SECTION A – CASE QUESTIONS (Total: 50 marks)

Answer the following ONE compulsory question which relates to the Case below. Marks
will be awarded for logical argumentation and appropriate presentation of the answers.

CASE

You are the accounting manager of Pass Holdings Limited (“PHL”), a listed company in Hong
Kong, engaged in the trading of construction materials. The balance sheets of PHL and its
investee companies, Success Insight Limited (“SIL”) and Outstanding Achievement Limited
(“OAL”), at 31 March 2007 are shown below:

Summary balance sheets at 31 March 2007:

PHL SIL OAL

$'000 $'000 $'000 $'000 $'000 $'000
Non-current assets
Investment property 54,900 - -
Equipment 5,000 32,500 15,700
Investments 30,000 - -
89,900 32,500 15,700
Current assets
Inventories 11,500 6,000 5,300
Receivables 1,800 4,200 4,800
Cash 800 4,000 3,000
14,100 14,200 13,100
104,000 46,700 28,800
Capital and reserves
Issued capital 40,000 20,000 15,000
Retained profit - opening 15,000 4,000 3,000
Profit for the year 14,200 13,700 4,800
69,200 37,700 22,800

Liabilities 34,800 9,000 6,000

104,000 46,700 28,800

Additional information:

PHL acquired 60% of the ordinary shares of SIL on 1 April 2006 for $20 million when the
issued ordinary share capital and the reserves of SIL were $20 million and $4 million
respectively.

At the date of acquisition of SIL, the fair value of its equipment was considered to be
$2 million greater than its carrying amount in SIL’s balance sheet though the economic
useful life remains unchanged. SIL had acquired the equipment on 1 April 2004 and the
equipment is depreciated on cost over 10 years.

PHL acquired 30% of the ordinary shares of OAL on 1 April 2006 for $10 million when the
issued ordinary share capital and the reserves of OAL were $15 million and $3 million
respectively.

Module A (May 2007 Session) Page 1 of 7

During the year ended 31 March 2007, SIL sold construction materials to both PHL and OAL.
Transfers were made by SIL at cost plus 25%. PHL held $2 million inventories of these
components at 31 March 2007 and OAL held $0.5 million at the same date.

PHL holds a property which was let out, charging arm’s length rentals, to SIL who uses it as
an office and a showroom. PHL acquired this property on 1 April 2006 at a price of
$54.9 million. The estimated useful life of the property was 50 years from 1 April 2006.
The fair value of the property at 31 March 2007 remains at $54.9 million and the rental
income to PHL for the year amounts to $3 million. This property is included in PHL’s
balance sheet in its fair value as an investment property. PHL adopts the cost model and
uses the straight-line method to depreciate property, plant and equipment.

After you sent a summary of the consolidated financial results of the PHL Group to PHL’s
directors for review, one of the directors, who is not a certified public accountant, sends you
an e-mail as follows:

To: Accounting Manager, PHL

From: Peter CHAN (Director)
c.c.: L.P. LEE, Mary CHEUNG, Paul WONG (Directors)
Date: 18 June 2007

Financial summary of PHL for the year ended 31 March 2007

Could you please clarify the following points relating to PHL’s draft financial summary which I
have just reviewed?

1) In your cover note you mentioned that part of the profit from the sales made by SIL
to OAL has been eliminated. I am puzzled about this elimination. Why is there
such an elimination of profit? Since PHL has not sold anything to OAL, what has
caused this elimination in PHL’s accounts?

2) I am also puzzled about the investment property that was found in the balance sheet
of PHL but not in the consolidated balance sheet. What has happened to this
investment property?

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

Best regards,

Peter

Module A (May 2007 Session) Page 2 of 7

Required:

Question 1 (50 marks – approximately 90 minutes)

(a) Prepare a memorandum in response to the issues raised by Mr. Peter CHAN.

(15 marks)

(b) Prepare an annex to your memorandum showing the consolidation journal

entries for the consolidated balance sheet as at 31 March 2007 regarding the
following (alternatively, you may show the consolidation adjustments in the form
of a worksheet):

(i) acquisition of SIL at 1 April 2006 (ignore taxation);

(7 marks)

(ii) consolidation adjustments for the year ended 31 March 2007, including but
not limited to fair value adjustment, re-classification of assets, elimination
of intragroup transactions, equity accounting and minority interests
(ignore taxation); and
(21 marks)

(iii) the deferred taxation effect (assume a tax rate at 15%).

(7 marks)

* * * END OF SECTION A * * *
(QUESTIONS)

Module A (May 2007 Session) Page 3 of 7

SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks)

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

Question 2 (10 marks – approximately 18 minutes)

Ms. Li, the Finance Manager of a company listed on The Stock Exchange of Hong Kong
Limited, is assessing the segment reporting requirements under HKFRS 8 Operating
Segments included in the financial statements of the company and has tentatively concluded
that:

(a) the company has a free choice in determining a business activity or business activities
as an operating segment;

(b) the company can have 12 reportable segments;

(c) segment information should be prepared in conformity with the accounting policies
adopted for preparing and presenting the financial statements of the company; and

(d) during the financial year, the company disposed of the businesses of one of its
reportable segments. The company is required to restate the comparatives segment
information in the financial statements for the current year.

Required:

Please comment on the above conclusions with reference to HKFRS 8 Operating

Segments.
(10 marks)

Module A (May 2007 Session) Page 4 of 7

Question 3 (12 marks – approximately 22 minutes)

Wealth Credit Limited (“WCL”) is a finance company which is engaged in the provision of
loans.

As at 31 December 2006, WCL had an outstanding loan of HK$20,000,000 to Borrower A

who had financial difficulties. The details of the loan were as follows:

Principal amount HK$20,000,000

Original term 1 June 2004 to 30 November 2006
Original interest rate 12% per annum compound
Original repayment date of principal On 30 November 2006
Original payment date of interest On 30 November 2006

As Borrower A had not repaid the loan on 30 November 2006, WCL agreed to extend the
credit for both the principal amount and interest due for another two years with no interest for
the extended term.

As at 31 December 2006, WCL had another outstanding loan of HK$12,000,000 to Borrower

B. The loan was made on 1 September 2005 for a term of two years, carries interest at
10% per annum and the interest is payable annually. On 1 September 2006, WCL entered
into an arrangement with another financial institution (the “FI”), for the sale of the loan at
HK$11,750,000. According to the agreement between WCL and the FI, WCL would collect
the principal and accrued interest directly from Borrower B on behalf of the FI. However,
WCL would be required to transfer the amount received from Borrower B to a designated
bank account which would earn interest at 0.01% per day. WCL would then remit the
interest earned together with the full amount of the principal and accrued interest to the FI
within three days. If WCL was not able to collect the full amount of the principal and
accrued interest from Borrower B, WCL would still be required to pay such amount to the FI.

Required:

(a) Explain whether WCL should recognise an impairment loss in respect of the
loan to Borrower A in its financial statements for the year ended
31 December 2006 and calculate the amount of impairment loss, if any.
(7 marks)

(b) Determine whether WCL should derecognise the loan to Borrower B in its
financial statements for the year ended 31 December 2006.
(5 marks)

Module A (May 2007 Session) Page 5 of 7

Question 4 (16 marks – approximately 28 minutes)

Broom Limited entered into an agreement to acquire 100% interest in Fortune Limited, a
company operating convenience stores in Hong Kong. The acquisition date was
1 November 2006.

During the negotiation process between Broom Limited and the shareholders of Fortune
Limited, it was agreed that twenty Fortune Limited convenience stores would be closed
down within three months of the change in control. Redundancy notices were sent to the
staff of the twenty convenience stores immediately after Broom Limited has taken control
over Fortune Limited. The closure of these stores was completed on 18 January 2007.
Total payment made in January 2007 for redundancy of staff was HK$1,850,000.

Prior to the date of acquisition, Fortune Limited had entered into a retrenchment package for
two directors, such that if the company were to be acquired by another party these two
directors would become entitled to a one-off aggregate payment of HK$1,200,000 each.
The payment was made on 6 December 2006.

On 1 September 2005, Fortune Limited granted a share option to the managing director to
acquire 50,000 shares of the company with a 3-year vesting period. The option had a strike
price of HK$10 per share and the fair value determined at the grant date was HK$180,000.
On 31 October 2006, Fortune Limited cancelled the share option and agreed to pay the
managing director HK$210,000 for the cancellation. The payment was made on
28 December 2006. The fair value of the share option at the date of cancellation was
HK$200,000.

For the acquisition, Broom Limited engaged a certified public accountancy firm to perform a
due diligence exercise on Fortune Limited’s financial statements. The due diligence report
was issued on 30 October 2006. A fee of HK$300,000 was paid for this service on
25 November 2006.

Required:

Explain the accounting treatment of the above payments in:

(a) Fortune Limited’s financial statements for the year ended 31 December 2006;
and
(8 marks)

(b) Broom Limited’s consolidated financial statements for the year ended
31 December 2006.
(8 marks)

Module A (May 2007 Session) Page 6 of 7

Question 5 (12 marks – approximately 22 minutes)

Peak Medical Technology Corporation (“PMT”) conducts research and product development
for an anaesthetic injection under contract with WY Corporation (“WY”), a pharmaceutical
company. The research and development contract requires that WY pays PMT an up-front
amount of HK$1.5 million when the contract is signed, HK$2 million upon the successful
completion of clinical trials, and HK$1.5 million upon the delivery of the first pilot unit of the
injection. All payments are non-refundable. The total cost of completion of the project is
estimated to be HK$3 million.

PMT has invested HK$25 million in equipment for its research and development centre,
which has an anticipated useful life of eight years. Depreciation is charged on a
straight-line basis. In the period of acquisition, PMT received a government grant of
HK$10 million towards purchase of the equipment, which is conditional on certain
employment targets being achieved within the next four years.

Required:

Determine how PMT should recognise and measure by reference to the relevant
accounting standards:

(a) the research and development contract; and

(7 marks)

(b) the government grant.

(5 marks)

* * * END OF EXAMINATION PAPER * * *

(QUESTIONS)

Module A (May 2007 Session) Page 7 of 7