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Fundamentals Level โ Skills Module
The Association of Chartered Certified Accountants
Financial Reporting
(International)
Tuesday 14 December 2010
Time allowed Reading and planning: 15 minutes Writing: 3 hours
ALL FIVE questions are compulsory and MUST be attempted.
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor.
This question paper must not be removed from the examination hall.
Paper F7 (INT)
ALL FIVE questions are compulsory and MUST be attempted
1 On 1 June 2010, Premier acquired 80% of the equity share capital of Sanford. The consideration consisted of two elements: a share exchange of three shares in Premier for every fi ve acquired shares in Sanford and the issue of a $100 6% loan note for every 500 shares acquired in Sanford. The share issue has not yet been recorded by Premier, but the issue of the loan notes has been recorded. At the date of acquisition shares in Premier had a market value of $5 each and the shares of Sanford had a stock market price of $3ยท50 each. Below are the summarised draft fi nancial statements of both companies. Statements of comprehensive income for the year ended 30 September 2010 Premier Sanford $โ000 $โ Revenue 92,500 45, Cost of sales (70,500) (36,000) โโโโโโโ โโโโโโโ Gross profi t 22,000 9, Distribution costs (2,500) (1,200) Administrative expenses (5,500) (2,400) Finance costs (100) nil โโโโโโโ โโโโโโโ Profi t before tax 13,900 5, Income tax expense (3,900) (1,500) โโโโโโโ โโโโโโโ Profi t for the year 10,000 3, Other comprehensive income: Gain on revaluation of land (note (i)) 500 nil โโโโโโโ โโโโโโโ Total comprehensive income 10,500 3, โโโโโโโ โโโโโโโ Statements of financial position as at 30 September 2010 Assets Non-current assets Property, plant and equipment 25,500 13, Investments 1,800 nil โโโโโโโ โโโโโโโ 27,300 13, Current assets 12,500 2, โโโโโโโ โโโโโโโ Total assets 39,800 16, โโโโโโโ โโโโโโโ Equity and liabilities Equity Equity shares of $1 each 12,000 5, Land revaluation reserve โ 30 September 2010 (note (i)) 2,000 nil Other equity reserve โ 30 September 2009 (note (iv)) 500 nil Retained earnings 12,300 4, โโโโโโโ โโโโโโโ 26,800 9, Non-current liabilities 6% loan notes 3,000 nil Current liabilities 10,000 6, โโโโโโโ โโโโโโโ Total equity and liabilities 39,800 16, โโโโโโโ โโโโโโโ The following information is relevant: (i) At the date of acquisition, the fair values of Sanfordโs assets were equal to their carrying amounts with the exception of its property. This had a fair value of $1ยท2 million below its carrying amount. This would lead to a reduction of the depreciation charge (in cost of sales) of $50,000 in the post-acquisition period. Sanford has not incorporated this value change into its entity fi nancial statements.
2 The following trial balance relates to Cavern as at 30 September 2010:
$โ000 $โ Equity shares of 20 cents each (note (i)) 50, 8% loan note (note (ii)) 30, Retained earnings โ 30 September 2009 12, Other equity reserve 3, Revaluation reserve 7, Share premium 11, Land and buildings at valuation โ 30 September 2009: Land ($7 million) and building ($36 million) (note (iii)) 43, Plant and equipment at cost (note (iii)) 67, Accumulated depreciation plant and equipment โ 30 September 2009 13, Available-for-sale investments (note (iv)) 15, Inventory at 30 September 2010 19, Trade receivables 29, Bank 4, Deferred tax (note (v)) 4, Trade payables 21, Revenue 182, Cost of sales 128, Administrative expenses (note (i)) 25, Distribution costs 8, Loan note interest paid 2, Bank interest 300 Investment income 700 Current tax (note (v)) 900 โโโโโโโโ โโโโโโโโ 340,600 340, โโโโโโโโ โโโโโโโโ The following notes are relevant: (i) Cavern has accounted for a fully subscribed rights issue of equity shares made on 1 April 2010 of one new share for every four in issue at 42 cents each. The company paid ordinary dividends of 3 cents per share on 30 November 2009 and 5 cents per share on 31 May 2010. The dividend payments are included in administrative expenses in the trial balance. (ii) The 8% loan note was issued on 1 October 2008 at its nominal (face) value of $30 million. The loan note will be redeemed on 30 September 2012 at a premium which gives the loan note an effective fi nance cost of 10% per annum. (iii) Non-current assets: Cavern revalues its land and building at the end of each accounting year. At 30 September 2010 the relevant value to be incorporated into the fi nancial statements is $41ยท8 million. The buildingโs remaining life at the beginning of the current year (1 October 2009) was 18 years. Cavern does not make an annual transfer from the revaluation reserve to retained earnings in respect of the realisation of the revaluation surplus. Ignore deferred tax on the revaluation surplus. Plant and equipment includes an item of plant bought for $10 million on 1 October 2009 that will have a 10-year life (using straight-line depreciation with no residual value). Production using this plant involves toxic chemicals which will cause decontamination costs to be incurred at the end of its life. The present value of these costs using a discount rate of 10% at 1 October 2009 was $4 million. Cavern has not provided any amount for this future decontamination cost. All other plant and equipment is depreciated at 12ยท5% per annum using the reducing balance method. No depreciation has yet been charged on any non-current asset for the year ended 30 September 2010. All depreciation is charged to cost of sales. (iv) The available-for-sale investments held at 30 September 2010 had a fair value of $13ยท5 million. There were no acquisitions or disposals of these investments during the year ended 30 September 2010.
5 [P.T.O.
(v) A provision for income tax for the year ended 30 September 2010 of $5ยท6 million is required. The balance on current tax represents the under/over provision of the tax liability for the year ended 30 September 2009. At 30 September 2010 the tax base of Cavernโs net assets was $15 million less than their carrying amounts. The movement on deferred tax should be taken to the income statement. The income tax rate of Cavern is 25%.
Required:
(a) Prepare the statement of comprehensive income for Cavern for the year ended 30 September 2010.
(b) Prepare the statement of changes in equity for Cavern for the year ended 30 September 2010.
(c) Prepare the statement of financial position of Cavern as at 30 September 2010.
Notes to the financial statements are not required.
The following mark allocation is provided as guidance for this question:
(a) 11 marks (b) 5 marks (c) 9 marks
(25 marks)
7 [P.T.O.
The following information has been obtained from the Chairmanโs Statement and the notes to the fi nancial statements:
โMarket conditions during the year ended 30 September 2010 proved very challenging due largely to diffi culties in the global economy as a result of a sharp recession which has led to steep falls in share prices and property values. Hardy has not been immune from these effects and our properties have suffered impairment losses of $6 million in the year.โ
The excess of these losses over previous surpluses has led to a charge to cost of sales of $1ยท5 million in addition to the normal depreciation charge.
โOur portfolio of investments at fair value through profi t or loss has been โmarked to marketโ (fair valued) resulting in a loss of $1ยท6 million (included in administrative expenses).โ
There were no additions to or disposals of non-current assets during the year.
โIn response to the downturn the company has unfortunately had to make a number of employees redundant incurring severance costs of $1ยท3million (included in cost of sales) and undertaken cost savings in advertising and other administrative expenses.โ
โThe diffi culty in the credit markets has meant that the fi nance cost of our variable rate bank loan has increased from 4ยท5% to 8%. In order to help cash fl ows, the company made a rights issue during the year and reduced the dividend per share by 50%.โ
โDespite the above events and associated costs, the Board believes the companyโs underlying performance has been quite resilient in these diffi cult times.โ
Required:
Analyse and discuss the financial performance and position of Hardy as portrayed by the above financial statements and the additional information provided.
Your analysis should be supported by profitability, liquidity and gearing and other appropriate ratios (up to 10 marks available).
(25 marks)
4 (a) IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors contains guidance on the use of accounting policies and accounting estimates.
Required: Explain the basis on which the management of an entity must select its accounting policies and distinguish, with an example, between changes in accounting policies and changes in accounting estimates. (5 marks)
(b) The directors of Tunshill are disappointed by the draft profi t for the year ended 30 September 2010. The companyโs assistant accountant has suggested two areas where she believes the reported profi t may be improved: (i) A major item of plant that cost $20 million to purchase and install on 1 October 2007 is being depreciated on a straight-line basis over a fi ve-year period (assuming no residual value). The plant is wearing well and at the beginning of the current year (1 October 2009) the production manager believed that the plant was likely to last eight years in total (i.e. from the date of its purchase). The assistant accountant has calculated that, based on an eight-year life (and no residual value) the accumulated depreciation of the plant at 30 September 2010 would be $7ยท5 million ($20 million/8 years x 3). In the fi nancial statements for the year ended 30 September 2009, the accumulated depreciation was $8 million ($20 million/5 years x 2). Therefore, by adopting an eight-year life, Tunshill can avoid a depreciation charge in the current year and instead credit $0ยท5 million ($8 million โ $7ยท5 million) to the income statement in the current year to improve the reported profi t. (5 marks) (ii) Most of Tunshillโs competitors value their inventory using the average cost (AVCO) basis, whereas Tunshill uses the fi rst in fi rst out (FIFO) basis. The value of Tunshillโs inventory at 30 September 2010 (on the FIFO basis) is $20 million, however on the AVCO basis it would be valued at $18 million. By adopting the same method (AVCO) as its competitors, the assistant accountant says the company would improve its profi t for the year ended 30 September 2010 by $2 million. Tunshillโs inventory at 30 September 2009 was reported as $15 million, however on the AVCO basis it would have been reported as $13ยท4 million. (5 marks)
Required: Comment on the acceptability of the assistant accountantโs suggestions and quantify how they would affect the fi nancial statements if they were implemented under IFRS. Ignore taxation. Note: the mark allocation is shown against each of the two items above.
(15 marks)
