The Examiner's Answers – F1 - Financial Operations Some of the answers that follow are fuller and more comprehensive than would be expected from a well-prepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike.
SECTION A Answer to Question One 1.1
C
1.2
B
1.3
Under the OECD model an entity will have residence in the country of its effective management.
1.4
Cost Excise duty VAT 15% Duty VAT
$15 $3 $18 $2.7 $3 $2.7 $5.7 x 2,000 = 11,400
Answer = D
1.5
C
1.6
A
1.7
D
Financial Operations
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May 2011
1.8 $000 Cost Acquired: Equity shares Share premium Retained earnings Fair value adjustment Goodwill
$000 185
150 15 (22) 10
153 32
1.9
Cost Share of profit for the year to 31 March 2011 Less dividend received Investment
6.5 x 30% = 3.5 x 30% =
$ 25,000 1,950 26,950 (1,050) 25,900
1.10 $33,000 x 25/125 x 50% = ÂŁ3,300
May 2011
2
Financial Operations
SECTION B
Answer to Question Two
(a) (i) 31 March 2010 Tax depreciation $500,000 x 50% = $250,000 Tax written down value = $250,000 FG’s corporate income tax due 31 March 2011 Profit Add depreciation Less tax depreciation ($250,000x25%) Taxable profits Tax at 25%
$192,000 $100,000 ($62,500) $229,500 $57,375
(ii) Deferred tax balance at 31 March 2011: Carrying Value Cost 500 Year to 31 March 2010 (100) 400 Year to 31 March 2011 (100) 300 At 31 March 2010: $400,000 - $250,000 = $150,000 At 31 March 2011: $300,000 - $187,500 = $112,500 $38,000 Tax at 25% = $9,500 Credit to income statement of $9,500
Tax base 500 (250) 250 (62.5) 187.5
(b) (i) A capital gain is a gain made when an asset not covered by income tax rules, is disposed of. E.g. Gains on disposal of investments and non-current assets. 1the selling price. Some tax authorities allow an element of inflation to be used to adjust the purchase price (indexation) and thus reduce tax. Capital gains tax seeks to tax capital gains.
Financial Operations
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May 2011
(ii) $000 1,000 6 994
Sale proceeds Tax allowable costs Net proceeds Cost of land Purchase price Surveyor’s fees Legal fees Clearance
850 5 8 15 878 116 29
Profit on disposal Capital gains tax at 25%
(c) (i)
Underlying tax is tax on the profits out of which of an overseas entity has paid a dividend to its holding entity. E.g. A subsidiary or associated entity pays a dividend out of its taxed profits. The underlying tax is the tax on its profits.
(ii)
$000 After tax profits Before tax profits Tax After tax profits
650 (130) 520
Gross Dividend Net dividend After tax of 20%
156 156/0.8 = 195
Underlying tax is 195/520 x 130 = 48.75
(d) The possible advantages of having principle-based accounting standards include: •
It will be harder to construct ways of avoiding the detailed requirements of individual standards. For example, a prescriptive standard may set out specific values that should be used when applying a standard. If an actual value is specified it may be possible for some entities to construct various means of avoiding the application of that requirement. Whereas if the standard sets out general principles it is much harder to avoid the standard’s requirements as a principle will apply no matter what value is put on it.
•
A prescriptive standard would require a certain treatment to be used, regardless of the situation, which could lead to similar items being treated the same way even if the circumstances are very different. Principle based standards will require a standard to be applied using professional judgment, which can help ensure that the correct application is used.
•
Principles-based GAAP should ensure that the spirit of the regulations is adhered to, whereas the prescriptive system is more likely to lead to the letter of the law being followed rather than the spirit. IFRSs are principle-based standards.
May 2011
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Financial Operations
(e) (i)
The Framework states that ‘the objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions’.
(ii)
The underlying assumptions in the Framework are going concern and accruals basis of accounting.
Going concern Financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Any intention to liquidate or significantly reduce the scale of its operations would require the accounts to be prepared on a different basis and this basis would have to be disclosed. Accruals basis of accounting Financial statements are prepared on the accruals basis of accounting where the effects of transactions are recognised when they occur and are recorded and reported in the accounting periods to which they relate, irrespective of cash flows arising from these transactions.
(f) According to CIMA’s Code of ethics for professional accountants CX is in a position where she may be compromising her integrity and objectivity. Integrity – This principle imposes an obligation to be truthful and honest on the accountant. A professional accountant should not be associated with reports and other information where she/he believe that the information contains misleading statements. This seems to be the case with the revised forecasts, CX believes that the revised forecasts are “grossly overstated”. Objectivity – A professional accountant should not allow conflict of interest or undue influence of others to override professional or business judgements or to compromise their professional judgements. The management board are overriding CX’s professional and business judgement as they are imposing their assumptions on the forecast profits. The possible options for CX in this situation would be: (i) To refuse to remain associated with the forecasts and disassociate herself from them as much as possible. (ii) To consider reporting the situation to appropriate authorities possibly after taking legal advice. (iii) To consider resignation of her post as a professional accountant.
Financial Operations
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May 2011
SECTION C Answer to Question Three MN - Statement of comprehensive income for the year ended 31 March 2011 Continuing Operations Revenue (1120-80) Cost of sales Gross Profit Administrative expenses Distribution costs Profit from operations Finance cost Profit before tax Income tax expense Profit for the period from continuing operations Discontinued Operations Loss for the period from discontinued operations
$000 W3 W3 W3
(120) (80)
W5 W4
W2
$000 1,040 (553) 487 (200) 287 (12) 275 (72) 203 (189)
Profit for the period
14
MN Statement of Financial Position at 31 March 2011 $000 Non-current assets Property, plant and equipment
W1
Current assets Inventory Trade receivables
$000
1,823
65 101 166
Non-current assets classified as held for sale Total assets
W2
Equity and liabilities Equity Share capital Share premium Retained earnings Total equity
600 200 761 1,561
Non-current liabilities Long term borrowings Deferred tax Total non-current liabilities Current liabilities Trade payables Tax payable Bank overdraft Provision for warranty Interest payable Total current liabilities Total equity and liabilities
May 2011
176 2,165
300 78 378
W6 W5
51 67 14 82 12 226 2,165
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Financial Operations
MN – Statement of changes in equity for the year ended 31 March 2011 Equity Share Accumulated shares Premium Profits $000 $000 $000 Balance at 1 April 2010 600 200 777 Statement of comprehensive income 14 for year Dividend paid . . (30) Balance at 31 March 2011 600 200 761
Total $000 1,577 14 (30) 1,561
Workings (All figures in $000) (W1)
Depreciation Buildings Balance b/fwd Year deprec @ 5% Total depreciation NBV Plant and equipment Balance b/fwd – cost Balance b/fwd – deprec NBV Year 20% NBV c/f Land Total P, P&E c/f
W2)
Continuing 700 35 175 525
Discontinued 40 2 22 18
240 142 98 20 78
60 35 25 5 20
1,220 1,823
150 188
Discontinued Activity
NCA Available for sale Balance c/f
Income Statement Revenue Cost of sales (130+7) Gross loss Administrative expenses Distribution costs Loss before tax Income tax credit Impairment of assets Loss for the period
Financial Operations
Net book value 188
Impairment 12
Revised book Value 176
$000 80 (137) (57) (40) (90) (187) 10 (177) (12) (189)
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May 2011
(W3)
Trial balance Less discontinued Depreciation – buildings W1 Depreciation – plant and equipment W1 Increase in warranty provision W6 Totals
(W4)
Tax Year Discontinued - tax credit add back Decrease in deferred tax (83-78)
(W5)
(W6)
Interest Years loan interest (300 x 4%)
Cost of sales 622 (130) 35 20
Administration
Distribution
160 (40)
170 (90)
6 553
. 120
. 80
67 10 77 (5) 72
12
Warranty Expected Values 190 x 10%= 20 x 15%= 80 x 75%= Bal c/f Bal b/f Charge for year
May 2011
$000 19 3 60 82 76 6
8
Financial Operations
Answer to Question Four
(a) OP Statement of Cashflows for the year ended 31 March 2011 $000 Cash flows from operating activities Profit before taxation
$000 1,089
Adjustments for: Legal claim provision Depreciation (W1) Development expenditure amortisation (W6) Brand name impairment Finance cost Loss on disposal of non-current tangible asset (W2) Operating profit before working capital changes Decrease in inventory Increase in trade receivables Increase in trade payables Cash generated from operations Interest paid (W3) Income taxes paid (W4) Net cash from operating activities Cash flows from investing activities Purchase of property, plant and equipment (W8) Proceeds from sale of equipment (W2) Development expenditure (W6) Net cash used in investing activities Cash flows from financing activities Proceeds from issue of share capital (W7) Repayment of long term borrowings Equity dividends paid* (W5) Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at 1 April 2010 Cash and cash equivalents at 31 March 2011
40 42 15 10 15 6
128 1,217
4 (70) 55 (11) 1,206 (25) (280)
(305) 901
(432) 5 (10) (437) 300 (150) (580) (430) 34 35 69
* this could also be shown as an operating cash flow
Financial Operations
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May 2011
Workings W1 – Depreciation for the year Plant and equipment Buildings
$000 25 17 42
W2 – Cash received on disposal of property plant and equipment $000 $000 Net book value 11 6 Loss on disposal Cash received 5 W3 – Interest Paid Balance B/F SoCI Balance C/F Paid
$000 20 15 35 10 25
W4 – Income Taxes paid $000 260 120
Balance b/f – corporate income tax - deferred tax
$000
380 280 660
Income statement Balance c/f – corporate income tax - deferred tax Tax paid
250 130
380 280
W5 – Dividends Paid $000 423 809 1,232 652 580
Retained earnings Balance b/f Profit for year Retained earnings Balance c/f Dividends paid W6 – Development expenditure paid Balance b/f Amortised in year
$000 65 (15) 50 60 10
Balance c/f New expenditure W7 – Proceeds from issue of share capital
$000 200 100 300
Shares Share premium Received
May 2011
10
Financial Operations
W8 – Non-current asset acquisitions Land Balance b/f Impairment Balance c/f Acquired in year Buildings Balance b/f Balance c/f Acquired in year
320 (65) 255 426 171
610 840 230
Plant and equipment Balance b/f 180 Disposal (45) 135 Balance c/f 166 Acquired in year Total acquired in year
31 432
Part (b) Finance Lease Workings $ Fair value 248,610 Interest 29,833 Payment (44,000) Bal 31 Mar 12 234,443 Interest 28,133 Payment (44,000) 218,576
Non-current liability
Current liability = 218,576 – 234,443 = 15,867 Depreciation = 248,610 x 10% = 24,861 Non-current assets = 248,610 – 24,861 = 223,749 Interest – 29,833 Finance Lease
Statement of Comprehensive Income:
Depreciation Interest
Statement of Financial Position:
Non-current assets Non-current liability Current liability Added back to cash flows from operating activities: Depreciation Interest Investment Activities: Finance lease payments
Statement of Cashflows:
Financial Operations
11
$000 24.8 29.8 223.8 218.6 15.9
24.8 29.8 44.0
May 2011