ADVANCED STAGE TECHNICAL INTEGRATION EXAMINATION

MONDAY 3 NOVEMBER 2014

(3 HOURS)

BUSINESS REPORTING
This paper consists of FOUR questions (100 marks).
1.

Ensure your candidate details are on the front of your answer booklet.

2.

Answer each question in black ballpoint pen only.

3.

Answers to each question must begin on a new page and must be clearly numbered.
Use both sides of the paper in your answer booklet.

4.

The examiner will take account of the way in which material is presented.

The questions in this paper have been prepared on the assumption that candidates do
not have a detailed knowledge of the types of organisations to which they relate. No
additional credit will be given to candidates displaying such knowledge.
Interest tables are provided with this examination paper.

IMPORTANT
Question papers contain confidential
information and must NOT be
removed from the examination hall.

You MUST enter your candidate number in this box

DO NOT TURN OVER UNTIL YOU

ARE INSTRUCTED TO BEGIN
WORK

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Page 1 of 15

BLANK PAGE

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Page 2 of 15

QUESTION 1
Robicorp plc is a listed company that develops robotic products for the defence industry. You
are Marina Nelitova, an ICAEW Chartered Accountant working within the finance team at
Robicorp. You receive the following email from Alex Murphy, who was appointed finance
director of Robicorp in October 2014.
To:
From:
Date:
Subject:

Marina Nelitova
Alex Murphy
3 November 2014
Review of financial statements for year ended 30 September 2014

I am attending a board meeting next week, and have concerns over the way my predecessor
has treated some transactions in the financial statements (Exhibit 1).
I would like you to review these transactions and:
(i) recommend any adjustments, with accompanying journal entries, that are required to
make the accounting treatment comply with IFRS, explaining the reasons for your
proposed changes; and
(ii) revise the draft basic earnings per share figure (Exhibit 2), taking into account your
adjustments, and calculate the diluted earnings per share.
Ignore any tax consequences for now.
Requirement
Reply to Alex Murphys email.

(23 marks)

Exhibit 1 Transactions requiring further review

(a)

On 1 October 2013 Robicorp started work on the development of a new robotic device,
the XL5. Monthly development costs of 2 million were incurred from that date until
1 January 2014, when Robicorp made a breakthrough in relation to this project. On that
date the XL5 was deemed financially and commercially viable and thereafter
development costs increased to 2.5 million per month until development work was
completed on 30 June 2014.
The XL5 went on sale on 1 August 2014. By 30 September 2014, Robicorp had
received orders for 3,000 units priced at 25,000 per unit, of which it had manufactured
and delivered 1,200 units to customers. The terms of trade required a non-refundable
payment in full on receipt of the order.
Robicorp anticipates the XL5 having a commercial life of four to five years, with total
sales of 36,000 units over that period. Variable production costs are 11,000 per unit.
In the draft financial statements for the year ended 30 September 2014, all XL5
development costs have been capitalised. Cash received in respect of the 3,000 units
ordered has been recognised as revenue because the orders are non-cancellable.

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Page 3 of 15

Entries made to reflect the above are:

Dr
Cr

Intangible assets
Cash

21.0 million
21.0 million

Dr
Cr

Cash
Revenue

75.0 million
75.0 million

Dr
Cr
Cr

Cost of sales
Cash
Accrued variable production costs

33.0 million
13.2 million
19.8 million

On 1 January 2014, to help fund the XL5 development and production, Robicorp issued
a 40 million, 3% convertible bond at par. The bond is redeemable on 1 January 2017
at par. Interest is paid annually in arrears on 31 December. Bondholders have the
choice on 1 January 2017 of: either converting the bonds into equity shares at the rate
of ten 1 shares for every 100 of bonds; or redeeming the bonds at par. Similar nonconvertible bonds for a company such as Robicorp pay interest at 10% per year.
Robicorp anticipates that all bondholders will choose to convert the bonds into shares.
Therefore in the draft financial statements the bonds have been treated as equity
shares.
In the draft financial statements the following accounting entries have been made in
respect of the bond and interest:

(b)

Dr
Cr
Cr

Cash
Share capital
Share premium

Dr
Cr

Finance costs
Accruals

40.0 million
4.0 million
36.0 million
0.9 million
0.9 million

On 1 October 2013, Robicorp introduced a share option scheme for 30 senior

executives. Each executive was granted 48,000 share options on that date. Each option
gives the right to acquire one share in Robicorp, for an exercise price of 4 per share, if
the executive is still in employment with the company at 1 October 2016, and the share
price at that date is at least 30% higher than the price at 1 October 2013. The
executives will be able to exercise these options from 1 October 2017.
The fair value of an option was 3.50 at 1 October 2013 and 5.30 at 30 September
2014. By 30 September 2014, two executives had left their jobs. Robicorp expects
another three executives to leave by 1 October 2016. The Robicorp share price at
30 September 2014 was 32% higher than at the grant date. The average share price of
Robicorp for the year ended 30 September 2014 was 7.60.
No accounting entries have been made in respect of the share option scheme.

(c)

On 1 April 2013, Robicorp bought 400,000 shares in Lopex Ltd for 6 each. This
represents 3% of the ordinary share capital of Lopex. This investment was treated by
Robicorp as an available-for-sale financial asset.

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Page 4 of 15

At 30 September 2013, Lopexs shares had a fair value of 9.20 each and Robicorp
measured its investment at 3.68 million in its financial statements at that date.
A gain of 1.28 million was recognised in other comprehensive income with a
corresponding available-for-sale reserve being created at 30 September 2013.
On 1 August 2014 Saltor plc, an unrelated company, acquired all the shares in Lopex in
a share-for-share exchange. The terms were 2.5 shares in Saltor for each share in
Lopex. At 1 August 2014, immediately before the takeover by Saltor, the fair value of a
Lopex share was 11.20. Saltors shares at 1 August 2014 were trading at 5.50 each.
No entries have been made in Robicorps financial statements for the year to
30 September 2014 to reflect the share-for-share exchange. Its investment continues to
be recognised at 3.68 million.
Robicorp intends to sell its shareholding in Saltor and to classify the investment as at
fair value through profit or loss. At 30 September 2014, Saltors shares had a bid-offer
spread of 480-485 pence. A sales commission of 4 pence per share would be incurred
upon disposal.
Exhibit 2 Robicorp: Calculation of basic earnings per share for year ended
30 September 2014

Profit after taxation

Share capital
At 1 October 2013
Convertible bond issue 1 January 2014
At 30 September 2014

65.82 million

Number of 1
ordinary shares
40 million
4 million
44 million

Basic earnings per share = 149.6 pence (65.82m/44m shares).

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Page 5 of 15

QUESTION 2
On 1 January 2012, three friends Tara, Fran and Nancy set up a partnership, TFN Apps, to
develop a mobile device application (App) called MakUpp. The App enables users to try
various make-up and hairstyle looks in a virtual environment. The App has had 2 million
downloads and has earned revenue for the partnership through advertising and
subscriptions.
Because their business was growing, the partners decided to incorporate their partnership as
MakOver Ltd on 1 July 2014. All assets of the TFN Apps partnership were transferred to
MakOver at that date. Tara also transferred a property she owned at Gan Road which was
used by the partnership.
MakOver has a 30 June year end for accounting and VAT purposes. The year end for the
partnership was also 30 June. Tara, Fran and Nancy are the only shareholders of MakOver.
Tara and Fran are the only directors of MakOver.
You work in the tax department of PDEK LLP, a firm of ICAEW Chartered Accountants. Your
firm acts as business and tax advisers for Tara, Fran and Nancy and for MakOver. Your
manager, Mia Sharp, has given you the following briefing:
I have left you an extract from the TFN Apps partnership tax file showing details of the
partnership taxable profits to 30 June 2014 and valuations of the assets transferred to
MakOver at 1 July 2014 (Exhibit 1).
Tara has sent me an email with some information and queries (Exhibit 2). I would like you
to:
(1) Draft an email to Tara, Fran and Nancy in non-technical language responding to Taras
queries which includes:

an explanation of the tax implications for Tara, Fran and Nancy and for MakOver of
the incorporation of the TFN Apps partnership on 1 July 2014; and

an explanation of the tax implications for Tara and for MakOver of the lease or sale of
the office property at Yale Street (Exhibit 2).

(2) Prepare a separate document for me showing the detailed workings which support your
response to Taras queries.
Requirement
Draft the documents requested by your manager, Mia Sharp.
(25 marks)

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Page 6 of 15

Exhibit 1 TFN Apps: Partnership taxable profits to 30 June 2014 and valuations of
the assets transferred to MakOver at 1 July 2014
The partnership commenced trading on 1 January 2012 and the taxable profits of the
business since commencement were as follows:
000
120
180
600

Six months ended 30 June 2012

Twelve months ended 30 June 2013
Twelve months ended 30 June 2014
The partnership profits were shared as follows:

%
50
25
25

Tara
Fran
Nancy

The partnership ceased to trade when MakOver was incorporated on 1 July 2014.
Valuations of the assets transferred to MakOver on its incorporation were prepared by
PDEKs business development unit and were as follows:
Valuation at
1 July 2014
000
Partnership assets
Goodwill
Plant and machinery
Computer system
Current assets

Other asset
Gan Road property

Cost
000

2,000
370
60
360

480
400

2,790

880

260

200

The Gan Road property was owned by Tara and was used for the purpose of the
partnerships trade. This property was let rent free to the partnership.
The issued share capital of MakOver comprises 100 1 ordinary shares. Each partner has
been issued with shares in MakOver in accordance with the partnership profit-sharing ratio.

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Page 7 of 15

Exhibit 2 Email from Tara

To:
From:
Date:
Subject:

Mia Sharp
Tara
3 November 2014
Tax queries

Dear Mia
I have the following queries, all of which I have discussed with Fran and Nancy, so please
respond to all of us in your reply:
(1)

Tax implications of the incorporation

We do not fully understand the tax implications of the incorporation of our partnership either
for ourselves or for MakOver. Please explain all the relevant tax liabilities.
As the partnership traded for only 3 months in the current tax year 2014-15 we expect to
have very little taxable income for income tax purposes. Because the company is struggling
for cash as a result of its rapid expansion, we have not withdrawn any salary or dividend from
the company and do not intend to do so before the end of the current tax year 2014-15.
Nancy had a baby in June 2014 and decided to take a career break. She has not worked for
MakOver. She is uncertain about her future and if she decides not to return to work by May
2015 she will sell all her shares to me and Fran. Fran and I are employed full-time by
MakOver.
Gan Road property
MakOver trades from a property previously owned by me at Gan Road and which I
transferred to MakOver on its incorporation. I bought this property in January 2012. I was
advised not to opt to tax this property but am unclear what the implications of this are. In any
case, the TFN Apps partnership has paid for all the running costs and repairs.
(2) Office property at Yale Street
MakOver now needs more office space. I own a freehold investment property on Yale Street
which I could either lease or sell to MakOver on 1 January 2015. I inherited this property in
2008 when its probate value was 480,000. There is an option to tax the rents from this
property. The property has been vacant since March 2014. I am willing to grant an eight-year
lease to MakOver on this property on market value terms. An independent surveyor valued
the premium on an eight-year lease with a rental of 24,000 pa at 80,000 and its
reversionary interest at 500,000.
Alternatively, I could sell the property to MakOver for its market value of 580,000. However,
as MakOver has only 80,000 spare cash, the balance of 500,000 would be left on loan to
me as a directors loan. Interest at 5% would be payable to me by MakOver. I think I am
entitled to a 10% tax rate on the profit on disposal of this property and it might, therefore, be
a good idea to take advantage of this in case the tax rules change in the future.
The lease or the sale transaction would take place on 1 January 2015. We would like you to
determine and explain the tax implications for me and for MakOver of either a lease or sale of
the Yale Street property.

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Page 8 of 15

QUESTION 3
You are Bobby Barnes, an audit senior working for Lorray & Knight LLP (L&K), a firm of
ICAEW Chartered Accountants. You are currently planning the audit of Maxvol plc for the
year ending 31 December 2014. Maxvol manufactures and distributes audio visual systems.
You receive a note from Liz Marchant, the manager responsible for the Maxvol audit:
On 1 October 2014, Maxvol acquired 75% of the issued share capital of Remixit Ltd. The
Maxvol finance director, Gil Jones, has provided details of this acquisition, together with
financial information for Remixit (Exhibit 1).
Remixit has historically been audited by SB Associates (SBA), a local firm of ICAEW
Chartered Accountants, which also acted as Remixits tax advisers. SBA completed the
Remixit audit for the year ended 31 December 2013 and then resigned as auditor in
July 2014.
Gil has asked L&K to take on the Remixit audit and I have arranged a meeting with him
tomorrow. The first audit of Remixit for which we would be responsible would be for the year
ending 31 December 2014. This would need to be completed by 15 February 2015 to meet
Maxvols reporting deadlines. Other services previously provided to Remixit by SBA would
now be provided by Maxvols internal financial reporting and taxation teams, so it is just the
role of auditor that we are being asked to take on.
We have written to SBA requesting disclosure of information which might be relevant to our
decision to accept or decline the Remixit audit appointment. SBAs reply is provided
(Exhibit 2).
Last week an L&K audit senior visited Remixit for an initial meeting with Kieran Mannering,
Remixits financial controller, to gain more background information and to discuss the
financial information provided by Gil. The notes of that meeting are also attached (Exhibit 3).
In preparation for my meeting tomorrow with Gil, please review the documents I have left you
and prepare a briefing note which addresses the following:

Set out the ethical issues that arise for L&K. Explain the implications for L&K, noting any
actions that it should take. Identify any additional information that L&K should request;

Explain the audit risks you have identified for the audit of Remixit for the year ending
31 December 2014 assuming that we accept the Remixit audit engagement. For each
risk, set out the key audit procedures you believe we should perform; and

Explain for the Maxvol group for the year ending 31 December 2014:
o
the financial reporting issues which arise as a consequence of the Remixit
acquisition; and
o
the group audit issues arising from the acquisition. Exclude any issues already
raised for the Remixit audit, unless there are different implications for the group.
Audit procedures are not required at the moment.

Requirement
Respond to Liz Marchants instructions.
(29 marks)

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Page 9 of 15

Exhibit 1 Details of Remixit acquisition provided by Maxvol finance director, Gil

Jones
Remixit was incorporated in 2006 by Barry Gibbons, who is also its chief executive and who
was its 100% shareholder until 1 October 2014. Remixit develops and distributes audio
mixing software and equipment. It has an excellent reputation for high-quality, specialist
products.
On 1 October 2014, Maxvol acquired 75% of the issued share capital of Remixit from Barry
for an initial cash consideration of 16 million. A further cash consideration of 4 million is
payable on 1 October 2015 if Remixits audited financial statements for the year ending
31 December 2014 show a profit before taxation of at least 3 million. Barry is continuing as
Remixits chief executive, although the other directors on the Remixit board are now
appointed by Maxvol.
Goodwill of 12.925 million (calculated as the consideration of 16 million less 75% of
Remixits net assets) was recognised in the Maxvol consolidated financial statements at the
date of acquisition. Summary financial information for Remixit for the 9 months ended
30 September 2014 is shown below:
9 months
ended
30 September
2014
Unaudited

Year
ended
31 December
2013
Audited

000

000

8,700
2,100
2,100

10,700
2,600
(600)
2,000

4,800
3,700
8,500

3,000
2,700
5,700

4,100
4,400
8,500

1,500
4,200
5,700

Notes

Statement of profit or loss

Revenue
Profit before taxation
Income tax expense
Profit for the period
Statement of financial position
Non-current assets:
Property, plant and equipment
Current assets
Total assets
Equity
Current liabilities
Total equity and liabilities
Notes

1.

The taxation charge for the year ending 31 December 2014 will be determined at the
year end.

2.

Remixits property, plant and equipment comprises:

Freehold land and buildings
Equipment

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000
3,000
1,800
4,800

Page 10 of 15

Freehold land and buildings were revalued at 30 September 2014 to 3 million. The
valuation was prepared by an external valuer on the basis of the existing use of the
freehold land and buildings. This resulted in a revaluation gain of 1.5 million. The site
includes land which the valuer has suggested could be developed for residential
purposes without impacting Remixits business. If the site was valued on this basis, its
total value would rise to 3.5 million. Equipment is carried at depreciated cost, based
on an estimated useful life of 5 years.
3.

An interim dividend of 1 million was paid on 15 June 2014.

Exhibit 2 Response from SBA to letter requesting disclosure of any information

relevant to L&Ks decision to accept or decline the Remixit audit appointment.
Dear Sirs
Remixit Ltd
Thank you for your letter dated 24 October 2014.
We have acted as auditor to Remixit for a number of years and resigned on 14 July 2014,
immediately after signing our audit report on the financial statements for the year ended
31 December 2013.
We disclose below certain matters which we believe you should consider in deciding whether
or not to accept the appointment as auditor of Remixit.
Our audit procedures for the year ended 31 December 2013 identified a fraud, in which an
employee had claimed inappropriate and excessive expenses. Although the amounts
involved were not material, we spent significant time investigating the fraud and considering
its impact for our audit. Remixit management has refused to pay us for this time and we are
therefore in dispute about fees.
We have been working with Remixits chief executive, Barry Gibbons, on his personal tax
matters and have obtained information which gives us some concern that, in the past,
Remixits management may not have been wholly open with us concerning the companys
tax affairs.
We note from your letter that you anticipate requesting access to our audit working papers
and regret that we will be unable to grant this or provide any further information on the
matters identified above due to the ongoing fee dispute with Remixit and the restrictions on
communication which the Remixit board has imposed.
Yours sincerely,
SB Associates

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Page 11 of 15

Exhibit 3 L&K audit seniors notes from meeting at Remixit

The notes below summarise the key points arising from a discussion with Kieran Mannering,
Remixits financial controller:

Remixit has a very small finance team, comprising Kieran and two part-time assistants.
Kieran reports directly to Barry Gibbons, who has always shown a close interest in the
results and is involved in all key accounting judgements. Historically Kieran has relied
on the SBA audit manager to provide assistance with any complex financial reporting
questions and to draft the financial statements.

To Kierans knowledge, no material audit issues have arisen in recent years, although
there was some discussion as to whether a five-year useful life remains appropriate for
equipment given that the factory equipment is used for much longer than this and
assets which are 15 to 20 years old are still in use.

The relationship with the previous auditor, SBA, was good until delays in completing the
2013 accounts caused a disagreement between the audit partner and Barry (who serve
together on a local golf club committee) and SBA was asked to resign.

Current liabilities at 30 September 2014 include a 400,000 provision for restructuring

following the acquisition by Maxvol.

No provision has been made in respect of a claim of 475,000 for damages and loss of
sales caused by a faulty audio mixing system supplied by the company. This claim was
received from one of Remixits major customers in August 2014. Remixits lawyer has
advised that it is possible, but not likely, that the claim will succeed given the terms on
which the sale was made and the fact that the warranty period had expired.

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Page 12 of 15

QUESTION 4
Hoop plc is an AIM-listed company which operates in the food packaging industry. It provides
a wide range of food products to UK and other European food retailers and food distributors.
You work for Rawls and Nosick LLP (RN), a firm of ICAEW Chartered Accountants. Hoop is
an audit client of RN. RN is currently completing the audit for the accounting year ended
30 June 2014.
You have been transferred to the Hoop audit to replace the current audit senior, Gary Kant,
who was needed by another client. The engagement manager, Jane Leigh, provided you with
some instructions:
I am concerned about the completion of this audit, as Gary is no longer available.
Additionally, the finance director is ill and the Hoop finance team lacks expertise on some
financial reporting matters. As a result, they may need some guidance on the final
adjustments to the financial statements. Gary has left several financial reporting and audit
issues unresolved, which he has highlighted in his working papers (Exhibit).
The planning materiality is 400,000 based on a profit before tax of 8 million and revenue
of 42 million. The engagement partners final review is scheduled for next week.
In order to complete the required procedures on time, I would like you to prepare a working
paper for the audit team in which, for each of the issues raised by Gary (Exhibit), you set out
and explain:

the appropriate financial reporting treatment; and

the key audit risks and the detailed audit procedures.

In addition, Hoop has been much more profitable this year, in comparison with recent years,
and consequently Gary believes that the Hoop board may be trying to reduce the profit for
the year, as much as possible, by its choice of accounting policies and estimates. I do not
agree with Gary, but we need more evidence. Therefore, for the issues highlighted by Gary
(Exhibit), please explain whether these give any evidence of manipulation of profit in order to
understate reported income.
I will ask the tax department to review the deferred tax and current tax at a later date, so do
not worry about tax for now.
Requirement
Respond to the instructions from the engagement manager, Jane Leigh.
(23 marks)

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Page 13 of 15

Exhibit Unresolved financial reporting and audit issues - prepared by Gary Kant
(1)

Pension obligation
Hoop operates a defined benefit pension scheme for its employees, although the
scheme was closed to new employees three years ago. Employees in the scheme are
required to make contributions. I have completed the audit procedures on the scheme
assets, valued at 19.4 million at 30 June 2014, and these have been reviewed. The
scheme assets at 30 June 2013 also had a value of 19.4 million.
In respect of pension obligations, however, my audit procedures are incomplete. I have
agreed the present value of the obligations with the actuary appointed by RN. I have
also verified the cash contributions and the benefits paid to supporting documentation. I
have not, however, had the chance to carry out any audit procedures in respect of the
service costs, past service costs or interest costs. I am concerned about this as Hoop
improved the pension benefits to all existing employee members of the scheme on
1 July 2013, based on their historic service with Hoop.
The only entries made by Hoop during the year are in respect of the employer pension
contributions and these payments have been treated as an expense.
Details of the scheme for the year ended 30 June 2014 are as follows:
'000
20,500
22,700
800
2,100

Present value of plan obligations at 30 June 2013

Present value of plan obligations at 30 June 2014
Past service cost (effective from 1 July 2013)
Current service cost
Pension contributions:
Employers pension contributions
Employees pension contributions
Benefits paid

1,000
900
1,500

Annual market yield on high-quality corporate bonds with a similar maturity date:
At 30 June 2013
4%
At 30 June 2014
5%
The current service cost accrues evenly throughout the year. The contributions and
benefits are paid on the 15th of each month during the year.
(2)

Change of accounting policy - inventories

The Hoop directors have informed me that they wish to change the accounting policy for
inventory measurement from first-in first-out (FIFO) to weighted average cost. Closing
inventories measured for the years ended 30 June under the two different methods are
as follows:

FIFO
Weighted average cost

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2013
000
785
782

2014
000
795
786

Page 14 of 15

I am concerned about the impact on profit of the change in the accounting policy for the
year ended 30 June 2014 and I am unsure about the audit procedures I need to perform
in respect of this issue.
(3)

Revenue recognition
Larger customers who order significant volumes of non-perishable produce require a
production run which is specific to them. In the past, some of these customers have
changed their minds after production has commenced and Hoop has been left with
inventories which it cannot sell.
As a result, Hoop has introduced new contract terms. These require customers to pay a
20% cash deposit prior to commencement of production in order to reduce the risk of
obsolete inventory.
At 30 June 2014, an order for packaged foods produced for a large customer,
DistribFoods plc, had been completed under these new contract terms. 30% of the
goods, by value, were still in inventory at 30 June 2014, while the remainder had been
delivered to the customer on 14 June 2014.
On 19 May 2014 a 20% deposit of 90,000 was received by Hoop from DistribFoods for
the entire order. Hoop recognised this 90,000 as revenue at that date, but did not
recognise any other revenue for this contract in the year ended 30 June 2014. The
production cost to Hoop of this contract was 200,000, which has been recognised,
in full, in cost of sales in the year ended 30 June 2014.

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