ICA PROFESSIONAL

FINANCIAL REPORTING
EXAMINATION QUESTIONS AND ANSWERS (THEORY)
MAY 2010
1. Explain the principles and reasoning for the use of equity accounting in preparing
consolidated financial statements.
ANS:
Equity accounting is one of the methods for a company with subsidiaries to account for
investments in its subsidiaries.
The investment is initially recorded in the consolidated statement of financial position at
cost to the group which is also the fair value of the group share of the acquired assets
and liabilities including goodwill arising on the investment. The carrying amount is
adjusted for any write-off or impairment of goodwill and is increased or decreased to
recognize its share of the profits or losses after the date of acquisition. The equity
method of accounting for investments in subsidiaries is suitable for interest greater than
2! but less than "! of the net assets in the subsidiary. #t is normally referred to as
$ssociates where there is significant influence%interest but not controlling interest.
2. &hat are the advantages of international harmonization '(are size fits all( global
standard) to*
i) #nvestors%lenders
ii) +ultinational companies
iii) ,thers
i. In!"#$%"&L!n'!%"
a) -.y using common sets of accounting standards/ cross border investors will be able
to compare apples with apples0 with a minimal adjustment of nearly transparent
company financial statements.
b) +ost non-domestic investors made by public investment companies and 1.. 11
are made by using analysts who specialize in examination of financial statements
from different countries leading to higher cost of communication.
c) .y using international standards/ investors comparability and understanding ability
of financial statements will be enhanced leading to better investment decisions.
ii. M()#in*#i$n*) C$+,*ni!"
.y using international standards/ companies will improve their image and thus avoid
-financial principle shopping0 syndrome. The benefits of harmonization are as follows*
a) 2reparation of consolidated accounts will be easier
b) #nternal communication and comparison of results would be enhanced leading to
improved management control
c) $ccess to international funds will be easier with an added benefit of lower cost of
capital
d) $ppraisal of foreign enterprises for ta3eover will be more straightforward4 and
e) 5ost savings and efficiency will result from less staff training in accounting
departments.
iii. O#-!%"
a) Tax authorities* harmonization will lead to greater efficiency and productivity
regarding collection of taxes and problems regarding transfer pricing.
b) 6eveloping countries* taxing and regulating multinationals will be easier.
c) #nternational economic groupings* gross-border trade and investments will be
easier/ eg. E7/ 78$/ 5hina/ 9apan/ etc.
.. .riefly state and describe five '") main wea3nesses of the :istorical 5ost 5onvention in
financial report ing.
;. <eturn on 5apital Employed '<,5E) can be distorted as a result of profits being
overstated in real terms and assets such as fixed assets being understated.
2. :istorical 5ost $ccounts may fail to show whether a company is earning
sufficient funds to enable it to maintain its capital real.
=. $lso/ historical cost accounts may fail to show the extent to which funds can
prudently be distributed in the form of dividends.
>. :istorical cost accounts can give misleading impression of growth and
profitability.
". #t does not express in current prices all of the resources employed in a business.
?. $nother possible wea3ness is the matching of current revenues expresses in
current prices with historical cost may result in inflated profits being reported.
MAY 2011
/. ,utline four '>) conditions under which the management of E#5 would be justified in their
decision 'with reference to #$8 2@ A5onsolidated and 8eparate Binancial 8tatementsA)
ANS:
$ parent may be exempted from presenting consolidated financial statement s if and
only if the following can e established*
'i) the parent is itself a wholly-owned subsidiary/ or the parent is a partially-owned
subsidiary of another entity and its other owners/ including those not otherwise entitled
to vote/ have been informed about/ and do not object to/ the parent not preparing
consolidated financial statements4
'ii) the parentCs debt or equity instruments are not traded in a public mar3et 'iii) the
parent did not file/ nor is it in the process of filing/ its financial statements with a
securities commission or other regulatory organization for the purpose of issuing any
class of instruments in a public mar3et4 and 'iv) the ultimate or any intermediate parent
of the parent produces consolidated financial statements available for public use that
comply with #nternational Binancial <eporting 8tandards. The 8tandard clarifies the
requirements for a parent exempted from preparing consolidated financial statements
when the parent elects/ or is required by local regulations/ to present separate financial
statements.
0. Explain the term (Dearing( in relation to the capital structure of a company limited by
shares.
ANS:
Dearing is the relationship between fixed interest bearing long term loans plus fixed
dividend bearing shares on one hand and equity share capital or equity fund on the
other. $n alternative term for gearing is leverage.
Dearing E long Term Foan G 2reference 8hares Equity Bund
Equity funds
1. ,utline the role and structure of #nternational $ccounting 8tandards .oard '#$8.).
ANS:
The formal $23!4#i!" of the #$8./ formulated in its mission statement are*
'a) To develop/ in the public interest/ a single set of high quality/ understandable and
enforceable global accounting standards that require transparent and
comparable information in general purpose financial statements.
'b) To co-operate with national accounting standard setters to achieve convergence
in accounting standards around the world.
'c) to develop a single set of high quality/ understandable/ enforceable and globally
accepted In#!%n*#i$n*) Fin*n4i*) R!,$%#in5 S#*n'*%'" (IFRS") through its
standard-setting body/ the In#!%n*#i$n*) A44$(n#in5 S#*n'*%'" 6$*%' (IAS6)4
'd) to promote the use and rigorous application of those standards4
'e) to ta3e account of the financial reporting needs of emerging economies and small
and medium-sized entities '8+Es)4 and
'f) to promote and facilitate adoption of #B<8s/ being the standards and
interpretations issued by the #$8./ through the convergence of national
accounting standards and #B<8s.
The "#%(4#(%! of the #$8. has the following main features.
'a) The .oard consists of ;2 full-time members and two part-time members.
'b) #t operates under the umbrella of The #$85 foundation 'which is an independent
corporation having two main bodies H the Trustees and the #$8..)
'c) The #$85 Boundation trustees appoint the #$8. members/ exercise oversight
and raise the funds needed.
'd) The #$8. has sole responsibility for setting accounting standards.
'e) There are also two further bodies/ the 8tandard $dvisory 5ouncil and the
#nternational Binancial <eporting #nterpretations 5ommittee.
MAY 2012
7. #$8 2@ -Consolidated and separate financial statements0 provides circumstances in
which an entity can be said to have control over another 'subsidiary). ,utline 8i! (0)
conditions that are indicative of the existence of control.
C$n'i#i$n":
;. The power to govern the financial and operating policies of an entity.
2. ,wnership of more than "! of the ordinary shares in the investee entity4
=. 5asting more than half of the voting rights because of an agreement with
other investors4
>. Doverning the financial and operating policies of the entity by law or by
agreement4
". $ppointment or removal of the majority of the members of the board of
directors and control of the entity is by that board4
?. 5asting the majority of votes at a meeting of the board of directors and
control is exercised by that board
9. Explain the concept of Ifair presentationC and compare it with Jtrue and fair i!:;
F*i% ,%!"!n#*#i$n *n' #%(! *n' 8*i% i!:
#$8 ; Presentation of Financial Statements describes the concept of fair presentation.
Bair presentation involves representing faithfully the effect of transactions/ other events
and conditions in accordance with the definitions and recognition criteria in the #$8.
Framework.
This is developed by stating that the application of #B<8/ interpretations and additional
disclosures will result in fair presentation.
The traditional 7K approach required financial statements to comply with the 5ompanies
$ct 'and therefore 7K standards) and give a true and fair view. True could be
approximated to Jrepresent faithfullyC and fair to Jfair presentationC. #$8 ; lin3s them by
stating that compliance with standards will give a fair presentation. $s a result there is
unli3ely to be any difference between the two.
&hilst not dealing with the concepts directly/ the #$8. Framework uses the descriptions
of fair presentation and true and fair view interchangeably in its discussion of the
application of the principal qualitative characteristics of financial information.
<. Explain the concept of I"(2"#*n4! $!%=8$%+; and its relationship to >8*i% ,%!"!n#*#i$n;
S(2"#*n4! $!% 8$%+ *n' 8*i% ,%!"!n#*#i$n
+ost transactions are reasonably straightforward and their substance 'their commercial
effect) is the same as their legal form. #n some complex transactions the true substance
may not be readily apparent. Their legal form may not adequately express the true
commercial effect of such transactions.
&here this is the case/ it may not be sufficient to account for them by merely recording
their form. The financial statements should represent commercial substance/ not just
legal form 'substance over form). #f a transaction gives rise to an asset or liability 'as
defined in the #$8. Framework)/ it should be accounted for on this basis even if this is
different from its legal form. $pplying the definitions of an asset and a liability identifies
the appropriate accounting treatment.
The #$8. Framework identifies that if information is to represent faithfully the
transactions it purports to represent/ then they should be accounted for in accordance
with their substance and economic reality and not merely their legal form. The substance
may not be consistent with the legal form of a transaction. $n example is a sale and
repurchase agreement.
10. Explain the circumstances in which non-compliance with the detailed provisions of an
accounting standard would be justified.
N$n=4$+,)i*n4! :i#- IFRS
#$8 ; allows non-compliance with a standard 'or interpretation) only where management
concludes that compliance would be so misleading as to conflict with objectives of
financial statements set out in the #$8. Framework. :owever this is only where the
relevant regulatory framewor3 requires/ or does not prohibit/ such a departure.
The standard uses the phrase Jwhere management concludesC which may indicate that
there a margin for those preparing the financial statements to use this exception where
they believe it is appropriate. :owever/ #$8 ; tal3s about this coming about Jin extremely
rare circumstancesC. To all intents and purposes/ these circumstances will never occur.
11. 6efine an #nvestment 2roperty 'in reference to. #$8 >)
In!"#+!n# ,%$,!%#? :Fand or building/ or part of a building/ or both/ held by the owner
or the lessee under a finance lease to earn rentals and%or for capital appreciation/ rather
than for use in production or supply of goods and services or for administrative purposes
or for sale in the ordinary course of business.
12. 6iscuss #:$ (2) situations under which a party can be said to be related.
R!)*#!' P*%#i!"
Entities are deemed to be related parties when one of them either*
;. :as the ability to control the other
2. 5an exercise significant influence over the other entity in ma3ing financial and
operating decisions4
=. :as joint control over the other
>. #s a joint venture in which the other entity is a joint venture4 or
". Bunctions as 3ey management personnel of the other entity.
1.. 8tate #-%!! (.) transactions which can be described as related party transactions which
must be disclosed.
8ome examples of %!)*#!' ,*%#? #%*n"*4#i$n" that may require disclosure by a
reporting entity include*
;. 2urchases or 8ale of goods 'finished or unfinished)
2. <endering or receiving of services
=. $gency arrangement
>. Feasing arrangement
". Transfer of research and development
?. Ficense agreements
@. Binancial transactions li3e loans and equity participation H in cash or in 3ind.
L. Duarantees and 5ollaterals
MAY 201.

1/. ,utline 8i! (0) objectives the #$8.Cs conceptual framewor3 of accounting see3s to
achieve.
The purpose of this framewor3 is to
;. $ssist the #$8. in the development of future accounting standards and in its
review of existing accounting standards
2. $ssist the #$8. by providing a basis for reducing the number of alternative
accounting treatments
=. $ssist national standard-setting bodies in developing national standards
>. $ssist accountants to apply relevant accounting standards in preparing financial
statements and in dealing with topics that do not form the subject of #nternational
accounting standards4
". $ssist auditors in forming an opinion as to whether financial statements conform
with relevant accounting standards4
?. $ssist users of financial statements in interpreting the information contained in
financial statements prepared in conformity with #nternational $ccounting
8tandards
10. 8tate the main contents of the #$8.Cs conceptual framewor3 for financial reporting.
The specific topics discussed under the framewor3 are as follows*
;. The objectives of financial 8tatements4
2. 7ser groups
=. $ssumptions underlying financial statement preparation4
>. Mualitative 5haracteristics of financial statements4
". The elements of financial statements4 their recognition and their measurement
?. The concepts of capital maintenance
11. 6escribe the role of #nternational $ccounting 8tandard .oard '#$8.) and outline the
standard setting process it adopts in coming out with #nternational Binancial <eporting
8tandards '#B<8s).
NO@ 2011
17. 5ontrol is presumed to exist when the parent owns directly or indirectly through
subsidiaries/ more than one-half of the ordinary shares of an entity. #n some exceptional
circumstances/ however/ control can be presumed even though the investor entity owns
"! or less of the shares of the investee entity. ,utline 8$(% (/) of such exceptional
circumstances.
ANS:
5ontrol is presumed to exist when the parent owns/ directly or indirectly through
subsidiaries more than half of the voting power of an entity unless/ an exceptional
circumstances/ it can be clearly demonstrated that such ownership does not constitute
control. 5ontrol also exists when the parent owns half or less the voting power of an
entity when there is*
;. power over more than half of the voting rights by virtue of an agreement with
other investors4
2. power to govern the financial and operating policies of the entity under a statute
or an agreement4
=. power to appoint or remove the majority of the members of the board of directors
or equivalent governing body and control of the entity is by that board or body4 or
>. power to cast the majority of votes at meetings of the board of directors or
equivalent governing body and control of the entity is by that board or body.
19. ,utline the provisions of 8ection " of the #ncorporated 2artnership $ct/ ;N?2 '$ct ;"2)
with respect to rules relating to application of a firm s property in settling accounts
between partners.
A,,)i4*#i$n $8 8i%+;" ,%$,!%#?
,n the winding up of a firm/ every partner and every former partner or his legal
representative who has not been paid the amount due him shall be entitled to have the
underta3ing and assets of the firm sold and the proceeds applied in payment of the
debts and liabilities of the firm. The surplus is applied to pay of what may be due to the
partners respectively. #n settling accounts between partners/ the following rules shall/
subject to any agreement/ be observed*
a. O Fosses/ other than deficiencies of capital shall be paid/ first out of profits/ next
out of capital and lastly/ if necessary/ by the partners individually in the proportion
in which they were entitled to share profits4
b. 6eficiencies of capital shall not be made up but shall be borne by the partners in
the proportion in which they were entitled to capital
c. O The assets of the firm shall be applied in the following manner and order4
i. #n paying the debts and liabilities of the firm to persons who are not
partners4
ii. #n paying to each partner rateably what is due from the firm to him for
advances as opposed to his agreed share of capital4
iii. #n paying to each partner reteably what is due from the firm to him in
respect of capital4
iv. The ultimate residue/ if any/ shall be divided among the partners in the
proportion in which profits are divisible
1<. +easurement is a 3ey criteria underpinning Binancial <eporting 8tandards. Explain the
8$(% (/) measurement bases proposed by the #$8. 5onceptual Bramewor3 of
accounting.
+easurement of the elements of financial statements
The Bramewor3 identifies four possible measurements bases*
;. :istorical cost
2. 5urrent cost
=. <ealizable value
>. 2resent value
Hi"#$%i4*) 4$"#* $ssets are recorded at the amount of cash or cash equivalents paid or
the fair value of the consideration given to acquire them at the time of acquisition.
Fiabilities are recorded at the amount of proceeds received in exchange for the
obligation.
C(%%!n# 4$"#: $ssets are carried at the amount of cash or cash equivalents required to
acquire them currently. Fiabilities are carried at the discounted amount currently required
to settle them.
R!*)iA*2)! *)(!* $ssets are carried at the amount which could currently be obtained by
an orderly disposal. Fiabilities are carried at their settlement values-the amount to be
paid to satisfy them in the normal course of business.
P%!"!n# *)(!: $ssets are carried at the present discounted value of the future net cash
inflows that the item is expected to generate in the normal course of business/ and
liabilities at the present discounted value of the expected outflows necessary to settle
them.
20. #$8 2= -.orrowing 5osts0 regulates the extent to which entities are allowed to capitalize
borrowing costs incurred on money borrowed to finance the acquisition of certain assets.
8tate the conditions to be met for*
'a) 5apitalization of borrowing costs to commence.
'b) 5apitalization of borrowing costs to cease.
ANS:
(*). C$++!n4!+!n# $8 4*,i#*)i"*#i$n
The capitalisation of borrowing costs as part of the cost of a qualifying asset shall
commence when*
;. expenditures for the asset are being incurred4
2. borrowing costs are being incurred4 and
=. activities that are necessary to prepare the asset for its intended use or sale are
in progress.
(2). C!""*#i$n $8 4*,i#*)i"*#i$n
5apitalization of borrowing costs shall cease when substantially all the activities
necessary to prepare the qualifying asset for its intended use or sale are complete. $n
asset is normally ready for its intended use or sale when the physical construction of the
asset is complete even though routine administrative wor3 might still continue. #f minor
modifications/ such as the decoration of a property to the purchaserCs or userCs
specification/ are all that are outstanding/ this indicates that substantially all the activities
are complete. &hen the construction of a qualifying asset is completed in parts and each
part is capable of being used while construction continues on other parts/ capitalisation
of borrowing costs shall cease when substantially all the activities necessary to prepare
that part for its intended use or sale are completed.
21. $nalyze the following ratios
T-! *n*)?#i4*) ("! $8 !*4- $8 #-!"! 8i! %*#i$":
;. Current ratio* - +easures ability to meet short-term obligations using short-term
assets.
2. Acid-test ratio* - +easures ability to meet short-term obligations using the most
liquid assets.
=. Inventory turnover* - +easures how quic3ly inventory is sold
>. Times interest earned* - +easures the ability to meet interest commitments
from current earnings. The higher the ratio/ the more safety there is for long-term
creditors.
". Debt-to-equity ratio* - +easures the level of protection creditors have in the
case of possible insolvency. #t is also used to help gauge the companyCs capacity
to ta3e on additional debt.
22. #dentify 8i! (0) limitations of ratio analysis.
The difficulties and limitations of ratio analysis include the following*
i. $lthough ratios are useful as a starting point in financial analysis/ they are not
an end in themselves. <atios can be used as indicators of what to pursue in a
more detailed analysis.
ii. 6ifferent companies often use different accounting methods 'e.g. B#B, versus
F#B, inventory valuation) and this can have an impact on the financial ratios
that does not reflect real differences in the operations and financial health of
the companies.
iii. +a3ing comparisons across industries can be difficult. 5ompanies in different
industries tend to have different financial ratios.
iv. 8ince the ratios are based on accounting statements/ they measure what has
happened in the past and not necessarily what will happen in the future.
NO@ 2012

2.. #n accordance with #$8 ; H 2resentation of Binancial 8tatements/ explain*
'ii) the components of a complete set of Binancial 8tatement/ and
'iii) the Elements of Binancial 8tatement

i. C$+,$n!n#" $8 Fin*n4i*) S#*#!+!n#":
;. $ statement of Binancial 2osition as at the end of the period4
2. $ statement of 5omprehensive #ncome for the period4
=. $ statement of changes in equity for the period4
>. Potes/ comprising a summary of significant accounting policies and other
explanatory information4
". $ statement of cash flow for the period4 and
?. $ statement of Binancial 2osition as at the beginning of the earliest comparative
period when an entity applies an accounting policy retrospectively or ma3es a
retrospective restatement of items in it Binancial 8tatement.
ii. E)!+!n#" $8 Fin*n4i*) S#*#!+!n#"
Binancial statements portray the financial effect of transactions and other events
by grouping them into broad classes according to their economic characteristics.
These broad classes are termed -the Elements of Binancial 8tatements0.
The elements directly related to the measurement of Binancial 2osition in the
8tatement of financial position are* $ssets/ Fiabilities and Equity. $ssets and
Fiabilities are sub-divided into Pon-5urrent and 5urrent $ssets and Fiabilities.
The Elements directly related to the measurement of performance in the
statement of comprehensive income are Expenses and #ncome.
Expenses is sub-divided into Expenses and Fosses while #ncome is sub-divided
into 8ales%<evenue%Turnover and Dains.
2/. 6etail out the treatment of the above events in accordance with #$8 2 H $ccounting for
Dovernment Drant and disclosure of Dovernment assistance.

D,QE<P+EPT D<$PT H There are two types of Dovernment Drants
The first is a Dovernment Drant related to $ssets/ while the second is a grant <elated to
#ncome.
G%*n# R!)*#!' #$ A""!#"* - are government grants whose primary conditions is that an
entity qualifying for them should purchase/ construct/ or otherwise/ acquire long-term
assets.
Drant related to $ssets/ shall be presented in the statement of financial position either
'i) by setting up the grant as deferred income and amortized over the useful life of the
$ssets or
'ii) by deducting the grant in arriving at the carrying amount of the asset.
,f the above treatment the first 'i) is preferred.
G%*n# %!)*#!' #$ In4$+! are Dovernment Drants other than those related to $ssets.
Drant related to income are*
'i) sometimes presented as a credit in the statement of 5omprehensive #ncome as other
separately or
'ii) they are deducted in exporting the related expense
,f the two methods of treating grant related to #ncome the first 'i) method is preferred.