Acca F7

Answers Fundamentals take aim Skills Module, Paper F7 (INT) Financial Reporting (International) 1 (a) declination 2008 Answers Pedantic merge income control for the stratum terminate 30 kinfolk 2008 $000 98,000 (72,000) 26,000 (3,000) (7,600) (500) 14,900 (5,400) 9,500 gross (85,000 + (42,000 x 6/12) 8,000 intra-group gross sales) Cost of sales (w (i)) Gross gain ground dissemination be (2,000 + (2,000 x 6/12)) Administrative expenses (6,000 + (3,200 x 6/12)) Finance make up (300 + (400 x 6/12)) Profit before impose Income tax expense (4,700 + (1,400 x 6/12)) Profit for the twelvemonth ascribable toEquity holders of the p atomic number 18nt Non-controlling vex (((3,000 x 6/12) (800 URP + 200 disparagement)) x 40%) (b) 9,300 200 9,500 Consolidated statement of fiscal position as at 30 folk 2008 Assets Non-current additions Property, lay and equipment (40,600 + 12,600 + 2,000 200 derogation adjustment (w (i))) Goodwill (w (ii)) incumbent assets (w (iii)) T otal assets Equity and liabilities Equity attri exactlyable to owners of the pargonnt Equity shares of $1 each ((10, 000 + 1,600) w (ii)) Share exchange premium (w (ii)) Retained inter pass (w (iv)) 55,000 4,500 59,500 21,400 80,900 11,600 ,000 35,700 55,300 6,100 61,400 Non-controlling interest (w (v)) Total integrity Non-current liabilities 10% loan nones (4,000 + 3,000) 7,000 Current liabilities (8,200 + 4,700 400 intra-group balance) 12,500 80,900 Total equity and liabilities whole kit (figures in brackets in $000) (i) Cost of sales Pedantic Sophistic (32,000 x 6/12) Intra-group sales URP in inventory Additional depreciation (2,000/5 years x 6/12) $000 63,000 16,000 (8,000) 800 200 72,000 The unrealised profit (URP) in inventory is cipher as ($8 zillion $52 billion) x 40/140 = $800,000. 1 (ii) Goodwill in Sophistic enthronization at toll Shares (4,000 x 60% x 2/3 x $6) Less Equity shares of Sophistic (4,000 x 60%) pre-acquisition reserves (5,000 x 60% fore see below) sane valuate adjustment (2,000 x 60%) $000 (2,400) (3,000) (1,200) Parents seemliness Non-controlling interests goodwill (per enquire) Total goodwill The pre-acquisition reserves are At 30 September 2008 Earned in the stakes acquisition period (3,000 x 6/12) Alternative calculation for goodwill in Sophistic Investment at cost (as above) Fair value of non-controlling interest (see below) Cost of the controlling interestLess fair value of give notice assets at acquisition (4,000 + 5,000 + 2,000) Total goodwill Fair value of non-controlling interest (at acquisition) Share of fair value of net assets (11,000 x 40%) Attributable goodwill per question $000 9,600 (6,600) 3,000 1,500 4,500 6,500 (1,500) 5,000 9,600 5,900 15,500 (11,000) 4,500 4,400 1,500 5,900 The 16 million shares (4,000 x 60% x 2/3) issued by Pedantic would be recorded as share super(p) of $16 million and share premium of $8 million (1,600 x $5). $000 16,000 6,600 (800) 200 (600) 21,400 (i ii) Current assets Pedantic Sophistic URP in inventory Cash in transit Intra-group balance (iv) Retained pay Pedantic per statement of fiscal position Sophistics post acquisition profit (((3,000 x 6/12) (800 URP + 200 depreciation)) x 60%) (v) Non-controlling interest (in statement of fiscal position) Net assets per statement of financial position URP in inventory Net fair value adjustment (2,000 200) Share of goodwill (per question) 12 $000 35,400 300 35,700 10,500 (800) 1,800 11,500 x 40% = 4,600 1,500 6,100 (a) Candel argument of comprehensive income for the year ended 30 September 2008 $000 297,500 (225,400) 72,100 (14,500) (21,900) (1,400) 34,300 (11,600) 22,700 Revenue (300,000 2,500) Cost of sales (w (i)) Gross profit Distribution be Administrative expenses (22,200 400 + 100 see note below) Finance be (200 + 1,200 (w (ii))) Profit before tax (Income tax expense (11,400 + (6,000 5,800 deferred tax)) Profit for the year Other comprehensive income Loss on lea sehold property reassessment (w (iii)) (4,500) Total comprehensive income for the year 8,200 demarcation as it is considered that the outcome of the legal action against Candel is unlikely to succeed (only a 20% chance) it is inappropriate to interpret for any damages. The potential damages are an example of a contingent liability which should be expose (at $2 million) as a note to the financial statements. The unrecoverable legal costs are a liability (the start of the legal action is a past event) and should be provided for in full. (b) Candel Statement of changes in equity for the year ended 30 September 2008 Balances at 1 October 2007 Dividend Comprehensive incomeBalances at 30 September 2008 (c) Equity shares $000 50,000 Revaluation reserve $000 10,000 50,000 (4,500) 5,500 Retained earnings $000 24,500 (6,000) 22,700 41,200 Total equity $000 84,500 (6,000) 18,200 96,700 $000 $000 Candel Statement of financial position as at 30 September 2008 Assets Non-current as sets (w (iii)) Property, plant and equipment (43,000 + 38,400) Development costs 81,400 14,800 96,200 Current assets strain mountain receivables 20,000 43,100 Total assets Equity and liabilities Equity (from (b))Equity shares of 25 cents each Revaluation reserve Retained earnings 63,100 159,300 50,000 5,500 41,200 Non-current liabilities Deferred tax 8% redeemable preference shares (20,000 + 400 (w (ii))) Current liabilities Trade payables (23,800 400 + 100 re legal action) Bank overdraft Current tax payable Total equity and liabilities 13 6,000 20,400 23,500 1,300 11,400 46,700 96,700 26,400 36,200 159,300 Workings (figures in brackets in $000) (i) Cost of sales Per outpouring balance Depreciation (w (iii)) leasehold property plant and equipmentLoss on garbage disposal of plant (4,000 2,500) Amortisation of exploitation costs (w (iii)) Research and development expensed (1,400 + 2,400 (w (iii))) (ii) $000 204,000 2,500 9,600 1,500 4,000 3,800 225,400 The finan ce cost of $12 million for the preference shares is establish on the effective rate of 12% applied to $20 million issue proceeds of the shares for the six months they have been in issue (20m x 12% x 6/12). The dividend paid of $800,000 is based on the nominal rate of 8%. The additional $400,000 (accrual) is added to the carrying quantity of the preference shares in the statement of financial position.As these shares are redeemable they are carapace-hardened as debt and their dividend is treated as a finance cost. (iii) Non-current assets Leasehold property Valuation at 1 October 2007 Depreciation for year (20 year life) 50,000 (2,500) 47,500 (43,000) 4,500 Carrying amount at date of revaluation Valuation at 30 September 2008 Revaluation deficit Plant and equipment per trial balance (76,600 24,600) Disposal (8,000 4,000) Depreciation for year (20%) Carrying amount at 30 September 2008 Capitalised/deferred development costs Carrying amount at 1 October 2007 (20,000 6,000) Amo rtised for year (20,000 x 20%)Capitalised during year (800 x 6 months) Carrying amount at 30 September 2008 $000 52,000 (4,000) 48,000 (9,600) 38,400 14,000 (4,000) 4,800 14,800 Note development costs can only be treated as an asset from the point where they meet the recognition criteria in IAS 38 Intangible assets. indeed development costs from 1 April to 30 September 2008 of $48 million (800 x 6 months) can be capitalised. These will not be amortised as the project is still in development. The research costs of $14 million plus three months development costs of $24 million (800 x 3 months) (i. . those prevailred before 1 April 2008) are treated as an expense. 3 (a) Equivalent ratios from the financial statements of Merlot (workings in $000) Return on year end capital employed (ROCE) Pre tax return on equity (ROE) Net asset turnover Gross profit coast Operating profit margin Current ratio Closing inventory holding period Trade receivables collection period Trade payables p ayment period Gearing Interest cover Dividend cover 209% 50% 23 multiplication 122% 98% 131 73 days 66 days 77 days 71% 33 times 14 times (1,400 + 590)/(2,800 + 3,200 + 500 + 3,000) x 100 ,400/2,800 x 100 20,500/(14,800 5,700) 2,500/20,500 x 100 2,000/20,500 x 100 7,300/5,700 3,600/18,000 x 365 3,700/20,500 x 365 3,800/18,000 x 365 (3,200 + 500 + 3,000)/9,500 x 100 2,000/600 1,000/700 As per the question, Merlots pacts infra finance leases (3,200 + 500) have been treated as debt when calculating the ROCE and gearing ratios. 14 (b) Assessment of the relative functioning and financial position of Grappa and Merlot for the year ended 30 September 2008 Introduction This report is based on the draft financial statements supplied and the ratios shown in (a) above.Although covering many aspects of performance and financial position, the report has been approached from the point of descry of a prospective acquisition of the entire equity of one of the deuce companies. Profitability The ROCE of 209% of Merlot is far superior to the 148% return achieved by Grappa. ROCE is traditionally seen as a bankers bill of managements general efficiency in the use of the finance/assets at its disposal. More elaborate analysis reveals that Merlots superior performance is due to its efficiency in the use of its net assets it achieved a net asset turnover of 23 times compared to only 12 times for Grappa.Put another way, Merlot makes sales of $230 per $1 invested in net assets compared to sales of only $120 per $1 invested for Grappa. The other element contributing to the ROCE is profit margins. In this area Merlots boilers suit performance is slightly inferior to that of Grappa, gross profit margins are almost identical, but Grappas operate profit margin is 105% compared to Merlots 98%. In this situation, where one partnerships ROCE is superior to anothers it is useful to look behind the figures and consider possible reasons for the high quality other than the obvious one o f greater efficiency on Merlots part.A major component of the ROCE is normally the carrying amount of the non-current assets. Consideration of these in this case reveals some interesting issues. Merlot does not own its premises whereas Grappa does. such(prenominal) a situation would not necessarily give a ROCE advantage to either association as the affix in capital employed of a company owning its factory would be compensated by a higher return due to not having a rental expense (and vice versa). If Merlots rental cost, as a percentage of the value of the related factory, was less than its overall ROCE, and then it would be contributing to its higher ROCE.There is insufficient information to determine this. Another applicable point may be that Merlots owned plant is nearing the end of its useful life (carrying amount is only 22% of its cost) and the company seems to be replacing owned plant with leased plant. once again this does not necessarily give Merlot an advantage, but the finance cost of the leased assets at only 75% is much start out than the overall ROCE (of either company) and therefore this does help to improve Merlots ROCE. The other important issue within the formation of the ROCE is the valuation basis of the companies non-current assets.From the question, it appears that Grappas factory is at current value (there is a property revaluation reserve) and note (ii) of the question indicates the use of historical cost for plant. The use of current value for the factory (as contrasted to historical cost) will be adversely impacting on Grappas ROCE. Merlot does not suffer this deterioration as it does not own its factory. The ROCE measures the overall efficiency of management however, as Victular is considering buying the equity of one of the two companies, it would be useful to consider the return on equity (ROE) as this is what Victular is buying.The ratios calculated are based on pre-tax loot this takes into account finance costs, but do es not cause taxation issues to distort the coincidence. clearly Merlots ROE at 50% is far superior to Grappas 191%. Again the issue of the revaluation of Grappas factory is making this ratio appear comparatively worse (than it would be if there had not been a revaluation). In these circumstances it would be much meaningful if the ROE was calculated based on the ask cost of each company (which has not been disclosed) as this would effectively be the carrying amount of the relevant equity for Victular. GearingFrom the gearing ratio it can be seen that 71% of Merlots assets are financed by borrowings (39% is attributable to Merlots policy of leasing its plant). This is very high in absolute terms and figure of speech Grappas level of gearing. The effect of gearing means that all of the profit after finance costs is attributable to the equity even though (in Merlots case) the equity represents only 29% of the financing of the net assets. Whilst this may seem advantageous to the equity shareholders of Merlot, it does not come without risk. The interest cover of Merlot is only 33 times whereas that of Grappa is 6 times.Merlots low interest cover is a direct moment of its high gearing and it makes profits vulnerable to relatively small changes in operating activity. For example, small reductions in sales, profit margins or small increases in operating expenses could result in losses and mean that interest charges would not be covered. Another observation is that Grappa has been able to take advantage of the receipt of government grants Merlot has not. This may be due to Grappa purchasing its plant (which may then be eligible for grants) whereas Merlot leases its plant.It may be that the lessor has received any grants available on the purchase of the plant and passed some of this benefit on to Merlot via lower lease finance costs (at 75% per annum, this is considerably lower than Merlot has to pay on its 10% loan notes). Liquidity Both companies have relative ly low liquid ratios of 12 and 13 for Grappa and Merlot respectively, although at least Grappa has $600,000 in the bank whereas Merlot has a $12 million overdraft. In this respect Merlots policy of high dividend payouts (leading to a low dividend cover and low retained earnings) is very questionable.Looking in more than depth, both companies have similar inventory days Merlot collects its receivables one week to begin with than Grappa (perhaps its credit control procedures are more active due to its large overdraft), and of notable difference is that Grappa receives (or takes) a lot longer credit period from its suppliers (108 days compared to 77 days). This may be a observation of Grappa being able to negotiate better credit terms because it has a higher credit rating. thick Although both companies may operate in a similar industry and have similar profits after tax, they would represent very opposite purchases.Merlots sales revenues are over 70% more than those of Grappa, it is financed by high levels of debt, it rents rather than owns property and it chooses to lease rather than buy its replacement plant. Also its be owned plant is nearing the end of its life. Its replacement will either require a exchange guesswork if it is to be purchased (Merlots overdraft of 15 $12 million already requires serious attention) or take in even higher levels of gearing if it continues its policy of leasing. In short although Merlots overall return seems more attractive than that of Grappa, it would represent a much more risky investment.Ultimately the investment decision may be determined by Victulars attitude to risk, possible synergies with its existing business activities, and not least, by the asking price for each investment (which has not been disclosed to us). (c) The generally recognised potential problems of using ratios for comparison purposes are inconsistent definitions of ratios financial statements may have been deliberately manipulated (creativ e accounting) polar companies may adopt different accounting policies (e. g. use of historical costs compared to current value) different managerial policies (e. . different companies offer customers different payment terms) statement of financial position figures may not be representative of average values throughout the year (this can be caused by seasonal trading or a large acquisition of non-current assets near the year end) the impact of price changes over time/distortion caused by pompousness When deciding whether to purchase a company, Victular should consider the following additional useful information 4 in this case the analysis has been made on the draft financial statements these may be unreliable or change when being finalised.Audited financial statements would add credibility and reliance to the analysis (assuming they receive an unmodified Auditors Report). preceding looking information such as profit and financial position forecasts, capital expenditure and ca sh budgets and the level of orders on the books. the current (fair) values of assets being acquired. the level of risk within a business. super profitable companies may also be highly risky, whereas a less profitable company may have more stable quality earnings not least would be the expected price to acquire a company.It may be that a poorer performing business may be a more attractive purchase because it is relatively cheaper and may offer more opportunity for improving efficiencies and profit growth. (a) A liability is a present certificate of indebtedness of an entity arising from past events, the settlement of which is expected to result in an outflow of economic benefits (normally cash). Provisions are defined as liabilities of uncertain timing or amount, i. e. they are normally estimates. In essence provisions should be recognised if they meet the definition of a liability.Equally they should not be recognised if they do not meet the definition. A statement of financial po sition would not give a fair representation if it did not include all of an entitys liabilities (or if it did include, as liabilities, items that were not liabilities). These definitions benefit the reliability of financial statements by preventing profits from being smoothed by making a provision to reduce profit in years when they are high and releasing those provisions to increase profit in years when they are low.It also means that the statement of financial position cannot rescind the immediate recognition of long-term liabilities (such as environmental provisions) on the basis that those liabilities have not matured. (b) (i) next costs associated with the acquisition/construction and use of non-current assets, such as the environmental costs in this case, should be treated as a liability as soon as they become unavoidable. For Promoil this would be at the uniform time as the platform is acquired and brought into use. The provision is for the present value of the expected co sts and this same amount is treated as part of the cost of the asset.The provision is unwound by charging a finance cost to the income statement each year and increasing the provision by the finance cost. Annual depreciation of the asset effectively allocates the (discounted) environmental costs over the life of the asset. Income statement for the year ended 30 September 2008 Depreciation (see below) Finance costs ($69 million x 8%) Statement of financial position as at 30 September 2008 Non-current assets Cost ($30 million + $69 million ($15 million x 046)) Depreciation (over 10 years) Non-current liabilities Environmental provision ($69 million x 108) (ii) $000 3,690 552 36,900 (3,690) 33,210 7,452 If there was no legal requirement to incur the environmental costs, then Promoil should not provide for them as they do not meet the definition of a liability. Thus the oil platform would be recorded at $30 million with $3 million depreciation and there would be no finance costs. Howe ver, if Promoil has a published policy that it will voluntarily incur environmental clean up costs of this type (or if this may be implied by its past practice), then this would be evidence of a constructive obligation under IAS 37 and the required treatment of the costs would be the same as in part (i) above. 6 5 Year ended/as at Income statement Depreciation (see workings) Maintenance (60,000/3 years) Discount received (840,000 x 5%) module training Statement of financial position (see below) Property, plant and equipment Cost Accumulated depreciation Carrying amount Workings Manufacturers base price Less trade discount (20%) Base cost weight charges Electrical installation cost Pre-production testing Initial capitalised cost 30 September 2006 30 September 2007 30 September 2008 $ $ $ 180,000 270,000 119,000 20,000 20,000 20,000 (42,000) 40,000 198,000 290,000 139,000 920,000 (180,000) 740,000 920,000 (450,000) 470,000 670,000 (119,000) 551,000 $ 1,050,000 (210,000) 840,000 30,000 28,000 22,000 920,000 The depreciable amount is $900,000 (920,000 20,000 residual value) and, based on an estimated machine life of 6,000 hours, this gives depreciation of $ one hundred fifty per machine hour. Therefore depreciation for the year ended 30 September 2006 is $180,000 ($150 x 1,200 hours) and for the year ended 30 September 2007 is $270,000 ($150 x 1,800 hours).Note early settlement discount, lag training in use of machine and maintenance are all revenue items and cannot be part of capitalised costs. Carrying amount at 1 October 2007 Subsequent expenditure Revised cost 470,000 200,000 670,000 The rewrite depreciable amount is $630,000 (670,000 40,000 residual value) and with a revised remaining life of 4,500 hours, this gives a depreciation charge of $140 per machine hour. Therefore depreciation for the year ended 30 September 2008 is $119,000 ($140 x 850 hours). 17Fundamentals Level Skills Module, Paper F7 (INT) Financial Reporting (Internation al) December 2008 Marking Scheme This planting scheme is given as a guide in the context of use of the suggested answers. Scope is given to markers to award marks for alternative approaches to a question, including relevant comment, and where well-reasoned conclusions are provided. This is particularly the case for written answers where there may be more than one acceptable solution. Marks 1 (a) (b) Income statement revenue cost of sales distribution costs administrative expenses inance costs income tax non-controlling interest 11/2 3 1/ 2 1 1/ 2 1/ 2 2 9 Statement of financial position property, plant and equipment goodwill current assets equity shares share premium retained earnings non-controlling interest 10% loan notes current liabilities Total for question 2 (a) (b) (c) Statement of comprehensive income revenue cost of sales distribution costs administrative expenses finance costs income tax other comprehensive income 2 5 11/2 1 1 2 2 1/ 2 1 16 25 1 5 1/ 2 11/2 11/2 11/2 1 1 2 Statement of changes in equity rought forward figures dividends comprehensive income 1 1 1 3 Statement of financial position property, plant and equipment deferred development costs inventory trade receivables deferred tax preference shares trade payables overdraft current tax payable Total for question 19 2 2 1/ 2 1/ 2 1 1 11/2 1/ 2 1 10 25 3 (a) (b) 1 mark per valid comment up to (c) Marks 8 Merlots ratios 1 mark per relevant point 12 Total for question 4 5 25 (a) 1 mark per relevant point 5 (b) (i) explanation of treatment depreciation finance cost non-current asset provision 2 1 2 1 7 (ii) figures for asset and depreciation if not a constructive obligation what may cause a constructive obligation subsequent treatment if it is a constructive obligation Total for question 5 1 1 1 3 15 Total for question 2 1 1 3 1 1 1 10 initial capitalised cost upgrade improves efficiency and life (therefore capitalise) revised carrying amount at 1 October 2007 annual depreciation (1 mark each y ear) maintenance costs charged at $20,000 each year discount received (in income statement) staff training (not capitalised and charged to income) 20