THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

FINANCIAL ACCOUNTING
PROFESSIONAL 1 EXAMINATION APRIL 2006 Time allowed 3.5 hours and 10 minutes to read the paper. Answer Questions 1 to 3 and Question 4 or 5.

1.

The following summarised draft balance sheets relate to Red Plc, Pink Limited and Blue Limited, as at 30th November 2005: Red m Assets: Non-current assets: Property, Plant and Equipment cost/valuation Investment in Pink Investment in Blue Pink m Blue m

1,230 640 260 2,130

605 605

256 256

Current Assets: Inventories Trade receivables Cash at bank and in hand Total Assets Equity and Liabilities: Called up share capital Share premium account Revaluation Reserve Profit and Loss Account Non-current liabilities Provision for liabilities and charges Current liabilities Total liabilities Total equity and liabilities

300 240 90 630 2,760

135 105 50 290 895

65 49 80 194 450

1,600 300 625 2,525 135 100 235 2,760

500 100 200 800 25 70 95 895

200 50 70 60 380 20 50 70 450

The following information is relevant to the preparation of the group financial statements: 1. Red plc had acquired eighty per cent of the ordinary share capital of Pink Limited on 1st December 2001 when the profit and loss reserve of Pink Limited was 100 million. The fair value of net assets of Pink Limited was 710 million at 1st December 2001. Any fair value adjustment related to net current assets and these net current assets had been realised by 30th November 2005. There had been no new issue of shares in the group since the current group structure was created.

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2.

Red plc acquired sixty per cent of the ordinary share capital of Blue Limited on 1st December 2003. The profit and loss reserves of Blue Limited on that date were 50 million. There was no revaluation reserve in the books of Blue Limited on 1st December 2003. The fair values of the net assets of Blue Limited at 1st December 2003 were not materially different from their carrying values. The Inventories of Red plc includes items purchased from Pink Limited for profit of 25% on cost in respect of these items. 75m. Pink had made a

3.

4.

Lactox, an important product of Red plc, is experiencing a decline in sales due to recent technological developments. The directors believe that certain plant used in the production of Lactox has suffered a permanent diminution in value. The following information is available: The carrying value, at historical cost, of the relevant plant at 30th November 2005 is selling price is estimated to be 1.75m. 2m and the net

The anticipated net cash inflows from Lactox are expected to be 750,000 per annum for the next three years. Red plc uses a discount rate of 12% in appraising its capital investments. Present value factors are as follows: Years 1 2 3 5. 12% .8929 .7972 .7118

The current liabilities of Pink Limited included 1m owing to Red plc. This included a cheque for 2m which had been sent to Red plc, on 28th November 2005, but which had not been received or entered by Red plc until 5th December 2005. On 31st May 2005 Pink Limited transferred to Red plc a fixed asset with a net book value of 1.8m at a transfer price of 1.9m. The asset had been purchased on 1st December 2004 at a cost of 2m with an estimated useful economic life of 5 years. At the date of transfer, the asset had a remaining useful economic life of 4.5 years. The group accounting policies require such assets to be depreciated using the straight-line basis. Depreciation is to be charged evenly in the year of acquisition and in the year of disposal on a time basis. The transfer of this asset and the associated depreciation calculations have been recorded in the individual books of both companies, and are included in the summarised balance sheets above.

6.

REQUIREMENT: (a) Prepare the consolidated balance sheet of Red Plc as at 30 November 2005 in accordance with IAS/IFRS and statutory requirements. (20 marks) Outline the requirements of IFRS 3 Business Combinations in circumstances where: (i) The terms of a business combination agreement may provide for an adjustment to the cost of the combination contingent on future events, such as a specified level of profit being maintained or achieved in future periods, or on the market price of the instruments issued being maintained. (5 marks) The contingent liability of an acquiree is not recognised by the acquiree before the business combination. (5 marks) [Total: 30 Marks]
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(b)

(ii)

2.

(a)

Pluto Limited is a company manufacturing digital cameras and non-digital cameras. The following draft income statement is available for the year ended 31st December 2005. INCOME STATEMENT FOR THE YEAR ENDED 31st DECEMBER 2005 000 Revenue Cost of Sales Gross Profit Net operating expenses Administration Distribution Operating profit Finance costs Profit for the financial year The following additional information is available: (1) As a result of the continued decline in the sale of non-digital cameras, a strategic decision was taken during the year to close the non-digital camera manufacturing plant. The following analysis is available for the year: Non-Digital Camera Manufacturing 000 2,100 1,600 550 200 Digital Camera Manufacturing 000 3,000 1,200 600 550 Total 000 5,100 2,800 1,150 750 (1,150) (750) 000 5,100 (2,800) 2,300

(1,900) 400 (70) 330

Revenue Cost of Sales Administration Distribution (2)

Included in administration expenses are redundancy costs of digital manufacturing plant.

260,000 in respect of the non-

(3)

Included in inventory at the year end are various out of date non-digital cameras. It has been decided that these non-digital cameras are worthless and are to be fully written down. They are included in inventory at a value of 410,000, but this write-off has not yet been reflected in the accounts. The Board of Directors decided to dispose of the non-digital manufacturing factory in Summer 2005. A suitable buyer was found in November 2005 and contracts for the sale were signed on 23rd December 2005 but the sale price of 4.5 million was not determined until January 2006. Legal expenses in connection with the sale, amounting to 225,000, were invoiced to the company in January 2006. This factory has been included in the draft balance sheet as at 31st December 2005 at a net book value of 2.5 million. The digital camera factory was re-valued at 31st December 2005 at 5.5 million. The factory originally cost 3 million and is included in the draft balance sheet as at 31st December 2005 at a net book value of 2.5 million.

(4)

(5)

REQUIREMENT: Re-draft the income statement of Pluto Limited for the year ended 31st December 2005 in accordance with international accounting standards, incorporating any adjustments you consider necessary. (20 marks) (b) (i) Explain the purpose of the statement of changes in equity as required by IAS 1 Presentation of Financial Statements. (4 marks) Draft an outline statement of changes in equity suitable for inclusion in the group financial statements of a publicly quoted company. The changes should reflect the range of matters that could arise for such a company. (6 marks) [Total 30 Marks]
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(ii)

3.

The following multiple choice question contains eight sections, each of which is followed by a choice of answers. Only one of each set of answers is strictly correct. REQUIREMENT: Give your answer to each section in the answer sheet provided. [Total: 20 marks]

1.

In the case of a public limited company, which of the following are distributable reserves? (a) (b) (c) share premium account capital redemption reserve excess of accumulated realised profits (which have not been capitalised or distributed) over accumulated realised losses (which have not been written off in a capital reduction or reorganisation) excess of accumulated unrealised profits (which have not been capitalised or distributed) over accumulated unrealised losses (which have not been written off in a capital reduction or reorganisation)

(d)

2.

Cast Ltd. acquired 80% of the ordinary share capital of Act Ltd. on 31st December 2004. The tangible non-current fixed assets of Act Ltd. at that date had a net book value of 180,000. On Cast Ltd.s acquisition of the shares, these fixed assets were revalued at 200,000. The revaluation had not been recorded in the books of Act Ltd Which of the following statements relating to the above transaction is correct in the books of the Cast Group?
(a) (b) (c) (d) DR Tangible non-current fixed assets DR Cost of control DR Tangible non-current fixed assets DR Cost of control 20,000 16,000 20,000 20,000 CR Cost of control CR Fixed assets CR Cost of control CR Minority interest CR Tangible non-current fixed assets CR Minority interest 20,000 16,000 16,000 4,000 16,000 4,000

3.

Mall & Co. sells four different products, and you have been provided with the following information at the companys year end: PRODUCT Cost price of inventory Estimated selling price of inventory Further selling and distribution costs to be incurred to sell A 5,000 4,900 500 B 3,000 4,100 300 C 7,000 7,300 200 D 900 900 100

At what value should Mall & Co. include the total inventory at the year end? (a) (b) (c) (d) 14,800 15,200 15,800 15,900

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4.

Centure Ltd. "Centure" has a financial year end of 31st December 2005. On 31st May 2005 Centure purchased 75% of the voting rights in Frame Ltd. "Frame". The following information is also available: Centure Frame Retained profit at 31st December 2004 was 470,000. Profit for the year ended 31st December 2005 was 80,000. Retained profit at 31st December 2004 was 90,000. Profit for the year ended 31st December 2005 was 30,000.

Assume that the profits accrue evenly over the course of the year for both companies. Which of the following statements relating to the consolidated accounts of Centure for the year ended 31st December is correct? (a) (b) (c) (d) 90,000 should be treated as pre-acquisition profit and credited to the cost of control account. 102,500 should be treated as post-acquisition profit, with 90,000 being debited to the cost of control account. 102,500 should be treated as pre-acquisition profit, with 76,875 being credited to the cost of control account. 120,000 should be treated as post-acquisition profit, with 90,000 being debited to the cost of control account.

5.

Polo Ltd., a company which prepares its accounts to 31st December, was formed on 1st January 2005 to undertake a single long-term contract. The contract is expected to generate a profit of 300,000, which represents 40% of the agreed contract price. Details of the contract for the first year of trading are as follows: Costs incurred Progress payments invoiced Progress payments received 200,000 187,500 125,000

At 31st December 2005, the contract is considered to be one third complete, the amounts to be included in inventories and debtors in accordance with IAS 11, Construction Contracts, are (a) (b) (c) (d) 6. Debtors 62,500 62,500 125,000 125,000 Inventories 50,000 87,500 50,000 87,500

On 1st January 2005 King Ltd. established a Research and Development Department to acquire scientific knowledge about the causes of MRA. During the departments first year of research it incurred the following costs: (i) (ii) (iii) (iv) Research staff salaries of 1,400,000. Purchase of laboratory for 650,000. The laboratory is estimated to have a ten year useful life and will be depreciated on the straight line basis. Purchase of testing equipment at a cost of 90,000 which is to be depreciated on the reducing balance basis, using a rate of 50% per annum. Research survey work costing 40,000 that will be fully funded by government.

How much of the above research and development expenditure should be written off in the year ended 31st December 2005? (a) (b) (c) (d) 1,400,000 1,510,000 1,550,000 2,140,000

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7.

The current market value of the ordinary shares of Scarlet plc. is 8 per share. The earnings per share of Scarlet plc. for the most recent financial year is 0.40 and its dividend cover is 2.5. The dividend yield to the ordinary shareholders of the company is (a) (b) (c) (d) 1% 2% 4% 5%

8.

Angen Ltd. owns three properties. Property A is where Angen Ltd. carries on its normal trading activities. Property B is occupied by an unrelated company which pays rent (negotiated at arms length) on a 99 year lease. Property C is occupied by a subsidiary company, also paying full market rate of rent. Which of the following is correct for the financial statements of Angen Ltd.? (a) (b) (c) (d) All three properties should be depreciated in the financial statements. Property A should be depreciated in the financial statements, but not Properties B and C. Properties A and B should be depreciated in the financial statements, but not Property C. Properties A and C should be depreciated in the financial statements, but not Property B.

4.

Rampco Group Limited "Rampco" is a rapidly expanding Manufacturing and Retail Group which operates from 16 freehold premises. Rampcos five year Corporate plan envisages a mix of organic and acquisitive growth strategies. These strategies will require additional site developments and borrowings. The Managing Director has held a meeting with the Finance Director to review the strength of the groups balance sheet and to assess what can be done to improve it. The Finance director suggested that consideration should be given to carrying the groups land and buildings at a valuation and to capitalising borrowing costs relating to new site developments. REQUIREMENT: You are required to draft a memo to the Finance Director of Rampco setting out in detail:(i) The requirements of IAS 16 Property, Plant and Equipment that would apply to Rampco if it were to adopt the valuation proposal. (12 Marks) The requirements of IAS 23 Borrowing Costs in respect of the proposal to capitalise borrowing costs relating to the development of new production / retail sites. (8 Marks) [Total: 20 marks]

(ii)

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5.

(a)

Outline the requirements of IAS 37 Provisions, Contingent Liabilities and Contingent Assets in respect of:(i) Recognition criteria for provisions. (4 Marks) (ii) Treatment of Contingent Liabilities. (3 Marks) (iii) Treatment of Contingent Assets. (3 Marks) The financial accountant of Padox Group Limited, "Padox", is finalising the work on the financial statements for the year ended 30 September 2005. The following is a list of the matters that might require some adjustment or disclosure in accordance with the requirements of IAS 37:(i) Due to the recent introduction of new environmental legislation, the staff of Padox require specific retraining in the procedures necessary to comply with the legislation. At the balance sheet date no retraining has taken place. The retraining is expected to cost 42,000. An employee of Padox was dismissed on the 1st May 2005 and to date Padox has incurred legal fees of 25,000. The claim for damages for wrongful dismissal from the employees solicitor is 95,000. The legal advice that the Directors have received is that the employees claim will not succeed. Padox installed specialised flooring for an indoor bowling centre in March 2005. In June 2005, it was discovered that specific areas of the flooring was warping. The Centres committee has instigated legal proceedings against Padox. Padox strongly disputes the claim and alleges that the Centres heating system was the cause of the warping. At the 30th September 2005, Padoxs Solicitor has advised the Company that they were unsure as to whether the outcome of the court action would find in the Companys favour or not. Alto Limited, a wholly owned subsidiary of Padox, is engaged in the installation of heating systems in major office block developments. The bank facility of Alto Limited is secured by assets held in the name of Padox. In July 2005 a major customer of Alto Limited was declared bankrupt and the financial position of Alto Limited has deteriorated significantly. Alto Limiteds bank has called for the borrowings to be repaid. (10 Marks)

(b)

(ii)

(iii)

(iv)

REQUIREMENT: Explain how each of the above matters (i) to (iv) should be treated in the financial statements of Padox Limited for the year ended 30th September 2005. You should assume that all amounts stated are material. [Total: 20 marks] END OF PAPER

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SUGGESTED SOLUTIONS

FINANCIAL ACCOUNTING
PROFESSIONAL 1 EXAMINATION APRIL 2006 Examiners note re solutions: The solutions presented here are intended to be comprehensive and act as a learning aid for candidates. The examiner would not anticipate that an exam candidate would have sufficient time to complete answers at the level of detail given in these solutions. Also, these narrative answers are intended to cover a range of answers and hence candidates would not generally be expected to list all the points given.

SOLUTION 1 (a) RED PLC CONSOLIDATED BALANCE SHEET AS AT 30 NOVEMBER 2005 2005 m ASSETS Non-current assets: Property, plant and equipment (1,230+605+.256-.198,575-.1-.01) Goodwill

2,090.69 152.00 2,242.69

Current assets: Inventories (300+135+65-15) Trade receivables (240+105+49-2-1) Cash and cash equivalents (90+50+80+2) Total assets 485.00 391.00 222.00 1,098.00 3,340.69 2005 m EQUITY AND LIABILITIES Equity attributable to equity holders of the parent: Share capital Share premium account Retained earnings Minority interest Total equity Non-current liabilities: Long-term provisions (135+25+20) Current liabilities: Trade and other payables (100+70+50-1) Total liabilities Total equity and liabilities 1,600.00 300.00 732.71 2,632.71 308.98 2,941.69 180.00

219.00 399.00 3,340.69

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Workings: W.1 Group structure: Subsidiary Pink % 80 80 20 20 Subsidiary Blue % 60 60 40 40

Group share: Direct Indirect Minority: Direct Indirect

W.2 Cost of Control m Cost of investment in Pink Cost of investment in Blue 640 260 Share Capital Pink 80% x Reserves Pink 80% x 100 500 m 400 80 80

Share Premium Pink 80% x 100 Fair value adjustment 80%x ( 710K 700K x 80%) 200 50 10

8 120 30 30 152 900

Share capital Blue 60%x

Share Premium Blue 60%x Reserves Blue 60%x50 Balance Goodwill 30/11/05 900 W.3 Consolidated Reserves m 12 8 .198,575 .08 .01 732.711 753.00

Inventory adjustment(W5) Fair Value Adjustment -Pink Impairment (W6) Non-Current Fixed Asset Profit elimination (W9) Non-Current Fixed Asset Depreciation (W9) 30/11/05 Balance c/d

Red plc Pink ( 200m- 100m)x80% Blue ( 60m- 50m)x60% Blue - Revaluation 70mx60%

m 625 80 6 42

753

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W.4 Minority Interests m 3.00 Share Capital Pink 20%x 500m .02 Reserves Pink 20%x 200m Share Premium 20%x100 Share Capital Blue 40% x 200m Share Premium Blue 40% x 50m Reserves Blue 40% x 60m Revaluation Blue 40% x 70m m 100 40 20 80 20 24 28 312

Inventory Adjustment (W5) Non-current fixed asset Profit elimination (W9)

30/11/05 Balance c/d

308.98 312.00

W.5 Inventory 75m = 15m = Cost plus 25% profit Dr m Consolidated Inventories Consolidated Reserves: Red plc 80%x 15m Minority Interest (Pink) W.6 Impairment of Plant Carrying value Recoverable Amount: (1) NRV 1.75M (2) Value in Use 750,000 x 0.8929 = 750,000 x 0.7972 = 750,000 x 0.7118 = = 2m 669,675 597,900 533,850 1,801,425 0.198,575m m 2 12 3 Cr m 15

Impairment =

1.801,425m =

DR. Consolidated Reserves of CR. Plant 0.198,575m

0.198,575m

W.7

Cash in Transit: m 2 m 2

Dr.

Bank Intercompany Debtor -Pink

W.8 Intercompany Balances: Intercompany Debtor Red Intercompany Creditor Pink

1 1

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W.9 Intercompany Disposal of Non-Current Tangible Fixed Assets Asset at Cost 1/12/04 Depn.6/12 x 20%x 2m At 31/5/05 Sale price Profit on sale in Pinks Books Adjustment: Cr. Fixed Assets Dr. Consolidated Reserves 80% Minority 1/6/05 30/11/05 Excess Depreciation: 1.9m x 20% x 6/12 = 0.19m Should be 2m x 20% x 6/12 = Dr .Consolidated reserves Cr.Fixed Assets 2m (.2) 1.8 1.9 .1 0.10m 0.08m 0.02m

0.20m .01m .01m

(b)

(i)

Contingent consideration IFRS 3 recognises that the terms of a business combination agreement may provide for an adjustment to the cost of the combination contingent on future events, such as a specified level of profit being maintained or achieved in future periods, or on the market price of the instruments issued being maintained. Where this is the case, IFR 3 requires that the acquirer shall include the amount of that adjustment in the cost of the combination at the acquisition date if the adjustment is probable and can be measured reliably. If the future events do not occur or the estimate needs to be revised, the cost of the business combination shall be adjusted accordingly.

(ii)

Contingent Liability In the case of contingent liabilities, the IASB takes the view that although a contingent liability of the acquiree is not recognised by the acquiree before the business combination, that contingent liability has a fair value, the amount of which reflects market expectations about any uncertainty surrounding the possibility that an outflow of resources embodying economic benefits will be required to settle the possible or present obligations. The acquirer recognises separately a contingent liability of the acquiree as part of allocating the cost of a business combination only if its fair value can be measured reliably. If its fair value cannot be measured reliably: (a) there is a resulting effect on the amount recognised as goodwill; and (b) the acquirer shall disclose the information about that contingent liability required to be disclosed by IAS 37. After their initial recognition, the acquirer shall measure contingent liabilities that are recognised separately at the higher of: (a) the amount that would be recognised in accordance with IAS 37, and (b) the amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue.

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SOLUTION 2
(a) PLUTO LIMITED INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2005 Continuing Operations 000 Revenue Cost of Sales Gross profit Net operating expenses: Administration Distribution Operating profit (loss) Redundancy costs Inventory write-down Profit on sale of factory (Working 1) Profit on ordinary activities before finance costs Finance costs Profit on ordinary activities before tax (note) Note: An alternative presentation would be to show a single amount on the face of the income statement in respect of discontinued operations and the analysis thereof in a note. Working 1: Profit on sale of factory (Event after the balance sheet date adjusting) Proceeds on sale Legal expenses Net book value Profit on sale (b) (i) The statement of changes in equity The net assets of an entity (its equity) can change for various reasons, principally income and expenses reported in the income statement and the introduction by or return of capital to share holders, although in addition, some items of income and expense are required to bypass the income statement. IAS 1 requires all items of income and expense recognised in a period to be included in the Income Statement unless another standard or an interpretation requires otherwise. Other standards require some gains and losses (such as revaluation increases and decreases, particular foreign exchange differences, gains or losses on re-measuring available-for-sale financial assets, and related amounts of current tax and deferred tax) to be recognised directly as changes in equity. The standard asserts that, because it is important to consider all items of income and expenses in assessing changes in an entitys financial position between two balance sheet dates, that the presentation of a statement of changes in equity is required to highlight an entitys total income and expenses, including those that are recognised directly in equity. Accordingly, IAS 1 requires the presentation of a statement of changes in equity showing on the face of the statement: (a) (b) (c) (d) profit or loss for the period; each item of income and expense for the period that, as required by other standards or by interpretations, is recognised directly in equity, and the total of these items; total income and expense for the period (calculated as the sum of (a) and (b), showing separately the total amounts attributable to equity holders of the parent and to minority interest; and for each component of equity, the effects of changes in accounting policies and corrections of errors recognised in accordance with IAS 8.
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Discontinuing Operations 000 2,100 (1,600) 500 (290) (200) (400) (260) (410) 1,775 1,115

Total 000 5,100 (2,800) 2,300 (890) (750) 250 (260) (410) 1,775 1,765 (70) 1,695

3,000 (1,200) 1,800 (600) (550) 650 650

000 4,500 (225) (2,500) 1,775

Items (a) to (c) above reflect the focus of the IASB on the balance sheet whereby any changes in net assets (aside of those arising from transactions with shareholders) are gains and losses, regarded as performance. In this vein, IAS 1 observes that changes in an entitys equity between two balance sheets dates reflect the increase or decrease in its net assets during the period. Except for changes resulting from transactions with equity holders acting in their capacity as equity holders (such as equity contributions, reacquisitions of the entitys own equity instruments and dividends) and transaction costs directly related to such transactions, the overall change in equity during a period represents the total amount of income and expenses, including gains and losses, generated by the entitys activities during that period (whether those items of income and expenses are recognised in profit or loss or directly as changes in equity).

(ii) GROUP STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31ST DECEMBER 2005
(in thousands of Euros) Share Capital Balance at 31 December 2004 brought forward Changes in equity for 2005: Loss on property revaluation Available-for-sale investment: Valuation gains/(losses) taken to equity Transferred to profit or loss on sale Cash flow hedges Gains/(losses) taken to equity Transferred to profit or loss for the period Transferred to initial carrying amount of hedged items Exchange differences on translating foreign operations Tax on items taken directly to or transferred from equity Net income recognised directly in equity (x) (x) (x) (x) x Other Translation Retained reserves* reserve earnings x (x) x Total Minority interest x Total Equity x

(x) X

(x) X

(x) X

X (x)

X (x)

X (x)

X (x)

(x)

(x)

(x)

(x)

(x)

(x)

(x)

X (x)

X (x)

X (x)

X (x)

X (x)

Profit for the period Total recognised income and expense for the period Dividends Issue of share capital Balance at 31 December 2005 X X X (x)

(x)

(x)

X (x)

X (x) X

X (x)

X (x) X

Other reserves are analysed into their components, if material.

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SOLUTION 3 1. 2. 3. 4. 5. C C B C C Inventories = Sales value of contract 450,000/3- 200,000 = 50,000. Debtors = Sales value of contract 6. 7. 8. B. B. D 1,400,000 + 650,000/10 + 750, - profit 300,000 = Total contract costs of

750,000/3- 125,000 = 1,510,000

125,000.

90,000/2 =

.4 / 2.5 = .16/8 x 100 = 2%

SOLUTION 4 Memorandum To: From: Re: Finance Director Financial Accountant Rampco Group Limited Accounting Policy Proposals relating to Land and Buildings and Borrowing Costs April 2006

Date:

As requested, I set out as follows the requirements of IAS 16 and IAS 23 regarding the above proposals. (i) Requirements of IAS 16 Property, Plant and Equipment in respect of the valuation of land and buildings: Cost Model: Property etc. should be carried at cost less any accumulated depreciation and impairment losses to date. Revaluation Model: Property etc. should be carried at fair value at date of revaluation less any subsequent accumulated depreciation and impairment losses. Revaluations should occur sufficiently regularly so that the amount does not differ materially from the fair value at the balance sheet date. Revaluations: The fair value of land and buildings is usually its market value, normally appraised by professionally qualified valuers. The frequency of revaluations depends on their movements. Some items of property may experience significant and volatile movements in fair value, thus necessitating annual revaluation. For those assets with insignificant movements, then a revaluation every three or five years may be sufficient.
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When an item of property is revalued, any accumulated depreciation at the date of the revaluation is either: Restated proportionately with the change in the gross carrying value; or Eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset (often adopted for buildings).

When an item of property is revalued, the entire class of property must be revalued. A class of property is a grouping of assets of a similar nature and use in an entitys operations. A class of assets may be revalued on a rolling basis provided the revaluation is completed within a short period of time and the revaluations are kept up to date. Any increase in valuation must be recognised directly in equity except to the extent that it reverses a revaluation decrease of the same asset previously recognised as an expense. In that case, it should be recognised in the income statement. A decrease shall be recognised in equity until the carrying amount reaches its depreciated historical cost, and thereafter in the income statement. The revaluation surplus may be transferred directly to retained earnings when the asset is derecognised, i.e. disposed of, or the asset used up. Transfers are not made through the income statement. The effects on taxes on income re the revaluation should be recognised in accordance with IAS 12 Income Taxes.

(ii)

Requirements of IAS 23 Borrowing Costs in respect of the capitalisation of borrowing costs: Recognition: Borrowing costs should be expended in the period they are incurred except to the extent that they are capitalised. However, borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. That can occur when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. Borrowing Costs Eligible for Capitalisation: These are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made. When an enterprise borrows funds specifically to obtain a particular asset, the borrowing costs can be readily ascertained. The exercise of judgement is required to determine the amount of borrowing costs to capitalise in circumstances where it is difficult to identify a direct relationship between borrowings and there costs e.g. central coordination of finance, use of a range of debt instruments, loans in foreign currencies. To the extent that funds are borrowed generally, then the amount capitalised should be determined by applying a weighted average capitalisation rate to the borrowings outstanding during the period. However, the amount of borrowing costs capitalised during a period should not exceed the amount of borrowing costs incurred during that period. Commencement of Capitalisation: Capitalisation should commence when: Expenditures on the assets are being incurred Borrowing costs are being incurred; and Activities to prepare the asset for intended use are in progress The activities necessary to prepare the asset encompass more than the physical construction of the asset. They include technical and administrative work prior to the commencement of physical construction. This excludes holdings costs, e.g. borrowing costs incurred while land acquired for building is held without any development activity.
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Suspension of Capitalisation: Capitalisation should be suspended during extended periods in which active development is interrupted. Cessation of Capitalisation: Capitalisation should cease when substantially all the activities necessary to prepare the asset for its intended use or sale are complete. Normally, when physical construction is complete but minor modifications are all that is outstanding; this would indicate that substantially all activities are complete. When the construction of a qualifying asset is completed in parts and each part is capable of being used, then capitalisation should cease when substantially all the activities necessary to prepare that part for use are completed. Disclosure: The following should be disclosed: The accounting policy for borrowing costs The amount of borrowing costs capitalised in the period The capitalisation rate used

SOLUTION 5 (a) (i) Recognition criteria for provisions: Provisions A provision should be recognised when: An enterprise has a legal or constructive obligation; It is probable that an outflow of resources will be required to settle the obligation; and A reliable estimate can be made of the obligation. In rare cases where it is not clear whether or not there is an obligation, a past event is deemed to give rise to a present obligation if it is more likely than not that a present obligation exists at the balance sheet date. All available evidence should be considered, including the opinion of experts. The financial statements deal with the financial position at the period end, not with the future. No provision can be recognised for costs that need to be incurred in the future. It must only be those that existed at the balance sheet date. However, provisions are required for penalties, clean-up costs and decommissioning costs, as these are legal obligations. In contrast, expenditure to operate in a future way by fitting smoke filters would not be permitted as the entity could change its method of operation to avoid the liability. For a liability to be created, it is not necessary to know the identity of the party to whom the liability is owed, it may be to the public at large. A board decision, by itself, does not result in a constructive obligation unless that decision has been communicated before the balance sheet date to those affected by it. An event may not immediately give rise to an obligation, but may do so in the future because of a change in law or statement to make the obligation constructive. If a new law has yet to be finalised, an obligation only arises when the legislation is virtually certain to be enacted. An entity should be able to determine a range of possible outcomes and therefore make an estimate of the obligation that is sufficiently reliable to use when recognising a provision. In extremely rare cases where no reliable estimate can be made, a liability exists that cannot be recognised. Instead, it should be disclosed as a contingent liability.
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(ii)

Treatment of Contingent Liabilities: Contingent Liabilities: An enterprise should not recognise a contingent liability. Instead it should be disclosed unless the possibility of an outflow of resources is remote. Where an entity is jointly and severally liable for an obligation, that part that is expected to be met by other parties is treated as a contingent liability. This must be assessed continually to determine where an outflow has become probable. If that is the case, it will become a provision in the year in which the change in probability occurs.

(iii)

Treatment of Contingent Assets: Contingents Assets: An entity should not recognise a contingent asset since this may result in the recognition of income that may never be realised. However, when realisation is virtually certain, then the related asset should be recognised. A contingent asset should be disclosed where an inflow of benefits is probable. Contingent assets are not recognised since this may result in recognition of income that may never be realised. However, when realisation is virtually certain then the related asset is not a contingent asset and should be recognised. Contingent assets should be continually assessed to ensure that they are appropriately accounted for.

(b)

(i)

No provision should be made for the cost of 42,000. Whilst the staff requires training, it may or may not actually take place. There is no legal or constructive obligation arising. The legal fees of 25,000 should be provided for as an accrued expense. The costs have been incurred and there is no certainty that if the company wins the case that it will recover its costs. The directors have to assess the advice of their solicitors which is that the claim will not succeed. The matter should be disclosed as a contingent liability in a carefully worded manner. In this case the legal advice suggests significant uncertainty over the outcome of the case. Rather than mislead users of the financial statements it would be best to disclose the matter as a contingent liability. On the assumption that the banks security is enforceable, then Padox is exposed to a real liability. A provision should be made by Padox for the full amount of the liability. In addition consideration should be given to the possibility of impairment of the assets of Alto Limited.

(ii)

(iii)

(iv)

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