SECTION A – CASE QUESTIONS (Total: 50 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation
and appropriate presentation of the answers.

CASE

Assume that you are Mr. David Li, the accounting manager of City Limited (“City”). City is a
company incorporated and listed in Hong Kong and is principally engaged in the
manufacturing of electronic products. The draft consolidated financial statements for the
year ended 31 March 2008 are shown as follows:

Consolidated Statement of Comprehensive Income for the year ended 31 March 2008
NOTES HK$’000
Revenue 2,348,314
Cost of sales (2,044,510)
Gross profit 303,804
Interest income 5,306
Selling and distribution costs (44,868)
Administrative expenses (136,085)
Loss on disposal of an associate (e) (7,888)
Finance costs (4,974)
Profit before tax (a) 115,295
Income tax expense (14,758)
PROFIT FOR THE YEAR 100,537
Other comprehensive income:
Exchange differences on translating foreign operations (g) 310
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 100,847

Consolidated Statement of Financial Position as at 31 March 2008

2008 2007
NOTES HK$’000 HK$’000
Non-current Assets
Property, plant and equipment (b) 115,568 114,170
Investment in an associate (e) -- 11,748
Club membership (d) 1,956 1,956
Pledged bank deposits (f) 6,582 6,232
124,106 134,106

Current Assets
Inventories 270,726 346,984
Trade receivables, deposits and prepayments 719,128 670,522
Pledged bank deposits (f) 2,322 13,522
Bank balances and cash 234,026 143,472
1,226,202 1,174,500

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Current Liabilities
Trade payables and accrued charges 675,602 708,524
Amount due to a related party 48,634 37,862
Tax liabilities 7,898 10,580
Obligations under finance leases – due within one year 220 2,690
Bank borrowings – due within one year 76,482 83,006
808,836 842,662
Net Current Assets 417,366 331,838
Total Assets less Current Liabilities 541,472 465,944

Equity
Share capital (c) 6,068 6,000
Reserves 518,706 443,618
Total Equity 524,774 449,618

Non-current Liabilities
Obligations under finance leases – due after one year -- 216
Bank borrowings – due after one year 10,412 8,908
Deferred tax liabilities 6,286 7,202
16,698 16,326
541,472 465,944

Consolidated Statement of Changes in Equity for the year ended 31 March 2008

Share Share Retained Translation Share Total

capital premium profits of foreign option equity
operations reserve
$’000 $’000 $’000 $’000 $’000 $’000
At 31 March 2007 6,000 154,490 284,821 590 3,717 449,618
Total comprehensive income
for the year -- -- 100,537 310 -- 100,847

Exercise of share options 68 4,050 -- -- (4,050) 68

Recognition of equity-settled
share-based payment -- -- -- -- 333 333

Final dividend paid

in respect of 2007 -- -- (16,990) -- -- (16,990)

Interim dividend declared

in respect of 2008 -- -- (9,102) -- -- (9,102)
At 31 March 2008 6,068 158,540 359,266 900 -- 524,774

Module A (September 2008 Session) Page 2 of 9

Additional information:

(a) PROFIT BEFORE TAX

2008 2007
HK$’000 HK$’000
Profit before tax has been arrived at after charging:
Depreciation 32,036 26,748
Equity-settled share-based payment 333 3,717
Loss on disposal of property, plant and equipment 802 436
Impairment loss recognised on trade receivables 210 --

(b) PROPERTY, PLANT AND EQUIPMENT

HK$’000
COST
At 31 March 2007 219,792
Additions 34,240
Disposals (2,898)
At 31 March 2008 251,134

DEPRECIATION
At 31 March 2007 105,622
Charge for the year 32,036
Eliminated on disposals (2,092)
At 31 March 2008 135,566

CARRYING AMOUNTS
At 31 March 2008 115,568
At 31 March 2007 114,170

(c) Pursuant to the service agreement between City and a director of City dated 1 May
2006, an option to subscribe for 6,800,000 shares in the Company at an exercise price
equal to the par value of HK$0.01 per share (the “Pre-IPO Share Option”) was granted
to the director. The Pre-IPO Share Option, which serves as an incentive for the
director, shall be exercised during the period from 1 May 2007 to 31 December 2008
and the option holder has to be in employment with City when he exercises the options.
The estimated fair value of the Pre-IPO Share Option at the date of grant is
HK$4,050,000.

(d) The club membership represents entrance fees paid to golf clubs held on a long-term
basis. It is considered by the management of City as having an indefinite useful life.

(e) On 1 April 2007, City disposed of its entire 20% interest in an associate for a cash
consideration of HK$3,860,000, resulting in a loss on disposal of HK$7,888,000.

(f) As at 31 March 2008, bank deposits of HK$8,904,000 had been pledged to secure
City’s banking facilities in terms of short-term bank borrowings and long-term
borrowings.

Module A (September 2008 Session) Page 3 of 9

(g) Exchange differences arising on translation of foreign operations recognised directly in
equity for the year ended 31 March 2008 were made on the translation of the financial
statements of the 100% owned foreign subsidiaries. The exchange gains/(losses)
were found to be made up as follows:

HK$’000
Inventories 120
Trade receivables 140
Trade payables (40)
Cash 90

After you sent these draft consolidated financial statements to City’s directors for review, a
new director who has just joined the board sent you an e-mail as follows:

To : David LI, Accounting Manager

From : Janice CHEUNG (Director)
c.c. : Michelle CHOW, Julian LIN, Fiona MERRILL (Directors)
Date : 18 May 2008

Consolidated financial statements of City as at 31 March 2008

Could you please clarify the following points relating to City’s draft consolidated financial
statements which I have just reviewed?

(A) So far as I understand, cash is cash. Why is there a total of three items showing our
bank deposits and cash in the consolidated statement of financial position? Also, I
cannot find the consolidated statement of cash flows. Please send it to me again.

(B) I note that the amount of the item “Club membership” has remained the same
throughout the two years in the consolidated statement of financial position. I believe
that non-current assets should be subject to depreciation and amortisation. Why does
the amount of this item remain the same?

(C) I have also found an item “Equity-settled share-based payment expense” in the note to
profit before tax. As we are only issuing equity to the employees, how would it affect
the profit before tax? Why is HK$333,000 recognised as an expense in 2008 while
the total estimated fair value is HK$4,050,000?

I would appreciate your clarification in time for the upcoming board meeting.

Best regards,

Janice

Module A (September 2008 Session) Page 4 of 9

Required:

Question 1 (50 marks – approximately 90 minutes)

(a) Prepare a memorandum in response to the issues raised by Ms. Janice CHEUNG.
In your memorandum, you should:

(i) discuss the reasons for the classification of bank deposits and cash into
three items as shown in the consolidated statement of financial position;

(8 marks)

(ii) discuss the accounting treatment of the “Club membership”; and

(7 marks)

(iii) discuss, with appropriate calculations, the accounting treatment of the

“Equity-settled share-based payment expense”.
(8 marks)

(b) Prepare an annex to your memorandum showing the consolidated statement of

cash flows for the year ended 31 March 2008.
(27 marks)

* * * * * * * *

Module A (September 2008 Session) Page 5 of 9

 End of Section A

Module A (September 2008 Session) Page 6 of 9

SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks)
Answer ALL of the following questions. Marks will be awarded for logical argumentation
and appropriate presentation of the answers.

Question 2 (10 marks – approximately 18 minutes)

Discuss the following statements:

(a) "In the preparation of the financial statements, we should update all accounting
estimates based on the latest available, reliable information at the date when the
financial statements are authorised for issue."
(5 marks)

(b) "It is an option for an entity with an investment in a subsidiary not to prepare
consolidated financial statements."
(5 marks)

Module A (September 2008 Session) Page 7 of 9

Question 3 (15 marks – approximately 27 minutes)

On 1 January 2007, Thompson Manufacturing Inc. (“TMI”), the lessor, entered into a
non-cancellable lease agreement for equipment with Silver Rod Company (“SRC”), the
lessee. The following information pertains to the lease:

Annual lease payment due at the beginning of each year, beginning on HK$53,069
1 January 2007
Option to purchase at the end of lease term HK$10,000
Lease term 5 years
Economic useful life of leased equipment 8 years

Lessor's manufacturing cost HK$200,000

Fair value of leased equipment at 1 January 2007 HK$227,500
Estimated unguaranteed residual value of leased equipment at the end HK$30,000
of lease term

Lessor's implicit rate 12.93%

Lessee's incremental borrowing rate 10%

Required:

(a) Discuss how the purchase option at the end of the lease term offered by TMI to
SRC will affect the classification of this lease by SRC.
(3 marks)

(b) Prepare an amortisation schedule that would be suitable for TMI for the lease
term.
(5 marks)

(c) Prepare all the journal entries that TMI should make for each of the years ended
31 December 2007 and 2008.
(7 marks)

Module A (September 2008 Session) Page 8 of 9

Question 4 (13 marks – approximately 23 minutes)

On 25 September 2007, Good Drink Limited (“GDL”) had a highly probable forecast sale of
1,000 tons of sugar expected to occur on or about 30 April 2008. GDL designated the cash
flows of the forecast sales as a hedged item and entered a futures contract to sell 1,000 tons
of sugar at $3,000 per ton on 30 April 2008.

Fair value of the sugar futures contract

At inception of the hedge Nil
On 31 December 2007 $80,000
On 30 April 2008 $50,000

GDL closed out the futures contract with a receipt of $50,000 on 30 April 2008 and sold the
inventory for $2,950,000. The cost of the inventory sold is $2,500,000.

Required:

(a) Prepare the journal entries that GDL should make during the year ended
31 December 2007 assuming hedge accounting is adopted and the hedge is
considered an effective hedge.
(2 marks)

(b) Prepare the journal entries that GDL should make on 30 April 2008.
(6 marks)

(c) Explain the differences in accounting treatment and entries on the futures
contract assuming GDL does not opt for the use of hedge accounting.
(5 marks)

Question 5 (12 marks – approximately 22 minutes)

(a) Explain the differences in calculation of diluted earnings per share between
contingently issuable shares and a convertible bond.
(8 marks)

(b) "In a business combination, if the fair value of the identifiable assets and
liabilities and contingent liabilities at the acquisition date can only be
determined provisionally, the acquirer shall adjust such provisional value upon
the finalisation of the fair value determination." Discuss.
(4 marks)

* * * END OF EXAMINATION PAPER * * *

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