ADVANCED ACCOUNTING AND FINANCIAL REPORTING

Final Examinations – Winter 2008

Suggested Answers

Ans.1 Golden Limited

Consolidated Income Statement
For the year ended June 30, 2008
Rs. in million
Sales (875 + 350 - 40) 1,185.00
Cost of sales (567 + 206 - 33.6 (W-1) (739.40)
Gross profit 445.60
Selling expenses (33 + 11) (44.00)
Administrative expenses (63 + 40) (103.00)
Interest expenses (30 + 22) (52.00)
Other income (65 - 36) [20 x Rs.2 x 90%) 29.00
Impairment losses
Goodwill (W-2) (9.18)
Investment in associates (W-3) (25.80)
Share of loss from associates [(Rs. 82 x 40%)+0.6] (33.40)
Profit before tax 207.22
Income tax expense (73 + 15) (88.00)
Profit for the year 119.22
Attributable to:
Ordinary shareholders of parent 114.26
Minority interest (W-4) 4.96
119.22
W-1: Adjustment in cost of sales Rs. in million
Intra-group purchases (40.00)
Additional depreciation on machines 4.00
Unrealized profit in inventories 2.40
(33.60)
W-2: Impairment on Goodwill
Shares issued (18 x 4/5 x Rs.20) 288.00
Less: Net assets acquired:
Share capital 200
Pre-acquisition reserves 24
Fair value adjustment (22 + 20 + 3) 45
269
Holding % 90% 242.10
Goodwill 45.90
20% Impairment in goodwill 9.18

W-3: Impairment in the value of investment in associates Rs. in million

Cash paid (6 x 12) 72.00
Less: Post acquisition losses:
Reserves on acquisition 40
Reserves at June 30, 2008 (108-82) 26
(14)
% holding 40% (5.60)
Elimination of unrealized gain to the extent of GL's share
(Rs. 11.5 x 0.15 / 1.15 x 40%) (0.60)
65.80
Fair value as per impairment testing 40.00
Impairment losses 25.80

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 ADVANCED ACCOUNTING AND FINANCIAL REPORTING
Final Examinations – Winter 2008
Suggested Answers

W-4: Minority Interests

Profit of YL 56.00
Less: Additional depreciation (4.00)
Unrealized profit in inventories (2.40)
49.60
Minority Interest % 10%
4.96

Ans.2(a) Silver Construction Limited

Extracts from Income Statement
For the year ended June 30, 2008
Rs. in million

Contract revenue recognized 2,318.18

Contract costs recognized (2,108.00)

Silver Construction Limited

Extracts from Balance Sheet
As of June 30, 2008
Rs. in million
ASSETS
Due from customers 106.75

LIABILITIES
Due to customers 21.76

Working Schedule
I II III IV V VI Total
-----------------------------Rupees in million-------------------------
Contract price 300 375 280 400 270 1,200 2,825.00
Incentive payments - - - 40 - - 40.00
Total contract price (A) 300 375 280 440 270 1,200 2,865.00

Contract cost incurred to date (B) 248 68 186 246 185 1,175 2,108.00
Estimated further costs 67 221 - 164 15 - 467.00
Total estimated costs to complete (C) 315 289 186 410 200 1,175 2,575.00

Completion % B / C x 100 (D) 78.73% 23.53% 100% 60% 92.50% 100%

Revenue to be recognized A x D (E) 236.19 88.24 280.00 264.00 249.75 1,200 2,318.18

Expected losses from contracts (A-C) (15.00) - - - - - (15.00)

Amount recoverable from customer (E) *233.00 88.24 280.00 264.00 249.75 1,200
Progress billings 200.00 110.00 280.00 235.00 205.00 1,200
Due from customers 33.00 - - 29.00 44.75 - 106.75
Due to customers - (21.76) - - - (21.76)
* Cost to be recognized – expected losses = 248 – 15 = 233

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 ADVANCED ACCOUNTING AND FINANCIAL REPORTING
Final Examinations – Winter 2008
Suggested Answers

(b) Comments on additional information

(i) Incentive payments are included in contract revenue when:

ƒ The contract is sufficiently advanced that it is probable that the specified performance standards will
be met or exceeded; and
ƒ The amount of the incentive payment can be measured reliably.
Since the Contract IV is in advance stage and the probability to achieve the target is very high, the
company should recognize the incentive payment to be received, on this contract.

(ii) Claims are recorded in contract revenue only when:

ƒ Negotiations have reached an advanced stage such that it is probable that the customer will accept the
claim; and
ƒ The amount that it is probable will be accepted by the customer can be measured reliably.

Since the claim amount can not be measured reliably, the claim should not be recognized as contract
revenue.

Ans.3 Date Particulars Dr. Cr.

(a) Jul 1, 07 Cash 100,000,000
Payable to Green Limited *65,751,623
Unwinding of discount on loan 34,248,377
* Rs. 100 million ÷ (1 + 15%)3 = Rs. 65,751,623

Jun 30, 08 Interest Expense 9,862,743

Payable to Green Limited 9,862,743
Rs. 65,751,623 x 15% = Rs. 9,862,743

Jun 30,08 Deferred Tax Expense 8,534,972

Deferred Tax Liability 8,534,972
(Rs. 34,248,377 – Rs. 9,862,743) x 35% = Rs. 8,534,972

(b) Jul 1, 07 Employee Compensation Expense (200,000 x Rs. 8) 1,600,000

Employee Stock Options Outstanding 1,600,000
(200,000 stock options to employees at Rs.5 when market price is
Rs.13)

Apr 30, 08 Bank account (190,000 x Rs. 5) 950,000

Employee stock options outstanding (190,000 x Rs. 8) 1,520,000
Equity share capital (190,000 x Rs. 10) 1,900,000
Share premium (190,000 x Rs. 3) 570,000
(190,000 equity shares of Rs.10 each at a premium of Rs.3 per
share, in exercise of stock options.)

Apr 30, 08 Employee Stock Options Outstanding (10,000 x Rs. 8) 80,000

Employee Compensation Expenses 80,000
(To record the lapse of stock options for 10,000 shares)

(c) May 31, 08 Receivable from Orange Limited 10,000,000

Equity – Fair Value Gain on AFS Investment *4,880,000
AFS Investment – GL (500,000*20) 10,000,000
Gain on de-recognition of Investment 4,880,000
500,000 x 20 - [(500,000 x 10) + 120,000 ] = Rs. 4,880,000

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 ADVANCED ACCOUNTING AND FINANCIAL REPORTING
Final Examinations – Winter 2008
Suggested Answers

May 31, 08 AFS Investment – Orange Limited (65*200,000) 13,000,000

Gain on initial recognition of AFS Investment 3,000,000
Receivable from Orange Limited 10,000,000

Ans.4 Rs. in '000'

Net assets at beginning of the year 350,050
Cash received / receivable on issuance of 765,900 units 85,015
Cash paid / payable on redemption of 717,480 units (77,488)
7,527
357,577

Element of (income) / loss and capital gains included in prices

of units issued less those in units redeemed – net (2,685)
Net income for the year (recognized income for the year) 65,325
Net assets at end of the year 420,217

Working
Sold Redeemed
No. of Units 765,900 717,480

Rupees in 000
Par value of units @ Rs. 100 76,590 71,748
Sale proceed / redemption value 85,015 77,488
Element of (income) / loss (8,425) 5,740

Net element (2,685)

Rs. in million
Ans.5 Assets carrying value as at June 30, 2008 (Asset)
Cost (Given) 6,570
Decommissioning liability on July 1, 2007 (780 / (1+0.08)20) 167
Depreciation for the year (321) Working 1
Adjustment for revision in provision for decommissioning cost 157 Working 2
6,573

Decommissioning liability on June 30, 2008 (1,021 / (1+0.06)19) 337

Working 1: Depreciation for the year (P&L)

Cost 6,570
Decommissioning liability on July 1, 2007 167
Residual value (320)
6,417
Depreciation (6,417 / 20) 321

Working 2: Increase in decommissioning liability during the year ended June

30, 2008
Decommissioning liability on June 30, 2008 337
Less: Decommissioning liability on July 1, 2007 (167)
Less: Unwinding of interest for the year (167 x 8%) (13)
157

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 ADVANCED ACCOUNTING AND FINANCIAL REPORTING
Final Examinations – Winter 2008
Suggested Answers

Ans.6 Expected errors /

change in Liquidity Ratios Profitability Ratios Gearing Ratios Business Valuation
assumptions
Impact: Impact: Impact: Impact:
Unfavourable Favourable Unfavourable Valuation will be
higher.

Justification: Justification: Justification: Justification:

The current portion of In case of operating Because of recording Profitability will
lease liability will lease, normally the the finance lease increase. Moreover,
negatively impact the full cost is charged obligations, gearing recording of property
If the leases turn out
liquidity ratios. earlier than useful ratios may be will increase the asset
to be finance leases
economic life of asset. negatively affected. base of the company.
Whereas in finance Both will have a
lease, depreciation positive impact on the
and financial charges valuation.
are expensed out over
the lease term which
is generally equal to
useful life.

Impact: Impact: Impact: Impact:

Favourable None. Favourable None.

Justification: Justification: Justification: Justification:

If these shares are Any classification of Because liability of Because net assets /
recorded as equity, preference shares will preference shares will income related to
If convertible then liabilities for not affect the amount / not be recognized. ordinary shareholders
preference shares are preference share income attributable to will remain the same.
accounted for as dividends will be ordinary shareholders
equity recorded when of the company.
dividend is declared
whereas in the present
case when the liability
for dividend will be
worked at year end as
current liability.
Impact: Impact: Impact: Impact:
Either favourable / Either favourable / None. Valuation may be
unfavourable unfavourable higher or lower.
(Both are possible) (Both are possible) (Both are possible)

Justification: Justification: Justification: Justification:

If assumptions used in If a certain As discussed in the Actuarial liabilities do The impact on
the actuarial valuation assumption, for case of liquidity ratio, not affect long term business valuation
turn out to be example, expected a higher than actual liabilities. Hence there will be similar to the
incorrect increase in salary* has rate of increase in will be no impact on impact on profitability
been taken as higher salary means that the gearing ratio. ratio and the impact
than actual, it means reported profit is However, it does on liquidity ratio.
that reported liability lower than the actual affect the equity but
is higher than the profit and vice versa. the consequent effect
actual liability and on gearing ratio is not
similarly, liquidity usually material.
ratio is unfavourable;
and vice versa.

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 ADVANCED ACCOUNTING AND FINANCIAL REPORTING
Final Examinations – Winter 2008
Suggested Answers

Expected errors /
change in Liquidity Ratios Profitability Ratios Gearing Ratios Business Valuation
assumptions
Impact: Impact: Impact: Impact:
Either favourable / Either favourable / Either favourable / Valuation may be
unfavourable unfavourable unfavourable higher or lower.
(Both are possible) (Both are possible) (Both are possible). (Both are possible)
If future cash flow or
Justification: Justification: Justification: Justification:
discount rate used for
Liquidity ratios will Profit may have been Any error will not The company may be
valuation of non-
only be affected due reported on a higher affect the long term overvalued if
financial assets proves
to impairment related side if impairment is liabilities but may impairment is short
to be incorrect
to current assets like short recorded and have significant recorded and vice
inventory, stores, etc. vice versa. (In case of impact on equity and versa.
Goodwill, impairment hence the gearing
once provided is not ratio.
revised.)
Impact: Impact: Impact: Impact:
None. Favourable None. Valuation may be
higher.

Justification: Justification: Justification: Justification:

Actual useful lives of It does not affect the Profit may have been Any change in useful Increase in earnings
property, plant and current liabilities or reported on a lower lives do not affect will have a positive
equipment may be the current assets. side because higher long term liabilities. impact on valuation.
more than the depreciation is Hence there will be no On the other hand
assumed lives charged if useful life impact on gearing increase in net assets
is estimated on a ratio. However, it will also have a
conservative basis. does affect the equity positive impact on the
but the consequent valuation.
effect on gearing
ratios is not usually
material.
Impact: Impact: Impact: Impact:
None. Either favourable / None. Valuation may be
unfavourable. higher or lower. (Both
(Both are possible) are possible)

If expected cost of Justification: Justification: Justification: Justification:

decommissioning and It does not affect the If the assumed It will not affect long The impact will be
discount rate used to short term liabilities discount rate is on the term liabilities. Hence similar to the impact
determine its present or assets. lower side or there will be no on profitability ratio.
value, proves to be expected cost of impact on gearing
incorrect. decommissioning is ratio. However, it
on the higher side, the does affect the equity
reported profit will be but the consequent
lower and vice versa. effect on gearing ratio
is not usually
material.
(The End)

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