The Examiner's Answers F1 - Financial Operations September 2012 Some of the answers that follow are fuller and more comprehensive than would be expected from a wellprepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike.
SECTION A Answers to Question One Rationale Question One consists of 10 objective test sub-questions. These are drawn from all sections of the syllabus. They are designed to examine breadth across the syllabus and thus cover many learning outcomes.
1.1
C
1.2
A
1.3
A
1.4
A scheduler system of taxation is a system that has a number of schedules that sets out how the different types of income should be treated for tax purposes.
1.5
C
1.6
B
1.7
To review new financial reporting issues, not specifically addressed in IFRSs. To clarify issues where unsatisfactory or conflicting interpretations have developed, with a view to reaching a consensus on the most appropriate treatment.
Financial Operations
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1.8 Cost Duties Indexation (40%) Selling price Selling cost Gain Tax at 25%
1.9
B
1.10
C
September 2012
$ 420,000 30,000 450,000 180,000 630,000 (700,000) 10,000 60,000 15,000
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F1 September 2012 ANSWERS
SECTION B Answers to Question Two
(a)
Rationale
To test candidates’ understanding of the requirements of IAS 12 relating to treatment of tax in the financial statements and the calculation of deferred tax. Tests learning outcome A4a. Suggested Approach
Calculate PY’s tax charge for the year to 31 March 2012. Explain the effect the tax increase would have on deferred tax and calculate the amount of increase.
(i)
PY Statement of comprehensive income for the year to 31 March 2012 – Taxation workings $000 Balance over-provided year to 31 March 2011 (1820 – 1795) (25) Charge for the year 1,980 20 Increase in deferred tax (560 – 540) 1,975
PY will charge $1,975,000 to its Statement of comprehensive income for taxation. (ii) The deferred tax provision is calculated using the latest estimate of future tax rates, the current rate usually being the best estimate of future rates. If a new rate is known to be likely to be introduced the new rate should be used. If the rate of income tax were to be increased to 30% PY’s deferred tax provision would need to be increased to: 560/0.25x0.3 = 672 An increase of $112,000 in the year ended 31 March 2012.
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(b)
Rationale
To test candidates’ understanding of the treatment of overseas earnings and double tax relief. Tests learning outcome A2a. Suggested Approach
Explain the three main methods of giving double taxation relief to entities with overseas earnings
The three main methods of giving double taxation relief are: 1. Exemption – the countries involved agree the types of income that will be exempt in one country or the other. 2. Deduction – the foreign tax is deducted from the foreign income and the net amount is taxable in the country of residence. 3. Tax credit – the tax paid in one country is allowed as a tax credit, at the lower tax rate (lower of the foreign tax rate and country of residence tax rate) in another country.
(c) Rationale
To test candidates’ understanding of income tax calculations. Tests learning outcome A3a. Suggested Approach
Calculate the tax effect of disposal of old vehicle. Calculate the depreciation and tax allowance due on the new vehicle. Calculate SM’s taxable profit Calculate tax due
Profit before tax Entertaining Loss on disposal Depreciation New vehicle depreciation Tax depreciation New vehicle tax depreciation (50%) Tax at 25%
$ 43,000 6,300 1,000 16,500 4,000 (19,300) (16,000) 35,500 8,875
SM is due to pay $8,875 tax for the year ended 31 March 2012 September 2012
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F1 September 2012 ANSWERS
(d) Rationale
To test candidates’ understanding of the treatment of construction contracts, IAS 11, in financial statements. Tests learning outcome C2a. Suggested Approach
Calculate overall profitability of contract. Calculate revenue and cost of sales for the year. Calculate amount due to client
Overall profitability: Revenue Total cost Predicted loss Year to 31 March 2012: Revenue (9000 x 35%) Cost of sales in year (10000 x 35%) Loss in year Additional expected loss
Amount due to client: Cost to date (WIP) Total loss Less cash received Due to client
$000 9,000 10,000 (1,000)
3,150 3,500 (350) (650) (1,000)
4,000 (1,000) (3,250) (250)
TY should include the following in its statement of comprehensive income for the year to 31 March 2012: Revenue (9000 x 35%)
3,150
Cost of sales Cost to date (10000 x 35%) 3,500 650 Additional expected loss 4,150
TY should include the following in its statement of financial position as at 31 March 2012: Under current liabilities: (250) Amount due to client
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(e) Rationale
To test candidates’ understanding of the development of an IFRS. Tests learning outcome B1e. Suggested Approach
Explain each of the five possible steps that an IFRS may go through during development.
The IASB standard setting process can involve the following steps: • The IASB establishes an advisory committee to advise on the issues arising from the project. The IASB consults with this committee and the IFRS advisory council throughout the development process. • IASB develops and publishes a Discussion Paper for public comment. • The IASB reviews the comments on the Discussion Paper and prepares and publishes an Exposure Draft for public comment. • The comments on the Exposure Draft are reviewed by the IASB and if necessary the Exposure Draft is amended before being issued as a final standard. • On occasion where there are significant changes to the exposure draft it may be reissued for further public comment before being issued as a final standard.
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F1 September 2012 ANSWERS
(f) Rationale
To test candidates’ understanding of the treatment of situations by the audit report. Tests learning outcome B1g. Suggested Approach
Explain how each of the two situations would be treated by an auditor in the audit report.
(i) Impact on the audit report The inventory value is material, 30% of profit and 4.5% of revenue and there is a lack of evidence to support the inventory valuation it will impact on the audit report opinion. As the auditors have agreed with VB’s directors on the treatment of the court case it will not affect the audit report opinion. (ii) Modification of audit report The auditors will have to issue a modified report for the inventory valuation as it is due to a material misstatement caused by insufficient appropriate evidence. The modification required is a qualified opinion expressed as showing a true and fair view ‘except for’ the inventory valuation. The auditors can issue an unqualified opinion for the court case. However there is material inherent uncertainty over the outcome of the court case so the unqualified report would have to include a “fundamental uncertainty” emphasis of matter.
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SECTION C
Question Three
Rationale
To test candidates’ ability to clear a suspense account. To test candidates’ ability to prepare a set of financial statements for a single entity, including the application of a number of IFRS/IAS. Tests learning outcome C 2a and C1a. Suggested Approach
Prepare journal entries to clear QWE’s suspense account Prepare the non-current asset depreciation and development amortisation calculations Prepare workings for cost of sales, administration and distribution costs Prepare all other required workings Prepare the statement of comprehensive income Prepare the statement of financial position Prepare the statement of changes in equity
(a) QWE Journal entries to clear suspense: Debit $000 15
Credit $000
Suspense account Plant and equipment disposal account Cash received on disposal of some plant and equipment
15
Research expense account Suspense account Research cost to be treated as an expense
20
20
(b) QWE - Statement of comprehensive income for the year ended 31 March 2012 $000 Revenue Cost of sales Gross Profit Administrative expenses Distribution costs Profit from operations Finance cost Profit before tax Income tax expense Profit for the period
W3 W3 W3 W4 W5
Statement of changes in equity for the year ended 31 March 2012 September 2012 8
(295) (72
$000 2,220 (1,675) 545 (367) 178 (20) 158 (116) 42
Financial Operations
F1 September 2012 ANSWERS
Balance at 1 April 2011 Statement of comprehensive income for year Dividend paid Balance at 31 March 2012
Equity shares $000 930
Share Premium $000 310
930
310
Retained Earnings $000 621 42 (62) 601
Total $000 1,861 42 (62) 1,841
QWE - Statement of Financial Position at 31 March 2012 $000 Non-current assets Property, plant and equipment Deferred development expenditure Current assets Inventory Trade receivables Cash and cash equivalents
W1 W2
$000
2,301 105 214 98 42 354 2,760
Total assets Equity and liabilities Equity Share capital Share premium Retained earnings Total equity
930 310 601 1,841
Non-current liabilities Long term borrowings Deferred tax Total non-current liabilities
500 111 611
Current liabilities Trade payables Tax payable Provision legal claim Interest payable Total current liabilities Total equity and liabilities
190 83 25 10 308 2,760
Workings (All figures in $000) (W1) Non-current assets Cost Balance b/fwd Disposal (W6) Balance c/fwd Depreciation Balance b/fwd Disposal (W6) Year (1610x3%) Year [(478-106)x12.5%)] Balance c/f Carrying Value Total P, P&E c/f
Financial Operations
Land 800 . 800
Buildings 1,610 . 1,610
0 . 0 . 0
386 . 386 48 . 434
800
1,176
Plant and equipment 560 (82) 478
185 (79) 106 47 153 325 2,301
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(W2) Deferred Development Expenditure Balance b/f Years amortisation – 10% Amortisation b/f Balance c/f
150 (15) (30) 105
(W3) Trial balance Amortisation development expenditure W2 Research (from part (a) Depreciation – buildings W1 Depreciation – plant and equipment W1 Gain on disposal PPE W6 Bad debt Legal claim Totals
(W4)
(W5)
Interest Years loan interest (500x4%) Paid Accrued Tax Last Year b/f Current year Increase in deferred tax
(W6)
Cost of sales 1,605 15 20
Administration 190
Distribution 72
48 47 (12) . 1,675
32 25 295
. 72
20 10 10
8 83 91 25 116
Disposal of plant and equipment Cost 82 (79) Less depreciation Carrying value 3 Proceeds (15) (12) Gain on disposal
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F1 September 2012 ANSWERS Question Four
Rationale
To test candidates’ understanding of intra-group sales of non-current assets. To test candidates’ ability to prepare a set of financial statements for a group of entities. Tests learning outcomes C2b and C1b, c and d. Suggested Approach
Explain the treatment of assets sold within a group. Calculate goodwill arising on acquisition of Plank. Calculate investment in associated entity Bush. Prepare workings for intra-group activities. Calculate consolidated retained earnings. Prepare the consolidated statement of comprehensive income Prepare consolidated statement of financial position.
(a) The sale to Plank must be recognised in the group consolidated accounts at carrying value, with no profit or loss recognised. Therefore the following adjustments need to be made: • Cancel the profit on the sale - reduce consolidated profit for the year/consolidated retained earnings by $20,000. • Cancel the increase in depreciation [($95,000-$75,000)/10], $2,000 - increase consolidated profit for the year/consolidated retained earnings by $2,000. • Reduce consolidated non-current assets – property, plant and equipment in the statement of financial position by $20,000-$2,000 = $18,000.
(b) Investment of Wood in Plank Wood purchased all 6,000,000 shares in Plank on 1 April 2011. 100% shares purchased therefore treat Plank as wholly owned subsidiary of Wood from 1 April 2011. Investment of Wood in Bush Wood purchased 1,540,000 of Bush’s 5,500,000 shares on 1 April 2011. This gave Wood 28% of Bush’s equity. As Wood has in excess of 20% of Bush’s equity and can exercise significant influence over all aspects of Bush’s strategic and operational decisions Wood will treat Bush as an associated entity from 1 April 2011. Workings (All workings in $000) (i) Fair value of net assets of Plank at acquisition Equity Shares 6,000 Retained earnings 1,280 Fair value adjustment 1,350 8,630
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(ii) Goodwill - Plank Cost Fair value of net assets acquired: Goodwill Impairment Balance at 31 March 2012
9,200 8,630 570 (80) 490
(iii) Investment in associate - Bush Cost Add group share of post acquisition profits (1,240 - 410) = 830 x 28% = Investment at 31 March 2012
2,420 232 2,652
(iv) Intra-group trading Mark up on cost 100% = 100/200 or 50% margin on selling price. Selling price 520; unrealised profit = 520 x 50% = 260 All goods remain in inventory - 260 Dr. Cr. Consolidated cost of sales 260 Consolidated current assets - inventory 260 Consolidated revenue 520 Consolidated cost of sales 520 Loan interest Dr Accrue interest receivable by Wood: Receivables - interest Interest receivable - SoCI Receivables - interest Loan interest payable Interest payable – SoCI Interest receivable -SoCI
Cr
155 155 155 155 155 155
Consolidated interest payable = (810+440-155) = 1,095 Consolidated Receivables - interest (155 - 155) = 0 Consolidated Trade Receivables Wood Plank Less intra-group sales Less cheque in transit
Consolidated Trade Payables Wood Plank Less intra-group sales
13,400 5,710 (520) (210) 18,380
3,910 3,740 (520) 7,130
(v) Excess depreciation Fair value adjustment – 1,350 Economic life 15 years, straight line basis Excess depreciation = 1,350/15 = 90
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F1 September 2012 ANSWERS (vi) Consolidated Retained Earnings Balance – Wood at 1 April 2011 (5,400-3,490) Add consolidated profit for year Balance 31 Jan 2012
1,910 5,829 7,739
(vii) Consolidated Property, plant and equipment Wood 11,820 Plank 7,240 Adjustment for sale of asset, net (see (a)) (18) Fair value adjustment 1,350 Excess depreciation (90) 20,302 Wood Group – Consolidated Statement of Comprehensive Income for year ended 31 March 2012 $000 Revenue(15,500+6,900-520) 21,880 Cost of sales (8,700+3,080-520+260+90+20-2) (11,628) Gross profit 10,252 Expenses (1,250+750+80) (2,080) Profit from operations 8,172 Share of profit of associated entity 232 Finance cost (1,095) Profit before tax 7,309 Tax (1,250+230) (1,480) Profit for the year 5,829 Wood Group - Consolidated Statement of Financial Position as at 31 March 2012 $000 $000 Non-Current Assets Property, plant and equipment (vii) 20,302 Goodwill (ii) 490 Investment in associate (iii) 2,652 23,444 Current Assets Inventory (12,060+3,215-260) 15,015 Trade receivables (iv) 18,380 Cash and cash equivalents (1,730+510+210) 2,450 35,845 Total assets 59,289 Equity and Liabilities Equity Shares Share premium Retained Earnings (vi)
38,900 5,520 7,739 52,159
Current Liabilities Trade payables (iv)
Financial Operations
7,130 59,289
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