This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON

279 0091 ZA

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences, the Diplomas in Economics and Social Sciences and Access Route for External Students

Financial Reporting

Wednesday, 18 May 2011 : 2.30pm to 5.45pm

Candidates should answer FOUR of the following SEVEN questions. All questions carry equal marks. Workings should be submitted for all questions requiring calculations. Any necessary assumptions introduced in answering a question are to be stated. Extracts from compound interest tables are given after the final question on this paper. 8-column accounting paper is provided at the end of this question paper. If used, it must be detached and fastened securely inside the answer book. A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book.

University of London 2011 UL11/0081

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PLEASE TURN OVER Page 1 of 8

1.

The statements of financial position (balance sheets) for Ear Ltd, Mouth Ltd and Nose Ltd as at 31 December 2010 are given as follows: Statements of Financial Position as at 31 December 2010 Ear Ltd Non-current asset (land) Investment Inventories Trade Receivables Dividend receivable from group companies Inter-company loans receivable from Mouth Ltd Inter-company loans receivable from Nose Ltd Cash 860,000 380,000 140,000 8,000 12,000 90,000 30,000 130,000 1,650,000 60,000 390,000 30,000 440,000 40,000 30,000 50,000 60,000 Mouth Ltd 260,000 Nose Ltd 300,000

Share capital (1 nominal value) Retained profits Revaluation reserve Trade payables Inter-company loans payable to Ear Ltd Dividend payable

600,000 260,000

100,000 210,000

200,000 160,000 30,000

730,000

30,000 40,000

10,000 20,000 20,000

60,000

10,000

1,650,000

390,000

440,000

Ear Ltd acquired 70% of Mouth Ltd for 290,000 on 1 January 2006 when Mouth Ltds share capital and reserves stood at 190,000. At this date the fair value of Mouth Ltd's non-current assets was 280,000 but they were recorded at their historical cost of 260,000. Mouth Ltd has not incorporated this revaluation in its books. Ear Ltd acquired 25% of Nose Ltd for 70,000 on 1 January 2007. At this date the fair value of Nose Ltd's non-current assets was 300,000 and Nose Ltd incorporated this revaluation into its accounts. The share capital and reserves on 1 January 2007 of Nose Ltd, including the revaluation reserve, stood at 250,000.

Question continues on following page

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No changes to the share capital of Mouth Ltd and Nose Ltd have occurred since their acquisition by Ear Ltd. At the year end, all group companies declare a dividend of 10p per share. These dividends have been accounted for correctly. Ear Ltd's inventory figure includes 10,000 of inventory which had been bought from Mouth Ltd. Mouth Ltd had paid 2,000 for these goods. Ear Ltds inventory figure also includes 15,000 of inventory which has been bought from Nose Ltd. Nose Ltd had paid 5,000 for these goods. Goodwill is to be capitalised. Impairment of 50,000 is seen against the value of the goodwill of Mouth Ltd in 2010. Required (a) Define a subsidiary and an associate company. Outline the differences in how such companies are accounted for. (6 marks) Prepare the consolidated statement of financial position for Ear Ltd as at 31 December 2010. (19 marks)

(b)

2.

Company M owns a manufacturing plant that cost 750,000 on 1 January 2009. The plant has a useful economic life of five years from this date and it is used to manufactures a product called the spike. There is no second hand market for the plant except as scrap and it is estimated that at the end of its useful life, or at any other time, it will cost 30,000 net of scrap proceeds, to dismantle and remove it. Annual operating costs are 300,000. The plant requires an overhaul costing 22,500 during the third year of its life. It produces a constant annual output, all of which can be sold, with an annual selling value of 600,000. During February 2010, a new model of the plant used to manufacture the spike is brought out. The directors of the company now intend to replace the existing spike plant with the new plant at the end of the existing plants life. The new plant costs 825,000 and has a six year useful life at the end of which its scrap value is expected to be 15,000. It incurs constant annual operating costs of 270,000 and produces a constant annual output, all of which can be sold, with a selling value 22,500 per annum higher than the output of the existing plant. When the new plant is installed for the first time the company will incur one off costs of 37,500 adapting the building housing the new plant. Any replacement plant together with the cost of adapting the building would be paid for at the time of replacement. All other cashflows occur at the end of the years concerned. The companys cost of capital is 10% per annum. Required (a) Define deprival value and discuss the strengths and limitations of deprival value as the basis of asset valuation in corporate financial reports (12 marks) Calculate the deprival value of the companys spike making plant as at 31 December 2010. (13 marks)

(b)

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3.

Bear Ltd started trading on 1 January 2010. The income statement and the statement of financial position for the first year of trading are given below: Income statement for 2010 Sales Cost of sales: Opening inventories Purchases Closing inventories Gross profit Depreciation Other expenses Net profit Statement of Financial Position as at 31 December 2010 Non-current assets plant and machinery Inventories Other net current assets Net assets Share capital (1 shares) Retained earnings Share capital and reserves The price change indices for the year were identified as follows: RPI Plant and machinery 100 120 130 150 Inventories (stock) 100 135 140 145 1,296,000 1,350,000

75,000 900,000 (90,000) (885,000) 465,000 (42,000) (150,000) 273,000

90,000 387,000 1,773,000 1,500,000 273,000 1,773,000

1 January 2010 30 June 2010 30 November 2010 31 December 2010

100 110 115 120

Closing inventory was acquired on 30 November 2010. All non-current assets and opening inventory were acquired on the first day of trading. Sales and purchases accrue evenly throughout the year. Question continues on following page

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Required (a) (b) What are fully stabilised current value financial statements? Discuss the advantages and limitations of fully stabilised current value financial statements. (7 marks) Prepare an income statement for Bear Ltd for the year ended 31 December 2010 and a statement of financial position for Bear Ltd as at 31 December 2010 using current value (replacement cost) accounting and using the financial capital maintenance concept. Base depreciation on the year-end value of non-current assets. (9 marks) Calculate the real realised and the real unrealised holding gains and losses on inventory and non-current assets that would appear in a set of fully stabilised current value accounts stabilised in pounds () as at 31 December 2010. Where would these items be recorded in the financial statements for 2010? (9 marks)

(c)

4.

Rhymes Ltd enters into two lease transactions in 2010 as follows: (1) An asset, asset A, which could be purchased outright for 102,004 is instead leased for three years. The useful economic life of the asset is three years and at the end of this time, the asset will have no residual value. Rhymes Ltd is responsible for all maintenance and repairs and for all insurance costs for asset A. The lease for asset A provides for halfyearly payments in advance of 20,000, the first payment being made on 1 January 2010. An asset, asset B, which could be purchased outright for 120,000 is leased for three years for annual payments of 30,000 per annum payable in advance. The useful economic life of asset B is eight years. At the end of the three years, Rhymes Ltd intends to return the asset. Rhymes Ltd is not responsible for maintaining and insuring asset B.

(2)

Required (a) (b) What are operating and finance leases? How should they be accounted for? (10 marks) Show how asset A and asset B would be accounted for by Rhymes Ltd in 2010 and 2011. (15 marks)

5.

Answer all parts of this question. (a) XYZ plc is considering whether to (i) issue share capital of 200,000 (1 nominal value shares) or (ii) issue 100,000 (1 nominal value shares) and raise 100,000 from a long term loan with an interest rate of 15% per annum. The future is uncertain and if XYZ plc has a good year, profit before interest and tax will be 100,000 but if it has a poor year, profit before interest and tax will be 20,000. Calculate profit after tax and earnings per share in both scenarios and comment on your results. Assume the tax rate is 35%. (8 marks) Identify and discuss the factors that influence the determination of the functional currency of an overseas subsidiary? (5 marks)

(b)

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(c)

A company entered into a construction contract with the following information: Date commenced Expected completion date Final contract price Costs to 31 December 2010 Value of work certified to 31 December 2010 Progress payments invoiced to 31 December 2010 Estimated costs to completion Required Show how the construction contract would be accounted for in the financial statements for the year ended 31 December 2010. (7 marks) 1 January2010 31 December 2011 4,000,000 1,200,000 1,240,000 220,000 1,000,000

(d)

Identify and discuss the differences to the financial statements if a company used the last in first out (LIFO) method for valuing inventory instead of the first in first out (FIFO) method for valuing inventory in times of rising prices? (5 marks)

6.

Either (a) What are non-current tangible assets and investment properties? Discuss the differences in the accounting treatment of non-current tangible assets and investment properties and discuss how the different accounting treatments affect the financial statements.

Or (b) Why do we need a conceptual framework? Discuss the advantages and limitations of conceptual frameworks.

7.

Either (a) Set out the definitions of well offness and measures of income suggested by Sir John Hicks and evaluate their usefulness, implications and limitations for financial reporting.

Or (b) Critically appraise both the traditional and economic arguments for and against accounting regulation.

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Compound interest factors over n periods at rate i per period. Table 1: Present value factors To determine the present value of a single payment of 1 received n periods from the present at a constant discount rate of x% per period

Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

5% 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 0.4581 0.4363 0.4155 0.3957 0.3769

6% 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651 0.6274 0.5919 0.5584 0.5268 0.4970 0.4688 0.4423 0.4173 0.3936 0.3714 0.3503 0.3305 0.3118

7% 0.9346 0.8734 0.8163 0.7629 0.7130 0.6663 0.6227 0.5820 0.5439 0.5083 0.4751 0.4440 0.4150 0.3878 0.3624 0.3387 0.3166 0.2959 0.2765 0.2584

8% 0.9259 0.8573 0.7938 0.7350 0.6806 0.6302 0.5835 0.5403 0.5002 0.4632 0.4289 0.3971 0.3677 0.3405 0.3152 0.2919 0.2703 0.2502 0.2317 0.2145

9% 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.5470 0.5019 0.4604 0.4224 0.3875 0.3555 0.3262 0.2992 0.2745 0.2519 0.2311 0.2120 0.1945 0.1784

10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 0.2633 0.2394 0.2176 0.1978 0.1799 0.1635 0.1486

12% 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 0.4523 0.4039 0.3606 0.3220 0.2875 0.2567 0.2292 0.2046 0.1827 0.1631 0.1456 0.1300 0.1161 0.1037

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Table 2: Cumulative present value factors (annuity factors) The table gives the present value of n annual payments of 1 received for the next n years with a constant discount rate of x% per year. For example, with a discount rate of 8% and with six annual payments of 1 the present value is 4.6229 Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 5% 0.9524 1.8594 2.7232 3.5460 4.3295 5.0757 5.7864 6.4632 7.1078 7.7217 8.3064 8.8633 9.3936 9.8986 10.3797 10.8378 11.2741 11.6896 12.0853 12.4622 6% 0.9434 1.8334 2.6730 3.4651 4.2124 4.9173 5.5824 6.2098 6.8017 7.3601 7.8869 8.3838 8.8527 9.2950 9.7122 10.1059 10.4773 10.8276 11.1581 11.4699 7% 0.9346 1.8080 2.6243 3.3872 4.1002 4.7665 5.3893 5.9713 6.5152 7.0236 7.4987 7.9427 8.3577 8.7455 9.1079 9.4466 9.7632 10.0591 10.3356 10.5940 8% 0.9259 1.7833 2.5771 3.3121 3.9927 4.6229 5.2064 5.7466 6.2469 6.7101 7.1390 7.5361 7.9038 8.2442 8.5595 8.8514 9.1216 9.3719 9.6036 9.8181 9% 0.9174 1.7591 2.5313 3.2397 3.8897 4.4859 5.0330 5.5348 5.9952 6.4177 6.8052 7.1607 7.4869 7.7862 8.0607 8.3126 8.5436 8.7556 8.9501 9.1285 10% 0.9091 1.7355 2.4869 3.1699 3.7908 4.3553 4.8684 5.3349 5.7590 6.1446 6.4951 6.8137 7.1034 7.3667 7.6061 7.8237 8.0216 8.2014 8.3649 8.5136 12% 0.8929 1.6901 2.4018 3.0373 3.6048 4.1114 4.5638 4.9676 5.3282 5.6502 5.9377 6.1944 6.4235 6.6282 6.8109 6.9740 7.1196 7.2497 7.3658 7.4694

END OF PAPER

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This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON

279 0091 ZB

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences, the Diplomas in Economics and Social Sciences and Access Route for External Students

Financial Reporting

Wednesday, 18 May 2011 : 2.30pm to 5.45pm

Candidates should answer FOUR of the following SEVEN questions. All questions carry equal marks. Workings should be submitted for all questions requiring calculations. Any necessary assumptions introduced in answering a question are to be stated. Extracts from compound interest tables are given after the final question on this paper. 8-column accounting paper is provided at the end of this question paper. If used, it must be detached and fastened securely inside the answer book. A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book.

University of London 2011 UL11/0082 PLEASE TURN OVER

D01

PLEASE TURN OVER Page 1 of 8

1.

The income statements (profit and loss accounts) of Arm Plc, Leg Ltd and Toe Ltd for the year ended 31 December 2010 are given as follows: Arm Plc Sales Cost of sales Gross profit Administration costs Distribution costs Dividends receivable Profit before tax Tax Profit after tax Transfers to reserves Dividends payable Retained profit for the year Retained profit brought forward Retained profit carried forward 1,000,000 (140,000) 860,000 (189,500) (104,000) 36,000 602,500 (200,000) 402,500 (60,000) (20,000) 322,500 1,600,000 1,922,500 Leg Ltd 400,000 (100,000) 300,000 (42,000) (26,000) 232,000 (60,000) 172,000 (30,000) (10,000) 132,000 600,000 732,000 Toe Ltd 200,000 (60,000) 140,000 (35,000) (10,000) 95,000 (20,000) 75,000 (24,000) (2,000) 49,000 400,000 449,000

Arm Plc acquired 60% of Leg Ltd on 1 January 2003 for 150,000 when Leg Ltd's retained profits were 80,000. The share capital of Leg Ltd totalled 50,000 on 1 January 2003. There has been no change in Leg Ltdd share capital since this date. During 2010 Leg Ltd sold goods costing 4,000 to Arm Plc for 14,000. 20% of this inventory is included in Arm Plcs inventory at the year end. Arm Plc acquired 30% of Toe Ltd on 1 January 2005 for 200,000 when Toe Ltds share capital and reserves were 75,000. The share capital of Toe Ltd is made up of 20,000 shares of 50p each. During 2010 Toe Ltd sold goods costing 6,000 to Arm Plc for 8,000. 50% of this inventory is still in Arm Plcs inventory at the year end. Goodwill is capitalised. Impairment of 5,000 was seen against the goodwill of Leg Ltd in 2008 and impairment of 10,000 was seen against the goodwill of Toe Ltd in 2010. At the year end Arm Plc charges both Leg Ltd and Toe Ltd a management fee of 5% of turnover. None of the companies have accounted for this management fee. Required (a) Define the following: i. subsidiary companies ii. non controlling interest (minority interest) iii. goodwill and impairment

(6 marks)

(b)

Prepare the consolidated income statement (profit and loss account) for Arm Plc for the year ended 31 December 2010. (19 marks)

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2.

Company M owns a manufacturing plant that cost 2,000,000 on 1 January 2009. The plant has a useful economic life of five years from this date and it is used to manufacture a product called the spike. There is no second hand market for the plant except as scrap and it is estimated that at the end of its useful life, or at any other time, it will cost 80,000 net of scrap proceeds, to dismantle and remove it. Annual operating costs are 800,000. The plant requires an overhaul costing 60,000 during the third year of its life. It produces a constant annual output, all of which can be sold, with an annual selling value of 1,600,000. During February 2010, a new model of the plant used to manufacture the spike is brought out. The directors of the company now intend to replace the existing spike plant with the new plant at the end of the existing plants useful life. The new plant costs 2,200,000 and has a six year useful life at the end of which its scrap value is expected to be 40,000. It incurs constant annul operating costs of 720,000 and produces a constant annual output, all of which can be sold for 60,000 per annum higher than the output of the existing plant. When the new plant is installed for the first time the company will incur one off costs of 100,000 adapting the building housing the new plant. Any replacement plant together with the cost of adapting the building would be paid for at the time of replacement. All other cashflows occur at the end of the years concerned. The companys cost of capital is 10% per annum. Required (a) Define deprival value and discuss the strengths and limitations of deprival value as the basis of asset valuation in corporate financial reports. (12 marks) Calculate the deprival value of the companys spike making plant at 31 December 2010. (13 marks)

(b)

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3.

Bear Ltd started trading on 1 January 2010. The income statement for the year ended 31 December 2010 and the statement of financial position as at 31 December 2010 are given as follows: Income statement for 2010 Sales Cost of sales Opening inventories Purchases Closing inventories Gross profit Expenses Depreciation Net profit Statement of financial position as at 31 December 2010 Non-current assets - plant and machinery Inventories Other net current assets Net assets Share capital (1 shares) Retained earnings Share capital and reserves The price change indices for the year were identified as follows: RPI Plant and machinery 200 240 260 300 Inventories (stock) 250 270 280 290 3,888,000 4,050,000

225,000 2,700,000 (270,000) (2,655,000) 1,395,000 (450,000) (126,000) 819,000

270,000 1,161,000 5,319,000 4,500,000 819,000 5,319,000

1 January 2010 30 June 2010 30 November 2010 31 December 2010

200 220 230 240

Closing inventory was acquired on 30 November 2010. All non-current assets and opening inventory were acquired on the first day of trading. Sales and purchases accrue evenly throughout the year. Question continues on following page UL11/0082
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Required (a) Define fully stabilised current value accounts and discuss their advantages and limitations. (7 marks) Prepare an income statement for Bear Ltd for the year ended 31 December 2010 and a statement of financial position for Bear Ltd as at 31 December 2010 using current value (replacement cost) accounting and using the financial capital maintenance concept. Base depreciation on the year-end value of non-current assets. (9 marks) Calculate the real realised and the real unrealised holding gains and losses on inventory and non-current assets that would appear in a set of fully stabilised current value accounts, stabilised in pounds () as at 31 December 2010. Where would these items be recorded in the financial statements for 2010? (9 marks)

(b)

(c)

4.

Rhymes Ltd enters into two lease transactions in 2010 as follows: (1) An asset, asset A, which could be purchased outright for 319,770 is instead leased for three years. The useful economic life of the asset is three years and at the end of this time, the asset will have no residual value. Rhymes Ltd is responsible for all maintenance and repairs and for all insurance costs for asset A. The lease for asset A provides for halfyearly payments in advance of 60,000, the first payment being made on 1 January 2010. An asset, asset B, which could be purchased outright for 360,000 is leased for three years for annual payments of 90,000 per annum payable in advance. The useful economic life of asset B is eight years. At the end of the three years, Rhymes Ltd intends to return the asset. Rhymes Ltd is not responsible for maintaining and insuring asset B.

(2)

Required (a) (b) What are operating and finance leases? How are they accounted for? (10 marks)

Show how asset A and asset B should be accounted for by of Rhymes Ltd in 2010 and 2011. (15 marks)

5.

Answer all parts of this question. (a) What is share premium? Discuss the permissible uses for the share premium account. (5 marks) XYZ plc is considering whether to (i) issue share capital of 400,000 (1 nominal value shares) or (ii) issue 200,000 (1 nominal value shares) and raise 200,000 from a long term loan with an interest rate of 15% per annum. The future is uncertain and if XYZ plc has a good year, profit before interest and tax will be 200,000 but if it has a poor year, profit before interest and tax will be 40,000. Calculate profit after tax and earnings per share in both scenarios and comment on your results. Assume the tax rate is 35%. (8 marks) Question continues on following page

(b)

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(c)

Prior to IFRS, the pooling of interest method was permissible. Explain the criteria then laid down for the use of the pooling of interest method and outline the reasons for the banning of the method. (5 marks) Technology Ltd entered into the following research and development expenditure in 2010: 600,000 700,000

(d)

Research (pure and applied) Development

The development costs relate to a project to develop a new product. The project is expected to be successful, leading to a new product which will generate substantial revenues for the company. The company has enough resources to fund the project. Staff costs of 400,000 have been incurred on the project during 2010. In addition capital expenditure of 300,000 has been incurred during 2010. The capital expenditure relates to the acquisition of equipment for final tests on the product and is depreciated using the straight line method. The equipment has a useful economic life of 3 years and is then expected to have no residual value Required Show how the research and development costs will be treated in the financial statements of Technology Ltd in 2010. (7 marks)

6.

Either (a) What are non-current tangible assets and investment properties? Discuss the differences in the accounting treatment of non-current tangible assets and investment properties and discuss how the different accounting treatments affect the financial statements.

Or (b) Discus the reasons for initiating standard setting in the 1970s and assess the adva ntages and limitations of standard setting in the UK.

7.

Either (a) Set out the definitions of well offness and measures of income suggested by Sir John Hicks and evaluate their usefulness, implications and limitations for financial reporting.

Or (b) Compare and contrast the different methods for translating the financial statements of foreign subsidiaries. Discuss how the foreign exchange reserves arise under each method, how they should be accounted for and the situations in which each of the methods should be used.

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Compound interest factors over n periods at rate i per period. Table 1: Present value factors To determine the present value of a single payment of 1 received n periods fr om the present at a constant discount rate of x% per period Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 5% 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 0.4581 0.4363 0.4155 0.3957 0.3769 6% 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651 0.6274 0.5919 0.5584 0.5268 0.4970 0.4688 0.4423 0.4173 0.3936 0.3714 0.3503 0.3305 0.3118 7% 0.9346 0.8734 0.8163 0.7629 0.7130 0.6663 0.6227 0.5820 0.5439 0.5083 0.4751 0.4440 0.4150 0.3878 0.3624 0.3387 0.3166 0.2959 0.2765 0.2584 8% 0.9259 0.8573 0.7938 0.7350 0.6806 0.6302 0.5835 0.5403 0.5002 0.4632 0.4289 0.3971 0.3677 0.3405 0.3152 0.2919 0.2703 0.2502 0.2317 0.2145 9% 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.5470 0.5019 0.4604 0.4224 0.3875 0.3555 0.3262 0.2992 0.2745 0.2519 0.2311 0.2120 0.1945 0.1784 10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 0.2633 0.2394 0.2176 0.1978 0.1799 0.1635 0.1486 12% 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 0.4523 0.4039 0.3606 0.3220 0.2875 0.2567 0.2292 0.2046 0.1827 0.1631 0.1456 0.1300 0.1161 0.1037

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Table 2: Cumulative present value factors (annuity factors) The table gives the present value of n annual payments of 1 received for the next n years with a constant discount rate of x% per year. For example, with a discount rate of 8% and with six annual payments of 1 the present value is 4.6229 Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 5% 0.9524 1.8594 2.7232 3.5460 4.3295 5.0757 5.7864 6.4632 7.1078 7.7217 8.3064 8.8633 9.3936 9.8986 10.3797 10.8378 11.2741 11.6896 12.0853 12.4622 6% 0.9434 1.8334 2.6730 3.4651 4.2124 4.9173 5.5824 6.2098 6.8017 7.3601 7.8869 8.3838 8.8527 9.2950 9.7122 10.1059 10.4773 10.8276 11.1581 11.4699 7% 0.9346 1.8080 2.6243 3.3872 4.1002 4.7665 5.3893 5.9713 6.5152 7.0236 7.4987 7.9427 8.3577 8.7455 9.1079 9.4466 9.7632 10.0591 10.3356 10.5940 8% 0.9259 1.7833 2.5771 3.3121 3.9927 4.6229 5.2064 5.7466 6.2469 6.7101 7.1390 7.5361 7.9038 8.2442 8.5595 8.8514 9.1216 9.3719 9.6036 9.8181 9% 0.9174 1.7591 2.5313 3.2397 3.8897 4.4859 5.0330 5.5348 5.9952 6.4177 6.8052 7.1607 7.4869 7.7862 8.0607 8.3126 8.5436 8.7556 8.9501 9.1285 10% 0.9091 1.7355 2.4869 3.1699 3.7908 4.3553 4.8684 5.3349 5.7590 6.1446 6.4951 6.8137 7.1034 7.3667 7.6061 7.8237 8.0216 8.2014 8.3649 8.5136 12% 0.8929 1.6901 2.4018 3.0373 3.6048 4.1114 4.5638 4.9676 5.3282 5.6502 5.9377 6.1944 6.4235 6.6282 6.8109 6.9740 7.1196 7.2497 7.3658 7.4694

END OF PAPER

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Examiners commentaries 2011

Examiners commentaries 2011

91 Financial reporting Important note
This commentary reflects the examination and assessment arrangements for this course in the academic year 201011. The format and structure of the examination may change in future years, and any such changes will be publicised on the virtual learning environment (VLE).

General remarks
Learning outcomes
At the end of this course, and having completed the Essential reading and activities, you should be able to: explain and apply a number of theoretical approaches to financial accounting record and analyse data prepare financial statements under alternative accounting conventions describe a number of regulatory issues relating to financial accounting critically evaluate theories and practices of, and other matters relating to, financial accounting.

What are the Examiners looking for?

The exam paper contains seven questions, five of which combine numerical and written components and two of which are essay based. Each of the essay questions has a choice of two essays. The combined questions require candidates to prepare calculations on a variety of topics as well as showing a critical grasp of the theories underlying the techniques. To do well candidates need to be able both to explain and evaluate the theories and prepare a range of financial statements and calculations. For quantitative parts of questions, Examiners are looking for accurate preparation of financial statements which follow generally accepted formats with clear headings and accurate application of accounting techniques to specific areas within financial reporting. Workings should always be provided clearly. Written components of combined questions require clear and coherent explanations of theories, techniques and practices and critical evaluation of theories and practices. Good answers to essay-based questions will be structured coherently and logically, include an introduction, a main body and conclusion and cover all parts of the essay question. Typically an essay-based question will require an explanation of an issue within financial reporting and a critical analysis of the issue. Explanations should be clear and include a discussion of key definitions with examples if appropriate. The critical analysis should show critical awareness of both
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91 Financial reporting

sides of an argument or application of a theory or concept to financial reporting with an assessment of its appropriateness to financial reporting.

Planning your time in the examination

All questions in the paper carry equal marks and equal time should be devoted to each question. It is important that candidates attempt four questions and all parts of each question they answer. Marks for each section are given to each section and should be used by candidates to guide their work and time allocation. Where questions are in parts, candidates should avoid excessively long answers to some parts and missing out other parts.

Key steps to improvement

Candidates can improve performance by improving the presentation of their work, providing clear workings, answering the required number of questions and attempting all sections of a question. Often candidates seem to focus attention on the preparation of financial statements and the financial calculations without being able to explain, discuss and evaluate the theories and practices central to financial reporting.

Question spotting
Many candidates are disappointed to find that their examination performance is poorer than they expected. This can be due to a number of different reasons and the Examiners commentaries suggest ways of addressing common problems and improving your performance. We want to draw your attention to one particular failing question spotting, that is, confining your examination preparation to a few question topics which have come up in past papers for the course. This can have very serious consequences. We recognise that candidates may not cover all topics in the syllabus in the same depth, but you need to be aware that Examiners are free to set questions on any aspect of the syllabus. This means that you need to study enough of the syllabus to enable you to answer the required number of examination questions. The syllabus can be found in the course information sheet in the section of the VLE dedicated to this course. You should read the syllabus very carefully and ensure that you cover sufficient material in preparation for the examination. Examiners will vary the topics and questions from year to year and may well set questions that have not appeared in past papers every topic on the syllabus is a legitimate examination target. So although past papers can be helpful in revision, you cannot assume that topics or specific questions that have come up in past examinations will occur again. If you rely on a question spotting strategy, it is likely you will find yourself in difficulties when you sit the examination paper. We strongly advise you not to adopt this strategy.

Examiners commentaries 2011

Examiners commentaries 2011

91 Financial reporting Zone A Important note
This commentary reflects the examination and assessment arrangements for this course in the academic year 201011. The format and structure of the examination may change in future years, and any such changes will be publicised on the virtual learning environment (VLE).

Format of the examination paper

Candidates should answer FOUR of the following SEVEN questions. All questions carry equal marks. Workings should be submitted for all questions requiring calculations. Any necessary assumptions introduced in answering a question are to be stated Extracts from compound interest tables are given after the final question on this paper. Eight-column accounting paper is provided at the end of this question paper. If used, it must be detached and fastened securely inside the answer book. A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book.

Comments on specific questions

Question 1 The statements of financial position (balance sheets) for Ear Ltd, Mouth Ltd and Nose Ltd as at 31 December 2010 are given as follows: Statements of Financial Position as at 31 December 2010 Non-current asset (land) Investment Inventories Trade Receivables Dividend receivable from group companies Inter-company loans receivable from Mouth Ltd Inter-company loans receivable from Nose Ltd Cash Ear Ltd. Mouth Ltd. 860,000 380,000 140,000 8,000 12,000 90,000 30,000 130,000 1,650,000 60,000 390,000 30,000 440,000 40,000 30,000 50,000 60,000 260,000 Nose Ltd. 300,000

91 Financial reporting

Share capital (1 nominal value) Retained profits Revaluation reserve Trade payables Inter-company loans payable to Ear Ltd Dividend payable

600,000 260,000 730,000 60,000 1,650,000

100,000 210,000 30,000 40,000 10,000 390,000

200,000 160,000 30,000 10,000 20,000 20,000 440,000

Ear Ltd acquired 70% of Mouth Ltd for 290,000 on 1 January 2006 when Mouth Ltds share capital and reserves stood at 190,000. At this date the fair value of Mouth Ltds non-current assets was 280,000 but they were recorded at their historical cost of 260,000. Mouth Ltd has not incorporated this revaluation in its books. [For the full question, please refer to the Examination paper.] Reading for the question Subject guide, Chapter 7. International financial reporting, Chapter 24. Approaching the question This question requires a detailed knowledge of preparation of consolidated financial statements, in this case consolidated statements of financial position. Candidates should know what consolidated financial statements are, why they are prepared, what companies are included in consolidated financial statements and the definitions and explanation of key items included in consolidated financial statements. For the preparation of consolidated statements, candidates need to know the formats of these statements and be able to calculate the different components of the statements. It is important that candidates show detailed workings of how they arrive at figures included in the financial statements. Part (a) full definitions of all terms are required and differences between how they should be accounted for should be clearly explained. Part b Solutions to Part b provided below with key workings Workings Non current assets Investments Goodwill Investment in associate co Inventories Trade receivables Interco receivables from nose Dividends receivable from nose Cash 1,140,000 20,000 100,500 95,000 172,000 38,000 30,000 5,000 240,000 130,000 + 60,000 + 50,000 25% * 380,000 140,000 + 40,000 8,000 860,000 + 280,000 38,000 290,000 70,000

Examiners commentaries 2011

Net assets Share capital P+L reserves NCI/Minority interests Trade payables Dividends payable Capital, reserves and liabilities Goodwill Mouth = 290,000 70% (190,000 + 20,000) = 143,000 Nose = 70,000 25% (250,000) = 7,500 Impairment = 50,000 Reserves Ear P+L Purp Revised P+L Share cap Revaln Capital and reserves 860,000 260,000 600,000 260,000

1,840,500 600,000 320,900 96,600 760,000 63,000 1,840,500 30% * 322,000

Mouth 210,000 (8,000) 202,000 100,000 20,000 322,000

Nose 160,000 (10,000) 150,000 200,000 30,000 380,000

Retained earnings = 260,000 + 70% (202,000 90,000) + 25% (150,000 20,000) 50,000 = 260,000 + 78,400 + 32,500 50,000 = 320,900 Alternative presentations are acceptable (e.g. goodwill of a added to investment in a as follows or calculated as cost of investment + share of post acq reserves impairment). Question 2 Company M owns a manufacturing plant that cost 750,000 on 1 January 2009. The plant has a useful economic life of five years from this date and it is used to manufactures a product called the spike. There is no second hand market for the plant except as scrap and it is estimated that at the end of its useful life, or at any other time, it will cost 30,000 net of scrap proceeds, to dismantle and remove it. Annual operating costs are 300,000. The plant requires an overhaul costing 22,500 during the third year of its life. It produces a constant annual output, all of which can be sold, with an annual selling value of 600,000. [For the full question, please refer to the Examination paper.] Reading for the question Subject guide, Chapter 6. International financial reporting, Chapters 5 and 6. Approaching the question This question covers both a discussion of deprival value and calculations relating to deprival value. Candidates should attempt both parts of the question and answer all the questions set. For the calculations, candidates need to be able to apply the concepts of deprival value to an example. It is important that candidates show detailed workings of how they arrive at their answer.
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Part a A good discussion of deprival value with examples together with the strengths and limitations of the concept is required. A discursive style should be used rather than bullet points. Part b Solutions with key workings are provided below. Aec = (825,000 + 4.3553 * 270,000 0.5645 * 15,000)/4.3553 = 457,480. Have budget 2010 Op costs of old machine Overhaul Removal New building work AEC Totals Have not budget Adapt building Aec Extra income Difference Df Pv 37,500 1 37,500 37,500 457,480 (22,500) 112,480 0.9091 102,256 457,480 (22,500) 134,980 0.8264 111,547 457,480 (22,500) 67,480 0.7513 50,698 0 0 457,480 0 322,500 300,000 367,500 2011 300,000 22,500 30,000 37,500 457,480 457,480 2012 300,000 2013 300,000 2014

Pv of difference = cost of replacing services of existing asset = 302,001 = = deprival value Note Some figures may be included differently in the AEC and have or have not budgets and full credit is given for correct workings if different to the above. Question 3 Bear Ltd started trading on 1 January 2010. The income statement and the statement of financial position for the first year of trading are given below: [For the full question, please refer to the Examination paper.] Reading for the question Subject guide, Chapter 5. International financial reporting, Chapter 7. Approaching the question This question covers both a discussion of fully stabilised current value accounts and the preparation of current value financial statements and calculations for key components of fully stabilised financial statements. Candidates should attempt both parts of the question and answer all the questions set. For the calculations, it is important that candidates show detailed workings of how they arrive at their answer.

Examiners commentaries 2011

Part a For the discussion of fully stabilised current value financial statements, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible. Part b Solutions for part b are provided below: IS Sales Cost of sales Op invent Purchases Clo invent GP Exp Depreciation profit Nca unrealised Nca realised Invent unrealised Invent realised Retained earnings Balance sheet Non current assets Inventories Other net current assets Net assets Share capital (1 shares) Retained earnings Share capital and reserves 1,296,000 90,000 387,000 1,773,000 1,500,000 273,000 1,773,000 150/100 1,944,000 145/140 93,214 387,000 2,424,214 1,500,000 924,214 2,424,214 273,000 75,000 900,000 (90,000) (885,000) 465,000 (150,000) (42,000) 150/100 135/140 135/100 101,250 900,000 (86,786) (914,464) 435,536 (150,000) (63,000) 222,536 648,000 21,000 3,214 29,464 924,214 1,350,000 1,350,000

91 Financial reporting

Part c Solutions for Part c are given below. Nca real unrealised Nca real realised Inventory real realised 1,944,000 1,296,000 * 120/100 = 388,800 63,000 42,000 * 120/100 =12,600 894,214 * 120/110 977,905 = 19,692

Inventory real unrealised 93,214 90,000 * 120/115 = (699) Question 4 Rhymes Ltd enters into two lease transactions in 2010 as follows: 1. An asset, asset A, which could be purchased outright for 102,004 is instead leased for three years. The useful economic life of the asset is three years and at the end of this time, the asset will have no residual value. Rhymes Ltd is responsible for all maintenance and repairs and for all insurance costs for asset A. The lease for asset A provides for half-yearly payments in advance of 20,000, the first payment being made on 1 January 2010. 2. An asset, asset B, which could be purchased outright for 120,000 is leased for three years for annual payments of 30,000 per annum payable in advance. The useful economic life of asset B is eight years. At the end of the three years, Rhymes Ltd intends to return the asset. Rhymes Ltd is not responsible for maintaining and insuring asset B. [For the full question, please refer to the examination paper.] Reading for the question Subject guide, Chapter 9. International financial reporting, Chapter 12. Approaching the question The question covers both a discussion on operating and finance leases and calculations showing how these would be accounted for in financial statements. For the discussion of operating and finance leases, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible. For the calculations, it is important that candidates show detailed workings of how they arrive at their answer. Part a A discussion of the definition of operating and finance leases with examples is required with discussion of how these different leases are accounted for. Part b Solutions for Part b are given below. Asset a Recognition that it is finance lease and reasons Rate implicit in the lease 102,004 = 20,000 + 20,000 a5]? a5]? = 82,004/20,000 a5]? = 4.1002 which gives a rate of 7% from tables.

Examiners commentaries 2011

Rental payments Date 1.1.2010 1.1.2010 1.7.2010 1.1.2011 1.7.2011 1.1.2012 1.7.2012 20,000 20,000 20,000 20,000 20,000 20,000 Rental payment Finance charge Reduction in Balance of obligation obligation under finance lease 102,004 X 5,740 4,742 3,674 2,531 1,308 20,000 14,260 15,258 16,326 17,469 18,692 82,004 67,744 52,486 36,160 18,691 0 Rounding difference

Income statement 2010 finance charge = 5,740 + accrual of 4,742 which relates to prior period 2011 finance charges = 3,674 + accrual of 2,531. Sfp Asset: non-current asset at 102,004 with annual depreciation of 34,001. 2010 net book value = 68,003. 2011 net book value =34,002. Liability 2010 Accrual of finance charge = 4,742 Lease obligation = 67,744 split between current of 31,584 and non current of 36,160 2011 Accrual of finance charge = 2,531. Lease obligation = 36,160 (all current). Asset B State that it is an operating lease and give the reason why. Lease payments in income statement = 30,000 in 2010 and 2011. Question 5 Answer all parts of this question. a. XYZ plc is considering whether to (i) issue share capital of 200,000 (1 nominal value shares) or (ii) issue 100,000 (1 nominal value shares) and raise 100,000 from a long term loan with an interest rate of 15% per annum. The future is uncertain and if XYZ plc has a good year, profit before interest and tax will be 100,000 but if it has a poor year, profit before interest and tax will be 20,000. Calculate profit after tax and earnings per share in both scenarios and comment on your results. Assume the tax rate is 35%. (8 marks) b. Identify and discuss the factors that influence the determination of the functional currency of an overseas subsidiary? (5 marks) [For the full question, please refer to the examination paper.] Reading for the question Subject guide, Chapters 8, 9, 11 and 14. International financial reporting, Chapters 12, 15, 25, 26 and 27.

91 Financial reporting

Approaching the question This question covers the accounting treatment of several different items, some parts requiring discussion of concepts or key items in financial statements and some parts require calculations. All parts of the question should be attempted with clear workings provided of any required calculations. The marks given to each section are indicated and these should be used as a guide for how long candidates should spend on each section. Solutions to Parts Part a Share capital PBIT Tax Pat e/s Share capital + debentures PBIT interest PBT Tax Pat e/s 100,000 (15,000) 85,000 (29,750) 55,250 0.55 20,000 (15,000) 5,000 (1,750) 3,250 0.03 Good 100,000 (35,000) 65,000 0.33 Bad 20,000 (7,000) 13,000 0.07

Appropriate comments should be made for example relating to variability and risk. Part b Up to five factors that influence the functional currency should be discussed. Part c Under IAS 11 Profit on contract = 4,000,000 1,200,000 1,000,000 = 1,800,000 Attributable profit = 1,8000,000 * 1,240,000/4,000,000 = 31% Income statement Sales Cost of sales 31% * 2,200,000 Profit 1,240,000 (682,000) 558,000

sfp = amounts recoverable = costs to date + recognised profit progress payments = 1,200,000 + 558,000 220,000 = 1,538,000 under ssap 9 income statement same balance sheet Work in progress = 518,000 Debtors 1,020,000. Part d The definition of LIFO and FIFO should be given and the differences between the methods and the impact of the difference methods on the financial statements should be discussed clearly.
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Examiners commentaries 2011

Question 6 Either a. What are non-current tangible assets and investment properties? Discuss the differences in the accounting treatment of non-current tangible assets and investment properties and discuss how the different accounting treatments affect the financial statements. or b. Why do we need a conceptual framework? Discuss the advantages and limitations of conceptual frameworks. This question related to a key component of financial statements, that of non-current assets and investment properties. Candidates need to be able to discuss the definitions of these items, analyse and discuss professional accounting requirements in these areas, and provide appropriate examples. A comparison of different accounting treatments and their impact on financial statements is important and must be explicitly covered in the answer. A discursive style should be adopted, avoiding bullet points if possible. Good answers should contain definitions of non-current tangible assets and investment properties and identify the different accounting treatments (depreciation, revaluations) possibly with a numerical example. The impact on the SFP and income statement needs to be discussed, again perhaps referring to a numerical example. Candidates may discuss the economic consequences of the different treatment. Part a Reading for the question Subject guide, Chapter 9. International financial reporting, Chapter 12. Approaching the question Good answers should contain definitions of non current tangible assets and investment properties and identify the different accounting treatments (depreciation, revaluations) possibly with a numerical example. The impact on the SFP and income statement needs to be discussed, again perhaps referring to a numerical example. Candidates may discuss the economic consequences of the different treatment. Part b Reading for the question Subject guide, Chapter 2. International financial reporting, Chapter 8. Approaching the question This question related to an important issue within financial reporting, that of the conceptual framework. Candidates need to be able to define conceptual frameworks and discuss advantages and limitations of conceptual frameworks. The question relates to standard setting in general and not to any specific accounting standard, but candidates may provide some examples of specific standards to illustrate their argument. However, candidates must not write exclusively about specific standards and not address the question set. A discursive style should be adopted, avoiding bullet points if possible. Good answers would define a conceptual framework and perhaps briefly outline the main contents of a typical conceptual framework. Both the
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advantages and disadvantages (see Chapter 2) should be discussed, with candidates assessing these advantages and disadvantages. Question 7 Either a. Set out the definitions of well offness and measures of income suggested by Sir John Hicks and evaluate their usefulness, implications and limitations for financial reporting. or b. Critically appraise both the traditional and economic arguments for and against accounting regulation. Part a Reading for the question Subject guide, Chapter 3. International financial reporting, Chapter 4. Approaching the question This question related to Hickss concepts of well-offness and income. Candidates need to be able to discuss and explain the concepts clearly using appropriate examples to illustrate their arguments. Equally important is the evaluation of the concepts in relation to financial reporting. A discursive style should be adopted, avoiding bullet points if possible. Good answers would describe and give examples of the required definitions, possibly referring to a numerical example. All three aspects of usefulness, implications and limitations (see Chapter 3) need to be addressed with some assessment of the issues raised. Part b Reading for the question Subject guide, Chapter 1. International financial reporting, Chapter 1. Approaching the question This question related to accounting regulation in general rather to any specific regulations. Candidates need to be able to define accounting regulation illustrating this with suitable examples. Candidates need to be able to discuss the advantages and disadvantages of accounting regulation form different theoretical perspectives and relate this to issues seen within accounting regulation in practice. A discursive style should be adopted, avoiding bullet points if possible. Good answers should define accounting regulation and perhaps outline the different types of regulation within accounting. Both traditional and economic arguments (for example, Beavers arguments) need to be discussed and assessed and arguments both for and against regulation need to be presented.

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Examiners commentaries 2011

Compound interest factors over n periods at rate i per period. To determine the present value of a single payment of 1 received n periods from the present at a constant discount rate of x% per period Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 5% 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 0.4581 0.4363 0.4155 0.3957 0.3769 6% 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651 0.6274 0.5919 0.5584 0.5268 0.4970 0.4688 0.4423 0.4173 0.3936 0.3714 0.3503 0.3305 0.3118 7% 0.9346 0.8734 0.8163 0.7629 0.7130 0.6663 0.6227 0.5820 0.5439 0.5083 0.4751 0.4440 0.4150 0.3878 0.3624 0.3387 0.3166 0.2959 0.2765 0.2584 8% 0.9259 0.8573 0.7938 0.7350 0.6806 0.6302 0.5835 0.5403 0.5002 0.4632 0.4289 0.3971 0.3677 0.3405 0.3152 0.2919 0.2703 0.2502 0.2317 0.2145 9% 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.5470 0.5019 0.4604 0.4224 0.3875 0.3555 0.3262 0.2992 0.2745 0.2519 0.2311 0.2120 0.1945 0.1784 10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 0.2633 0.2394 0.2176 0.1978 0.1799 0.1635 0.1486 12% 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 0.4523 0.4039 0.3606 0.3220 0.2875 0.2567 0.2292 0.2046 0.1827 0.1631 0.1456 0.1300 0.1161 0.1037

Table 1: Present value factors

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Table 2: Cumulative present value factors (annuity factors) The table gives the present value of n annual payments of 1 received for the next n years with a constant discount rate of x% per year. For example, with a discount rate of 8% and with six annual payments of 1 the present value is 4.6229 Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 5% 0.9524 1.8594 2.7232 3.5460 4.3295 5.0757 5.7864 6.4632 7.1078 7.7217 8.3064 8.8633 9.3936 9.8986 10.3797 10.8378 11.2741 11.6896 12.0853 12.4622 6% 0.9434 1.8334 2.6730 3.4651 4.2124 4.9173 5.5824 6.2098 6.8017 7.3601 7.8869 8.3838 8.8527 9.2950 9.7122 10.1059 10.4773 10.8276 11.1581 11.4699 7% 0.9346 1.8080 2.6243 3.3872 4.1002 4.7665 5.3893 5.9713 6.5152 7.0236 7.4987 7.9427 8.3577 8.7455 9.1079 9.4466 9.7632 10.0591 10.3356 10.5940 8% 0.9259 1.7833 2.5771 3.3121 3.9927 4.6229 5.2064 5.7466 6.2469 6.7101 7.1390 7.5361 7.9038 8.2442 8.5595 8.8514 9.1216 9.3719 9.6036 9.8181 9% 0.9174 1.7591 2.5313 3.2397 3.8897 4.4859 5.0330 5.5348 5.9952 6.4177 6.8052 7.1607 7.4869 7.7862 8.0607 8.3126 8.5436 8.7556 8.9501 9.1285 10% 0.9091 1.7355 2.4869 3.1699 3.7908 4.3553 4.8684 5.3349 5.7590 6.1446 6.4951 6.8137 7.1034 7.3667 7.6061 7.8237 8.0216 8.2014 8.3649 8.5136 12% 0.8929 1.6901 2.4018 3.0373 3.6048 4.1114 4.5638 4.9676 5.3282 5.6502 5.9377 6.1944 6.4235 6.6282 6.8109 6.9740 7.1196 7.2497 7.3658 7.4694

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Examiners commentaries 2011

Examiners commentaries 2011

91 Financial reporting Zone B Important note
This commentary reflects the examination and assessment arrangements for this course in the academic year 201011. The format and structure of the examination may change in future years, and any such changes will be publicised on the virtual learning environment (VLE).

Format of the examination paper

Candidates should answer FOUR of the following SEVEN questions. All questions carry equal marks. Workings should be submitted for all questions requiring calculations. Any necessary assumptions introduced in answering a question are to be stated. Extracts from compound interest tables are given after the final question on this paper. Eight-column accounting paper is provided at the end of this question paper. If used, it must be detached and fastened securely inside the answer book. A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book.

Comments on specific questions

Question 1 The income statements (profit and loss accounts) of Arm Plc, Leg Ltd and Toe Ltd for the year ended 31 December 2010 are given as follows: Arm Plc Sales Cost of sales Gross profit Administration costs Distributionistribution costs Dividends receivable Profit before tax Tax Profit after tax Transfers to reserves Dividends payable Retained profit for the year Retained profit brought forward Retained profit carried forward 1,000,000 (140,000) 860,000 (189,500) (104,000) 36,000 602,500 (200,000) 402,500 (60,000) (20,000) 322,500 1,600,000 1,922,500 232,000 (60,000) 172,000 (30,000) (10,000) 132,000 600,000 732,000 95,000 (20,000) 75,000 (24,000) (2,000) 49,000 400,000 449,000
1

Leg Ltd 400,000 (100,000) 300,000 (42,000) (26,000)

Toe Ltd 200,000 (60,000) 140,000 (35,000) (10,000)

91 Financial reporting

Arm Plc acquired 60% of Leg Ltd on 1 January 2003 for 150,000 when Leg Ltds retained profits were 80,000. The share capital of Leg Ltd totalled 50,000 on 1 January 2003. There has been no change in Leg Ltdd share capital since this date. [For the full question, please refer to the Examination paper.] Reading for the question Subject guide, Chapter 7. International financial reporting, Chapter 24. Approaching the question This question requires a detailed knowledge of preparation of consolidated financial statements, in this case consolidated income statements. Candidates should know what consolidated financial statements are, why they are prepared, what companies are included in consolidated financial statements and the definitions and explanation of key items included in consolidated financial statements. For the preparation of consolidated statements, candidates need to know the formats of these statements and be able to calculate the different components of the statements. It is important that candidates show detailed workings of how they arrive at figures included in the financial statements. Part a All definitions need to be discussed fully. Part b Solutions are provided below. All workings in 000.

Sales (1,000 + 400 14) Cost of sales (140 +100 14 + 2) Gross profit Administration costs (189.5 + 42) Distribution costs (104 + 26) Investment income (36 6 0.6) Management fee from a Share of Associates earnings 0.3 * (95 1 10) Goodwill Profit before tax Tax 200 + 60 + 30% * (20) Profit after tax NCI / Mint 40% (172 20 2) Transfer to reserves 60 + 0.6 * 30 + 0.3 * 24 Dividends payable Profit for the year Retained profit brought forward Retained profit carried forward Workings

1,386,000 (228,000) 1,158,000 (231,500) (130,000) 29,400 10,000 25,200 (10,000) 851,100 (266,000) 585,100 (60,000) (85,200) (20,000) 419,900 2,007,500 2,427,400

Ret Profit brought forward= 1,600 + 60% (600 80) + 30% (400 65) 5 = 1,600 + 312 + 100.5 5 = 2,007.5
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Examiners commentaries 2011

Question 2 Company M owns a manufacturing plant that cost 2,000,000 on 1 January 2009. The plant has a useful economic life of five years from this date and it is used to manufacture a product called the spike. There is no second hand market for the plant except as scrap and it is estimated that at the end of its useful life, or at any other time, it will cost 80,000 net of scrap proceeds, to dismantle and remove it. Annual operating costs are 800,000. The plant requires an overhaul costing 60,000 during the third year of its life. It produces a constant annual output, all of which can be sold, with an annual selling value of 1,600,000. [For the full question, please refer to the Examination paper.] Reading for the question Subject guide, Chapter 6. International financial reporting, Chapters 5 and 6. Approaching the question This question covers both a discussion of deprival value and calculations relating to deprival value. Candidates should attempt both parts of the question and answer all the questions set. For the calculations, candidates need to be able to apply the concepts of deprival value to an example. It is important that candidates show detailed workings of how they arrive at their answer. Part a For the discussion of deprival value, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible. Part b Solutions to Part b are given below. Aec = (2,200,000 + 4.3553 * 720,000 0.5645 * 40,000)/4.3553 = 1,219,947. Have 2010 Op. costs of old machine Overhaul Removal New building work AEC Totals Have not Adapt building Aec Extra income Difference Df Pv 100,000 1 100,000 100,000 1,219,947 1,219,947 1,219,947 1,219,947 (60,000) 299,947 0.9091 272,682 (60,000) 359,947 0.8264 297,460 (60,000) 179,947 0.7513 135,194 0 0 0 860,000 800,000 2011 800,000 60,000 80,000 100,000 1,219,947 980,000 1,219,947 2012 800,000 2013 800,000 2014

Pv of difference = cost of replacing services of existing asset = 805,336 = deprival value.

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Note: Some figures may be included differently in the AEC and have or have not budgets and full credit is given for correct workings if different to the above. Question 3 Bear Ltd started trading on 1 January 2010. The income statement for the year ended 31 December 2010 and the statement of financial position as at 31 December 2010 are given as follows: Income statement for 2010 Sales Cost of sales Opening inventories Purchases Closing inventories Gross profit Expenses Depreciation Net profit Statement of financial position as at 31 December 2010 Non-current assets plant and machinery Inventories Other net current assets Net assets Share capital (1 shares) Retained earnings Share capital and reserves [For the full question, please refer to the Examination paper.] Reading for the question Subject guide, Chapter 5. International financial reporting, Chapter 7. Approaching the question This question covers both a discussion of fully stabilised current value accounts and the preparation of current value financial statements and calculations for key components of fully stabilised financial statements. Candidates should attempt both parts of the question and answer all the questions set. For the calculations, it is important that candidates show detailed workings of how they arrive at their answer. Part a For the discussion of fully stabilised current value financial statements, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible.
4

4,050,000

225,000 2,700,000 (270,000) (2,655,000) 1,395,000 (450,000) (126,000) 819,000

3,888,000 270,000 1,161,000 5,319,000 4,500,000 819,000 5,319,000

Examiners commentaries 2011

Part b Solutions to Part b are given below. IS Sales Cost of sales Op invent Purchases Clo invent GP Exp Depreciation Nca unrealised Invent unrealised NCA realised Invent realised Retained earnings Balance sheet SFP Non-current assets Inventories Other net current assets Net assets Share capital (1 shares) Retained earnings Share capital and reserves Part c Nca real unrealised Nca real realised Invent real realised 5,832,000 3,888,000 * 120/100 = 1,166,400. 189,000 126,000 * 120/100 = 37,800. 2,682,643 * 120/110 2,933,716 = (7,196). 819,000 4,050,000 225,000 2,700,000 (270,000) (2,655,000) 1,395,000 (450,000) (126,000) 270/250 270/280 243,000 2,700,000 (260,357) (2,682,643) 1,367,357 (450,000) (189,000) 728,357 1,944,000 9,642 63,000 27,643 2,772,642 4,050,000

250/200

3,888,000 270,000 1,161,000 5319,000 4,500,000 819,000 5,319,000

300/200 290/280

5832,000 279,642 1,161,000 7,272,642 4,500,000 2,772,642 7,272,642

Invent real unrealised 279,642 270,000 * 120/115 = (2,097).

91 Financial reporting

Question 4 Rhymes Ltd enters into two lease transactions in 2010 as follows: 1. An asset, asset A, which could be purchased outright for 319,770 is instead leased for three years. The useful economic life of the asset is three years and at the end of this time, the asset will have no residual value. Rhymes Ltd is responsible for all maintenance and repairs and for all insurance costs for asset A. The lease for asset A provides for halfyearly payments in advance of 60,000, the first payment being made on 1 January 2010. 2. An asset, asset B, which could be purchased outright for 360,000 is leased for three years for annual payments of 90,000 per annum payable in advance. The useful economic life of asset B is eight years. At the end of the three years, Rhymes Ltd intends to return the asset. Rhymes Ltd is not responsible for maintaining and insuring asset B. [For the full question, please refer to the Examination paper.] Reading for the question Subject guide, Chapter 9. International financial reporting, Chapter 12. Approaching the question The question covers both a discussion on operating and finance leases and calculations showing how these would be accounted for in financial statements. For the discussion of operating and finance leases, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible. For the calculations, it is important that candidates show detailed workings of how they arrive at their answer. Part a A discussion of the definition of operating and finance leases with examples is required with discussion of how these different leases are accounted for. Part b Solutions for Part b are given below. The answer requires a recognition that it is finance lease, and the reason for this. Asset a Rate implicit in the lease: 319,770 = 60,000 +60,000 a5]? a5]? = 259,770/60,000 a5]? = 4.3295 which gives a rate of 5% from tables.

Examiners commentaries 2011

Rental payments Date 1.1.2010 1.1.2010 1.7.2010 1.1.2011 1.7.2011 1.1.2012 1.7.2012 Rental payment Finance charge Reduction in obligation Balance of obligation under finance lease 319,770 60,000 60,000 60,000 60,000 60,000 60,000 x 12,989 10,638 8,170 5,579 2,857 60,000 47,011 49,362 51,830 54,421 57,143 259,770 212,759 163,397 111,567 57,146 0 Rounding difference

Income statement 2010 finance charge =12,989 + accrual of 10,638 which relates to prior period. 2011 finance charges = 8,170 + accrual of 5,579. Sfp Asset: non-current asset at 319,770, with annual depreciation of 106,590. 2010 net book value = 213,180. 2011 net book value =106,590. Liability 2010 Accrual of finance charge = 10,638. Lease obligation = 212,759. Current = 101,192. Non-current = 111, 567. 2011 Accrual of finance charge = 5,579. Lease obligation = 111,567 all current. Asset B Operating lease Operating lease and reason why. Lease payments in income statement = 90,000 in 2010 and 2011.

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Question 5 Answer all parts of this question. a. What is share premium? Discuss the permissible uses for the share premium account. (5 marks) b. XYZ plc is considering whether to (i) issue share capital of 400,000 (1 nominal value shares) or (ii) issue 200,000 (1 nominal value shares) and raise 200,000 from a long term loan with an interest rate of 15% per annum. The future is uncertain and if XYZ plc has a good year, profit before interest and tax will be 200,000 but if it has a poor year, profit before interest and tax will be 40,000. Calculate profit after tax and earnings per share in both scenarios and comment on your results. Assume the tax rate is 35%. (8 marks) [For the full question, please refer to the Examination paper.] Reading for the question Subject guide, Chapters 7, 10, 12 and 14. International financial reporting, Chapters 13, 16, 18, 24, 26 and 27. Approaching the question This question covers the accounting treatment of several different items, some parts requiring discussion of concepts or key items in financial statements and some parts require calculations. All parts of the question should be attempted with clear workings provided of any required calculations. The marks given to each section are indicated and these should be used as a guide for how long candidates should spend on each section. Solutions to parts a. Definition of share premium and its uses should be fully discussed. b. Share capital PBIT Tax Pat e/s Share capital + debentures PBIT Interest PBT Tax Pat e/s 200,000 (30,000) 170,000 (59,500) 110,500 0.553 40,000 (30,000) 10,000 (3,500) 6,500 0.033 Good 200,000 (70,000) 130,000 0.325 Bad 40,000 (14,000) 26,000 0.065

Appropriate comments should be made for example on variability and risk. c. Both the criteria for merger accounting and the reasons for why it was banned need to be fully discussed. d. Research will be written off to income statement as an expense. Development project: Development will be capitalised and amortised if it meets criteria which this project appears to. Identify criteria. Capitalise staff costs of 400,000 and depreciation of 100,000.
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Examiners commentaries 2011

Note: full marks were given if candidates assumed that the development costs were in addition to staff costs and capital expenditure. Question 6 Either a. What are non-current tangible assets and investment properties? Discuss the differences in the accounting treatment of non-current tangible assets and investment properties and discuss how the different accounting treatments affect the financial statements. Or b. Discuss the reasons for initiating standard setting in the 1970s and assess the advantages and limitations of standard setting in the UK. Part a Reading for the question Subject guide, Chapter 9. International financial reporting, Chapter 12. Approaching the question This question related to a key component of financial statements, that of non-current assets and investment properties. Candidates need to be able to discuss the definitions of these items, to analyse and discuss professional accounting requirements in these areas, and provide appropriate examples. A comparison of different accounting treatments and their impact on financial statements is important and must be explicitly covered in the answer. A discursive style should be adopted, avoiding bullet points if possible. Good answers should contain definitions of non-current tangible assets and investment properties and identify the different accounting treatments (depreciation, revaluations) possibly with a numerical example. The impact on the SFP and income statement needs to be discussed, again perhaps referring to a numerical example. Candidates may discuss the economic consequences of the different treatment. Part b Reading for the question Subject guide, Chapter 1. International financial reporting, Chapter 1. Approaching the question This question related to an important issue within financial reporting, that of standard setting in the UK. Candidates need to be able to define standard setting and discuss advantage and limitations of standard setting, a topical subject in financial reporting. The question relates to standard setting in general and not to any specific accounting standard but candidates may provide some examples of specific standards to illustrate their argument. However, candidates must not write exclusively about specific standard and not address the question set. A discursive style should be adopted, avoiding bullet points if possible. Good answers should outline the process of standard setting in the UK and may provide a definition of what an accounting standard is. Answers should discuss the reasons for standard setting (see Chapter 1) and discuss the advantages and disadvantage of standard setting. Candidates
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may also discuss recent developments in standard setting in the UK and discuss the improvements and advantages and limitations of the recent developments. Question 7 Either a. Set out the definitions of well offness and measures of income suggested by Sir John Hicks and evaluate their usefulness, implications and limitations for financial reporting. Or b. Compare and contrast the different methods for translating the financial statements of foreign subsidiaries. Discuss how the foreign exchange reserves arise under each method, how they should be accounted for and the situations in which each of the methods should be used. Part a Reading for the question Subject guide, Chapter 3. International financial reporting, Chapter 4. Approaching the question This question related to Hickss concepts of well-offness and income. Candidates need to be able to discuss and explain the concepts clearly using appropriate examples to illustrate their arguments. Equally important is the evaluation of the concepts in relation to financial reporting. A discursive style should be adopted, avoiding bullet points if possible. Good answers would describe and give examples of the required definitions, possibly referring to a numerical example. All three aspects of usefulness, implications and limitations (see Chapter 3) need to be addressed with some assessment of the issues raised. Part b Reading for the question Subject guide, Chapter 8. International financial reporting, Chapter 25. Approaching the question The question related to the topic of foreign exchange within financial reporting. Candidates need to be able to explain the accounting techniques, providing suitable examples to illustrate their answer. Candidates also need to be able to compare and contrast different techniques in this question, identify the key similarities and differences between the different techniques and explain and discuss the impact of different techniques on financial statements. A discursive style should be adopted, avoiding bullet points if possible. Good answers should outline the temporal and closing rate methods and compare and contrast these methods, for example, the key exchange rates used, where the FX is accounted for, treatment of goodwill, etc., possibly referring to a numerical example. Candidates should describe the situations when the different methods should be used and identify the factors which indicate the functional currency and which method is required.

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Examiners commentaries 2011

Compound interest factors over n periods at rate i per period. Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 5% 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 0.4581 0.4363 0.4155 0.3957 0.3769 6% 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651 0.6274 0.5919 0.5584 0.5268 0.4970 0.4688 0.4423 0.4173 0.3936 0.3714 0.3503 0.3305 0.3118 7% 0.9346 0.8734 0.8163 0.7629 0.7130 0.6663 0.6227 0.5820 0.5439 0.5083 0.4751 0.4440 0.4150 0.3878 0.3624 0.3387 0.3166 0.2959 0.2765 0.2584 8% 0.9259 0.8573 0.7938 0.7350 0.6806 0.6302 0.5835 0.5403 0.5002 0.4632 0.4289 0.3971 0.3677 0.3405 0.3152 0.2919 0.2703 0.2502 0.2317 0.2145 9% 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.5470 0.5019 0.4604 0.4224 0.3875 0.3555 0.3262 0.2992 0.2745 0.2519 0.2311 0.2120 0.1945 0.1784 10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 0.2633 0.2394 0.2176 0.1978 0.1799 0.1635 0.1486 12% 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 0.4523 0.4039 0.3606 0.3220 0.2875 0.2567 0.2292 0.2046 0.1827 0.1631 0.1456 0.1300 0.1161 0.1037

Table 1: Present value factors To determine the present value of a single payment of 1 received n periods from the present at a constant discount rate of x% per period Table 2: Cumulative present value factors (annuity factors) The table gives the present value of n annual payments of 1 received for the next n years with a constant discount rate of x% per year. For example, with a discount rate of 8% and with six annual payments of 1 the present value is 4.6229. Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 5% 0.9524 1.8594 2.7232 3.5460 4.3295 5.0757 5.7864 6.4632 7.1078 7.7217 8.3064 8.8633 9.3936 9.8986 10.3797 6% 0.9434 1.8334 2.6730 3.4651 4.2124 4.9173 5.5824 6.2098 6.8017 7.3601 7.8869 8.3838 8.8527 9.2950 9.7122 7% 0.9346 1.8080 2.6243 3.3872 4.1002 4.7665 5.3893 5.9713 6.5152 7.0236 7.4987 7.9427 8.3577 8.7455 9.1079 8% 0.9259 1.7833 2.5771 3.3121 3.9927 4.6229 5.2064 5.7466 6.2469 6.7101 7.1390 7.5361 7.9038 8.2442 8.5595 9% 0.9174 1.7591 2.5313 3.2397 3.8897 4.4859 5.0330 5.5348 5.9952 6.4177 6.8052 7.1607 7.4869 7.7862 8.0607 10% 0.9091 1.7355 2.4869 3.1699 3.7908 4.3553 4.8684 5.3349 5.7590 6.1446 6.4951 6.8137 7.1034 7.3667 7.6061 12% 0.8929 1.6901 2.4018 3.0373 3.6048 4.1114 4.5638 4.9676 5.3282 5.6502 5.9377 6.1944 6.4235 6.6282 6.8109
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16 17 18 19 20

10.8378 11.2741 11.6896 12.0853 12.4622

10.1059 10.4773 10.8276 11.1581 11.4699

9.4466 9.7632 10.0591 10.3356 10.5940

8.8514 9.1216 9.3719 9.6036 9.8181

8.3126 8.5436 8.7556 8.9501 9.1285

7.8237 8.0216 8.2014 8.3649 8.5136

6.9740 7.1196 7.2497 7.3658 7.4694

12