SECTION A – CASE QUESTIONS (Total: 50 marks)

To : Janice CHEUNG (Director)

From : David LI, Accounting Manager
c.c. : Michelle CHOW, Julian LIN, Fiona MERRILL (Directors)
Date : dd/mm/yyyy

I refer to your e-mail dated 18 May 2008 regarding your queries about the draft
consolidated financial statements for City as at 31 March 2008.

Answer 1(a)(i)

Pledged bank deposits

HKAS 1 requires the face of the statement of financial position to include a line item that
presents the cash and cash equivalents.

HKAS 7 states that cash comprises cash on hand and demand deposits while cash
equivalents are short-term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in value.

Since pledged bank deposits are not readily convertible to known amounts of cash without
an insignificant risk of changes in value, they are not included in the cash and cash
equivalents.

HKAS 1 also specifies that additional line items, headings and subtotals shall be presented
on the face of the statement of financial position when such presentation is relevant to an
understanding of the entity’s financial position.

Paragraph 14 of HKFRS 7 requires an entity to disclose:

• the carrying amount of financial assets it has pledged as collateral for liabilities or
contingent liabilities, including amounts that have been reclassified in accordance
with paragraph 37(a) of HKAS 39; and
• the terms and conditions relating to its pledge.

Paragraph 31 of HKFRS 7 requires an entity to disclose information that enables users of

its financial statements to evaluate the nature and extent of risks arising from financial
instruments to which the entity is exposed at the reporting date.

Pledged bank deposits and their relevant financial liability create a potentially significant
exposure to risks and hence their terms and conditions warrant disclosure.

The amounts represent deposits pledged to banks to secure banking facilities granted to
the Group. This denotes that as at 31 March 2008, bank deposits of HK$8,904,000 (2007:
HK$19,754,000) had been pledged to secure City’s banking facilities.

Module A (September 2008 Session) Page 1 of 12

HKAS 1 requires that “an asset shall be classified as current when it satisfies any of the
following criteria:

(a) it is expected to be realised in, or is intended for sale or consumption in, the entity’s
normal operating cycle;
(b) it is held primarily for the purpose of being traded;
(c) it is expected to be realised within twelve months after the end of the reporting
period; or
(d) it is cash or a cash equivalent (as defined in HKAS 7 Statement of Cash Flows)
unless it is restricted from being exchanged or used to settle a liability for at least
twelve months after the end of the reporting period.

All other assets shall be classified as non-current. Therefore, the bank deposits and cash
should be classified into three items in accordance with the nature of the amount, i.e. cash
and cash equivalents, pledged bank deposits classified as current assets and pledged bank
deposits classified as non-current assets.

The amounts denote that deposits amounting to HK$2,322,000 (2007: HK$13,522,000)

have been pledged to secure short-term bank borrowings and are therefore classified as
current assets; and the remaining deposits amounting to HK$6,582,000 (2007:
HK$6,232,000) have been pledged to secure long-term borrowings and are therefore
classified as non-current assets.

The pledged bank deposits will be released and reclassified from “Pledged bank deposits”
to “Bank balances and cash” upon settlement of the relevant bank borrowings.

Answer 1(a)(ii)

Club membership

The club membership represents entrance fees paid to clubs held on a long-term basis.
Typically, it is recognised as an intangible asset since it is an identifiable non-monetary
asset without physical substance.

The accounting for an intangible asset is based on its useful life. An intangible asset with
a finite useful life is amortised, and an intangible asset with an indefinite useful life is not.
Therefore, an entity shall assess whether the useful life of an intangible asset is finite or
indefinite.

HKAS 38 requires an intangible asset to be regarded as having an indefinite useful life

when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the
period over which the asset is expected to generate net cash inflows for the entity.

The term ‘indefinite’ does not mean ‘infinite’. The useful life of an intangible asset reflects
only that level of future maintenance expenditure required to maintain the asset at its
standard of performance assessed at the time of estimating the asset’s useful life, and the
entity’s ability and intention to reach such a level. A conclusion that the useful life of an
intangible asset is indefinite should not depend on planned future expenditure in excess of
that required to maintain the asset at that standard of performance.

Since there is no foreseeable limit to the period over which the club membership is
expected to generate net cash inflows for City, the management of City considered the club
membership as having an indefinite useful life.

Module A (September 2008 Session) Page 2 of 12

An intangible asset with an indefinite useful life should not be amortised. Therefore the
club membership, which is considered by the management of the Group as having an
indefinite useful life, will not be amortised until the useful life is determined to be finite upon
reassessment of the useful life annually by the management.

The useful life of the club membership should be reviewed each reporting period to
determine whether events and circumstances continue to support an indefinite useful life
assessment for that asset. If they do not, the change in the useful life assessment from
indefinite to finite should be accounted for as a change in an accounting estimate.

As a result, the club membership with indefinite useful life is carried at cost less any
identified impairment loss and is tested for impairment annually.

During the year ended 31 March 2008, the club membership shall be tested for impairment
by comparing its carrying amount with its recoverable amount. If the recoverable amount
exceeds the carrying amount, the management can conclude that no impairment loss
needed to be charged for the current year and hence the carrying amount of the club
membership remains the same throughout the two years.

As an intangible asset assessed as having an indefinite useful life, HKAS 38 requires City
to disclose the carrying amount of the club membership and the reasons supporting the
indefinite useful life assessment.

Answer 1(a)(iii)

Equity-settled share-based payment transactions - Share options granted to

employees of the Group

HKFRS 2 defines equity-settled share-based payment transactions as transactions in which

the reporting entity receives goods or services as consideration for equity instruments of the
entity, which equity instruments can include shares or share options.

For equity-settled share-based payment transactions, the entity shall measure the goods or
services received, and the corresponding increase in equity, directly, at the fair value of the
goods or services received, unless that fair value cannot be estimated reliably. If the entity
cannot estimate reliably the fair value of the goods or services received, the entity shall
measure their value, and the corresponding increase in equity, indirectly, by reference to
the fair value of the equity instruments granted.

There is a general assumption that transactions with employees cannot be reliably

measured on the basis of the value of the services being provided. Therefore,
transactions with employees are typically measured at the fair value of the equity
instruments being granted.

The grant date is 1 May 2006. The requirement for the holder to be in employment with
City when he exercises the options is effectively a vesting condition.

The vesting date should be 1 May 2007, which is the first date that the option holder is
entitled to exercise the options. The options vest over the one year ending 1 May 2007.

Since the option vest over the one year ending 1 May 2007, it is presumed that the services
to be rendered by the director as consideration for the options will be received in the one
year vesting period.

Module A (September 2008 Session) Page 3 of 12

Therefore, City should recognise 335/365 (335 days out of 365 days) of the services to be
received as an expense during the year ended 31 March 2007 with a corresponding
increase in equity (share option reserve).

The amount should be measured by reference to the fair value of the options as at 1 May
2006, i.e. the fair value of services received determined by reference to the fair value of
share options granted at the grant date is expensed on a straight-line basis over the vesting
period, with a corresponding increase in equity (share option reserve).

Therefore, City recognised the total expense of HK$333,000 (HK$4,050,000 x 30/365) for
the year ended 31 March 2008 (2007: HK$3,717,000 (HK$4,050,000 x 335/365)) in relation
to share options granted by the Company.

At the end of each reporting period, City should revise its estimates of the number of
options that are expected to ultimately vest. The impact of the revision of the estimates is
recognised in profit or loss, with a corresponding adjustment to share option reserve.

At the time when the share options are exercised, the amount previously recognised in
share option reserve shall be transferred to share premium. Thus, HK$4,050,000 has
been transferred from the share option reserve to the share premium account as shown in
the consolidated statement of changes in equity.

I hope the above explanation has answered your questions. Please feel free to contact
me if you have further queries.

Best regards
David LI

Module A (September 2008 Session) Page 4 of 12

Answer 1(b)

Consolidated Statement of Cash Flows for the year ended 31 March 2008
HK$'000
Operating activities
Profit before tax 115,295
Adjustments for:
Finance costs 4,974
Share-based payment expense 333
Depreciation 32,036
Impairment loss recognised on trade receivables 210
Interest income (5,306)
Loss on disposal of property, plant and equipment 802
Loss on disposal of an associate 7,888
Operating cash flows before movements in working capital 156,232
Decrease in inventories
(270,726 – exchange difference 120) – 346,984 76,378
Increase in trade debtors, deposits and prepayments
(719,128 – exchange difference 140) + impairment 210 – 670,522 (48,676)
Decrease in trade creditors and accrued charges
(675,602 – exchange difference 40) – 708,524 (32,962)
Increase in amount due to a related party (48,634 – 37,862) 10,772
Cash generated from operating activities 161,744
Tax paid (current 10,580 + deferred 7,202 + I/S 14,758 – closing current
7,898 – closing deferred 6,286) (18,356)
Net cash generated from operating activities 143,388

Investing activities
Purchases of property, plant and equipment (34,240)
Proceeds on disposal of property, plant and equipment
(2,898 – 2,092) – 802 4
Proceeds on disposal of an associate (Note e) 3,860
Decrease in pledged bank deposits
(6,582 + 2,322) – (6,232 + 13,522) 10,850
Interest received 5,306
Net cash used in investing activities (14,220)

Financing activities
Repayment of obligations under finance leases (2,690 + 216) – 220 (2,686)
Proceeds on issue of shares (6,068 – 6,000) 68
Repayment of bank borrowings (83,006 + 8,908) – (76,482 + 10,412) (5,020)
Dividends paid (16,990 + 9,102) (26,092)
Interest paid (4,974)
Net cash used in financing activities (38,704)

Net increase in cash and cash equivalents 90,464

Effect of foreign exchange rate changes (Note g) 90
Cash and cash equivalents at the beginning of the year 143,472
Cash and cash equivalents at the end of the year
representing bank balances and cash 234,026

Module A (September 2008 Session) Page 5 of 12

Alternatively, candidates may present Statement of Cash Flows by using direct
method:

HK$’000
Cash generated from operating activities:

Cash receipts from customers

(670,522 + 2,348,314 – (719,128 – exchange gain 140
+ impairment loss 210) 2,299,638

Cash paid to suppliers and employees (Note 1) (2,137,894)

Cash generated from operating activities 161,744

Note 1:

Cash paid to suppliers and employees

Opening inventories + purchase – closing inventories = cost of sales

346,984 + purchase – (270,726 – exchange gain 120) = 2,044,510
thus purchase = 1,968,132

Opening trade payables and accrued charges 708,524

Opening amount due to a related party 37,862
Purchase 1,968,132
Selling and distribution costs 44,868
Administrative expenses 136,085
less: share-based payment expense (333)
less: depreciation (32,036)
less: impairment loss recognised on trade receivables (210)
less: loss on disposal of property, plant and equipment (802)
less: closing trade payables and accrued charges (675,602)
add: exchange difference 40
less: closing amount due to a related party (48,634)
2,137,894

* * * END OF SECTION A * * *

Module A (September 2008 Session) Page 6 of 12

SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks)

Answer 2(a)

The financial statements should be prepared so as to reflect events occurring up to the end
of the reporting period and conditions existing at the end of the reporting period.

A change in an accounting estimate is an adjustment of the carrying amount of an asset or

a liability, or the amount of the periodic consumption of an asset, that results from the
assessment of the present status of, and expected future benefits and obligations
associated with, assets and liabilities.

Events after the reporting period include those events up to the date when the financial
statements are authorised for issue.

The statement is correct to the extent that the latest information at the date when the
financial statements are authorised for issue constitutes an adjusting event which provides
additional evidence of conditions existing at the end of the reporting period.

Non-adjusting events do not give rise to a need for changes in the amounts recognised in
the financial statements.

Change in accounting estimate based on the events happened after the reporting period
and up to the date when the financial statements are authorised for issue should not be
adjusted in the reporting period but recognised in the period affected by the change.

Answer 2(b)

The statement is incorrect.

Under HKAS 27, parents should prepare consolidated financial statements in which they
consolidate their investments in subsidiaries subject to one exception when ALL of the
following conditions set out in HKAS 27.10 are met:

(a) the parent is itself a wholly-owned subsidiary, or the parent is a partially-owned

subsidiary of another entity and its other owners, including those not otherwise
entitled to vote, have been informed about, and do not object to, the parent not
preparing consolidated financial statements;

(b) the parent's debt or equity instruments are not traded in a public market (a domestic
or foreign stock exchange or an over-the-counter market, including local and regional
markets);

(c) the parent did not file, nor is it in the process of filing, its financial statements with a
securities commission or other regulatory organisation for the purpose of issuing any
class of instruments in a public market; and

(d) the ultimate or any intermediate parent of the parent produces consolidated financial
statements available for public use that comply with Hong Kong Financial Reporting
Standards or International Financial Reporting Standards.

If on acquisition of a subsidiary meets the criteria to be classified as held for sale in

accordance with HKFRS 5, it shall be accounted for in accordance with that standard.

Module A (September 2008 Session) Page 7 of 12

Answer 3(a)

Purchase option regarding classification of the lease by SRC

According to HKAS 17.10, if the lessee (SRC) has the option to purchase the asset at a
price that is expected to be sufficiently lower than the fair value at the date the option
becomes exercisable for it to be reasonably certain, at the inception of the lease, that the
option will be exercised, it would normally lead to a lease being classified as a finance
lease.

The option price is HK$10,000. In view of the fact that SRC estimated the economic
useful life of the leased equipment to be 8 years while the lease term is just 5 years, plus
the fair value of the leased equipment at 1 January 2007 is HK$227,500, it is reasonable to
expect that the option price is sufficiently lower than the then fair value after 5 years.
Therefore, SRC should classify the lease as a finance lease.

Answer 3(b)

12.93% is the implicit rate that, at the inception of the lease, causes the aggregate present
value of the minimum lease payment and the unguaranteed residual value to be equal to
the fair value of the leased asset:

Present
Annual Unguaranteed value
lease residual at implicit rate
Date payment value 12.93%
HK$ HK$ HK$
01/01/2007 53,069 53,069
1
01/01/2008 53,069 46,993 = 53,069 / (1.1293)
2
01/01/2009 53,069 41,612 = 53,069 / (1.1293)
3
01/01/2010 53,069 36,848 = 53,069 / (1.1293)
4
01/01/2011 53,069 32,629 = 53,069 / (1.1293)
5
31/12/2011 30,000 16,333 = 30,000 / (1.1293)
227,484

Year Balance of lease Annual lease Interest Balance of lease

net investment payment 12.93% net investment
at 1 Jan at 31 Dec
HK$ HK$ HK$ HK$
2007 227,500 53,069 22,554 196,985
2008 196,985 53,069 18,608 162,524
2009 162,524 53,069 14,153 123,608
2010 123,608 53,069 9,121 79,660
2011 79,660 53,069 3,438 30,029

Module A (September 2008 Session) Page 8 of 12

Answer 3(c)

Journal entries that TMI should make for each of the years ended 31 December 2007 and
2008:

2007

HK$ HK$
DR Lease payment receivable 227,500
CR Revenue 227,500

To record the revenue and the lease payment receivable for the finance lease of the
equipment.

DR Cost of sales 200,000

CR Inventory 200,000

To record the cost of sales for the finance lease of the equipment.

DR Cash 53,069
CR Lease payment receivable 53,069

To record the receipt of the lease payment.

DR Lease payment receivable 22,554

CR Interest income 22,554

To record the interest income for the year recognised at the implicit rate.

2008

DR Cash 53,069
CR Lease payment receivable 53,069

To record the receipt of the lease payment.

DR Lease payment receivable 18,608

CR Interest income 18,608

To record the interest income for the year recognised at the implicit rate.

Answer 4(a)

Journal entries that GDL should make during the year ended 31 December 2007:

HK$ HK$
Dr Sugar futures contract
/ financial derivatives 80,000
Cr Other comprehensive income - hedging reserve 80,000

To record the sugar futures contract at fair value with the changes in fair value of the
derivative recorded in other comprehensive income.

Module A (September 2008 Session) Page 9 of 12

Answer 4(b)

Journal entries that GDL should make on 30 April 2008:

HK$ HK$
Dr Other comprehensive income
– hedging reserve 30,000
Cr Sugar futures contract / financial derivatives 30,000

To record the sugar futures contract at fair value with the changes in fair value of the
derivative recorded in other comprehensive income.

Dr Cash 50,000
Cr Sugar futures contract / financial derivatives 50,000

To record the settlement of the sugar futures contract.

Dr Cost of goods sold 2,500,000

Cr Inventory 2,500,000

To record the cost of good sold for the inventory sale.

Dr Cash 2,950,000
Dr Other comprehensive income
– hedging reserve 50,000
Cr Revenue 3,000,000

To record the hedged forecast sale.

Answer 4(c)

If GDL does not opt for the use of hedge accounting, it shall apply the normal recognition
and measurement requirements of HKAS 39 for the sugar futures contract, i.e. a derivative
as held for trading financial instrument at fair value through profit or loss. Gain or loss
arising from a change in the fair value shall be recognised in profit or loss. Accordingly,
the journal entry that GDL should make during the year ended 31 December 2007 should
be:

HK$ HK$
Dr Sugar futures contract
/ financial derivatives 80,000
Cr Income statement – gain on derivative contract 80,000

To record the sugar futures contract at fair value with the changes in fair value of the
derivative recorded in profit or loss.

Module A (September 2008 Session) Page 10 of 12

And the journal entries that GDL should make on 30 April 2008 in relation to the sugar
futures contract should be:

Dr Income statement –
loss on derivative contract 30,000
Cr Sugar futures contract / financial derivatives 30,000

Dr Cash 50,000
Cr Sugar futures contract / financial derivatives 50,000

To record the sugar futures contract at fair value with the changes in fair value of the
derivative recorded in profit or loss and the settlement of the contract.

Dr Cash 2,950,000
Cr Revenue 2,950,000

Dr Cost of goods sold 2,500,000

Cr Inventory 2,500,000

To record the revenue and cost of good sold of the inventory sale.

Answer 5(a)

Contingently issuable shares are shares issuable for little or no cash or other consideration
upon the satisfaction of specified conditions in a contingent share agreement.

Contingently issuable shares are treated as outstanding and included in the calculation of
the diluted earnings per share if the conditions are satisfied (i.e. the events have occurred).

If the conditions are not satisfied, the number of contingently issuable shares included in
the diluted earnings per share calculation is based on the number of shares that would be
issuable if the end of the period were the end of the contingency period.

Contingently issuable shares are included from the beginning of the period (or from the
date of the contingent share agreement, if later).

A convertible bond is a potential ordinary share, i.e. a financial instrument or other contract
that may entitle its holders to an ordinary share.

For the purpose of calculating diluted earnings per share, an entity shall adjust profit or loss
attributable to ordinary equity holders of the parent entity by the after-tax effect of any
interest recognised in the period related to the dilutive convertible bond and any other
changes in income or expenses that would result from conversion of the dilutive convertible
bond.

The number of ordinary shares shall be the weighted average number of ordinary shares
calculated for basic earnings per share plus the weighted average number of ordinary
shares that would be issued on the conversion of the dilutive convertible bond into ordinary
shares.

The dilutive convertible bond shall be deemed to have been converted into ordinary shares
at the beginning of the period, or if later, the date of the issue of the convertible bond.

Module A (September 2008 Session) Page 11 of 12

Both contingently issuable shares and convertible bonds shall be included in the calculation
of dilutive earnings per share when they are dilutive, i.e. when and only when, their
conversion to ordinary shares or issue of additional ordinary shares would decrease
earnings per share or increase loss per share from continuing operations.

Answer 5(b)

Under HKFRS 3.45 (Revised), adjustments to provisional values may be made within a
period not exceed one year from the acquisition date and accounted for as if they were
made at the acquisition date.

Therefore, the acquiree's net assets are calculated as if the adjusted fair value was
recognised at the acquisition date.

Goodwill or any discount on acquisition recognised shall be adjusted from the acquisition
date by an amount equal to the adjustments to the fair value at the acquisition date of the
identifiable asset, liability or contingent liability being recognised or adjusted.

Comparative figures are restated accordingly.

Revisions of estimates identified after the twelve-month period are not adjusted
retrospectively, but accounted for in the period in which they are identified.

After the measurement period ends, the acquirer shall revise the accounting for a business
combination only to correct an error in accordance with HKAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors.

* * * END OF EXAMINATION PAPER * * *

Module A (September 2008 Session) Page 12 of 12