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LICENTIATE LEVEL
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L1: FINANCIAL REPORTING

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MONDAY 15TH JUNE 2015

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TOTAL MARKS – 100; TIME ALLOWED: THREE (3) HOURS

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INSTRUCTIONS TO CANDIDATES

1. You have fifteen (15) minutes reading time. Use it to study the examination paper
carefully so that you understand what to do in each question. You will be told when to
start writing.

2. This paper is divided into TWO sections:

Section A: Two (2) Compulsory Questions.

Section B: Three (3) Optional Questions. Attempt any Two (2) questions.

3. Enter your student number and your National Registration Card number on the front of
the answer booklet. Your name must NOT appear anywhere on your answer booklet.

4. Do NOT write in pencil (except for graphs and diagrams).

5. The marks shown against the requirement(s) for each question should be taken as an
indication of the expected length and depth of the answer.

6. All workings must be done in the answer booklet.

7. Present legible and tidy work.

8. Graph paper (if required) is provided at the end of the answer booklet.

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Section A

There are two (2) questions in this section. Attempt both questions.

QUESTION ONE

(a) The following draft statements of profit or loss and other comprehensive income relate
to Cota Plc, Dota Plc and Bota Plc for the year ended 31st May 2015

Cota Plc Dota Plc Bota Plc

K’million K’million K’million

Revenue 300 150 100

Cost of sales (180) (80) (60)
Gross profit 120 70 40
Other income 12 - -
Distribution costs (30) (15) (10)
Administrative costs (60) (30) (20)
Finance costs (9) (4) (3)
Profit before tax 33 21 7
Taxation (11) (7) (2)
Profit for the period 22 14 5

Additional information

1) Cota Plc acquired 7.5 million of 10 million issued equity shares of Dota Plc on 1st
September 2014 for a consideration of K80 million payable on 31st October 2017. The
fair values of Dota’s net assets were materially equal to their carrying values at
acquisition date except for the following item:

Fair value carrying value

K’million K’million

Plant 20 18

Plant had a useful economic life of four (4) years at 1st September 2014.

Dota Plc has not incorporated the fair value change in its financial statements.

Cota Plc has not incorporated cost of 7.5 million equity shares acquired in Dota Plc in its
financial statements.

Cota Plc has an annual cost of capital of 10%.

2) Cota Plc acquired 40% of the equity share capital of Bota Plc on 1st March 2015 for a
cash consideration of K4 million. Bota Plc had K8 million issued equity share capital of
K0.40 each at acquisition date. It has not issued any additional shares since acquisition

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 date. The fair values of net assets of Bota Plc were equal to their carrying values on 1st
March 2015.

3) Goodwill in Dota Plc and investment in Bota Plc had been impaired by K2 million and
K0.1 million respectively.

4) In the post acquisition period, Cota Plc sold goods to Dota Plc for K20 million. Cota Plc
adds a mark up of 25% on all its sales. 70% of these goods had been sold by Dota Plc
by 31st May 2015.

5) Included in other income of Cota Plc are dividends received from Dota Plc and Bota Plc.
Dota Plc and Bota Plc declared and paid dividends per share of K0.80 and K0.50
respectively for the year ending 31st May 2015. The balance of other income figure
relates to interest received from other investments.

6) It is group policy to value non-controlling interest using their fair value at the date of
subsidiary’s acquisition.

7) Unless otherwise stated, assume all profits and losses accrue evenly throughout the
year.

8) The following discount factors may be used were applicable

Discount rate 10%

Year Discount Factor

1 0.91
2 0.83
3 0.75

Required:

Prepare a consolidated statement of profit or loss and other comprehensive income for
the year ended 31st May 2015. (25 marks)

(b) Balata Plc acquired 60% of the equity shares in Nasa Plc on 1st September 2014 for a
cash consideration of K130 million.

The following information is relevant:

(i) The following information relates to Nasa Plc as at 1st September 2014:

K’000

Equity share capital 120,000

Share premium 30,000
Retained earnings at 1st June 2014 40,000

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 (ii) Nasa Plc made a loss of K10 million for the year ended 31st May 2015.

(iii) The fair value of Nasa Plc’s net assets were above their carrying values by K2
million. This related to non-depreciable land. Fair value adjustment has not yet
been incorporated in the financial statements of Nasa Plc.

(iv) It is Balata Plc’s policy to value non-controlling interests at acquisition at its

proportionate share of the fair value of identifiable net assets of Nasa Plc.

(v) Goodwill in Nasa Plc has not suffered any impairment loss at 31st May 2015.

Required:

Calculate goodwill in Nasa Plc as at 1st September 2014. (5 marks)

[Total: 30 marks]

QUESTION TWO

The following trial balance has been extracted from the accounting records of Sally plc at 31
March 2015, before the preparation of financial statements.

K’000 K’000

Revenue 121,500

Cost of sales 14,556

Freehold land at 2011 revaluation Note (iv) 90,500

Buildings at cost 75,600

Buildings-Accumulated depreciation 45,360

Administrative expenses 15,400

Distribution expenses 11,200

Research and development Note (i) 42,500

Inventories at 31 March 2015 Note (ii) 7,865

Interest paid Note (v) 1,310

Retained earnings 23,457

Trade Receivables and payables 9,045 8,720

Cash at bank 8,100

Short-term investments 116,812

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10% bank loan repayable 2017 Note (v) 26,200

Corporation tax Note (vii) 2,300

Provision for liabilities as at 1 April 2014 Note (vi) 62,500

Revaluation Reserve Note (iv) 25,000

Share capital ( K 1 each) 70,370

Share premium 7,481

______ ______

392,888 392,888

The following further information is also available:

(i) Research and development expenditure for the year to 31 March 2015 comprises the
following:

 K37,500,000 spent on a joint project with a university investigating the potential use
of a certain chemical to reduce pollution levels in mine areas.

 K5,000,000 on the development of new computer software that will enable the
company to operate an Inventory control system that will greatly reduce the costs
associated with holding excessive amounts of inventory. Sally Ltd expects the system
to come into operation on 1 June 2015.

Any research expenditure is charged to cost of sales.

(ii) The inventories at 31 March 2015 include inventory items that cost K4,480,000.
However, Sally Ltd will only be able to sell these inventory items for K1,180,000.

(iii) Buildings are depreciated on a straight line basis over 25 years estimated useful
economic lives. No depreciation has been charged on buildings for the year ended
31 March 2015.

Note: Assume nil scrap value for buildings.

(iv) Land is re-valued regularly in accordance with the requirements of IAS 16 Property,
Plant and Equipment. Sally Ltd acquired land for K65,500,000 10 years ago. This
land was valued at K90,500,000 and K52,500,000 on 31 March 2011 and 31 March
2015 respectively.

The re-valuation at 31 March 2015 is not reflected in the trial balance.

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 Note: Land and buildings are used for administrative purposes.

(v) The company got the loan on 1 April 2013. Interest on the bank loan for the last six
months of the year has not been included in the trial balance.

(vi) Since April 2013 Sally Ltd has been involved in a legal dispute with one of its
customers, Mesan Ltd for failure to supply goods on agreed time. On 1 April 2014
Legal advice from lawyers was that Sally Ltd would probably compensate Mesan Ltd
K62,500,000. However, the compensation amount was revised to K55,000,000 at 31
March 2015.

(vii) The corporation tax balance in the trial balance relates to an over provision in 2014.
Corporation tax for the year ended 31 March 2015 is estimated to be K5,700,000.

Required:

In a format that is suitable for publication and in accordance with the requirements of IAS 1
Presentation of Financial Statements prepare:

(a) A statement of profit or loss and other comprehensive income for Sally Ltd for the year
ended 31 March 2015. (18 marks)

(b) A statement of financial position for Sally Ltd at 31 March 2015. (12 marks)

NOTE: Notes to the financial statements are not required. [Total: 30 marks]

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SECTION B

Attempt any Two (2) questions in this section.

QUESTION THREE

(a) IAS 10 ‘Events after the reporting date’ covers accounting treatment of transactions that
take place between the reporting date and the date when financial statements are
authorised for issue.

(i) Distinguish between adjusting and non-adjusting events. (4 marks)

(ii) Maba Limited included in its financial statements for the year to 31st March 2015
inventories with a total cost of K400, 000. This figure included inventories with a
cost of K100,000 that were sold on 12th May 2015 for a gross selling price of
K100,000. The company paid a commission of 10% of gross selling price to its
sales staff.

Note: Maba Limited prepared its financial statements on 31st March 2015. They
were authorised for issue on 30th May 2015.

Required:

Explain how this transaction would be treated in the financial statements of Maba
Limited for the year to 31st March 2015, in accordance with IAS 10 ‘ Events after
the reporting date’. (4 marks)

(b) Paba Enterprises is a supermarket that is based in Western province of Zambia. It has
been experiencing rapid decrease in revenue due to increased competition from other
supermarkets. Consequently, it was reviewed for impairment on 31st May 2015.

The carrying value and recoverable amount of the supermarket were K2.5 million and
K2 million respectively.

The carrying value is analysed as follows:

K’000

Computers (note (i)) 700

Furniture and fittings (note (ii)) 300
Motor vehicles 600
Other non-current assets 400
Inventories (note (iii)) 450
Cash and cash equivalents 50
2,500

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 The following information is relevant:

(i) Computers could be sold for K720,000 on the second hand market.

(ii) Furniture and fittings had a net realisable value of K250,000.

(iii) One third of the inventories shown above had expired. They would be discarded
while the balance could be sold for an amount equal to their carrying value.

Required:

(i) Calculate the impairment loss (1 mark)

(ii) Explain how the impairment loss calculated in (i) above would be treated in the
financial statements of Paba Enterprises for the year to 31st May 2015.
(6 marks)

(c) Naca Limited commenced construction of a bridge on the Kafue River on 1st June 2014
for an agreed price of K2.4 million. The bridge is expected to be completed on 30th
November 2015.

The following information relates to bridge construction as at 31st May 2015.

K’000

Costs incurred to date 2,000

Estimated costs to complete construction 420
Progress payments received 2,120

Naca Limited recognises profits on construction contracts using the following formula;

Costs incurred to date

Total contract costs

Required:

Explain how the construction of the bridge will be accounted for in the financial
statements of Naca Limited for the year to 31st May 2015. (5 marks)

[Total: 20 marks]

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QUESTION FOUR

Walela is a publicly listed company. Its financial statements for the year ended 31 December
2014 plus comparatives for the year ended 31 December 2013 are shown below:

Statement of profit or loss and other comprehensive income for the year ended:

31 December 2014 31 December2013

K’000 K’000
Revenue 124,000 100,000
Cost of sales (87,200) (74,400)
Gross profit 36,800 25,600
Distribution costs (14,400) (9,600)
Administrative expenses (8,800) (6,400)
Finance costs (note (i) ) (1,600) (1,400)
Profit before tax 12,000 8,200
Income tax expense (4,000) (3,000)
Profit for the year 8,000 5,200
Other comprehensive income 5,400 nil
Total comprehensive income 13,400 5,200
Statement of financial position as
at:
31 December 2014 31 December2013
ASSETS K’000 K’000
Non current
Property, plant and equipment 56,000 42,800
Deferred development expenditure 4,000 nil
Total non current assets 60,000 42,800
Current
Inventory 13,200 15,200
Trade receivables 11,800 8,800
Bank 200 5,200
Total current assets 25,200 29,200
Total assets 85,200 72,000
EQUITY AND LIABILITIES
Equity
Equity shares of K1 each 32,000 32,000
Revaluation reserve 5,400 nil
Retained earnings 12,800 7,000
Shareholders’ funds 50,200 39,000
Non current liabilities
8% loan notes 5,600 12,500
Deferred tax 6,000 3,200
Finance lease obligation 4,800 3,600
16,400 19,300

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Current liabilities
Finance lease obligations 3,000 2,400
Trade payables 10,600 8,400
Current tax payable 5,000 2,900
Total current liabilities 18,600 13,700
Total equity and liabilities 85,200 72,000

Additional information:

(i) Finance costs are divided as follows between loan interest and lease interest in the two
years ended:

Loan interest lease interest

K’000 K’000
31 December 2014 600 1,000
31 December 2013 1,000 400

(ii) On 1 April 2014, Walela acquired additional item of plant under a finance lease that had
a fair value of K6 million. On this date, it also revalued its property upwards by K8
million and transferred K2.6 million of the resulting revaluation reserve to deferred tax.
Walela did not dispose off any non current assets during the period.

(iii) Depreciation of property, plant and equipment and amortization of deferred

development expenditure included in cost of sales for the year ended 31 December 2014
are K3.6 million and K0.8 million respectively.

Required:

(a) Calculate the following ratios for Walela for both years:

(i) Return on capital employed

(ii) Operating profit margin
(iii) Trade receivables collection period
(iv) Inventory holding period
(v) Current ratio
(vi) Total capital gearing ratio (6 marks)

Note: for the purpose of calculating ROCE and Gearing, all finance lease obligations are
treated as long term interest bearing borrowing.

(b) Analyse the operating, financial performance and position of Walela for the year
ended 31 December 2014 based on the ratios calculated in (a) above.
(9 marks)

(c) In addition to the above performance measurement metrics, directors of Walela

wish to use a statement of cash flow to assess the performance of the company
in the current year.

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 Required:
Compute the following figures for inclusion in the statement of cash flows needed
by the directors:

(i) Income tax paid

(ii) Amount paid to acquire Property, plant and equipment
(5 marks)
[Total: 20 marks]

QUESTION FIVE

(a) Maala Ltd is in the business of buying and selling groceries and other household goods
through its head office premises and its branches in Kitwe and Chipata. Purchases are
purely made by head office in Ndola.

The Head office accountant is not sure of how to treat unrealized profits in respect of
branch closing inventory and goods in transit.

Required:

Describe the accounting treatment of unrealized profits in respect of branch closing

inventory and goods in transit. (4 marks)

(b) Billience Airlines has decided to expand its operations by increasing the number of
routes and by acquiring bigger airplanes. The company prepares its accounts to 31
March each year. On 1 April 2014, Billience Airlines acquired an airplane under a lease
from Boeing plc. The fair value of the leased airplane is K23,450,000 and the lease is for
six years which is the same as it’s useful economic life and at the end of which it will
have no residual value. Depreciation is charged on a straight line basis. Billience Airlines
is responsible for all maintenance and insurance costs. The lease provides for six yearly
payments of K4,500,000 in advance, the first being made on 1 April 2014. Billience
Airlines’ Finance Director has indicated that the amount involved with this lease
agreement is material. The annual interest rate implicit in the lease is 6%.

Required:

(i) Explain why the above lease cannot be accounted for as an operating lease.
(3 marks)

(ii) Calculate amounts that will appear in the financial statements of Billience Airlines
for the year ended 31 March 2015, in respect of this leased asset. (5 marks)

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(c) IASB conceptual framework for financial reporting requires financial statements to be
prepared on the basis that they comply with certain accounting assumptions and
qualitative characteristics.

Required:

Explain the following fundamental qualitative characteristics of financial information.

(i) Relevance (2 marks)

(iii) Faithful presentation (2 marks)

(d) Statement of cash flow has various advantages over statement of profit or loss and
other comprehensive income. However, it does have its disadvantages.

Required:

Explain two (2) disadvantages of statement of cash flow. (4 marks)

[Total: 20 marks]

END OF PAPER

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 LI FINANCIAL REPORTING SOLUTIONS
SOLUTION ONE

a) Cota group
Consolidated statement of profit or loss and other comprehensive
income for the year ended 31st May 2015
K’000
Revenue [300+(9/12 x 150)] – 20(intra group) 392,500
Cost of sales W1 (221,575)
Gross profit 170,925
Other income 12 – [(7.5mx K0.8)+(40%xK8m/K0.4 xK0.5)] 2,000
Distribution cost 30+(9/12 x 15) (41,250)
Administrative cost [60+(9/12 x30)] +2(goodwill imp.) (84,500)
Finance costs 9+(9/12 x 4) + 4.5W3 (16,500)
Profit before tax 30,675
Share of associate profit after tax [40%x(3/12x5)] – 0.1imp. 400
Taxation 11+(9/12 x 7) (16,250)
Profit for the period 14,825
Attributable to:
Equity holders of parent (bal. fig.) 12,793.75
Non-controlling interest W2 2,031.25
14,825

Workings
W1 Cost of sales K’000
As per question: Cota 180,000
Dota 9/12 x 80 60,000
Less: Intra group purchases (20,000)
Add: Deptn on FV adjust. (20-18)x ¼yrs x 9/12 375
Add: Unrealised profit 30% x25/125 x K20m 1,200
221,575

W2 Non-controlling interests K’000

Share of:
Profit for the period 25%x(9/12 x 14) 2,625
Deptn on FV adj. 25% x 0.375W1 (93.75)
Goodwill imp. 25% x 2 (500)
2,031.25

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 W3 Deferred consideration K’000
PV of consideration at 1st Sept. 2014 (80 x 0.75) 60,000
Add: unwinding of discount 10% x 60 x9/12 4,500
Liability at 31st May 2015 64,500

b) Calculation of Goodwill in Nasa Plc

K’000 K’000

Consideration 130,000
Non-controlling interest at acquisition 40%x 189,500 75,800
Fair value of net assets at acquisition:
Share capital 120,000
Share premium 30,000
Retained earnings 40,000 – (10,000 x 3/12) 37,500
Fair value adjustment 2,000
(189,500)
Goodwill 16,300

SOLUTION TWO

Sally Ltd Statement of Comprehensive Income for the year ended 31 March
2015

K’000

Revenue 121,500
Cost of Sales (w1) (55,356)
Gross Profit 66,144
Administrative Expenses (w1) (23,924)
Distribution Costs (w1) (11,200)
Operating Profit 31,020
Finance Costs (1,310+1,310) (2,620)
Profit before tax 28,400
Taxation (5,700-2,300) (3,400)
Profit for the year 25,000
Other Comprehensive Income
Reversal of Revaluation Gain (25,000)
Total Comprehensive Income for the year 0

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Sally Ltd Statement of financial position of the as at 31 March 2015

ASSETS K’000
Non-Current
Tangible
Property, plant and equipment W3 79,716

Intangible
Development Costs 5,000
84,716

Current
Inventory (7,865 -3,300) 4,565
Trade receivables 9,045
Cash 8,100
Short-term Investments 116,812
138,522

Total Assets 223,238

EQUITY AND LIABILITIES

Share Capital (K 1 each) 70,370

Retained Earnings (23,457+25,000) 48,457
Revaluation reserve (25,000 – 25,000) nil
Share Premium 7,481
126,308
Non-Current Liabilities
Loan 26,200
Current Liabilities (W2) 70,730
Total Equity and Liabilities 223,238

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Workings

W1

Cost of sales Administrative Expenses Distribution Cost

As per Trail balance 14,556 15,400 11,200

Closing Inventory adjustment 3,300
Research costs;
University project 37,500
Depreciation: Buildings(K75.6/25yrs) 3,024
Revaluation deficit: Freehold land 13,000
Decrease in Liability provision ______ (7,500) _____
55,356 23,924 11,200

W2 Current Liabilities
Payables 8,720
Tax 5,700
Liability provision 55,000
Interest 1,310
70,730

W3 Property, plant and equipment

Land Buildings Total

K’000 K’000 K’000

Cost/ valuation b/f 90,500 75,600 166,100
Revaluation deficit (38,000) - (38,000)
Cost/ valuation 52,500 75,600 128,100

Accumulated deptn b/f - 45,360 45,360

Depreciation charge W1 - 3,024 3,024
Accumulated deptn c/f - 48,384 48,384
Carrying amount at 31 March 2015 52,500 27,216 79,716

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SOLUTION THREE

a)

(i) Adjusting events are those events, favourable or otherwise that provide
additional information to what existed at reporting date. They are therefore
used to update the financial statements.

While non-adjusting events do not provide additional information to what

existed at reporting date. They are therefore, simply disclosed in the financial
statements.

(ii) IAS 10 Évents after the reporting period’ applies to the period between 31st
March 2015 and 30th May 2015. Selling of inventory falls within this period as it
happened on 12th May 2015. The transaction is an adjusting event as it
provides more information on the valuation of inventory at 31st March 2015.
According to IAS 2 ‘Inventory’, inventories should be valued at the lower of cost
and net realisable value. Net realisable was equal to K90,000 (100,000 x 90%)
while the cost amounted to K100,000. In this case the net realisable value is
less than the cost. The inventory should therefore be written down by K10,000
(100,000 – 90,000). The effect of this would be to reduce profit for the year to
31st March 2015 by K10,000. Further, the company should review the remaining
inventories for the possibility of their cost being more than their net realisable
value.

b) Impairment loss arises when carrying value of an asset and/or cash generating unit
is more than its recoverable amount. The cash generating unit had a carrying value
of K2.5million and recoverable amount of K2million giving an impairment loss of
K0.5million. The impairment loss should first be allocated to assets that have
specifically been impaired. These are inventories and furniture and fittings. K0.15m
(1/3 xK450m) should be allocated to inventories while K0.05m (K0.3m –K0.25m) to
furniture and fittings. The balance of K0.3m (K0.5m – K0.15m – K0.05m) has to be
allocated to the remaining non-current assets on a pro rata basis. However, no
impairment loss should be allocated to computers as their recoverable amount is
more than their carrying value. K0.18m (K0.6m/K1m x K0.3m) should go to motor
vehicles and K0.12m (K0.4m/K1m x K0.3m) to other non-current assets. The total
impairment loss of K0.5m would go to statement of profit or loss as an expense.

c) The contract is expected to result in a loss of K20,000 W1. The entire loss should be
recognised immediately in the statement of profit or loss for the year to 31st May
2015. Revenue and cost of sales of K1.98m W2 and K2m will also be recognised in

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the statement of profit or loss. Contract payable of K140,000 W3 will be shown
under current liabilities in the statement of financial position as at 31st May 2015.

Workings

W1 Calculation of contract profitability

K’000 K’000
Contract price 2,400
Total contract cost:
Costs incurred to date 2,000
Costs to completion 420
(2,420)
Estimated loss 20

W2 Statement of profit or loss (extract)

K’000
Revenue (bal. fig) 1,980
Costs of sales (2,000)
Loss 20

W3 Receivable or payable under contract

K’000
Costs incurred to date 2,000
Less: loss recognised (20)
1,980
Less: progress payments received (2,120)
Payable under contract 140

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SOLUTION FOUR

a) Calculation of ratios (figures in formula substitution all in ‘000)

i) PROFITABILITY 2014 2013

1. Return on capital employed (ROCE)=

Operating profit/capital employed:

12,000 + 1,600/63,600 x 100 = 21.4%

8,200 + 1,400/57,500 x 100 = 16.7%

2. Operating margin =
Operating profit/revenue:
12,000 + 1,600/124,000 x 100 11%

8,200 + 1,400/100,000 x 100 9.6%

EFFICIENCY

3. Receivables days =

Receivables/revenue x 365 days:

11,800/124,000 x 365 35 days
8,800/100,000 x 365 days 32 days

4. Inventory days =
Inventory/cost of sales x 365 days
13,200/87,200 x 365 days = 55 days
15,200/74,400 x 365 days = 75 days

5. Current ratio =

current assets/current liabilities:

25,200/18,600 = 1.4:1
29,200/13,700 = 2.1:1

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 LONG TERM SOLVENCY

6. Gearing =
Interest bearing debt/equity + interest bearing debt:
(5,600 + 4,800 + 3,000/50,200 +5,600 + 4,800 + 3,000) 21%
(12,500 + 3,600 + 2,400/39,000 + 12,500 + 3,600 + 2,400)
32%

b) Profitability
The primary measure of profitability is the Return on Capital Employed (ROCE).
Walela’s performance in 2014 has improved in terms of ROCE, that is by 28%
(21.4% – 16.7%/16.7% x100). It entails Walela makes better use of assets in
generating profit in the current year as compared to previous year. This
improvement would have been higher had Walela not revalued its Property, Plant
and Equipment (PPE).

A review of components of ROCE show that all of them contributed to its

improvement.

Gross profit margin improved by 16% (29.7% -25.6%/25.6% x100). This could
be due to either increase in selling prices or reduction in cost of sales. The same
reasons apply to the improvement in operating margins which show an
improvement of 15% (11% – 9.6%/9.6% x 100).

The other component of ROCE is asset turnover. It measures how well a company
uses its assets to generate revenue. Walela has had some success increasing
Revenue per K1 invested by 12.1% (1.95 – 1.74/1.74 x 100. With the new
investment in PPE and the new finance leased asset, this is an excellent
achievement for future well being of Walela. Also, some improvement could be
due to development project coming on board in 2014. Since it is being amortized,
its generating revenues that have contributed to improved asset turnover and
hence profitability.

Efficiency

Inventory days have reduced from 75 days to 55 days in 2014, a reduction of 20

days. This is indicative of improved efficiency with which marketing team
operates and quality in the product. With the increase in revenue, this may not
be due to products being marked down to get rid of it. However, receivables days
have increased to 35 in 2014 from 32 in 2013. This may have been due to the
credit control department’s inability to cope with the 24% increase in sales.
However the increase is within acceptable levels that need not cause worry and
panic. Payables days have slightly increased, from 41 days to 44 days. This could
be the knock on effect of increase in receivable days and overall decline in liquidity

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 in the current year. Though a positive development for the purpose of Walela’s
cash management operations, this may lead to bad will with suppliers.

Liquidity

Walela’s liquidity has declined over the current year. The current ratio has gone
down from 2.1 to 1.4 and the acid test ratio is down from 1.0 to 0.6. This is
despite a reduction in inventory holding period by 20 days. Probably, Walela could
have sold much of the goods on credit to boost its sales in the current period
which went up by 24%. It may as well be due to Walela having had to pay K6.9
million loan note which may have impacted on its liquidity. This could be
substantiated by reduction in cash in the period despite the increase in retained
earnings. The reduction in liquidity is however within acceptable threshold.

Gearing

The repayment of 8% loan note of K6.9 less the net increase in finance lease
obligations of K1.8million has reduced the overall interest bearing long term loan
by K5.1 million (K6.9 – 1.8). this development led to reduction in gearing from
32% to 21%, a positive development. Many shareholders will be happier with this
development, as it entails lower interest expense, leaving more profits available
for distribution as dividends to them. There is already a reduction this year in the
interest expense of 40% (1,000 – 600/1,000 x 100), even though that on leased
plant has increased and the interest rate is not known. However, debt is not
always a bad thing for Walela, the cost of debt is only 8%, given that the
company’s ROCE is 21.4% in the current year, in excess of cost of borrowing
means returns on any investment exceed the cost of financing the investment.
The shareholders therefore benefit from cheap capital that will boost their capital
growth.

c) View workings below for the following amounts to be included in the

statement of cash flows:
i) Income tax pad (w1) K1.7 million
ii) Amount paid to acquire property, plant and equipment (w2) K2.800

WORKINGS

1. Income tax paid:K’000

Provision b/f: deferred 3,200
Current 2,900
Charge for the year 4,000
Revaluation surplus 2,600
Provision c/f: deferred (6,000)
Current (5,000)
Cash paid 1,700

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 OR
INCOME TAX ACCOUNT
K’000 K’000
Cash paid (bal fig) 1,700 Bal b/f: deferred 3,200
Balances c/f: deferred 6,000 Current 2,900
Current 5,000 SPL 4,000
- Revaluation surplus 2,600
12,700 12,700

2. Amount paid to acquire property, plant and equipment

K’000
Balance c/f 56,000
Depreciation charge 3,600
Balance b/f (42,800)
Finance lease obligation (6,000)
Revaluation surplus (8,000)
Cash paid 2,800

OR

PROPERTY, PLANT AND EQUIPMENT ACCOUNT

K’000 K’000
Balances b/f 42,800 Depreciation 3,600
Additions (bal fig.) 2,800
Finance leased asset 6,000
Revaluation surplus 8,000 Balance c/f 56,000
59,600 59,600

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SOLUTION FIVE

a) In branch accounting, it is usual for head office to transfer goods to the branch at
cost plus a profit loading. If these goods are sold to external customers during the
accounting period, the head office realizes the profit. If the goods remain in
inventory at the reporting date, the profit recorded by head office remains
unrealized. An allowance for this unrealized profit to be made by Head office by
making the following double entry:

 Dr Head office profit or loss statement

 Cr allowance for unrealized profit;

To record the unrealized profit in both inventory and goods in transit.

 Any unrealized profit related to branch inventory is deducted from branch

current account
 Any unrealized profit related to goods in transit is deducted from goods in
transit.
 Note that there is no need to record unrealized profit in the combined
statement of profit or loss as inventories in it are recorded at cost. The
same cost figure of inventory in statement of profit or loss goes to
statement of financial position.

b) A lease is defined by IAS17 leases as “an agreement whereby the lessor conveys to
the lessee in return for a payment of series of payment the right to use an asset for
an agreed period of time”.

i) A finance lease is “a lease that transfers substantially all the risks and rewards
incidental to ownership of an asset. Title may or may not eventually be
transferred”.
An operating lease is “a lease other than a finance lease”.
This cannot be classified as an operating lease because of the following reasons
1. The lease covers the whole of the economic life of the asset
2. The lesee company is required to maintain and insure it, this may be
deemed to transfer substantially all of the risks and rewards of ownership

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 ii) The schedule will appear as follows

Period Obligation at Payment Finance Charge Obligation at

Start of period @ 6% end of period

(31st March)

1 April 14 23,450.00 (4,500) 1,137 20,087.00

1 April 15 20,087.00 (4,500) 935.22 16,522.22

The following figures will appear in the statement of financial position as at 31st
March 2015 relating to obligations under finance lease.

Non-current asset K19,542,000 (23,450,000-3,908,330)

Non-current liabilities (20,087 – 4,500) K15,587,000

Current liabilities K4,500,000

Note: the current liability of K4,500,000 is made up of K935,220 interest and

K3,564,780 capital payment.

Amount that will appear in the Statements of profit or loss and other
comprehensive income for the year ended 31st March are as follows

Year Finance Charge Depreciation

2015 1,137 3,908.33

c) (i) Relevance

Relevant financial information must possess either predictive or confirmatory

value or both. Further, it

 Should be capable of influencing the economic decisions of users

 Should be provided in time to influence those decisions.

(ii) Faithful presentation

This demands that information must be complete, neutral i.e. free from bias, and
free from error. For information to be complete, all necessary information has to
be included in the financial statements.

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d) Two (2) disadvantages of statement of cash flow

 It is not possible to arrive at actual profit or loss of the company by simply

looking at the statement of cash flow as it only shows the cash position,
particularly when direct method is used to calculate cash flows from operating
activities.

 The statement of cash flow is of no use to the company if it is used in isolation.

It has to be used in conjunction with other statements such as statement of
financial position and statement of profit or loss.

 In determining cash and cash equivalents, short term investments are assumed
to have three months maturity period and it is up to management to decide
what constitute short term investment. This may be abused by management to
show a good position for cash and cash equivalents.

END OF SOLUTIONS

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