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ACCA – Paper P2 (INT/UK) Corporate Reporting September and December 2015 Final Assessment

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Please complete your personal details above. All scripts should ideally be submitted to your Kaplan centre for marking via email to help speed up the marking process. Please scan this form and your answer script in a single PDF and email it to your Kaplan centre. Alternatively you may post your script to us. If so, please use the correct Royal Mail tariff (large letter). Classroom students may submit scripts to their local centre in person. You will be provided with the dated receipt below which you should retain as proof of submission.

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Do not open this paper until instructed by the supervisor

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September and December 2015

Paper P2

Corporate Reporting

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ACCA FINAL ASSESSMENT

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© Kaplan Financial Limited, 2015

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The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials. All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

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AC C A P 2 ( IN T/ U K) : C OR POR A TE RE P OR T IN G

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SECTION A This question is compulsory and MUST be answered

Gross profit Distribution costs Administrative expenses

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Operating profit Investment income Finance costs Profit before taxation Taxation Profit for the period

Hardwood $m 166 (84) ––––– 82 (12) (30) ––––– 40 4 (8) ––––– 36 (10) ––––– 26 –––––

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Revenue Cost of sales

Carpet $m 128 (62) ––––– 66 (16) (22) ––––– 28 1 (5) ––––– 24 (6) ––––– 18 –––––

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The following notes are relevant to the preparation of the consolidated financial statements: Tiles purchased 80% of the ordinary shares of Carpet on 1 May 20X3 for $96 million. The fair value of the identifiable net assets acquired was $90 million. At the acquisition date, the share capital and retained earnings of Carpet were $10 million and $57 million respectively and other components of equity were $8 million. The excess of the fair value of the identifiable net assets over their carrying amounts at the acquisition date was due to a broadcasting licence which, at 1 May 20X3, had a remaining useful life of 5 years. Amortisation is presented in administrative expenses. The non-controlling interest in Carpet at the acquisition date was calculated as its proportionate share of the fair value of the subsidiary’s identifiable net assets.

2

Tiles purchased 80% of the ordinary shares in Hardwood four years ago for $130 million. The fair value of Hardwood’s net assets at the acquisition date was $100 million and the non-controlling interest at the acquisition date was measured at its fair value of $23 million. On 1 February 20X5, Tiles sold 70% of the ordinary shares of Hardwood for $170 million. Hardwood’s identifiable net assets were $140 million at the disposal date. Goodwill arising on the acquisition of Hardwood had not been impaired. Tiles’ remaining 10% holding in the shares of Hardwood had a fair value of $11 million on 1 February 20X5 and was designated to be measured at fair value through other comprehensive income. The fair value of the 10% holding at 30 April 20X5 was $11.5 million. In the current year, Tiles has posted no accounting entries in respect of Hardwood in its individual financial statements. Hardwood does not meet the criteria to be presented as a discontinued operation.

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Tiles $m 216 (89) ––––– 127 (15) (18) ––––– 94 3 (10) ––––– 87 (17) ––––– 70 –––––

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Tiles is a public limited company which has investments in a number of other companies. These companies prepare their financial statements in accordance with International Financial Reporting Standards. The draft statements of profit or loss for Tiles and its investments for the year ended 30 April 20X5 are presented below:

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During the year, Tiles sold goods to Carpet for $14 million. All of the goods had been sold to third parties by 30 April 20X5.

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On 1 May 20X4, Tiles purchased an item of property, plant and equipment for $30 million and attributed it a 30 year useful life. The depreciation charge for the year has been accounted for. On 30 April 20X5, a surveyor valued the asset at $32 million. Tiles has not yet accounted for this revaluation or for any deferred tax relating to the asset. The asset’s cost is written down for tax purposes at a rate of 10% per annum. The applicable tax rate is 20%.

6

On 1 March 20X5, Tiles sold goods to a customer located overseas for CU25 million. The sale was correctly recorded by Tiles but no other accounting entries have been posted in respect of this transaction. By 30 April 20X5, the invoice had not been settled. The following exchange rates are relevant:

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On 30 April 20X5, goodwill impairment testing was performed in relation to Carpet. The recoverable amount of the net assets of Carpet was $113 million. On that date, Carpet had share capital of $10 million, retained earnings of $80 million and other components of equity of $9 million. The broadcasting licence (note 1) has not been sold. There have been no prior goodwill impairments.

CU: $1 5.0 4.7

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1 March 20X5 30 April 20X5

Foreign exchange gains and losses are presented in administrative expenses. On 1 May 20X4, Tiles made a loan of $20 million to a key supplier. The loan is due to be repaid at par on 30 April 20X7. Interest is charged in arrears at 2% per annum. Market rates of interest are currently 8%. Tiles recorded a financial asset at $20 million and recognised the interest received during the year in profit or loss. Any adjustments required to profit in respect of this transaction should be presented in investment income.

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Ignore the taxation effects of adjustments unless specified. Assume that any loss allowances required in respect of financial assets have already been correctly accounted for.

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Required:

Prepare the consolidated statement of profit or loss and other comprehensive income for the Tiles Group for the year ended 30 April 20X5. (35 marks)

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(a)

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Saffron, an entity unrelated to the Tiles group, operates in a country whose currency is the Franc (FR). Saffron makes 70% of its sales in Francs and 30% of its sales in dollars ($). Any dollar receipts are immediately converted into Francs. Saffron’s ordinary shares are 90% owned by another entity called Cumin. Cumin’s functional currency is the dollar. Saffron’s line of business is different from the rest of the Cumin group, and it operates with considerable autonomy. Saffron relies on finance in the form of local-currency bank loans, rather than intra-group finance. Required: (b)

Apply the rules in IAS 21 The Effects of Changes in Foreign Exchange Rates to determine the functional currency of Saffron. (9 marks)

(c)

Discuss the importance of ethical behaviour when producing consolidated financial statements. (6 marks) (Total: 50 marks)

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SECTION B TWO questions ONLY to be answered

(a)

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Brick is a company that manufactures and sells mobile phones and mobile phone contracts. It prepares its financial statements under International Financial Reporting Standards and has a year end of 30 April 20X4. Brick launched a promotion during the year to attract new customers to its network. Under this promotion, customers sign a non-cancellable contract to subscribe to the Brick network for twelve months. The cost is $30 per month, payable at the end of each month. This price includes a new handset and network access. The normal retail price of these elements is as follows: Handset Network access (per month)

On 1 May 20X3, Brick bid $100m for a license to use the radio spectrum for the next generation of mobile phone services. These services will be offered to customers from 20X5.

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(b)

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In total, 100,000 new customers signed up for this promotion. The contracts all began on 1 March 20X4. (7 marks)

Brick must pay a fee of 400,000 Dinar (DN) on 31 December 20X4. The directors of Brick have become increasingly concerned about exchange rate fluctuations and therefore, on 1 February 20X4, entered into a futures contract to buy DN400,000 for $200,000 on 31 December 20X4. This contract was designated as a cash flow hedge, all necessary documentation was completed, and all hedge effectiveness criteria were met.

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(c)

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Some investment analysts have argued in the press that Brick may have over-paid for this license. Market research has shown that most customers are extremely satisfied with current network speeds. It is therefore widely believed that this ‘next generation’ of mobile phone services will not gain mainstream popularity until 20X6 at the earliest. Under the terms of purchase, Brick is prohibited from selling the license to other mobile phone operators. (5 marks)

Brick needed to raise finance during the period and therefore entered into a sale and finance leaseback transaction. On 1 May 20X3, it sold property, plant and equipment with a carrying amount of $4.5m to the bank for proceeds of $6 million. This was then leased back on a 15 year term, with payments of $650,000 due annually in arrears. The rate of interest implicit in the lease is 7.1%. (6 marks)

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(d)

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Based on published exchange rates, DN400,000 would cost $228,000 on 30 April 20X4. The fair value of the futures contract at 30 April 20X4 had risen to $30,000. (5 marks)

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Required:

Discuss how the above events should be accounted for in the financial statements of Brick for the year ended 30 April 20X4.

Note: the mark allocation is shown against each of the four events above.

Professional marks will be awarded in question 2 for the clarity and quality of the presentation and discussion. (2 marks) (Total: 25 marks) KA PL AN P U BLI SH IN G

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Golden Gate is a newly formed public limited company involved in property development. Their financial statements are prepared in accordance with International Financial Reporting Standards (IFRS). The following accounting issues have arisen in the year ended 30 June 20X4 and need to be resolved.

(b)

During the year ended 30 June 20X4, a decision was made to relocate Golden Gate’s key business functions in an attempt to reduce operating costs. The decision to relocate was communicated to those affected in June 20X4. Relocation expenses will not be paid until August 20X4 and are estimated at $3m. The directors of Golden Gate do not believe that the cost of $3m should be shown in the financial statements for the year ended 30 June 20X4 because no expenditure has been incurred. (5 marks)

(c)

Golden Gate has a defined contribution pension scheme that all employees are enrolled into. However, in the year ended 30 June 20X4, it set up an additional fund (Fund) as a way of enhancing post-retirement benefits. The terms of the Fund are as follows:

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Golden Gate owns investment properties, which are measured at fair value. The investment properties are held to earn rental income in the long term. Although the sales prices of similar properties are available, the directors believe that a fair value measurement based on their estimates of future rental income would more faithfully represent the value of the properties to Golden Gate. The directors are unsure as to whether this complies with the requirements of IFRS. (5 marks)

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Employees with more than two years’ service will be automatically enrolled into the Fund. Golden Gate’s contributions into the Fund are voluntary. In the year ended 30 April 2015, its contributions were equivalent to 1% of wages and salaries. Whilst the fund is in existence members will, upon retirement, receive an annual lump sum based on their number of years of service. Golden Gate can cancel the Fund at any point. If cancelled, no further benefits or compensation will be paid to members.

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Previously, the national press have been critical of Golden Gate because of its low levels of employee remuneration, which have generally increased below the level of inflation. As a result, some believe that the announcement of the Fund is simply a public relations exercise, and many employees remain sceptical about Golden Gate’s commitment to it. On 1 February 20X4, Golden Gate purchased a property located overseas for CU2m. This property is to be sold in the ordinary course of business. On 30 June 20X4, it had an estimated net sales price of CU2.5m. This valuation was confirmed post year-end. There have been significant fluctuations in the currency markets. The following exchange rates are relevant:

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(d)

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The directors wish to know how they should have accounted for the Fund. (8 marks)

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Date 1 February 20X4 30 June 20X4

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CU:$1 2.1 3.0 (5 marks)

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(a)

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Required: Discuss how the above events should be accounted for in the financial statements of Golden Gate for the year ended 30 June 20X4. Note: the mark allocation is shown against each of the four events above.

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Professional marks will be awarded in question 3 for the clarity and quality of the presentation and discussion. (2 marks) (Total: 25 marks)

(a)

Required:

(ii)

Explain what is meant by ‘equity accounting’.

(4 marks)

(iii)

Outline potential criticisms of equity accounting.

(5 marks)

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Within the context of IAS 28, explain what is meant by ‘significant influence’. Provide examples to illustrate your answer. (5 marks)

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(b)

(i)

On 1 January 20X4, Bolo purchased 45% of the ordinary shares of Kata. Consideration paid was $3 million. The carrying amounts of the net assets of Kata at that date were $2.4 million and approximated their fair values. The statement of financial position for Kata as at 31 December 20X4 was as follows:

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Property, plant & equipment Inventories

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Total assets

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Share capital Retained earnings Loans

Equity and liabilities

$m 14 1 –––– 15 –––– 1 2 12 –––– 15 ––––

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The directors of Bolo are unsure whether to treat Kata as an associate or a subsidiary in the consolidated financial statements. They believe that this decision will have a minimal impact on the consolidated financial statements and is therefore unimportant.

When relevant, Bolo measures non-controlling interests using the proportion of net assets method.

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A revised version of IAS 28 Investments in Associates and Joint Ventures was issued in May 2011. The standard defines an associate as an entity over which an investor has ‘significant influence’. IAS 28 states that associates should be accounted for using the equity method in the consolidated financial statements. However, equity accounting, and its purpose, have been increasingly criticised in recent years.

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Required: Discuss and compare the impact on the consolidated financial statements of Bolo if the investment in Kata is accounted for as:

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• a subsidiary, or • an associate. (9 marks) Professional marks will be awarded in question 4 for the clarity and quality of the presentation and discussion. (2 marks)

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(Total: 25 marks)

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ACCA

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Paper P2 (INT/UK)

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Corporate Reporting

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September and December 2015

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Final Assessment – Answers To gain maximum benefit, do not refer to these answers until you have completed the final assessment questions and submitted them for marking.

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© Kaplan Financial Limited, 2015

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The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, and consequential or otherwise arising in relation to the use of such materials. All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

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1

TILES

Key answer tips

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Consolidated statement of profit or loss and other comprehensive income for the year ended 30 April 20X5

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(a)

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Revenue ($216 + $128 + (9/12 × $166) – $14 (W6)) Cost of sales ($89 + $62 + (9/12 × $84) – $14 (W6)) Gross profit Distribution costs ($15 + $16 + (9/12 × $12)) Administrative expenses (W11)

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Profit from operations Profit on disposal (W5) Investment income ($3 + $1 + (9/12 × $4) – $3.1 (W9) + $1.0 (W9)) Finance costs ($10 + $5 + (9/12 × $8))

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Profit before taxation Taxation ($17 + $6 + (9/12 × $10) + $0.4 (W7)) Profit for the period

$m

Marks

454.5 (200.0) –––––– 254.5 (40.0) (85.2) –––––– 129.3 19.0 4.9

1.0 (W6) 1.0 (W6)

(21.0) –––––– 132.2 (30.9) –––––– 101.3

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Other comprehensive income Items that will not be reclassified to profit or loss in future periods Gain on financial asset (W5) Revaluation of property, plant and equipment (W7) Income tax relating to items that will not be reclassified to profit or loss (W7)

Total comprehensive income for the period

0.5 3.0 (0.6)

3.0 (W11)

4.0 (W5) 2.0

1.0

1.0 1.0 1.0

–––––– 104.2 ––––––

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Part (a) of this question is a group accounting question. Tiles lost control of Hardwood during the year. Hardwood is therefore consolidated until the disposal date and a profit or loss on disposal must be calculated. Part (b) of the question requires knowledge and application of the rules governing functional currency. Remember to start your answer by stating relevant definitions and rules per the accounting standard (IAS 21), and then apply these to the scenario. Part (c) covers ethics, and this is something which should be expected within the compulsory question. Make sure that your answer is specific to the question.

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0.5 (bal.) 2.0 (W10)

97.3 6.9 –––––– 104.2 ––––––

0.5 (bal.)

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Total comprehensive income attributable to: Equity holders of Tiles (bal. fig.) Non-controlling interest (W10)

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Presentation of profit/TCI split (even if left blank) Labelling OCI as items that will not be reclassified to P/L Pro-rating of Hardwood’s results Calculation of excess amortisation (W2) Calculation of group impairment loss (W3) Calculation of Carpet’s goodwill (W4) Calculation of revaluation gain (W7) Calculation of deferred tax (W7) Calculation of forex gain (W8) Calculation of financial asset fair value (W9) Calculation of financial asset impairment (W9) Calculation of financial asset interest adjustment (W9) Maximum marks

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Workings

1.0 1.0 1.0 1.0 4.0 1.0 1.0 2.0 1.0 2.0 1.0 1.0 –––––– 35.0 ––––––

(W1) Group structure

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Tiles

Carpet

80% for 9/12 year Hardwood

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80% for full year

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94.4 6.9 –––––– 101.3 ––––––

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Profit attributable to: Equity holders of Tiles (bal. fig.) Non-controlling interest (W10)

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(W2) Carpet’s net assets

–––– 90 ––––

Rep. date $m 10 9 80 15

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Share capital Other components Retained earnings Licence (bal. fig) Excess amortization (2 years × $3m (see note below))

Acq’n $m 10 8 57 15

(6) –––– 108 ––––

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Rep. date net assets (W2)

Recoverable amount

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Impairment

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Goodwill (W4) Notional NCI ($24m × (20/80))

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(W3) Carpet impairment review

$m 108.0

Marks 2 (W2)

24.0 6.0 –––––– 138.0 (113.0) –––––– 25.0 ––––––

(W4) 1

1 –––––– 3 max ––––––

The impairment loss is allocated to the group based on shareholding. The impairment loss attributable to the group is therefore $20 million ($25m × 80%). (1 mark)

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The goodwill attributable to the NCI is not recognised under the share of net assets method. Therefore the NCI share of the impairment is not recognised.

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(W4) Goodwill of Carpet

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Consideration NCI at acquisition (20% × $90m (W2)) FV of net assets at acquisition (W2)

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Goodwill pre-impairment

$m 96.0 18.0

Marks 0.5 0.5

(90.0) ––––– 24.0 –––––

0.5 ––––– 1 max –––––

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The excess amortisation on the licence is $3m per year ($15m/5 years). This is recorded in administrative expenses (W11). (1 mark)

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(W5) Profit on disposal Proceeds from disposal Fair value of interest retained

$m 170 11 ––––

$m

Marks 0.5 0.5

Goodwill disposed: Consideration NCI at acquisition Net assets at acquisition

130 23 (100) –––––

0.5 0.5 0.5

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(53)

(140)

NCI at disposal: NCI at acquisition NCI % of post-acquisition net assets (20% × ($140 – $100))

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Net assets at disposal:

0.5 0.5 0.5

23 8

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––––

Profit on disposal

31 –––– 19 ––––

–––––– 4 max ––––––

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The interest retained is initially recognised at $11 million and must be revalued to its fair value of $11.5 million at the reporting date. Since the shares have been designated to be measured at fair value through other comprehensive income, a gain of $0.5 million ($11.5m – $11.0m) will be recorded in other comprehensive income.

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(W6) Intra-group trading

The intragroup trading of $14 million must be removed from revenue and cost of sales. $14m

Cr Cost of sales

$14m

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Dr Revenue

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(W7) Revaluation

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Before the revaluation, the asset had a carrying amount of $29m (29/30 × $30m). The revaluation gain that needs to be recorded in other comprehensive income is therefore $3m ($32m – $29m).

Dr PPE

$3m

Cr OCI

$3m

(1 mark for calc. of reval. gain)

The deferred tax balance is calculated based on the difference between the asset’s carrying amount of $32m and its tax base of $27m ($30m × 90%). As such, the deferred tax liability required is $1m (($32m – $27m) × 20%). (1 mark for deferred tax liability)

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Goodwill at disposal

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The deferred tax relating to the $3m revaluation gain is recorded in OCI. The remainder of the deferred tax is recorded in profit or loss. Dr OCI ($3m × 20%)

$0.6m

Dr Tax expense in P/L

$0.4m (1 mark for profit/OCI split)

Cr Deferred tax liability $1.0m

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(W8) Foreign exchange

The transaction would initially be recorded at the historic rate of exchange. This means that revenue and a corresponding receivable would have been recorded at $5m (CU25m/5). The receivable is a monetary asset and so is retranslated at the reporting date using the closing rate of exchange. This gives a year end receivable of $5.3m (CU25/4.7).

Cr Profit or loss

$0.3m

(W9) Financial asset

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$0.3m

(1 mark for calc. of forex gain)

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Dr Receivables

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The loan to the supplier is a financial asset and so should initially be recorded at its fair value. However, the interest rate on the loan is not at a market rate. Therefore, the fair value must be calculated by discounting the future cash receipts to present value using the market rate of interest.

as

30/4/X5 30/4/X6 30/4/X7

Cash flow $m 0.4 0.4 20.4 –––––

Disc. rate

Present value Marks $m 1/1.08 0.37 1/1.082 0.34 1/1.083 16.19 ––––– Fair value 16.9 2 ––––– (1 mark for cash flows, 1 mark for discount rates)

tud

Date

cc

The asset should have been written down on initial recognition from $20 million to $16.9 million, giving a loss of $3.1 million in profit or loss. Dr Profit or loss

$3.1m

Cr Financial asset

$3.1m

(1 mark for calc. of impairment loss)

fre

ea

Investment income should be recognised using the effective rate of interest of 8%. Therefore the investment income that should have been recorded is $1.4 million ($16.9m × 8%). Currently, Tiles has only $0.4 million ($20m × 2%), meaning that investment income must be increased by $1.0 million. Dr Financial asset

$1.0m

Cr Profit or loss

$1.0m

(1 mark for calc. of interest adjustment)

KA PL AN P U BLI SH IN G

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The foreign exchange gain of $0.3m ($5.3m – $5.0m) is recorded in the statement of profit or loss.

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(W10) Profit attributable to the non-controlling interest Marks

× 20%

$m 0.5 0.5 ––––– 1 max –––––

.co m

$m 18.0 (3.0) ––––– 15.0

Profit of Carpet Excess amortisation (W2)

––––– 3.0 –––––

Profit attributable to NCI

Marks

ter

× 20%

ial

––––– 19.5

$m

––––– 3.9 –––––

Profit attributable to NCI

0.5

0.5 ––––– 1 max –––––

(W11) Administrative expenses

ym a

The total profit attributable to the NCI is $6.9 million ($3.0m + $3.9m).

1.0 1.0 1.0

The functional currency is the currency of the primary economic environment where an entity operates. (1 mark)

cc

(b)

as

tud

Tiles Carpet Hardwood (9/12 × $30) Excess amortisation (W2) Goodwill impairment (W3) Foreign exchange (W8)

Marks

$m 18.0 22.0 22.5 3.0 20.0 (0.3) ––––– 85.2 –––––

An entity should consider the following when determining its functional currency: • •

the currency that mainly influences sales prices for goods and services

ea

•

the currency of the country whose competitive forces and regulations mainly determine the sales price of goods and services

fre

the currency that mainly influences labour, materials and other costs of providing goods and services. (Primary indicators: 2 marks max) The following factors should also be considered:

8

•

the currency in which funds from financing activities are generated

•

the currency in which receipts from operating activities are retained. (Secondary indicators: 2 marks max) K APL AN P UB LI SHIN G

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$m 19.5

Profit of Hardwood (9/12 × $26m)

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When determining the functional currency of a foreign subsidiary, the following should be considered to determine if its functional currency is the same as its parent: whether the activities of the foreign operation are carried out as an extension of the reporting entity, rather than being carried out with a significant degree of autonomy

•

whether transactions with the reporting entity are a high or a low proportion of the foreign operation’s activities.

.co m

•

(Group indicators: 2 marks max) (IAS 21 knowledge: 5 marks max) Saffron makes most of its sales in Francs, suggesting that Francs are the functional currency. (1 mark)

ial

ter

Saffron takes out finance in its local currency, suggesting that Francs are the functional currency. (1 mark) Saffron is relatively autonomous from the rest of the Cumin group, suggesting that its functional currency is not the dollar. (1 mark)

(IAS 21 application: 4 marks max) (Part b: 9 marks max)

Financial statements are important to a range of user groups, such as shareholders, banks, employees and suppliers. These groups rely on the directors to faithfully represent the performance and position of the company. (1 mark)

tud

(c)

ym a

All things considered, it would seem that the functionary currency of Saffron is the Franc. (1 mark)

A faithful representation is often presumed to have been provided if accounting standards have been complied with. Therefore, it is essential that the directors adhere to the requirements of IFRS 3 and IFRS 10. (1 mark)

cc

Whether a relationship of control or significant influence exists. Identifying the acquiring company. Identifying the acquisition date. Establishing the fair value of the consideration paid for a subsidiary. Establishing the fair value of the identifiable net assets a subsidiary. Establishing the fair value of the NCI at acquisition.

ea

• • • • • •

as

The production of consolidated financial statements requires judgement in a number of areas, such as:

fre

(1 mark per example of judgement: 2 marks max) These decisions will impact on the users’ perception of the performance and position of the group: If an investee has significant debt then management may have a motivation to exclude it from consolidation by arguing that no control is exercised. The financial position of the group will therefore look stronger due to the absence of this debt.

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Any operating receipts in dollars are immediately converted to Francs, suggesting that Francs are the functional currency. (1 mark)

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By under-stating the fair value of contingent payments required to acquire a subsidiary, liabilities and goodwill in the consolidated statements will be understated. This would improve gearing and would also improve asset turnover ratios. (1 mark per reasonable example of F/S impact of judgement: 2 marks max)

.co m

Professional ethics is a vital part of the accountancy profession and ACCA members are bound by its Code of Ethics and Conduct. This sets out the importance of the fundamental principles of confidentiality, objectivity, professional behaviour, integrity, and professional competence and due care. (1 mark) Integrity is defined as being honest and straight-forward. Attempting to disguise control relationships or to account using incorrect fair values shows a lack of integrity. (1 mark)

ial

(a) (b) (c)

Group statement P or L and OCI Functional currency Ethical issues

Marks 35 9 6 ––– 50 –––

fre

ea

cc

as

tud

Total

ym a

Marking scheme

ter

(Part c: 6 marks max)

10

K APL AN P UB LI SHIN G

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If such a decision has been motivated by a desire to achieve bonus targets, satisfy the goals of shareholders or to meet bank covenants, then this demonstrates a lack of objectivity. (1 mark)

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2

BRICK

Key answer tips

.co m

This question covers a number of standards that have proved popular with the P2 examiner. A thorough understanding of these topics is therefore essential. Part (a) tests revenue recognition. Ensure that you get the easy marks available for stating the relevant rules from IFRS 15 Revenue from Contracts with Customers before trying to apply them to the scenario.

ial

ter

Part (c) tests cash flow hedge accounting. The accounting treatment of a hedge is actually relatively simple, but many students are confused by the terminology in the questions. Make sure that you read the question very carefully.

(a)

ym a

Part (d) covers the accounting treatment of a sale and finance leaseback. The key rule to remember is that any profit made on the sale itself is deferred and released to profit or loss over the lease term. IFRS 15 says that the separate performance obligations within a contract must be identified. (1 mark) The contract price should be allocated to the separate performance obligations based on stand-alone selling prices. (1 mark)

tud

Revenue should be recognised when (or as) a performance obligation is satisfied. (1 mark)

as

The handset and the other services have been sold together at a discount to the normal individual retail price. Revenue could therefore be allocated based on the stand-alone selling price of each component. (1 mark) (Knowledge of IFRS 15: 3 marks max)

cc

The total contact price is $360 ($30 × 12 months). The total recommended retail price of the individual elements is $430 ($250 + ($15 × 12 months)). The contract therefore means that customers pay 83.7% of the normal recommended retail price. (1 mark)

ea

The revenue related to the sale of the handsets is $20.9m ($250 × 83.7% × 100,000) and this should be recognised on 1 March 20X4 when control of the good passes. (1 mark)

fre

Revenue from the network access should be recognised over time because the service is simultaneously received and consumed by the customer. (1 mark)

The revenue relating to the network access is $15.1m ($15 × 12 months × 83.7% × 100,000). Two months’ worth of service have been provided to the customers, so only $2.5m ($15.1m × 2/12) should be recognised as revenue in the year ended 30 April 20X4. (1 mark)

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Part (b) requires knowledge of both IAS 38 Intangible Assets and IAS 36 Impairment of Assets. In the exam, watch out for assets that were over-paid for or which are not performing as well as expected – they require an impairment review.

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Brick has received $6m ($30 × 2 months × 100,000) but has recognised revenue of $23.4m ($20.9m + $2.5m). Therefore the difference of $17.4m ($23.4m – $6m) should be recognised as a receivable on the statement of financial position. (1 mark) (Application of IFRS 15: 4 marks max) (Part a: 7 marks max) Purchased intangible assets are initially recognised at cost. Therefore, the license should be recognised at $100m. (1 mark)

.co m

(b)

Intangible assets should be amortised over their useful economic life when the asset is ready for use. Therefore, no amortisation will be charged until 20X5. (1 mark) (Basic IAS 38 knowledge: 1 mark max)

ial

All assets with indications of impairment should be tested for impairment.

(1 mark)

ter

An impairment review involves comparing the asset’s carrying value to its recoverable amount. The recoverable amount is the higher of the fair value less costs to sell and the value in use. (1 mark)

ym a

The value in use will be determined by estimating the future cash flows that will be derived from the asset and discounting them to present value. (1 mark) The discount rate used should be a pre-tax rate that reflects market assessments of the time value of money and the risks specific to the asset. (1 mark) Any impairment loss would be recognised in the statement of profit or loss. (1 mark) (Knowledge of IAS 36: 1 mark max)

tud

The press reports would suggest that Brick has overpaid for the license and therefore that the carrying amount is too high. (1 mark) The licence cannot be sold. This means that its fair value less costs to sell is $nil. (1 mark)

as

Since a license does not generate cash inflows and outflows by itself, it may have to be tested for impairment as part of a larger cash generating unit (CGU). (1 mark) If this was the case, any impairment would firstly be set off against goodwill within the CGU and then allocated to the other assets on a pro-rata basis. (1 mark)

(Application of IAS 36: 3 marks max) (Part b: 5 marks max)

A cash flow hedge is the hedge of the exposure to variability in cash flows that are attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction and that could affect profit or loss. (1 mark)

fre

(c)

ea

cc

The fact that significant cash inflows are not expected until 20X6 will mean that impairment is more likely. This is because cash flows arising further in the future will be discounted more heavily, thus reducing the value-in-use. (1 mark)

If a cash flow hedge meets all required conditions then the portion of the gain or loss on the instrument that is determined to be an effective hedge shall be recognised in other comprehensive income and the ineffective portion should be recognised in profit or loss. (1 mark) (Knowledge of IFRS 9: 2 marks max)

12

K APL AN P UB LI SHIN G

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Intangible assets that are not yet ready for use are tested for impairment annually. (1 mark)

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Assuming that there is no purchase price, there will be no accounting entries when the futures contract is entered into. (1 mark)

.co m

At 30 April 20X4, Brick is expecting to have to pay $28,000 more ($228,000 – $200,000) to acquire DN 400,000 than they were at the inception of the hedge (1 February 20X4). The fair value of the hedging instrument has, however, increased by $28,000 over the same period. (1 mark) At 30 April 20X4, the futures contract will be recognised as a financial asset at its fair value of $30,000. A gain of $28,000 will be recognised in other comprehensive income and the remaining gain of $2,000 will be recorded in profit or loss. (1 mark) (Application of IFRS 9: 3 max)

ial

(d)

Under a sale and finance leaseback, any profit on disposal should be deferred and recognised over the lease term. (1 mark)

ter

(IAS 17 knowledge: 1 mark)

ym a

The gain on disposal of $1.5m ($6m – $4.5m) is deferred and released to profit or loss over the lease term. Therefore, $0.1m ($1.5m/15 years) will be released to profit or loss in the current period, leaving deferred profit on the statement of financial position of $1.4m ($1.5m – $0.1m). (1 mark) An asset and corresponding finance lease liability should be recognised at the fair value of $6 million. (1 mark)

tud

The depreciation expense recognised in the statement of profit or loss will be $0.4m ($6m/15 years) and the asset will be held on the statement of financial position at a carrying value of $5.6m ($6m – $0.4m). (1 mark) The lease liability will be increased by the rate of interest implicit in the lease. This will give rise to a finance cost of $0.426m ($6m × 7.1%) in the statement of profit or loss. (1 mark)

(IAS 17 application: 5 marks) (Part d: 6 marks max)

ACCA Marking scheme

Revenue Intangibles and impairment Cash flow hedge Sale and leaseback Professional marks

fre

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

ea

cc

as

The liability will be reduced by the cash repayment of $0.65m. The liability will therefore be held on the statement of financial position at $5.776m ($6m + $0.426m – $0.65m). (1 mark)

Total

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Marks 7 5 5 6 2 ––– 25 –––

13

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(Part c: 5 marks max)

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3

GOLDEN GATE

Key answer tips

.co m

In Section B questions, make sure that you demonstrate your knowledge of the relevant rules from the accounting standards before applying them to the scenario. For instance, there are easy marks to obtain for stating how a fair value should be measured (part a) and when a provision should be recognised (part b). Remember to attempt all parts of the question. If you miss out a part then you will lose professional marks.

ial

IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (1 mark)

ym a

ter

When determining a fair value, the standard emphasises the use of level one inputs wherever possible. These are unadjusted quoted prices on an active market. This means that there must be a market which is trading with sufficient frequency and volume for identical assets or liabilities to achieve a reliable estimate of fair value. (1 mark) Level 2 inputs are inputs other than quoted prices in level one which are observable for the asset or liability to be measured. (1 mark)

tud

Level 3 inputs are unobservable inputs. These should be kept to a minimum and used only when insufficient data can be obtained from level 1 and 2 inputs. (1 mark) (IFRS 13 knowledge: 3 marks max)

Forecasts of future rental income are a level 3 input and must not be used to determine a fair value if level 1 or 2 inputs can be obtained. (1 mark)

as

Golden Gate has access to selling price for similar properties. Although adjustments would be required for differences such as size, location and age to determine the fair value of their properties, this is likely to constitute a level 2 input. (1 mark)

(IFRS 13 application: 2 marks max) (Part (a): 5 marks max)

To recognise a provision as per IAS 37, the following criteria must be satisfied: There must be a present obligation from a past event There must be a probable outflow of economic benefit The costs to settle the obligation must be capable of being estimated reliably.

fre

• • •

ea

(b)

cc

As such, the sales price of similar properties should be used to determine the fair value of the investment properties. (1 mark)

(2 marks if given in full)

To recognise a restructuring provision, a constructive obligation must exist at the reporting date. (1 mark)

A restructuring provision should not include costs associated with the ongoing activities of the business. (1 mark) (Knowledge of IAS 37: 3 marks max) 14

K APL AN P UB LI SHIN G

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(a)

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A constructive obligation does exist at the reporting date because the restructuring has been communicated to those affected. (1 mark) However, relocation costs relate to the future conduct of the business and therefore no provision is required. (1 mark)

.co m

The directors are correct in their assertion that no provision is allowed (although their reasoning is incorrect). (1 mark) (Application of IAS 37: 2 marks max) (Part b: 5 marks max)

ter

A constructive obligation is where past practice or published policies have created a valid expectation that the entity will discharge certain responsibilities. (1 mark) Under defined contribution plans, actuarial risk (that benefits will be less than expected) falls, in substance, on employees. (1 mark)

ym a

Under defined contribution plans, investment risk (that assets invested will be insufficient to meet expected benefits) falls, in substance, on employees. (1 mark) Defined benefit plans are post-employment plans that are not defined contribution plans. (1 mark) (IAS 19 knowledge: 3 marks max)

tud

It is possible that the money in the Fund will not be sufficient to pay employees the retirement benefits stated in the plan. (1 mark) Therefore it could be argued that Golden Gate does bear some actuarial and investment risk because, if it continues with the Fund, it would need to make up for this shortfall. (1 mark)

as

However, of greater importance is the fact that Golden Gate has no obligation to pay benefits to Fund members. (1 mark)

cc

The scheme can be cancelled at any point and therefore no legal obligation exists. (1 mark)

ea

It would also seem to be no constructive obligation to pay benefits because the Fund is new and therefore there is no past practice of paying benefits to retired members. (1 mark)

fre

Moreover, Golden Gate has historically paid low levels remuneration to employees. The employees are therefore unlikely to have a valid expectation that Golden Gate would continue with the Fund, particularly if its cost is higher than expected. (1 mark) As a result of Golden Gate’s lack of a legal or constructive obligation to pay further contributions if the level of assets is insufficient, the Fund should be accounted for as a defined contribution scheme. (1 mark) This means that the contributions payable in the period should be recognised as an expense in profit or loss. (1 mark)

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Defined contribution plans are post-employment benefit plans under which an entity pays fixed contributions into a separate entity and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods. (1 mark)

ial

(c)

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Tutorial note

.co m

You may have concluded that the Fund should be treated as a defined benefit pension plan. You would still score 1 mark per point, as long as your argument is clear and you have applied IAS 19 to the scenario. (IAS 19 application: 5 marks max) (Part b total: 8 marks)

(d)

(1 mark)

Items to be sold in the ordinary course of business are inventory.

ial

Per IAS 21, a foreign currency transaction should be initially recorded by applying the spot rate on the date of the transaction. (1 mark) (1 mark)

ter

As a non-monetary asset, the cost of the inventory is not re-translated.

Per IAS 21, NRV should be translated at the exchange rate ruling on the date when it was determined. (1 mark)

ym a

(Knowledge of IAS 2 and IAS 21: 2 marks max)

The inventory should initially be recorded at $0.95m (CU2m/2.1).

(1 mark)

The NRV of the inventory is $0.83m (CU2.5m/3.0).

(1 mark)

tud

The inventory must therefore be written down from its cost of $0.95m to its NRV of $0.83m. This will give rise to an expense of $0.12m ($0.95m – $0.83m) in the statement of profit or loss. (1 mark) (Application of IAS 2 and IAS 21: 3 marks max) (Part d: 5 marks max)

fre

ea

Total

Marks 5 5 8 5 2 ––– 25 –––

Fair values Provisions Pensions Inventory and exchange rates Professional marks

cc

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

as

ACCA Marking scheme

16

K APL AN P UB LI SHIN G

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Inventory is initially recorded at cost. At the reporting date, inventory must be valued at the lower of cost and net realisable value (NRV). (1 mark)

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4

EQUITY ACCOUNTING

Key answer tips

.co m

Question 4 is always an essay-style question requirement, which can include a small computational or applied element. It may focus upon current issues in financial reporting, or upon a theoretical or conceptual issue. Equity accounting is an issue that has been the focus of recent articles in Accounting and Business magazine. It is therefore a current issue that the examiner may expect you to be familiar with. Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies. (1 mark)

ial

(i)

ter

Significant influence is assumed when the investor holds at least 20 per cent of the voting power of the investee, unless it can be clearly demonstrated that this is not the case. (1 mark)

ym a

It is assumed that an investor does not have significant influence over an investee if they hold less than twenty per cent of the voting power, unless it can be demonstrated that this is not the case. (1 mark) A majority ownership by another company does not preclude the investor from having significant influence. (1 mark) Significant influence is usually evidenced in one of the following ways:

tud

(1 mark each) (Part a (i): 5 marks max)

Under the equity method, the investment is initially recognised at cost. (1 mark)

cc

(ii)

Representation on the board of directors Participation in policy making processes Material transactions between the entity and its investee Interchange of management personnel Provision of essential technical information.

as

• • • • •

ea

The carrying amount of the investment is adjusted to recognise the investor’s share of the profit (or loss) and other comprehensive income of the investee after the date of acquisition. (1 mark)

fre

Distributions received from an investee reduce the carrying amount of the investment. (1 mark) The investor’s share of the profit (or loss) and other comprehensive income of the investee in the reporting period is recognised in the statement of profit or loss and other comprehensive income. (1 mark)

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(a)

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Transactions and balances (such as sales and purchases, and receivables and payables) between the group and an associate are no eliminated. (1 mark) However, the investor can only recognise gains from transactions with the investee to the extent of the unrelated investors’ interests in the investee (i.e. the investor’s share of the gains must not be recognised). (1 mark) (iii)

.co m

(Part a (ii): 4 marks max) Purpose and nature

There is confusion about the purpose of equity accounting. For instance, is it a type of one-line consolidation or a way of valuing a financial instrument? (1 mark) This leads to diversity in how equity accounting is applied.

(1 mark)

ial

ter

Cost

IAS 28 does not specify how to calculate the cost of an associate.

(1 mark)

Other net asset changes

ym a

Transactions costs are often added onto the carrying amount of financial instruments, but they are expensed when purchasing a subsidiary. Therefore, the treatment adopted by different companies may be inconsistent. (1 mark) IAS 28 does not specify how to treat changes in the net assets of an associate, other than those recorded in profit or loss or other comprehensive income. (1 mark)

tud

Examples of these net asset changes include: • •

as

Issues of share capital to parties other than the investor Buybacks of equity instruments from shareholders other than the investor • Equity-settled share-based payments. (1 mark each) Elimination

cc

There is no specific guidance on how the investor’s share of gains from transactions with the investee should be eliminated. (1 mark)

ea

It could be argued that it is contradictory to eliminate the group’s share of unrealised profits from transactions with an associate, but that there is no elimination of sales and purchases. (1 mark)

Judgement

fre

Distinguishing between significant influence and control is judgemental and in some cases can be difficult. However, this decision can have a hugely material impact on the financial statements. (1 mark)

18

(Part a (iii): 5 marks max)

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Proposed amendments to IAS 28 have been criticised as short-term measures that do not address the need to establish a clear conceptual basis for equity accounting. (1 mark)

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(b)

Subsidiary If accounted for as a subsidiary:

• • •

The assets, liabilities, incomes and expenses of Kata would be consolidated in full. Goodwill of $1.92 million (W1) would be recognised. The group would recognise its share of Kata’s post-acquisition retained earnings. This amounts to $0.27 million (45% × ($2m – ($2.4m – $1.0m)). The group would recognise a non-controlling interest in respect of Kata of $1.65 million (W2).

.co m

•

(1 mark per point)

(Subsidiary: 3 marks max)

ial

The investment in Kata at the year-end would be carried at $3.27 million (W3). (1 mark)

ter

In the statement of profit or loss, the group would show its share of Kata’s profit of $0.27 million (W3). (1 mark) Comparison of impact Assets

ym a

(Associate: 1 marks max)

Consolidating Kata would lead to a higher non-current asset position than if equity accounting was used (PPE of $14 million and goodwill of $1.92 million compared with an investment in the associate of $3.27 million). (1 mark)

tud

This will make the group look more asset rich, which may help it to raise finance in the future. (1 mark)

Liabilities

as

However, consolidating Kata’s large PPE balance may have a detrimental impact on the group’s non-current asset turnover, thus making the group look less efficient at generating profits. (1 mark)

cc

Consolidating the loans of Kata may have a negative impact on the group’s gearing ratio. (1 mark) This may have the effect of making the group look riskier than if equity accounting was used. (1 mark)

ea

A higher gearing ratio may make it harder for the group to raise finance in the future. (1 mark)

Profit or loss

fre

Consolidating the incomes and expenses of Kata line by line will impact key profit or loss figures, such as revenue, gross profit and profit from operations. (1 mark)

Increased revenues will make the group’s market share look more impressive. (1 mark)

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Associate

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Kata is profitable so consolidating its results will improve the group’s profit from operations. This may have a positive impact on investor perception. (1 mark) If Kata was accounted for using the equity method, the group would simply shows its share of Kata’s profits as a single line below profit from operations. This would therefore have no impact (positive or negative) on the group’s operating profit.

.co m

(1 mark)

(Impact: 5 marks max)

Workings (W1) Goodwill

(W2) Non-controlling interest

tud

(W3) Investment in associate

ial

ym a

NCI at acquisition NCI % of post-acq’n net assets 55% × ($3m – $2.4m)

ter

Goodwill

cc

as

Cost Group % of post-acq’n P/L 45% × ($2m – ($2.4m – $1.0m))

$m 1.32 0.33 ––––– 1.65 ––––– $m 3.0 0.27 ––––– 3.27 –––––

fre

ea

Note: the same answer could be obtained by taking the group’s share of the post-acquisition movement in the associate’s net assets (equivalent to the movement in its share capital and retained earnings).

(a)

(b)

Total

20

(Part b: 9 marks max) Marking scheme

(i) Significant influence (ii) Equity accounting (iii) Criticisms Impact on F/S Professional marks

Marks 5 4 5 9 2 ––– 25 –––

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Consideration NCI at acquisition (55% × $2.4m) Fair value of net assets at acquisition

$m 3.0 1.32 (2.40) ––––– 1.92 –––––

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