The Examiner's Answers – F1 - Financial Operations - Nov 2011

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

D

1.2

D

1.3

A

1.4 $000 600 5 605 363 968 (1,200) 9 223 55.75

Cost Additional costs Indexation (605x60%) Selling price Selling costs Taxable gain Tax @ 25% Answer = A

1.5

B

1.6

C

1.7

A

1.8

C

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1.9

B

1.10

C

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SECTION B

Answer to Question Two

(a) $ 165,000

Profit before tax Add back: Entertaining PP&E and Vehicle depreciation (note 1)

9,800 45,000 219,800 (74,000) 145,800 36,450

Less tax allowances – PPE and Vehicle (note 1) Taxable amount Tax at 25%

Total tax charged to Income Statement for year ended 31 March 2011 $ 36,450 7,250 43,700

Estimated tax for year to 31 March 2011 Deferred tax increase (note 1)

Note 1: Vehicle – Cost $18,000 Depreciation 18000/6 = $3,000 Tax allowance – first year 50% = $9,000 Depreciation

Tax allowances

- PPE -Vehicle

42,000 3,000

45,000

- PPE -Vehicle

65,000 9,000

74,000

Deferred tax increase in year

29,000 x 25% = $7,250

(b) Perfume consignment income, expenditure and VAT are as follows: Totals (incl VAT) $ Expenditure: Cost Exise duty Input VAT @ 15% Repackaging costs Total costs Sales revenue Net (i) (ii)

50,000 10,000 60,000 9,000 69,000 9,775 78,775 105,800 27,025

VAT

Net of VAT

$

$

9,000 1,275 10,275 13,800 3,525

60,000 8,500 68,500 92,000 23,500

Net profit is $23,500 Net Vat due to be paid is $3,525

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(c) A tax base is something that is liable to tax, e.g. income or consumption of goods.

Tax bases regularly used by governments are: •

income – for example, income taxes and taxes on an entity’s profits;

•

capital or wealth – for example, taxes on capital gains and taxes on inherited wealth;

•

consumption – for example, excise duties and sales taxes/VAT.

(d)

The International Accounting Standards Board’s (IASB) Framework for the Preparation and Presentation of Financial Statements (Framework) section on concepts of capital and capital maintenance discusses concepts of capital, determining profit under each concept and capital maintenance.

Concepts of capital The Framework refers to two concepts of capital: financial concept of capital and physical concept of capital.

Most entities adopt the financial concept of capital which deals with the net assets or equity of the entity.

If, instead of being primarily concerned with the invested capital of the entity, the users are concerned with, for example, the operating capability of the entity, then the physical concept of capital should be used.

Capital maintenance In general terms, an entity has maintained its capital if it has as much capital at the end of the period as it had at the beginning of the period. The key in capital maintenance is deciding which concept is being adopted, because this then defines the basis on which profit is calculated.

Financial capital maintenance is measured in either nominal monetary units or units of constant purchasing power.

Physical capital maintenance requires the adoption of the current cost basis of measurement – an appreciation of what it would cost to replace assets at current prices.

The main difference between the two is how they treat the effects of increases in prices of assets and liabilities.

(e) (i)

By definition, a matter is material ‘if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements’ (IASB Framework).

Materiality cannot always be measured in terms of any objective criteria. Some items are material due to their size but some matters are material by their very nature.

If size is used in the case of LMN $500,000 is 11% of profit and 1.25% of turnover.

Both would be regarded as material due to the size.

(ii)

International Standard on Auditing 701(revised) Modifications to the independent Auditors Report deals with qualified audit reports. ISA 701 classifies qualified audit reports into categories.

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The report category required for LMN would be “Matters that Do Affect the Auditor’s Opinion - A qualified opinion”.

A qualified opinion is expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management is not so material and pervasive as to require an adverse opinion or a disclaimer of opinion. The qualified opinion will be expressed as being ‘except for’ the effects of the misclassification of the research expenditure.

(f)

Section 220 of the CIMA Code of Ethics deals with preparation and reporting of information.

A professional accountant in business should prepare or present such information fairly, honestly and in accordance with relevant professional standards so that the information will be understood in its context.

Section 220 requires a professional accountant in business to maintain information for which they are responsible in a manner that: (a) Describes clearly the true nature of business transactions, assets or liabilities; (b) Classifies and records information in a timely and proper manner; and (c) Represents the facts accurately and completely in all material respects.

The approaches from other staff are threats to compliance with the fundamental principles. If RS altered the figures they would not describe clearly the true nature of the business transactions nor would they represent the facts accurately.

RS may be tempted out of self-interest as he will benefit from the increased bonus.

RS must also comply with the CIMA codes fundamental principles of integrity and objectivity. Changing the management information would breach both of these principles.

Safeguards should be applied to eliminate the threats or reduce them to an acceptable level. As other staff are offering incentives RS will need to decline these and refuse to alter the accounting information.

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SECTION C Answer to Question Three ABC - Statement of comprehensive income for the year ended 30 September 2011 $000 Revenue Cost of sales Gross Profit Administrative expenses Distribution costs Profit from operations Finance cost Profit before tax Income tax expense Net profit for the period

W7 W8 W3 W3

(1,045) (590)

W5 W6

$000 15,900 10,931 4,969 (1,635) 3,334 (115) 3,219 (944) 2,275

ABC - Statement of Financial Position at 30 September 2011 $000 Non-current assets Property, plant and equipment

W2

Current assets Inventory Gross amounts due from customers for contract work Trade receivables Cash and cash equivalents

W1

8,948

310 490 785 440 2,025 10,973

Total assets Equity and liabilities Equity Share capital Share premium Retained earnings Total equity

2,500 1,500 2,652 6,652

Non-current liabilities Long term borrowings Deferred tax Total non-current liabilities

W6

2,300 269 2,569

Current liabilities Trade payables Tax payable Gross amounts due to customers for contract work Interest payable Total current liabilities Total equity and liabilities

November 2011

$000

6

W1 W5

235 910 550 57 1,752 10,973

Financial Operations

ABC - Statement of changes in equity for the year ended 30 September 2011 Equity Share Retained shares Premium Earnings $000 $000 $000 Balance at 1 October 2011 2,500 1,500 627 Statement of comprehensive income for year 2,275 Dividend paid (250) Balance at 30 September 2011 2,500 1,500 2,652

Total $000 4,627 2,275 (250) 6,652

Workings (All figures in $000) W1

Construction Contracts Contract 1

Overall profitability test Revenue Total cost Profit Loss

(3,750 + 5,400)

SoCI Revenue Cost of sales Profit/(Loss) Expected loss on rest of contract Total loss on Contract 2

Contract 2

11,000 9,150 1,850

(2,250 + 6,750)

(1,000) Contract 1 (40% x 11,000) 4,400 (40% x 9,150) (3,660) 740

Contract 2 (25% x 8,000) 2,000 (25% x 9,000) 2,250 (250) (750) (1,000)

SoFP Cost incurred to date Profit/(loss) Cash received from clients Amounts due from clients Amounts due to clients

3,750 740 (4,000) 490

2,250 (1,000) (1,800) (550)

Alternative Method: Revenue Cash received on account

4,400 4,000

2,000 1,800 200 (750)

400 Expected loss Cost of Sales Construction work in progress

3,660 3,750

2,250 2,250 90

Due to customer Due from customer

Financial Operations

8,000 9,000

0 (550)

490

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W2 - Depreciation Buildings Balance b/fwd Year deprec @ 5% Depreciation b/f Total depreciation NBV Land Total property Plant and equipment Balance 30/9/11 – cost Balance 30/9/10 – deprec NBV Disposal

7,500 375 3,750 4,125 3,375 3,500 6,875 4,930 2,156 2,774 (10) 2,764 691

Depreciation Year 25% NBV c/f Total P, P&E c/f

2,073 8,948

W3

Cost of sales 3,210 375 691

Trial balance Depreciation – buildings W2 Depreciation – plant and equipment W2 Bad debt Gain on disposal of P&E W4 Totals

(5) 4,271

Administration

Distribution

1,020

590

25 .

1,045

.

590

W4 Plant and equipment disposal NBV 10 Selling price 15 Profit 5 W5

W6

Interest Years loan interest Paid Current liability

2,300 x 5% =

Tax Balance b/f Year Increase in deferred tax Income statement

15 910 925 19 944

Statement of financial position Current liability – tax Provision deferred tax Increase

W7

115 58 57

Revenue Sales Construction contracts W1

November 2011

910 250 19 269

9,500 6,400 15,900

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W8

Cost of sales Cost of sales W3 Construction contracts W1 Expected loss

Financial Operations

4,271 5,910 750 10,931

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Answer to Question Four

(a) Control is the power to govern the financial and operating policies of an entity so as to obtain benefit from its activities.

There is a presumption that control exists where the investor entity owns over half of the voting power of the other entity.

IAS 27 also sets out circumstances where control can be established with less than 50% of the equity votes: • • • •

Where there is power over more than half the voting rights by virtue of an agreement with other investors.

Where there is power to govern the financial and operating policies of the entity under a statute or agreement.

Power to appoint or remove the majority of board of directors or equivalent governing body.

Power to cast the majority of votes at meetings of the board of directors or equivalent body.

(b) Workings (i) Investment of PH in SU PH purchased all 48,000 shares in SU on 1 October 2010.

100% shares purchased therefore treat SU as wholly owned subsidiary of PH from 1 October 2010.

Investment of PH in AJ PH purchased 8,000,000 of AJ’s 24,000,000 shares on 1 October 2010.

This gave PH one third (33.33%) of AJ’s equity.

As PH has in excess of 20% of AJ’s equity and can exercise significant influence over all aspects of AJ’s strategic and operational decisions PH will treat AJ as an associated entity from 1 October 2010. (ii) Fair value of net assets of SU at acquisition $000 Cost Equity Shares 48,000 Retained earnings 7,680 Fair value adjustment 1,300

$000 75,590

56,980 18,610

Goodwill – SU (iii) Investment in associate - AJ

$000 16,400

Cost Add group share of post acquisition profits (28,800-24,990) = 3,810 x 33.33% Investment at 30 September 2011

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1,270 17,670

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(iv) Intra-group trading Mark up on cost 1/3 = 33.33/133.33 or 25% margin on selling price.

Selling price $4,800,000; unrealised profit = $4,800,000 x 25% = $1,200,000 Dr. $000 1,200

Consolidated cost of sales (retained earnings) Consolidated current assets - inventory

Cr. $000 1,200

$000 Current accounts: PH current account with SU Less cheque in transit

10,000 2,800 7,200 7,200

SU current account with PH

Cancels Cancels

(v) Consolidated Retained Earnings $000

$000 26,500

Balance PH SU - group share of post acquisition profits (15,600 – 7,680) = Associate - AJ, group share of post acquisition profits (iii) Excess depreciation (vii) Cancel unrealised profit in inventory (iv) (vi) Consolidated Property, plant and equipment PH SU Fair value adjustment Excess depreciation (vii) Excess Depreciation Fair value adjustment on acquisition Useful life remaining 20 years Annual excess depreciation 1,300/20 = 65

7,920 1,270 (65) (1,200) 34,425

50,390 57,590 1,300 (65) 109,215 1,300

Group - Consolidated Statement of Financial Position as at 30 September 2011 $000 $000 Non-Current Assets Property, plant and equipment (vi) Goodwill (ii) Investment in associate (iii)

109,215 18,610 17,670 145,495

Current Assets Inventory (10,160+14,410-1,200) Trade receivables (21,400+13,200-90) Cash and cash equivalents (1,260+3,600+2,800)

23,370 34,510 7,660 65,540 211,035

Equity and Liabilities Equity Shares Retained Earnings (v)

126,000 34,425 160,425

Non-current liabilities Borrowings Current Liabilities Trade payables (12,600+5,400-90)

Financial Operations

32,700 17,910 211,035

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