PROFESSIONAL 1 EXAMINATION - AUGUST 2008

You are required to answer Questions 1, 2 and 3. You are also required to answer either Question 4 or 5. (If you provide answers to both Questions 4 and 5, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first answer to hand for Questions 4 or 5 will be marked.) PRO-FORMA INCOME STATEMENT BY NATURE, INCOME STATEMENT BY FUNCTION AND BALANCE SHEET ARE PROVIDED

CORPORATE REPORTING

NOTES

TIME ALLOWED: INSTRUCTIONS:

3.5 hours, plus 10 minutes to read the paper. During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Please read each Question carefully. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates' answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted.

The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

CORPORATE REPORTING
PROFESSIONAL 1 EXAMINATION AUGUST 2008

Time allowed 3.5 hours, plus 10 minutes to read the paper. You are required to answer Questions 1, 2 and 3.

Answer Questions 1 to 3 and Question 4 or 5.

1.

The Finance Director of Rivervale PLC, a company that collects and recycles household waste, has provided you with the two most recent income statements and balance sheets with a view to you preparing cash flow information for the Board of Directors. Income Statements for the year ended 31 December 2007 2006 m m Revenue 5,600 3,900 Cost of sales (3,360) (2,340) Gross profit 2,240 1,560 Operating expenses (870) (920) 1,370 640 Gain on disposal of intangible assets 10 Operating profit 1,380 640 Finance costs (160) (90) Profit before tax 1,220 550 Income tax expense (450) (190) Profit after tax 770 360 Assets Non-current assets Property, plant and equipment (Note 1) Intangible assets Current assets Inventories Receivables Short term equity investments Cash Bank deposit accounts Total Assets Balance Sheets as at 31 December 2007 2006 m m 5,870 730 6,600

1,300 840 60 10 2,210 8,810

4,100 570 4,670

820 400 120 20 80 1,440 6,110

Non-current liabilities 9% Debentures 2011 Provision for liabilities Finance lease obligation

Equity and Liabilities Equity Ordinary share capital 1 Share premium Revaluation reserve Retained earnings

2,800 400 840 1,750 5,790

Current liabilities (Note 2) Total Equity and Liabilities

Page 1

1,660 8,810

1,150 30 180 1,360

1,050

2,400 200 540 1,120 4,260 60 1,110

740 6,110

1.

Extract from notes to financial statements.

Property, plant and equipment

Cost 1 January 2007 Revaluation Additions Disposals Cost 31 December 2007

Land & Buildings m 9,950 200 320 10,470 6,600 (100) 220 6,720 3,350 3,750 2007 m 600 350 60 360 120 20 150 1,660

Plant & Equipment m 1,400 1,560 (180) 2,780 850 (140) 400 1,110 1,670 550

Motor Vehicles m 700 500 1,200 500 250 750 200 450 2006 m 340 150 20 180 40 10 740

Total m 12,050 200 2,380 (180) 14,450 7,950 (140) (100) 870 8,580

Depreciation 1 January 2007 Disposals Revaluation Charge for year Depreciation 31 December 2007

Net Book Value 31 December 2006

Net Book Value 31 December 2007

4,100 5,870

2.

Current liabilities

Additional information:
(a)

Trade payables Payable on plant & equipment Finance lease obligation Income taxation Dividends Interest accrual Bank overdraft

(b) (c) (d) (e)

Some plant and equipment was disposed of during the year for 60 million. Plant and equipment additions include some machinery purchased on a finance lease. The finance lease capital obligation element of the lease rental payments amounted to 40 million in 2007. Lease interest paid is included in finance costs. During March 2007, the company made a bonus issue from the share premium account of one new ordinary share for every eight held at that date. A further share issue for cash was made in October 2007. A dividend of 120 million was declared by the Directors and approved by Shareholders before the 31 December 2007 year end. An interim dividend of 20 million was paid in June 2007.

REQUIREMENTS: (a)

The provision for liabilities relates to a court case for illegal dumping initiated by a local county council against Rivervale PLC in April 2007.

In June 2007, Rivervale PLC sold a waste iron collection licence for 30 million. There were no other disposals of intangibles. All intangible assets are amortised over 5 years, including a full year in year of purchase and none in year of disposal. Amortisation is included in cost of sales.

(b)

Prepare the cash flow statement for the year ended 31 December 2007 of Rivervale PLC in accordance with IAS 7 Cash Flow Statements. (23 Marks) Presentation (1 Mark)

Prepare a brief report on the liquidity position of Rivervale PLC for the Non-Executive Directors on the board who are concerned about the drastic fall in cash and cash equivalents during 2007. (6 Marks)
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[TOTAL: 30 MARKS]

2.

Trappa PLC acquired 75% of the ordinary shares of Tony Ltd in July 2004 when the retained earnings of Tony Ltd were 100 million. On 1 January 2007 Trappa PLC acquired 30% of the ordinary shares of Tardy Ltd. Balance Sheets as at 31 December 2007 Trappa m 640 180 80 900 240 260 40 80 620 1,520 400 340 740 400 280 60 40 380 1,520 780 Tony m 360 360 120 140 Tardy m 200 200 70 75

Assets Non-current assets Property, plant and equipment Investment in Tony Ltd. Investment in Tardy Ltd. Current assets Inventories Trade and other receivables Loan to Tony Ltd Cash and cash equivalents Equity and Liabilities Equity Ordinary share capital 1 Retained earnings Non-current liabilities Loans Current liabilities Trade Payables Other payables Dividends payable Total liabilities Total Assets

15 275 635

15 160 360 100 120 220 40 70 20 10 100 360 140

120 280 400 130 50 15 40 105

Total Equity and Liabilities The following information is also relevant: 1.

235 635

2. 3.

5.

4.

During 2007 Tardy Ltd sold goods for 60 million to Trappa PLC at a mark up of 50%. One third of these goods are still in inventory of Trappa PLC at the year end.
Page 3

Profits after tax of Tardy Ltd for the year ended 31 December 2007 were 70 million.

The trade payables of Trappa PLC includes 20 million owing to Tony Ltd in respect of the above goods purchased. The trade receivables amount in the current assets of Tony Ltd includes a balance with the parent company of 26 million. Further investigations revealed that a cheque sent by Trappa PLC in early December was still in the desk drawer of Tony Ltds Assistant Accountant.

During 2007, Tony Ltd sold goods to Trappa PLC for 32 million at a margin of 25%. One half of these goods remained in the inventory of Trappa PLC at the year end.

At the date of acquisition, the property of Tony Ltd was undervalued by 40 million and this has not been reflected in the financial statements of Tony Ltd. At that date, the average remaining useful life of the property was 20 years. A full years depreciation is charged in year of acquisition and none in year of disposal.

6. 7.

The dividends included in the Current Liabilities of Tony Ltd and Tardy Ltd are the final declared dividends for 2007, which were approved by their respective shareholders before the year end. Trappa PLC has not yet included its share of any dividends receivable in its financial statements.

Assume the profits and dividends of all three companies are earned evenly over the financial year and that there have been no recent issues of share capital in either Tony Ltd or Tardy Ltd.

(a)

REQUIREMENTS:

(b)

Prepare the Consolidated Balance Sheet of the Trappa Group PLC as at 31 December 2007 in a format suitable for publication under International Financial Reporting Standards. (20 Marks) Presentation (1 Mark)

The Trappa Group PLC are considering the acquisition of 100% of the ordinary share capital of a company based in London, Brady Ltd., whose functional currency is the pound () sterling. The Trappa Group would expect that Brady Ltd would continue to operate and be managed independent of its parents operations, subject to overall head office control. Set out briefly the impact on the consolidated financial statements of Trappa Group PLC of acquiring a foreign subsidiary such as Brady Ltd. (4 Marks) (i)

(c)

(ii)

Explain what is meant by the term Associate and when one should be recognised in the consolidated financial statements. (2 Marks)

Set out briefly the accounting impact of an Associate on a consolidated income statement and balance sheet. (3 Marks) [TOTAL: 30 MARKS]

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3.

The following multiple choice question contains eight sections, each of which is followed by a choice of answers. Only one of each set of answers is strictly correct. REQUIREMENTS: Give your answer to each section in the answer sheet provided. [TOTAL: 20 MARKS]

1.

Smart PLC has an issued ordinary share capital of 2,000,000 shares of 1 each. During the financial year to 31 December 2007 they paid an interim dividend of 4c per share. On 10 December the Directors also proposed that the final dividend for the year would be 6c per share. The dividend was approved by the shareholders on 31 March 2008 and paid on 10 April. In the 31 December 2007 financial statements the following amounts would appear in respect of dividends (a) (b) (c) (d) Statement of Changes in Equity 200,000 120,000 120,000 80,000 Balance Sheet 120,000 120,000 -

2.

Buildup Ltd is an established company in the construction industry and undertook a 15-month contract to build an apartment block, which was almost complete at the year-end. Details of the contract as at their year end 31st May 2008 are as follows: Cost of work done Cost of work certified Progress payments invoiced and received Estimate of final total cost, including future costs of rectification and guaranteed work Final contract price Apartment Contract 000 4,050 3,840 3,250 4,500 6,400

It is company policy that profit is to be recognised on a percentage completion basis, being calculated as the costs incurred to date as a proportion of total estimated costs. How much (in 000) should Buildup Ltd include in Revenue in the income statement in relation to the above contract for the year ended 31st May 2008 (a) (b) (c) (d) 3,250. 5,350. 5,760. 5,461.

3.

XPRS Ltd is showing a gross profit of 300,000 in its Income Statement for the year ended 31 March 2008. This includes a closing inventory valuation of 50,000. It has been discovered that an item of stock included in year end inventory at its cost of 5,000 is now obsolete and may only be sold for 4,200. It would cost 200 to advertise and 300 to deliver this item. The correct gross profit amount in the Income Statement of XPRS Ltd for the year ended 31 March 2008 is: (a) (b) (c) (d) 301,300. 298,700. 300,800. 299,200.

4.

(a) (b) (c) (d)

Which of the following does not meet the definition of a financial asset? Trade receivables. Cash. Equity shares in another entity. Inventories.

Page 5

5.

For its 31 March 2008 year end, an entity has decided, for cost-benefit reasons, to calculate the finance costs in respect of all new finance leases using the sum of the digits method as opposed to the actuarial method which it has used up to now. In the financial statements for the year end 31 March 2008 this is disclosed as: (a) (b) (c) (d) a a a a change in accounting estimate. prior year adjustment for a material error. change in accounting policy with retrospective application. change in accounting policy with prospective application.

6.

Katies Kitchens Ltd, a bespoke kitchens manufacturer prepares its financial statements to 31 December each year. On 1 January 2007 the company commenced the five year lease of a specialised timber cutting machine. The lease rental consists of five payments of 24,000, paid in advance. The purchase price of this type of machine was 104,000 at the date of the lease commencing and the rate of interest inherent in the lease is 7.75%. Katies Kitchens Ltd has an option to purchase the machine outright for 1 at the end of the five years. It is estimated that the useful life of the machine is eight years with no residual value. If the lease is to be accounted for as a finance lease under IAS 17 Leases, the effect of the lease on the Income Statement and Balance Sheet of Katies Kitchens Ltd at 31 December 2007 would be: (a) (b) (c) (d) Profits Decrease by 6,200 Decrease by 24,000 Decrease by 19,200 Decrease by 21,060 Non-current Assets Increase by 83,200 Increase by 104,000 Increase by 91,000 Increase by 91,000 Liabilities Increase by 80,000 Increase by 104,000 Increase by 86,200 Increase by 88,060

7.

On 31 December 2007, its financial year end, Diggers PLC formally decided to sell a factory building that it is no longer using. The company is confident that it will be sold quickly. The building originally cost 650,000 on 1 January 2000 and was depreciated at 2% per annum. It was revalued to 1,000,000 on 1 January 2003 and had a useful life of 40 years at that date. The company has engaged a commercial property selling agent who has valued the property at 900,000 at 31 December 2007. The agent charges 1% commission and it would cost 20,000 to advertise the factory. The carrying value of the factory in the balance sheet of Diggers PLC at 31 December 2007 should be: (a) (b) (c) (d) 875,000. 871,000. 546,000. 900,000.

8.

Which of the following will NOT lead to a foreign exchange gain or loss being presented in the income statement? a) c) b)

d)

A difference between the exchange rate at which goods are recorded as purchased and the rate on the day when payment is made. A difference between the rate of exchange on the date on which goods are sold and the rate of exchange on the date when the foreign currency receipt is lodged. A difference between the exchange rate when the goods are purchased and recorded in Inventory and the rate at the balance sheet date. A difference between the exchange rate when the goods are purchased and recorded in Payables and the rate at the balance sheet date.

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4.

IAS 38 Intangible Assets sets out the rules for the recognition, measurement, presentation and disclosure of all intangible assets including goodwill. REQUIREMENTS: (a) Define what is meant by an intangible asset and set out the criteria to be satisfied so that costs (excluding development expenditure) may be recognised as an intangible asset on an entitys balance sheet. (7 Marks) Explain how the criteria in (a) above apply to the accounting treatment of: (i) (ii) Internally generated intangibles; and Separately purchased intangibles.

(b)

(c)

The Directors of Speakalot PLC, a telecoms and broadband company, wish to include the following items of expenditure in 2007 as intangible assets in their balance sheet as at 31 December 2007:
G

Illustrate your answers with an example in each case.

(6 Marks)

A new five year broadband licence for the Dublin region, for which they paid 800,000 to the government on 1 January 2007.

The 500,000 cost of the two year staff training and development campaign commenced by the company during the year. The company expects the training and development to achieve cost savings of 200,000 per annum over the next three years.

Write a brief memo to the Finance Director explaining how the above expenditures should be accounted for in the financial statements of Speakalot PLC for the year ended 31 December 2007, in accordance with IAS 38 Intangible Assets. (7 Marks) [TOTAL: 20 MARKS]

The broadband brand name Connectalot was valued by an external brand management company at 3 million. This brand has been supported during the year by a door to door marketing campaign costing 300,000. The company expects to achieve a market share of 10%, which will yield profits of about 400,000 annually for five years.

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5.

IAS 8 Accounting Policies, Accounting Estimates and Errors sets out the criteria for selecting, applying and changing accounting policies as well as relevant disclosures. It also sets out how to account for and present fraud and errors in the financial statements. REQUIREMENTS: a) Outline the meaning of the following terms: Accounting policy. Accounting estimate. (4 Marks)

G G

b) c)

Set out the circumstances in which a company is allowed to make a change in accounting policy. (3 Marks)

Set out the required accounting treatment where a company discovers an error in the financial statements in: (i) (ii) The current accounting period; and A previous accounting period. (4 Marks)

d)

Explain, with the aid of any relevant calculations, how the following independent scenarios should be presented in the financial statements of Robots PLC for the year ended 31 December 2007: (i) At 31 December 2007, Robots PLC decided to revalue all of its property for the first time. The revaluation surplus was 1 million.

(ii) (iii)

At 1 January 2007, the company decided to extend the useful life of all its vans and trucks by two years. This has a material effect on its profit for 2007.

In November 2007, the company discovered that the Sales Director had been creating false sales on credit to fictitious customers. This took place in a sales channel where his son was the Manager. The sales amounted to 120,000 in 2007, 180,000 in 2006 and 90,000 in 2005. These sales were not picked up by the credit control department and the receivables were all outstanding at 31 December 2007. (9 Marks)

[TOTAL: 20 MARKS]

END OF PAPER

Page 8

SUGGESTED SOLUTIONS

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

CORPORATE REPORTING
PROFESSIONAL 1 EXAMINATION AUGUST 2008

SOLUTION 1 (a) Cash Flow statement for the year ended 31 December 2007 Cash flow from operating activities Profit before taxation Adjustments Gain on disposal of intangible assets Finance cost Depreciation of PPE Amortisation of Intangible assets Provision for liabilities Profit on disposal of PPE Operating Profit before working capital changes Movements in Working capital Inventory increase (1300-820) Receivables increase (840-400) Payables increase (600-340) Cash generated from operations

W1

W2

(10) 160 870 216.9 30 (20)

1,220.0

Marks

1,246.9 2,466.9 (480.0) (440.0) 260.0 1,806.9

0.5 0.5 0.5 1 0.5 1 0.5 0.5 0.5 1 1 1.5 0.5 4 3 0.5 1 2 1 0.5

0.5

Interest paid Taxation paid Dividend paid [or Financing activities] Net Cash flows from operating activities

W4 W5 W6

Cash flows from Investing activities Proceeds from disposal of PPE Purchase of PPE Purchase of Intangible assets Proceeds from disposal of intangible assets Disposal of equity investments (120-60)

(150.0) (270.0) (60.0) 1,326.9

W2 W1

Cash flow from financing activities Proceeds from issue of share capital Increase in long term borrowings (1150 - 1050) Payments of finance lease liabilities [Capital element] Net decrease in cash and cash equivalents Cash and cash equivalents 31/12/2006 Cash and cash equivalents 31/12/2007

60.0 (1,980.0) (396.9) 30.0 60.0 (2,226.9) 600.0 100.0 (40.0) 660.0

(240.0)

100.0 (140.0)

0.5 0.5

Page 9

Note to cash flow statement 2007 m Cash 10 Bank (150) (140) Workings W1 Balance b/d Acquired for cash less 2007 amort ***

2006 m 20 80 100

Movement m (10) (230) (240)

Presentation: 1 Mark (24 Marks) 20.0 137.5 730.0 887.5

Intangible assets 570.0 Disposal* 317.5 Amortisation c/f 2006** Balance c/d 887.5 m 30 (10) 20

* **

Intangible asset disposal proceeds Gain on disposal Book value of license sold

NOTE: ***

Amortisation @ 4years

Amortisation of Intangibles: - c/f 2006 Opening balance Disposal @book value

Assumes that the unsold intangible assets carried forward from 2006 were purchased in that year. 317.5 396.9 = investing cash flow 79.4 137.5 79.4 216.9 m 180 (140) m

570 (20) 550 137.50

Total amortisation in 2007 Intangibles c/f prior year 2006 Intangibles purchased in 2007 W2 Property, plant & equipment

Amortisation of 2007 purchases of intangible assets. Cash paid less amortisation => gross cash paid for intangibles = 317.5/0.8 Amortisation = difference

Plant & equipment additions gross Less: Finance Lease additions W3

Page 10

Gain on disposal: Proceeds Cost less: Accum. Depreciation Gain on disposal PPE Payments for additions: Land & buildings Plant & equipment (see below) Motor vehicles To CF Statement

320 1,160 500 1,980

(40) 20

60

1,560 (200) 1,360

Payments to acquire PPE - BAL Balance c/d - CL W3

Capital payables account 1,160 Balance b/d - CL 350 P & E additions 1,510

Payments Balance c/d - CL Balance c/d - NCL

W4

Lease obligation Balance b/d - CL 40 Balance b/d - NCL 60 Asset additions - Balancing figure 180 280 Interest payable Balance b/d - CL 150 IS charge 20 170

150 1,360 1,510 20 60 200 280

Payments - Balancing figure 160 Balance c/d - CL

10 170 180 450 630 40 140 180

W5

Payments - Balancing figure Balance c/d - CL

W6

Payments - Balancing figure Balance c/d - CL Final dividend accrued Interim dividend paid

Dividends payable Balance b/d - CL 60 SOCE total - see below 120 180 m 120 20 140

Taxation payable Balance b/d - CL 270 IS charge 360 630

W7 Balance c/d - CL

Share capital Balance b/d Bonus issue (1/8) to Share Premium 2,800 Cash Issue - Balancing figure 2,800 Share premium 300 Balance b/d Cash issue - Balancing figure 400 700 m 100 500 600

2,400

300 100 2,800 200 500 700

Balance c/d

Bonus issue - Share Capital

Total Issue for cash: Share capital Share premium

Page 11

(b) To: From: Re:

Introduction The short-term cash position of the company has been in free fall over the period 2006-07 from positive cash and bank balance of 100m in 2006 to a net overdraft situation of 140m in 2007, a negative movement of 240m in one year. Following are some of the main causes of this negative cash situation. Key Issues: The main cause of this loss of cash is the dramatic growth in the period yielding sales growth of 43%. The company is profitable but liquidity indicators such as the current and acid test ratios have disimproved dramatically (see Appendix).

Non-executive Directors Financial Controller Liquidity position of Rivervale PLC

Report on Liquidity of Rivervale PLC

In its quest to expand, the company has relaxed its control over working capital matters with receivables days increasing by 18 days to 55 days. This was partly covered by taking 13 days longer to cover payables. We need to be careful not to endanger further growth with supply problems due to slow payment.

The company has expanded very quickly with 1,980m paid for property, plant and equipment additions in order to generate the sales growth. Intangible assets purchases cost 397m. This was financed mainly through a share issue of 600m and an increase in long-term borrowings of 100m. Operating cash flows were positive but short-term borrowings, such as the overdraft, were also used to finance this growth.

Operating cash flows were positive and this needs to continue in order to pay for the 2007 expansion and any future growth. Interest cover based on profits has increased and is well covered by operating cash flows. Gearing has actually fallen from 25% to 20% which indicates a capacity to take on more long term funding.

Appendix: Key ratios Ratio

The short-term borrowings should be replaced by longer term debt if the company wishes to continue to expand in a controlled manner and not fall into the trap of overtrading. Operating cash flows are also financing the growth but working capital is close to spiralling out of control as the company has concentrated on expansion. This will need to be corrected. Short-term dividend policy should also be reviewed. 2007 2006

Conclusion Share capital funding increased in the period but the bonus issue could be seen to be unnecessary. Also in a period of high growth, it could also be thought unnecessary to triple the declared final dividend to 120m. This puts further pressure on short term cash.

Current ratio Acid test ratio Interest cover Receivables days Payables days Gearing

1.33: 1 0.55: 1 4.81 times 55 days 65 days 20%

Report presentation 0.5 marks Key ratios 2 marks Discussion 3.5 marks (6 Marks) [Total : 30 Marks]

1.95: 1 0.83: 1 4 times 37 days 53 days 25%

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SOLUTION 2

Assets Non-current assets Property, plant and equipment Investment in Associates

Trappa Group PLC Consolidated Balance Sheet as at 31 December 2007 m W8 W5 W9 W10 W13 W10 1,032.0 98.0 1,130.0 354.0 374.0 3.0 101.0 832.0

Marks

1.5 1.5 1.5 1.0 0.5 1.0

Current assets Inventories Trade and other receivables Dividends receivable from associate Cash and cash equivalents [80+15+6] Total Assets

Equity and Liabilities Equity Ordinary share capital 1 Retained earnings Minority Interest

1,962.0

W3 W4

Non-current liabilities Loans [400+130-40 intercompany] Current liabilities Trade Payables Other payables [60+15] Dividends payable to equity Dividend payable to minority Total liabilities W11

400.0 530.0 930.0 107.0 1,037.0 490.0 310.0 75.0 40.0 10.0 435.0 1,962.0 925.0

0.5 6.5 2.5

1.0 1.0 0.5 0.5 0.5

W13 W13

Total Equity and Liabilities

Presentation : 1 mark (21 Marks) Workings 1.

Tony - subsidiary Tardy - Associate

Group structure

Group share 75% 30%

Minority Interest 25% -

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2.

Goodwill - subsidiary Goodwill - gain to IS Cost of investment

Note: Per IFRS 3 - 'Negative' Goodwill is to be treated as a gain and credited to income. 3. Consolidated Retained Earnings Consolidated Retained Earnings 75.0 Trappa Tony 6.0 Interest in associate 3.0 [30% x (120 - 60) - 2] (W6, 7) 530.0 684.0 70.0 Goodwill - gain (W1) Subsidiary dividends (W13) Associate dividends (W13)

Cost of Control Account - Tony Ltd 180.0 Share capital - 75% x 120m Retained earnings -75% x100m 15.0 Fair value adjs (W12) 195.0

90.0 75.0 30.0 195.0

Depreciation on FV adj (W12) Unrealised Inventory profit - 75% Balance Sheet 4. Minority Interest Minority interest - 25% x 280m

Cost of control - pre-acquisition

340.0 280.0 15.0 30.0 3.0 684.0 30.0 70.0 10.0 16.0

Balance Sheet

Depreciation on FV adj (W12) Unrealised Inventory profit

5. Investment In Associate Method 1 Cost of investment Retained Earnings *

Minority Interest 2.0 Share capital - 25% 1.0 Retained earnings Fair value adjs (W12) 107.0 110.0 Investment in Associate 80.0 18.0 Balance Sheet 98.0

110.0

* Post acquisition retained Earnings = 30% x (120 - 60) = 18.0

98.0 98.0

6. Goodwill in Associate Cost of investment

Method 2 m Group share of net assets of Associate [30% x 220m] 66.0 Goodwill 32.0 98.0
Cost of Control Account - Tony Ltd 80.0 Share capital - 30% x 100m Retained earnings -30% x60m** Goodwill 80.0 30.0 18.0 32.0 80.0

** Retained earnings at date of acquisition 1 January 2007 m Retained earnings 31 December 2007 120.0 Profit for year (70.0) Dividends for year 10.0 Retained earnings 1 January 2007 60.0
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7.

Dr Income of Associate/ Retained earnings Cr Inventory [ 30% x (60m x 50/150 x 1/3)]

Sale of goods from Associate to Parent

m 2.0

m 2.0

(a) (b)

Note: The upstream transaction of the sale of goods from Tony Ltd to Trappa Plc can be treated in one of two ways as IAS 28 is not completely clear on the issue: Dr Share of income of associates (IS), Cr Inventories or Dr Share of income of associates (IS), Cr Investment in Associate (BS) with the group share in the associate x unrealised profit on the transaction.

Neither the revenue amount nor the trading balance are removed as IAS 28 is clear that an associate is not part of the group in the same was that a subsidiary is and therefore neither Inter-company balances nor trading revenues are removed. 8. Property Plant and Equipment m 640.0 360.0 40.0 (8.0) 1,032.0

Balance per BS - Trappa Balance per BS - Tony Fair value adjustment (W12) Depreciation on FV adj (W12)

9.

Inventories Balance per BS - Trappa Balance per BS - Tony Unrealised Inventory profit [ 32m x 1/2 x 25%] Unrealised Inventory profit - associate W7

Note: Unrealised profit in inventory - sale of goods from Tony Ltd to Trappa Plc m m Dr Retained Earnings - 75% 3.0 Dr Minority Interest - 25% 1.0 Cr Inventory [ 32m x 1/2 x 25%] 4.0 10. Trade and other receivables m 260.0 140.0 (26.0) 374.0 m 26

m 240.0 120.0 (4.0) (2.0) 354.0

Balance per BS - Trappa Balance per BS - Tony Inter-company trading balance Note: Inter-company trading balance with subsidiary m Dr Bank 6 Dr Payables 20 Cr Receivables

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11.

Trade Payables Balance per BS - Trappa Balance per BS - Tony Inter-company trading balance (see W10 above)

12.

13.

Dr Retained Earnings - 75% 6.0 Dr Minority Interest - 25% 2.0 Cr Property Plant and Equipment [40m/20 x 4years] Dividends Subsidiary Dividends not accounted for by Parent m 30.0

Depreciation must be charged on the additional value.

Fair Value adjustment (ii) Tutorial note: The PPE fair value adjustment should be reflected in the value of Tony Ltd PPE and therefore the Consolidated PPE. m m Dr Property Plant and Equipment 40.0 Cr Cost of control - 75% 30.0 Cr Minority interest - 25% 10.0

m 280.0 50.0 (20.0) 310.0

8.0 m

Dividend payable to minority interest Total dividend - Tony Ltd Dividend to Parent (b)

Dividends receivable from associate not accounted for by Parent Dr Dividends receivable (30% x 10 m) 3.0 Cr Retained earnings 40.0 (30.0) 10.0

Dr Dividends payable (75% x 40 m) Cr Retained earnings

30.0 3.0

Acquisition of a foreign currency subsidiary: 1.

Students should include the following key points in their memo:

2.

3.

The closing rate method of foreign currency translation would be required to consolidate Brady Ltd under IAS 21, as the presentation currency of Brady Ltd is different to its functional currency. The closing rate method involves the following: ii. i. The net assets and the goodwill on acquisition are translated at the rate ruling on the date of acquisition. The balance sheet assets and liabilities of the subsidiary are re-translated annually at the closing rate on the balance sheet date, i.e. 31 December. The income statement of the subsidiary is translated at the rate ruling on the date of the transaction, however the average exchange rate for the financial year is usually used for practical purposes. Foreign exchange gains or losses which arise on the re-translation of the net investment in the subsidiary are included in equity until the disposal of the subsidiary. This is usually done through the mechanism of a Foreign Exchange Translation Reserve. (4 Marks)
Page 16

As Brady Ltd would be run semi-autonomously its functional currency would continue to be sterling.

iii. iv.

(c) (i)

Circumstance where an associate is recognised in consolidated financial statements:

G

An Associate is an entity, including an unincorporated entity such as a partnership, over which the investor has significant influence and that is neither a subsidiary nor an interest in a joint venture. Where an entity holds 20% or greater of the voting power of the investee it is deemed to hold significant influence unless it can be clearly demonstrated otherwise.

o o o o o (ii)

If less than 20% of the voting power of the investee is held then significant influence can be demonstrated in one or more of the following ways: Board of directors representation; Participation in the policy making process, including dividend policy; Material transactions with the investee; Interchange of material personnel; Provision of essential technical information.

The impact of an associate using the Equity method is as follows:

Equity accounting is used to include an associate in the consolidated income statement and balance sheet.

(2 Marks)

The group retained earnings includes the group share of post acquisition retained earnings less goodwill impairments. (3 Marks) [Total : 30 Marks]

Consolidated balance sheet A non-current asset, called the Investment in Associate, is calculated as the original cost of the investment plus (or less) the groups post acquisition share of retained profits (losses) less impairment losses on any goodwill in the associate.

Consolidated income statement The Group share of the profit after tax of the associate is shown as a single line item before the group profit before taxation.

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SOLUTION 3 1. Solution (d)

2. 3.

As the 6c per share dividend was only proposed by the directors and not approved by the shareholders pre year end it does not meet the definition of a liability under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Solution (c) Cost to date/Estimate of final cost x 6,400 = 5,760

If closing inventory valuation decreases so does gross profit, therefore 4. 6. Correct Gross profit = 300,000 - 1,300 = 298,700. Solution (d) Inventories Solution (a) - a change in accounting estimate. Increase by 91,000 Increase by 86,200 Capital Bal o/s 80,000 62,200

Valuation of inventory = lower of cost and net realisable value (NRV) Cost 5,000 Selling Price 4,200 Selling costs (200+300) 500 NRV (3,700) Inventory write-down 1,300

Solution (b) 298,700

5.

Decrease by 19,200 2007 2008 Period 1 2

Solution (c)

7.

Solution (b) 871,000

Net Book Value of Asset 31 /12/07 [104,000-13,000]

Depreciation on finance lease [104,000/ 8 years] Total impact on profits [6,200 + 13,000]

Opening Rental Balance in advance 104,000 24,000 80,000 24,000

Capital Finance Payment Cost 7.75% 24,000 6,200 17,800 4,821 13,000 19,200

Interest accrual 6,200 4,821

Total Liabil 86,200 65,021

91,000

IFRS 5 Qualifies as asset held for sale New Carrying amount is to be lower of NBV and fair value less costs to sell Revalued amount 1/1/2003 Depreciation per annum (40 years) NBV at 31/12/2007 [5 yrs Deprec] 1,000,000 25,000 875,000 900,000 (9,000) (20,000) 871,000

Fair value less costs to sell = Less Commission 1% Less Advertising 8.

Solution (c) A difference between the exchange rate when the goods are purchased and recorded in Inventory and the rate at the balance sheet date.
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SOLUTION 4 (a)

(b) (i)

(iii) Leads to future economic benefits It is necessary and probable that future economic benefits can be attributed to the asset and will flow to the entity. These future economic benefits can be due to the future sale of the asset, through annual revenues or through cost savings generated by the asset. It is also necessary that the cost of the asset can be measured reliably. (3 x 2 Marks = 6 Marks) (7 Marks) Internally generated intangibles;

(ii) Controlled by the entity Control over the asset must be protected by legal rights, e.g. technical knowledge. Skills of employees and/ or training costs are not normally recognised as an intangible asset as the company cannot control the future actions of its staff.

(i) Identifiable The key determination here is of the existence of the asset. The standard states that it must be separately identifiable from other assets or Goodwill. Otherwise it should arise from contractual or other legal rights.

IAS 38 Intangible Assets defines and intangible asset as an identifiable non-monetary asset with out physical substance. (1 Mark) IAS 38 states that an intangible asset is recognised if the asset is (i) Identifiable (ii) Controlled by the entity (iii) Leads to future economic benefits.

An asset is defined in the IASB Framework for the Preparation and Presentation of Financial Statements as a resource controlled by the entity as a result of past events and from which economic benefits are expected to flow to the entity.

(ii)

The cost of intangibles, such as a licence or a brand name, can be reliably measured as the price paid. The item can also be separately identifiable. If acquired as part of a business combination, the asset must be identified and its fair value determined based on an active market or arms length transaction. (3 marks including 1 mark for example)

Separately purchased intangibles

Expenditure generated internally, such as training costs, cannot be separately identified as being directly related to an intangible asset and not just normal operating costs. Therefore it is impossible to measure the cost of the intangible asset reliably. Also, it is impossible to state that any future economic benefits generated are due to the specific expenditure in question. (3 marks including 1 mark for example)

(6 Marks )

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(c)

I will set out below the proper accounting treatment of the three items of expenditure that you are considering accounting for as intangible assets in the financial statements for the year ended 31 December 2007. The accounting treatments set out below follow the requirements of IAS 38 Intangible Assets.
G

To: From: Re:

MEMO

The Finance Director of Speakalot PLC A. Consultant Expenditure on Intangible Assets

The 500,000 cost of the two year staff training and development campaign commenced by the company during the year cannot be treated as an asset as it cannot be separately identified as creating an asset (as opposed to being operating expenditure). Also, the staff who are being trained and developed cannot be controlled by the company. The 500,000 is therefore treated as expenditure charged to the income statement in the appropriate period. If the full two year campaign is paid in advance during 2007, then a prepayment of 250,000 in relation to 2008 may be shown in current assets as long as the campaign will be completed or the amount is recoverable. The broadband brand name Connectalot was valued by an external brand management company at 3 million. This brand has been supported during the year by the door to door marketing campaign costing 300,000. IAS 38 does not permit the recognition of internally generated brand names. The company expects to achieve a market share of 10% which is worth profits of about 400,000 annually for five years. The cost of the advertising campaign cannot be seen as the sole reason for the generation of the 400,000 profits and be separately identifiable as doing so. It is also impossible to differentiate between expenditure that is normal operating expenditure and that which may lead to future economic benefits. Any supporting expenditure must be charged to the income statement. It is also impossible to put a reliable cost (measurement) on the brand. (2.5 Marks) (7 Marks) [Total : 20 Marks] (2.5 Marks)

The new five year broadband licence for the Dublin region, which cost 800,000 on 1 January 2007 can be accounted for as an intangible asset and presented on the face of the balance sheet under the heading of Non-current assets. The asset is amortised over its useful economic life which in this case is five years. The asset is therefore presented at a carrying amount of 640,000 with the amortisation of 160,000 being charged to the income statement in 2007 as an expense. (2 Marks)

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SOLUTION 5 IAS 8 Accounting policies, accounting estimates and errors a)

G

An accounting policy is a specific principle, base, convention, rule or practice that has been adopted by a reporting entity when preparing and presenting its financial statements.
G

Accounting policy

b)

An accounting estimate is the method by which accounting policies are applied in order to calculate the carrying value of an asset or liability or the amount of the periodic consumption of an asset. Accounting estimates involve the use of professional judgement. (2 x 2 Marks = 4 Marks) Changes in accounting policy should be rare and can only occur in the following circumstances:
G G

Accounting estimate

c)

Set out the required accounting treatment where a company discovers an error in the financial statements in: The error is corrected in the financial statements in the current accounting period. Error discovered relating to a previous accounting period (i) Error discovered in the current accounting period; and (1 Mark)

Where there is a change in legislation; Where there is a change in the requirements of an accounting standard as adopted by an accounting standard setting body; and If the change results in a more appropriate presentation of the particular events or transactions in the entitys financial statements. (3 x 1 Mark = 3 Marks)

(ii)

The item is then accounted for correctly in the financial statements from that point on. Full disclosure of the issue is also provided.

This involves: (a) restating the comparative amounts for the prior period in which the error occurred; or (b) where the error occurred before the earliest period presented, the opening balances of the assets, liabilities or equity affected must be restated for that period.

IAS 8 requires that these are corrected retrospectively, i.e. that the financial statements (including the corresponding period) are now presented as if the error never occurred.

(d) (i)

Only where it is impractical to determine the cumulative effect of any error on prior periods is it permissible to account for the error on a prospective basis (i.e. treated correctly from the point at which the error was discovered. (3 Marks) (4 Marks) Dr PPE Cr Revaluation Reserve. The revaluation is a change in accounting policy and should be disclosed as such in the notes to the financial statements. Details of the revaluation should be provided and the assets are depreciated based on their new valuations. 2 Marks
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(ii)

(iii)

The fraud / error will be corrected as follows:

G

The fraud created false revenue and a false receivable. The impact of the fraud on the financial statements is that the overall company retained profit is overstated and the carrying amount of the receivables balance in the financial statements is also overstated. The opening balance of receivables as at 1 January 2006 is restated to its correct amount deducting the 2005 sales of 90,000.

This is a change in accounting estimate with the depreciation amount being revised prospectively. The depreciation charge is calculated as the current carrying amount of the assets divided by the new expected useful life. As the change has a material affect on profits this should be disclosed in the notes. 2 Marks

The income statement revenue and the receivables balance in the 2006 comparative figures are corrected. This will reduce the 2006 profits by 180,000. The carrying amount of the receivables will be reduced by a total of 270,000 [2005 +2006 amounts].

The opening balance of retained earnings brought forward at 1 January 2006 is reduced by 90,000. This change is highlighted separately in either the Statement of Changes in Equity or in the Note on Reserve Movements.

The corrected retained earnings balance at 1 January 2007 is carried forward and income statement revenue for 2007 is reduced by 120,000. This carrying value of the 2007 receivables is now reduced by 390,000 [120,000+ 180,000 + 90,000]. The detail of the above is disclosed in the notes to the financial statements. 5 Marks (9 Marks)

[TOTAL : 20 MARKS]

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