Diploma in International Financial Reporting

Thursday 9 December 2010

Time allowed Reading and planning: Writing:

15 minutes 3 hours

This paper is divided into two sections: Section A This ONE question is compulsory and MUST be attempted Section B THREE questions ONLY to be attempted Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.

The Association of Chartered Certied Accountants

Dip IFR

Epsilon is a listed entity. You are the nancial controller of the entity and its consolidated nancial statements for the year ended 30 September 2010 are being prepared. Your assistant, who has prepared the rst draft of the statements, is unsure about the correct treatment of a number of transactions and has asked for your advice. Details of the transactions are given below: Transaction (a) On 1 October 2009 Epsilon issued 5 million loan notes that had a value of $1 per note. The issue costs were 3 cents per note. Each note holder will receive interest of 5 cents per note on 30 September of each year starting on 30 September 2010. The loan notes are repayable on 30 September 2019 at $120 per note. As an alternative to repayment the loan note holders can elect to exchange their notes for shares in Epsilon. On 1 October 2009 the credit rating of Epsilon was such that it would have had to offer investors in non-convertible loan notes a rate of return of 9% per annum on any investment. The impact of issue costs would increase the effective interest rate on such loan notes to 945%. The following information regarding discount rates may be relevant: Discount rate 5% 9% Present value of $1 receivable at the end of year 10 61 cents 42 cents Cumulative present value of $1 receivable at the end of years 110 $772 $642 (6 marks) Transaction (b) On 1 October 2009 Epsilon began to lease a property which it intended to use as ofce space. The lease was for a 10-year period at the end of which the property had to be returned to the lessor in its original condition. The lease rentals were set at $800,000 per annum, payable in arrears on 30 September each year. However, as an inducement to persuade Epsilon to sign the leasing contract the lessor paid Epsilon $1 million on 1 October 2009. Shortly after beginning to use the property Epsilon began work in altering the internal design of the property to more adequately suit its purposes. This work was completed on 31 March 2010 at a total cost of $12 million. It is estimated that it will cost Epsilon $600,000 to restore the property to its original condition on 30 September 2019. An appropriate risk adjusted discount rate is 10% per annum. The present value of $1 payable in 9 years time at an annual discount rate of 10% is approximately 404 cents. (11 marks) Transaction (c) On 1 October 2003 Epsilon had purchased an equity investment in a listed entity. Epsilon purchased 1 million shares at the then quoted price of $2 per share. This shareholding does not allow Epsilon to exercise control or signicant inuence over the listed entity. Epsilon intended to keep the shares for their growth potential rather than treat them as part of a trading portfolio. All the shares were still held by Epsilon on 30 September 2009 and at that date their quoted price was $320 per share. On 30 June 2010 Epsilon sold 600,000 of the shares for $360 per share. On 30 September 2010 the quoted price of the shares was $350 per share. (8 marks) Required: For each transaction prepare extracts from the nancial statements for the year ended 30 September 2010. Your extracts should be supported by appropriate explanations. Note: The mark allocation is shown against each of the three transactions above. (25 marks)

This is a blank page. Question 4 begins on page 8.

[P.T.O.

(a) IAS 33 Earnings per share requires certain entities to disclose information about earnings per share (EPS) in their nancial statements. Required: Describe: (i) (ii) (iii) (iv) Those entities to which IAS 33 applies; The way in which EPS (both basic and diluted) should be computed in outline ONLY; The numerical disclosure requirements regarding EPS for entities that have no discontinued operations; The additional numerical disclosure requirements regarding EPS for entities that report discontinued operations. (7 marks)

(b) Kappa is a listed entity that made a prot after tax of $35 million for the year ended 30 September 2010. There were no discontinued operations. At 1 October 2009 Kappa had 70 million ordinary shares and 30 million preferred shares in issue. The preferred shares were correctly presented in equity within the statement of nancial position. In the year ended 30 September 2010 Kappa declared and paid a dividend of 12 cents per share to the ordinary shareholders and 6 cents per share to the preferred shareholders. On 31 December 2009 Kappa made a fully subscribed rights issue of two ordinary shares for every seven held at $135 per share. The fair value of an ordinary share at 31 December 2009 was $180. Throughout the nancial year Kappa had 20 million convertible loan notes on which interest of 5 cents per note was payable annually in arrears. The carrying value of the liability element of the loan note at 1 October 2009 was $23 million and the effective rate of interest was 7%. The rate of income tax in the jurisdiction in which Kappa operates is 20% and the nance cost that is charged in the statement of comprehensive income is subject to income tax at that rate. The notes are convertible into ordinary shares from 1 October 2011 at the option of the note-holder. The conversion terms are one ordinary share for every loan note held. Required: Compute the basic and diluted EPS of Kappa for the year ended 30 September 2010. (8 marks)

(c) In recent years it has become increasingly common for entities to issue equity instruments in exchange for goods and services. Such transactions are collectively referred to as equity settled share based payments. Required: Explain: (i) When equity settled share based payments should be recognised in nancial statements; (ii) How equity settled share based payments should be measured (distinguishing between payments to employees and payments to other parties); (iii) Where in the statement of comprehensive income and statement of nancial position equity settled share based payments should be reported. (5 marks)

(d) On 1 October 2008 Kappa granted share options to 500 sales staff. The entitlement of each member of staff depended on the achievement of overall sales targets in the three-year period to 30 September 2011. Details are as follows: Cumulative sales less than $100 million: 100 options each. Cumulative sales between $100 million and $150 million: 150 options each. Cumulative sales more than $150 million: 200 options each.

The options had a fair value of $120 per option on 1 October 2008. This had increased to $130 per option by 30 September 2009 and by 30 September 2010 the fair value of an option was $135 per option. When the options were granted and at 30 September 2009 management estimated that total sales in the three-year period would be $130 million. However, following a very good year in the year to 30 September 2010 that estimate was revised to $160 million. Required: Compute the charge to the statement of comprehensive income for the year ended 30 September 2010 in respect of the above arrangement and the amount included in the statement of nancial position at 30 September 2010. (5 marks) (25 marks)

[P.T.O.

(a) Omega is an entity with a number of subsidiaries. The year end of the entity is 30 September. On 1 January 2008 Omega acquired an 80% interest in Friendly. Details of the acquisition were as follows: Omega acquired 800,000 shares in Friendly by issuing two equity shares for every ve acquired. The fair value of an Omega share on 1 January 2008 was $4 and the fair value of a Friendly share $140. The costs of issue were 5 cents per share. Omega incurred further legal and professional costs of $100,000 that directly related to the acquisition. The fair values of the identiable net assets of Friendly at 1 January 2008 were measured at $13 million.

Omega initially measured the non-controlling interest in Friendly at fair value. They used the market value of a Friendly share for this purpose. No impairment of goodwill arising on the acquisition of Friendly was required at 30 September 2008 or 2009. Friendly comprises three cash generating units A, B and C. When Friendly was acquired the directors of Omega estimated that the goodwill arising on acquisition could reasonably be allocated to units A:B:C on a 2:2:1 basis. The carrying values of the assets in these cash generating units and their recoverable amounts are as follows: Unit Carrying value (before goodwill allocation) $000 600 550 450 Recoverable amount $000 740 650 400

A B C Required: (i)

Compute the carrying value of the goodwill arising on acquisition of Friendly in the consolidated statement of nancial position of Omega at 30 September 2010 following the impairment review.

(ii) Compute the total impairment loss arising as a result of the impairment review, identifying how much of this loss would be allocated to the non-controlling interests in Friendly. (11 marks) (b) During the year ended 30 September 2010 Omega acquired a subsidiary, Newsub, that was located in a jurisdiction that allows individual entities to use either local accounting standards or international nancial reporting standards (IFRS). In previous periods Newsub has prepared nancial statements under local accounting standards. Having become part of the Omega group the directors of Newsub have decided to prepare the individual nancial statements of that company using IFRS for the year ended 30 September 2010. The directors of Newsub are aware that there is a set procedure under IFRS for entities that adopt IFRS having previously used local accounting standards but they are unaware of the details. Required: Explain the procedure that will need to be adopted by Newsub in preparing its nancial statements under IFRS for the year ended 30 September 2010 given that previous nancial statements were prepared under local accounting standards. You do NOT need to describe any exceptions to the normal procedure in detail but referring to them in general terms will gain you credit. (6 marks) (c) On 1 October 2009 Omega sold a property it owned for $90 million and leased it back on a 10-year operating lease for rentals of $8 million per annum, payable on 30 September in arrears. The carrying value of the property in the nancial statements of Omega at 1 October was $55 million and its market value on that date was $70 million. Required: Compute the amounts that will be shown in the statement of comprehensive income for the year ended 30 September 2010 and in the statement of nancial position at 30 September 2010 in respect of the sale and leaseback. (5 marks)

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(d) During the year ended 30 September 2010 Omega sold a machine to a customer that proved to have a design fault. The customer has returned the machine to Omega and demanded repayment of the purchase price of $5 million plus compensation for lost sales of $500,000. It is highly likely that Omega will make this payment in January 2011. The directors of Omega consider it probable that the $48 million of the above amount can be recovered from the original manufacturer of the machine and this amount could reasonably be expected to be received in March 2011. Required: Explain how both the claim and the counter-claim will be treated in the nancial statements of Omega for the year ended 30 September 2010. (3 marks) (25 marks)

End of Question Paper

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Answers

Explanation and calculations The lease of the property would be regarded as an operating lease because a 10-year lease would not be long enough to transfer the risks and rewards of ownership to Epsilon. Therefore the lease rentals will be charged as an expense in the income statement over the lease term, normally on a straight-line basis. Under the principles of SIC 15 Operating leases incentives the inducement will be recognised over the lease term, effectively as a reduced rental. Therefore the annual rental expense will be 700 (1/10(800 x 10 1,000)). This will be charged in the statement of comprehensive income in arriving at the prot for the period. Epsilon has received net cash of 200 (1,000 800) from the lessor during the year and so there will be a closing payable of 900 (700 + 200) at the year end. This will be reduced by 100 (800 700) per annum over the remaining nine year term of the lease. Therefore 100 of this payable will be a current liability and 800 (900 100) will be non-current. Tutorial note Alternatively the 900 closing payable could be taken to be 9/10 of the inducement of 1,000 that, under the principles of IAS 17, needs to be recognised over the lease term. The costs of altering the property give Epsilon access to economic benets over the remaining 9 years of the lease and should be capitalised as property, plant and equipment. Additionally, under the principles of IAS 37 Provisions, contingent liabilities and contingent assets Epsilon has an obligation to restore the property that needs to be recognised as a provision. Given the signing of the lease agreement the obligating event is the completion of the alterations. This provision should be appropriately discounted to 242 (600 x $0404) to reect the time value of money. Because the provision has been measured on a discounted basis unwinding of the discount needs to be accounted for by debiting nance costs in the statement of comprehensive income and crediting the provision in the statement of nancial position. The relevant amount for the current year is 12 (242 x 10% x 6/12). Therefore the closing provision will be 254 (242 +12). The debit entry for initial recognition of the provision is to property, plant and equipment because it represents a further cost of access to the economic benets available from the property. Therefore the total amount that will be taken to property, plant and equipment is 1,442 (1,200 + 242). This amount will be depreciated over the useful economic life of 9 years to give a charge to the income statement (as an operating cost) in the current year of 76 (1,442 x /9). The closing balance on PPE will therefore be 1,366 (1,442 76). Transaction (c) Extract from nancial statements Statement of comprehensive income Gain on sale of shares of 960 in prot and loss section. Unrealised gain of 120 on re-measurement of shares held at the year end in other comprehensive income. The previously unrealised gain of 720 realised on the sale of shares reclassied out of other comprehensive income as part of the gain on sale of shares of 960 (see above). Statement of nancial position Financial asset (probably non-current) of 1,400. Valuation surplus relating to the remaining investment of 600 as a component of equity. Explanation and calculations The shares would be regarded as nancial assets under the principles of IAS 39 Financial instruments: recognition and measurement. They would be classied as available for sale nancial assets as they are not part of a trading portfolio. Available for sale nancial assets are measured at fair value, with gains or losses on re-measurement recognised as other comprehensive income until the shares are sold. Therefore a gain of 1,200 (1,000 x ($320 $200) will have been recognised in other comprehensive income in prior periods. In the current period 720 (1,200 x 600/1,000) of this gain becomes realised when the shares are sold. IAS 39 requires that in such circumstances the realised gain is reclassied as part of the prot on sale of the shares, which will be 960 (600 ($360 $320) + 720). The unsold shares will remain in the statement of nancial position as nancial assets (probably non-current) at their fair value of 1,400 (400 x $350). A gain on re-measurement of 120 (400 x ($350 $320) will be recognised as other comprehensive income in the statement of comprehensive income for the year. The closing balance in other components of equity relating to the investment will be 600 (400 x ($350 $200)).

(a)

IAS 33 applies to entities whose ordinary shares or potential ordinary shares are traded in a public market (a potential ordinary share is a nancial instrument that gives the holder a right to acquire ordinary shares). Other entities who voluntarily disclose earnings per share (EPS) information must do so in accordance with the requirements of IAS 33. For entities that have no discontinued operations IAS 33 requires disclosure of basic and diluted EPS on the face of the statements of comprehensive income or (where separately presented) the income statement. The basic EPS of an entity is the prot attributable to the ordinary shareholders (or, in the case of a group, the ordinary shareholders of the parent) divided by the weighted average number of ordinary shares in issue in the period. The diluted EPS is a hypothetical measure of EPS that adjusts the basic EPS measure for the potential effects on earnings and number of shares for the effects of all dilutive potential ordinary shares.

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For entities that have discontinued operations IAS 33 requires disclosure of the EPS for total prots, and for prots on continuing operations, on the face of the statement of comprehensive income (or income statement, if separately presented). The EPS for discontinued operations also needs to be disclosed, but entities are permitted to make this disclosure in the notes to the nancial statements if they wish. (b) 1. 2. 3. 4. 5. 6. 7. Computation of earnings for EPS purposes 35,000 (30,000 x 6%) = 33,200. Computation of theoretical ex-rights fair value and adjustment factor (7 x $180 + 2 x $135) x 1/9 = $170. So adjustment factor is 180/170 Computation of weighted average number of shares in issue (70,000 x 3/12 x 180/170) + (90,000 x 9/12) = 86,029 Compute basic EPS 33,200/86,029 = 386 cents Compute earnings for diluted EPS 33,200 + ((23,000 x 7%) x 80%) = 34,488 Compute number for diluted EPS 86,029 + 20,000 = 106,029 Compute diluted EPS 34,488/106,029 = 325 cents

(c)

Equity settled share based payments should be recognised from the grant date. This is the date when the entity confers on the other party the right to equity instruments, dependent in some cases on vesting conditions. If there are no vesting conditions, the whole amount should be recognised immediately. If there are vesting conditions, the amount should be recognised on a systematic basis over the vesting period. The payments should be measured at fair value. In this context fair value means the fair value of the equity instruments granted in the case of transactions with employees. In the case of transactions with other parties fair value means the fair value of the goods and services received. The amount recognised in each period should be debited to the statement of comprehensive income as an operating cost (unless it qualies for inclusion in the cost of another asset, e.g. inventory). The credit entry is to equity. IFRS does not specify which component.

(d)

The cumulative amount recognised at 30 September 2010 is 500 x 200 x $120 x 2/3 = $80,000. This is shown in the statement of nancial position as part of equity. The cumulative amount recognised at 30 September 2009 is 500 x 150 x $120 x 1/3 = $30,000. So the amount recognised in the statement of comprehensive income for the year is $50,000 ($80,000 $30,000).

Marks 5 (a) 1. Computation of goodwill on acquisition Cost of investment (800,000 x 2/5 x $4) Fair value of non-controlling interest (200,000 x $14) Fair value of identiable net assets at date of acquisition So goodwill equals 1,280 280 (1,300) 260 1 1

NB: Acquisition costs are not included as part of the fair value of the consideration given under IFRS 3 2. Calculation of impairment loss Unit Before allocation 600 550 400* Carrying value Allocation 104 104 52 After allocation 704 654 452 Recoverable amount Impairment loss

A B C

740 650 400

Nil 4 52

1 1 1

* After writing down assets in the individual CGU to recoverable amount

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Marks 3. Calculation of closing goodwill Goodwill arising on acquisition (W1) Impairment loss (W2) So closing goodwill equals 4. Calculation of overall impairment loss Arising on goodwill (W3) Arising on assets in unit C (450 400) So total loss equals 260 (56) 204 56 50 106

212 (20%) of the above is allocated to the NCI with the balance allocated to the shareholders of Omega

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(b)

The nancial statements of Newsub for the year ended 30 September 2010 need to be prepared under international nancial reporting standards (IFRS) that are effective at the reporting date 30 September 2010. This applies to the nancial statements for the current period as well as the comparative information. The comparative information will have been presented under local accounting standards in previous years and so it will need to be restated. Given the need to present a comparative statement of changes in equity Newsub will need to compute the equity under IFRS at 1 October 2008. Therefore Newsub will need a statement of nancial position under IFRS at that date. This is referred to in IFRS 1 First time adoption of IFRS as the opening IFRS statement of nancial position. The opening IFRS statement of nancial position will need to be prepared under IFRS that are in force on 30 September 2010, the reporting date. Subject to certain specic exemptions that are given for practical reasons, this principle needs to be applied fully retrospectively to assets and liabilities of Newsub at 1 October 2008. In the rst IFRS nancial statements IFRS 1 requires a reconciliation of amounts that were presented under local accounting standards in previous periods to the amounts presented as comparatives under IFRS in the current period. This means that there will need to be a reconciliation of: The comprehensive income for the year ended 30 September 2009. The equity at 1 October 2008 and 30 September 2009.

(c)

Since the lease is an operating lease the property will be removed from the nancial statements. A prot on sale of $15 million ($70 million $55 million) will be shown as other income in the statement of comprehensive income. The rental expense of $8 million will be shown as an operating cost in the statement of comprehensive income. The difference of $20 million between the disposal proceeds ($90 million) and the market value of the asset ($70 million) will be shown as deferred income and released to the statement of comprehensive income over the lease term of 10 years. Therefore $2 million ($20 million x 1/10) will be credited to the statement of comprehensive income in the year ended 30 September 2010, probably as a reduction in operating costs. The remaining deferred income balance of $18 million ($20 million $2 million) will be included as a liability in the statement of nancial position. $2 million of this will be a current liability and $16 million ($18 million $2 million) will be non-current.

(d)

The international nancial reporting standard that is relevant to this issue is IAS 37 Provisions, contingent liabilities and contingent assets. The amount payable to the customer of $55 million should be recognised as a provision in the statement of nancial position. The obligating event is the sale of goods under the warranty. There is a probable outow of economic benets that can be reliably estimated. The amount potentially recoverable from the manufacturer is a contingent asset which should not be recognised in the nancial statements unless the recovery is virtually certain. Where (as in this case) the recovery is probable the contingent asset should be disclosed in the notes to the nancial statements.

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Diploma in International Financial Reporting

December 2010 Marking Scheme Marks 25

Marks as annotated on model answer NB if proportional consolidation NOT used for Gamma only give a maximum of 2 of the 3 marks highlighted in bold on the answer

Marks as annotated on model answer

25

(a)

Principle liability/equity split Calculate split Correct treatment of issue costs up to Compute nance cost and say where shown Compute closing liability and say where shown Compute closing equity balance and say where shown Total

1 1 1 1 1 6 1 1 1 1 1 1 1 1 1 11 1 1 1 1 1 1 1 1 8

(b)

Correctly conclude operating lease Principle rental expense in SCI Principle of correct treatment of inducement Calculate rental expense for year Calculate accrued rental expense and split Principle capitalise costs of $1.2m Principle make provision (with explanation) Calculate unwinding of discount Unwinding of discount is nance cost and provision is non-current liability Principle capitalise future restoration costs Compute depreciation Compute closing PPE value and state non-current asset Total

(c)

Principle shares a nancial asset Correct classication as AFS Explain measurement implications including reclassication on sale Compute unrealised gain arising in prior periods Compute total gain on sale and state where shown Identify reclassied gain and describe treatment in OCI Compute additional gain on remaining shares and describe treatment Compute and describe carrying value of shares in SFP Total

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(a)

Comment on scope up to Describe calculation of basic EPS up to Describe calculation of diluted EPS up to Disclosures for entities without discontinued operations Additional disclosures for entities with discontinued operations up to Total

Marks 1 1 1 1 1 7 1 3 1 1 8 2 1 1 5 1 2 1 5

(b)

Compute earnings for basic EPS up to Compute number for basic EPS up to So compute basic EPS in cents Compute earnings for diluted EPS Compute number for diluted EPS So compute diluted EPS in cents Total

(c)

Recognition criteria up to Measurement basis up to Reporting requirements up to Total

(d)

Principle charge in SCI is difference between closing and opening amounts in SFP Compute closing amount ( per element) Compute opening amount ( for $120, for 150, for 1/3) Calculate amount in SCI Total

(a) (b)

Marks as annotated on model answer All amounts need to be measured using IFRS in force at reporting date Principle of opening IFRS SFP with identied date up to Appreciate application fully retrospectively with principle of exceptions Explain reconciliations needed Total

11 1 2 1 1 6 1 1 1 1 5 1 1 3

(c)

Principle de-recognise property Compute correct prot on sale and discuss treatment $8 million shown as rental expense Principle $20 million is deferred income in SFP Split into current and non-current amounts Total

(d)

Explanation of provision Explanation of contingent asset Total

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Diploma in International Financial Reporting

Thursday 10 June 2010

Time allowed Reading and planning: Writing:

15 minutes 3 hours

This paper is divided into two sections: Section A This ONE question is compulsory and MUST be attempted Section B THREE questions ONLY to be attempted Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.

The Association of Chartered Certied Accountants

Dip IFR

Epsilon is a listed entity preparing nancial statements to 31 March each year. Details of the following complex transactions that have occurred in recent periods appear below: (a) On 1 April 2007 Lambda, another entity, issued 200,000 bonds that had a nominal value of $100 per bond. The bonds were issued at $90 per bond and were redeemable at nominal value on 31 March 2012. Epsilon purchased all 200,000 of these bonds and intended to hold them to their maturity date. Annual interest payments of $6 per bond were due on 31 March in arrears. The effective annual rate of interest inherent in the bonds was 85%. Lambda paid the interest due on 31 March 2008 and 31 March 2009 in full. On 31 March 2009 it became apparent that Lambda was in nancial difculty and would be unable to make all the repayments due on the loan. An agreement was reached whereby Lambda would make reduced interest payments of $2 per bond on 31 March 2010, 2011 and 2012 and would then redeem the bonds at nominal value on 31 March 2012. On 31 March 2009 Epsilon would have required an annual effective return of 75% on new investments of this nature. The reduced interest of $2 per bond was received by Epsilon on 31 March 2010. On 31 March 2010 there was every expectation that the revised future repayment terms would be adhered to by Lambda. Epsilon does not wish to measure nancial instruments at fair value unless this is required by International Financial Reporting Standards. Relevant discount factors are as follows: Present value of $1 receivable in: 1 year 2 years 3 years Required: Produce relevant extracts that show how the bond investment would be reported in the statement of nancial position of Epsilon at 31 March 2008, 2009 and 2010 and in the statement of comprehensive income for the years ended 31 March 2008, 2009 and 2010. Provide any explanations you consider relevant. (12 marks) (b) On 1 April 2009 Epsilon began to lease an ofce building on a 10-year operating lease. For the rst ve years of the lease the annual lease rentals were set at $400,000, payable in advance. For the second ve years this annual rental is to increase to $450,000, payable in advance. On 1 April 2009 Epsilon carried out some alterations to the property involving the erection of temporary partitions to create suitable ofce space. The total cost of the alterations was $600,000. Under the terms of the lease the building had to be returned to the owner in its original condition. The estimated cost of removing the partitions at the end of the lease term is $300,000. A relevant risk adjusted discount rate is 5% per annum. The present value of $1 payable in 10 years at a discount rate of 5% is 614 cents. Required: Produce relevant extracts that show how this transaction would be reported in the statement of nancial position of Epsilon at 31 March 2010 and in the statement of comprehensive income for the year ended 31 March 2010. Provide any explanations you consider relevant. (9 marks) 75% 930 cents 865 cents 805 cents 85% 922 cents 849 cents 783 cents

(c) On 1 October 2009 Epsilon ordered a quantity of inventory from a customer whose functional currency was the Euro. The agreed purchase price was 200,000 Euros. The inventory was delivered on 1 December 2009 and paid for on 31 January 2010. Half the inventory was sold prior to 31 March 2010. Relevant exchange rates are as follows ($s to 1 Euro): 1 October 2009 120 1 December 2009 125 31 January 2010 130 31 March 2010 135. Epsilon made no attempt to hedge the exchange risk arising out of the purchase of inventory denominated in Euros. Required: Produce relevant extracts that show how this transaction would be reported in the statement of nancial position of Epsilon at 31 March 2010 and in the statement of comprehensive income for the year ended 31 March 2010. Provide any explanations you consider relevant. (4 marks) (25 marks)

[P.T.O.

(a) Revenue is usually one of the largest numbers that appears in the nancial statements of an entity. Therefore it is important to ensure that revenue is recognised and measured appropriately. IAS 18 Revenue was issued in order to provide standard accounting practice in this area. Required: (i) Describe the meaning of revenue and the basis on which it should be measured under the principles of IAS 18; (3 marks)

(ii) Outline the criteria that need to be satised before revenue can be recognised under the principles of IAS 18. You should consider revenue from the sale of goods and from the rendering of services separately. (5 marks) (b) Kappa is an entity that prepares nancial statements to 31 March each year. During the year ended 31 March 2010 the following transactions occurred: (i) On 29 March 2010 Kappa delivered two machines to a customer. Details relating to the machines are as follows: Machine A B Construction cost $ 190,000 200,000 Invoiced price $ 250,000 300,000

Machine A was unpacked and connected to the power supply necessary to operate the machine on 2 April 2010. As soon as this was done, the machine was able to operate immediately. Machine B needed to be installed by an expert tter before it was capable of operating in the intended manner. The installation process was complete, and the machine passed ready for use, on 4 April 2010. The customer paid for both machines on 30 April 2010. (5 marks)

(ii) On 15 March 2010 Kappa transferred goods to a third party, Omicron, on a consignment basis. Omicron undertook to sell the goods on behalf of Kappa and remit the proceeds, less a commission of 10%, when the nal purchaser paid Omicron for them. The invoiced value of these goods (the price payable by the nal purchaser was $400,000). The goods cost Kappa $320,000 to manufacture. By 31 March 2010 Omicron had sold goods at an invoiced price of $240,000 and received payments of $160,000. No payment had been made to Kappa by Omicron by 31 March 2010. Since 31 March 2010 Omicron has sold the remaining goods, received all the proceeds, and remitted $360,000 ($400,000 x 90%) to Kappa. (5 marks) (iii) On 1 April 2009 Kappa sold a property it owned to a bank for $3,000,000. The carrying value of the property at 1 April 2009 was $2,000,000, of which $1,200,000 was depreciable. The remaining useful economic life of the depreciable element was 30 years from 1 April 2009. Kappa continued to occupy the property and be responsible for its security and maintenance. The market value of the property on 1 April 2009 was $5,000,000 and it is considered unlikely that this will fall signicantly in the foreseeable future. Kappa measures all its property, plant and equipment under the cost model. The terms of the sale allowed Kappa the option to repurchase the property as follows: On 31 March 2010 for $3,300,000. On 31 March 2011 for $3,630,000. On 31 March 2012 for $3,993,000.

(7 marks)

Required: For each of the above transactions: Explain and compute, by applying the principles of IAS 18, how much revenue should be recognised in the statement of comprehensive income for the year ended 31 March 2010. Identify and compute any other amounts relating to each transaction that will be included in the statement of comprehensive income for the year ended 31 March 2010 and the statement of nancial position at 31 March 2010. (25 marks)

[P.T.O.

Omega prepares nancial statements under International Financial Reporting Standards (IFRS). In the two-year period ended 31 March 2010 the following events occurred: (a) On 1 October 2008 Omega began the construction of a new factory. Costs relating to the factory were as follows: Details Purchase of land on which to build the factory Cost of levelling the land prior to beginning construction Cost of materials needed to construct the factory (Note 1) Monthly employment costs of the construction staff (Note 1) Monthly amount of other overheads directly related to the construction (Note 1) Payments to external advisors relating to the construction Income from temporary use of part of the site as a car park during the construction period. Costs of relocating staff to work in the new factory Costs relating to the public opening of the factory (Note 2) Amount $000 20,000 850 8,000 500 200 500 (250) 400 200

Note 1 In December 2008 a re destroyed materials costing $500,000. The cost of these materials is included in the material gure that is given above. Construction work was suspended for two weeks because of the re. The construction workers continued to be paid during this two-week period and other additional overheads of $40,000 were incurred in this period. These related to keeping the construction site secure during the temporary cessation of construction. Note 2 Construction of the factory was completed on 28 February 2009 and the construction workers transferred to other projects from that date. The factory was not available for use until 31 March 2009, when the factory was inspected by local government ofcials (as required by local legal regulations) and certied as safe for use. The factory was not actually brought into use until 31 May 2009, following a public opening ceremony. Note 3 The costs of construction were mainly nanced by a loan of $30 million that was arranged during September 2008. The effective annual interest rate on the loan was 8%. The proceeds were invested prior to being needed to nance the construction cost and in the period ended 31 March 2009 the temporary investment produced income of $300,000. Note 4 The depreciable element of the factory comprises the building costs. The majority of these costs have an estimated useful economic life of 40 years. However, the factory roof will need to be replaced after 20 years. The estimated cost of replacing the roof at current prices is $24 million. Note 5 Omega computes its depreciation charge on a monthly basis and measures property, plant and equipment using the cost model. Note 6 No impairment of the factory had occurred by 31 March 2010. Required: Compute the carrying value of the factory in the statement of nancial position of Omega at 31 March 2010. You should support your computations with appropriate explanations of the amount you have included for the cost of the factory and for its subsequent depreciation. (17 marks)

10

(b) On 31 December 2009 the directors of Omega decided to dispose of two properties in different locations. Both properties were actively marketed by the directors from 1 January 2010 and sales are expected before the end of July 2010. Summary details of the two properties are as follows: Property Carrying amount at 31 March 2009 $000 25,000 22,000 Depreciable amount at 31 March 2009 $000 15,000 16,000 Estimated future economic life at 31 March 2009 $000 30 years 40 years Estimated fair value less costs to sell at 31 December 2009 $000 28,000 18,000

A B

Property A was available for sale without modications from 1 January 2010 onwards. On 31 March 2010 the directors of Omega were reasonably condent that a sale could be secured for $28 million. However, after the year-end property prices in the area in which property A is located started to decline. This was due to an unexpected adverse local economic event in April 2010. Following this event the directors of Omega estimated that property A would now be sold for $22 million less selling costs and they are very condent that this lower price can be achieved. Property B needed repair work carried out on it before a sale could be completed. This repair work was carried out in the two-week period beginning 10 April 2010. The costs of this repair work are reected in the estimated fair value less costs to sell gure for property B of $18 million (see above). This estimate remains valid. Required: Compute: The carrying values of both properties in the statement of nancial position of Omega at 31 March 2010. The amounts charged to the statement of comprehensive income in respect of both properties for the year ended 31 March 2010.

You should support your computations with appropriate explanations of the treatments you have adopted. (8 marks) (25 marks)

End of Question Paper

11

Answers

Transaction (b) Summary (all in 000s) Statement of comprehensive income year ended 31 March 2010 Lease rental 425 Depreciation 78 (60 + 18) Finance cost 9 Statement of nancial position at 31 March 2010 Non-current assets 706 (540 + 166) Non-current liabilities 218 (25 + 193) Explanations The lease is an operating lease so the rentals are charged as an expense in the statement of comprehensive income. IAS 17 Leases states that this charge should be on a straight-line basis unless another pattern is clearly more appropriate. The total lease rentals are 4,250 (400 x 5 + 450 x 5). Therefore the charge to the income statement each year will be 425 (4,250 x 1/10). Since the rental actually paid in the year to 31 March 2010 is 400 there will be an accrual of 25 (425 400) in the statement of nancial position as at 31 March 2010. Even though the lease is operating the lease improvements are capitalised as a non-current asset with a useful economic life of 10 years. This means that depreciation of 60 (600 x 1/10) will be required and the closing non-current assets balance relating to the improvements at 31 March 2010 will be 540 (600 60). Under the principles of IAS 37 Provisions, contingent liabilities and contingent assets the carrying out of alterations to the leased asset creates an obligating event to restore the asset at the end of the lease and so a provision must be recognised. The amount of the provision is the present value of the expected future payments, which is 184 (300 x 0614). This expenditure provides access to future economic benets so it is capitalised along with the alterations themselves. This creates additional depreciation of 18 (184 x 1/10) and an addition to non-current assets at 31 March 2010 of 166 (184 18). As the date for restoration approaches the discount unwinds and this is reected by a nance cost in the statement of comprehensive income. For the year ended 31 March 2010 this cost is 9 (184 x 5%). The closing provision will be 193 (184 + 9). Transaction (c) Summary Statement of comprehensive income year ended 31 March 2010 Cost of sales $125,000 ($250,000 x 50%) Exchange loss on settlement of trade payable $10,000. Statement of nancial position at 31 March 2010 Inventory $125,000. Explanations A liability to pay for the goods arises on 1 December 2009 when they are delivered. On this date $250,000 (200,000 x 125) is debited to inventory and credited to trade payables. When the liability was settled 200,000 Euros cost $260,000 (200,000 x 130) so an exchange loss of $10,000 ($260,000 $250,000) is recognised in the statement of comprehensive income. The inventory is a non-monetary asset and so is measured using the rate of exchange in force when purchased. No exchange difference arises.

(a)

(i)

IAS 18 denes revenue as the gross inow of economic benets in a period arising in the course of the ordinary activities of an entity when those inows result in an increase in equity, other than increases relating to contributions from equity participants. Revenue does not include amounts collected on behalf of third parties, such as sales taxes. Revenue should be measured at the fair value of the consideration received or receivable.

(ii)

Revenue from the sale of goods should be recognised when: (i) (ii) (iii) (iv) (v) The entity has transferred to the buyer the signicant risks and rewards of ownership of the goods. The entity retains neither managerial involvement in, nor effective control over, the goods sold. The amount of revenue can be measured reliably. It is probable that the economic benets associated with the transaction will ow to the entity. The costs incurred or to be incurred in respect of the transaction can be measured reliably.

Revenue from the rendering of services should be recognised when: (i) (ii) (iii) (iv) The amount of revenue can be measured reliably. It is probable that the economic benets associated with the transaction will ow to the entity. The stage of completion of the transaction at the end of the reporting period can be measured reliably The costs incurred or to be incurred in respect of the transaction can be measured reliably.

20

(b)

(i)

Where goods are subject to installation and inspection, revenue is normally recognised only when installation and inspection are complete. However, where the installation process is simple in nature revenue is recognised immediately upon the buyer accepting the goods. This means that revenue of $250,000 from the sale of Machine A can be recognised in the year to March 2010, with $250,000 being debited to trade receivables. The cost of construction of the machine of $190,000 will be included in cost of sales. However, revenue from the sale of Machine B cannot be recognised until April 2010, when the installation process is complete. Therefore, this machine will be included in inventory at its construction cost of $200,000.

(ii)

Where goods are sold on consignment then the appendix to IAS 18 indicates that revenue should be recognised when the recipient (Omicron in this case) sells the goods to a third party. The only way this could be accelerated under the general principles of the standard would be where the terms of the consignment clearly transfer the risks and rewards of ownership of the consigned inventory to Omicron on delivery, which is not the case here. Therefore, only those goods sold by Omicron to the ultimate purchaser prior to 31 March should be recognised as revenue. The amount of revenue that should be recognised is the fair value of the consideration payable by the nal purchaser, which in this case is $240,000. The manufactured cost of the goods treated as sold should be taken to cost of sales. This amount is $192,000 ($320,000 x ($240,000/$400,000)). The commission payable of $24,000 ($240,000 x 10%) should also be treated as part of cost of sales. $216,000 ($240,000 $24,000) should be debited to trade receivables. The cost of goods unsold by Omicron at 31 March 2010 of $128,000 ($320,000 $192,000) should be included in the inventory of Kappa at 31 March 2010.

(iii) For sale transactions with an option or commitment to repurchase IAS 18 requires an analysis of the transaction to ascertain whether, in substance, the seller has transferred the risks and rewards of ownership to the buyer. If this transfer has not occurred, the transaction is treated as a nancing arrangement that does not give rise to revenue. In this case the terms of the sale leave Kappa occupying the property, with responsibility for its maintenance. Also it is highly likely that the option to repurchase will be exercised either on 31 March 2011 or 2012. Therefore, no revenue would be recognised and the sales proceeds would be treated as a borrowing. This means that the asset would remain an asset of Kappa and be subject to depreciation of $40,000 ($1,200,000 x 1/30). The closing carrying value of the asset would be $1,960,000 ($2,000,000 $40,000). The longer Kappa takes to repurchase the property the higher the repurchase price. It can be seen that this repurchase is increasing at 10% per annum compound e.g. $3,300,000/$3,000,000 = 110. Therefore the borrowing is treated as a nancial liability measured at amortised cost with an effective annual interest rate of 10%. The nance cost for the year ended 31 March 2010 would be $300,000 ($3,000,000 x 10%) and the closing borrowing $3,300,000 ($3,000,000 + $300,000). This would be shown as a liability.

21

Marks 5 (a) Computation of cost (all numbers in $000s) Details Purchase of land Levelling of land Purchase of materials Costs of construction workers Other construction overheads Consultants fees Income from car park Relocation costs Costs of opening factory Capitalised nance costs Total cost Amount 20,000 850 7,500 2,250 900 500 Nil Nil Nil 32,000 800 32,800 1 1 1 Explanation Direct cost of construction Direct cost of construction Not including cost of materials lost in re Construction period ve months, less idle two weeks Construction period as above. Ignore overheads incurred after construction complete Direct cost of construction Income from operations incidental to the construction taken to the statement of comprehensive income Not a direct cost of construction Not a direct cost of construction Five and a half months interest on $30 million at 8%, less temporary investment of surplus funds 2 1 1 11/2 11/2 11/2 1 11/2 1 1

Computation of depreciation charged to 31 March 2010 Depreciate from 1 April 2009 (the date available for use) The depreciable amount is 12,300 (32,000 20,000 + 800 x 12/32) The depreciation for the year is 368 (2,400 x 1/20 + (12,300 2,400) x 1/40) Computation of carrying value at 31 March 2010 Cost Depreciation Carrying value Tutorial Note The need to replace the roof in 20 years time is recognised through component depreciation rather than by recognising a provision (b) (all numbers in $000s) Summary of accounting treatments Statement of nancial position at 31 March 2010. Non-current assets 18,000 Current assets (or non-current assets held for sale) 24,625. Statement of comprehensive income for the year ended 31 March 2010 Depreciation 775 (375 + 400) Impairment 3,600 (21,600 18,000) From 1 January 2010 property A would be regarded as held for sale under the principles of IFRS 5 Non-current assets held for sale and discontinued operations. The property is available for immediate sale in its present condition and is being actively marketed at a reasonable price. On the other hand property B would not, since it cannot be sold until necessary repairs are carried out. Property A would be depreciated up to the date of classication as held for sale but not thereafter. Therefore, depreciation of 375 (15,000 x 1/30 x 9/12) would be necessary in the year to 31 March 2010. The property would be removed from non-current assets and shown in current assets or in a separate section of the assets side of the statement of nancial position. It would be measured at the lower of its carrying value of the date of classication of 24,625 (25,000 375) and its fair value less costs to sell of 28,000 24,625 in this case. The decline in property prices affecting this property relates to an economic event occurring after the reporting date. Therefore, it would be regarded as a non-adjusting event after the reporting date. The event would be disclosed as a note to the nancial statements but the decline in value would not be recognised. Property B would be depreciated for the whole period and would remain in non-current assets. The depreciation required for the year ended 31 March 2010 would be 400 (16,000 x 1/40). The fact that its fair value less costs to sell is estimated at $18 million whilst the carrying value prior to any write down is 21,600 (22,000 400) is prima-facie evidence of impairment. Given that the property is to be sold even though it cannot be classied as held for sale at 31 March 2010 this is the best indicator of the recoverable amount of the property. 32,800 (368) 32,432
1/ 1/ 2

2 17

22

Diploma in International Financial Reporting

June 2010 Marking Scheme Marks 25

Marks as indicated on answers

Marks as indicated on answers

25

(a)

Identify correct measurement basis Measure nancial asset and related income up to 31 March 2009 pre-impairment Identify impairment issue Principle measure PV of newly expected cash ows Principle use 85% discount rate Marks for discounting calculations Identify impairment loss and new carrying value Principle of 2010 measurement at amortised cost of 85% Marks for 2010 calculations Total for part 3(a)

1 2 1 1 1 21/2 11/2 1 1 12 1 1 1 1 1 1 1 2 9 1 1 1 1 4

(b)

Principle rental expense in statement of comprehensive income Compute charge for year Identify accrual as non-current liability (only 1/2 if this not stated) Principle capitalise improvements and depreciate Calculations re: above Principle recognise provision and debit non-current assets Calculation of amount to capitalise Compute depreciation and nance cost Total for part 3(b)

(c)

Principle account for transaction from 1 December 2009 Compute opening carrying value of inventory and trade payables Compute exchange loss on settlement of trade payable Compute closing inventory balance and charge to cost of sales re: sold goods Total for part 3(c)

23

(a)

(i)

Denition of revenue (gross, normal course of business, not equity contributions) Identify measurement base as fair value (only 1/2 if they say invoiced price) Total for part (a)(i)

Marks 2 1 3 21/2 21/2 5 2 2 1 5 2 3 5 2 1 1 1 1 1 7

(ii)

Timing of recognition re: goods 1/2 each up to Timing of recognition re: services 1/2 each up to Total for part (ii)

(b)

(i)

General principle of when revenue recognised Application to sale of machine A Application to sale of machine B Total for part (b)(i)

(ii)

General principle of when revenue recognised Application to sale and computation of amount of revenue, cost of sales, trade receivables and inventory Total for part (ii)

(iii) General principle of when revenue recognised Conclude no revenue here Treatment of PPE Conclude proceeds of borrowing Compute nance cost State closing liability Total for part (iii)

(a) (b)

Marks as indicated on answers Conclusions about classication as held for sale 1 each Depreciation of property A Measurement and disclosure of property A is statement of nancial position Depreciation of property B Identify and discuss impairment issue with property B Disclosure of property B in statement of nancial position Total for event 2

17 2 1 2 1 1 1 8

24

Diploma in International Financial Reporting

Thursday 9 June 2011

Time allowed Reading and planning: Writing:

15 minutes 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

Dip IFR

This is a blank page. The question paper begins on page 3.

ALL FOUR questions are compulsory and MUST be attempted 1 The income statements and summarised statements of changes in equity of Alpha, Beta and Gamma for the year ended 31 March 2011 are given below: Income Statements Alpha $000 470,000 (256,000) 214,000 (18,000) (19,000) 37,300 (68,000) 146,300 (41,000) 105,300 540,000 105,300 (52,000) 593,300 Beta $000 434,000 (218,000) 216,000 (17,000) (16,000) Nil (65,000) 118,000 (33,000) 85,000 390,000 85,000 (40,000) 435,000 Gamma $000 226,000 (176,000) 50,000 (15,000) (17,000) Nil (44,000) (26,000) Nil (26,000) 192,000 (26,000) Nil 166,000

Revenue Cost of sales Gross profit Distribution costs Administrative expenses Investment income (Note 5) Finance cost (Note 6) Profit/(loss) before tax Income tax expense Profit/(loss) for the year Summarised Statements of Changes in Equity Balance at 1 April 2010 Comprehensive income for the year Dividends paid on 31 December 2010 Balance at 31 March 2011 Note 1 purchase of shares in Beta

On 1 October 2009 Alpha purchased 75 million of the 100 million equity shares in Beta. Details of the share purchase were as follows: Alpha issued two new equity shares for every three shares acquired in Beta. On 1 October 2009 the market value of an Alpha share was $6 and the market value of a Beta share was $320. Alpha agreed to make an additional cash payment of $1 for every share acquired in Beta to be paid on 30 September 2011. This payment is contingent on the profits of Beta exceeding a cumulative target in the two-year period ending 30 September 2011. The fair value of this contingent payment was $55 million on 1 October 2009. The fair value had risen to $58 million by 31 March 2010 and to $64 million by 31 March 2011. The directors of Alpha correctly accounted for this contingent consideration in its financial statements for the year ended 31 March 2010 but no changes have been made to the carrying value of the contingent consideration since 31 March 2010. Alpha incurred legal and professional costs of $5 million connected with the acquisition; $24 million of these costs related to the cost of issuing shares. Alpha correctly accounted for these acquisition costs in its financial statements for the year ended 31 March 2010.

Alpha decided to value the non-controlling interest in Beta at the date of acquisition at fair value in its consolidated financial statements. The market value of a Beta share at that date was used to calculate the fair value of the noncontrolling interest. The equity of Beta as shown in its own financial statements at 1 October 2009 was $300 million. At that date the property, plant and equipment (PPE) of Beta had a carrying value of $240 million and a fair value of $280 million. The estimated future useful economic life of the PPE of Beta was four years from 1 October 2009. No disposals of PPE occurred between 1 October 2009 and 31 March 2011. On 1 October 2009 the directors estimated that the internally generated brand name of Beta had a fair value of $30 million and a future useful economic life of 30 years. All depreciation and amortisation is charged on a monthly basis and presented in cost of sales.

[P.T.O.

Note 2 impairment review On 31 March 2010 and 31 March 2011 the goodwill on consolidation of Beta was reviewed for impairment. No impairment of the goodwill was necessary as a result of the review on 31 March 2010. Beta is regarded as a single cash generating unit for impairment purposes and at 31 March 2011 its recoverable amount was estimated as $550 million. Any impairment of goodwill is charged to cost of sales. Note 3 purchase of shares in Gamma On 1 October 2010 Alpha purchased 40% of the equity shares of Gamma for $75 million in cash. This purchase allowed Alpha to exercise a significant influence over Gamma. No material differences between the market value and the book value of the net assets of Gamma were apparent at the date of the share purchase. On 31 March 2011 an impairment review was conducted resulting in an impairment required of $18 million. Note 4 inter-company sales Beta supplies products to Alpha and Gamma. Sales of the products to Alpha and Gamma during the year ended 31 March 2011 were as follows (all sales were made at a mark-up of 331/3% on cost): Sales to Alpha $18 million. Sales to Gamma $12 million.

At 31 March 2011 and 31 March 2010 the inventories of Alpha and Gamma included the following amounts in respect of goods purchased from Beta. Amount in inventory at 31 March 2011 31 March 2010 $000 $000 3,600 2,100 2,700 Nil

Alpha Gamma Note 5 Equity investments

At 1 April 2010 Alpha had two equity investments that it designated as fair value through other comprehensive income in accordance with IFRS 9 Financial Instruments. At the date of acquisition: Name Original cost $000 12,000 11,000 Fair value at 31 March 2010 2011 $000 $000 15,000 n/a 14,000 15,400

Delta Epsilon

On 31 January 2011 Alpha disposed of its investment in Delta for $195 million and showed a profit on sale of $45 million ($195 million $15 million) as part of investment income. Apart from recording the receipt of dividend income no other entries have been made in the financial statements for the year ended 31 March 2011 regarding the investment in Epsilon. Both investments had been correctly treated in the financial statements for the year ended 31 March 2010. Note 6 Convertible notes On 1 April 2010 Alpha issued 300 million loan notes of $1 per note at par. The loan notes entitled the holders to an interest payment of 5 cents per note, payable annually in arrears. The loan notes are repayable at par on 31 March 2015. As an alternative to repayment the holders can elect to convert the notes into equity shares in Alpha. On 1 April 2010 investors in non-convertible notes would expect an annual return of 8%. You are given the following discount factors: Discount rate 5% 8% Present value of $1 payable At the end of year 5 Cumulatively at the end of years 15 784 cents $433 681 cents $399

On 1 April 2010 the directors of Alpha recorded a loan liability of $300 million and in the year ended 31 March 2011 a finance cost of $15 million (300 million x 5 cents) in respect of these notes.

Note 7 Environmental damage During the year ended 31 March 2011 Alpha began production at three newly acquired factories. The normal production process at each factory results in environmental damage. Alpha has a policy of only rectifying such damage when legally required to do so. Details of the damage caused at the three sites up to and including 31 March 2011 are as follows: Factory A B C Damage caused by 31 March 2011 $000 3,000 1,000 2,000 Clean-up legislation in place at 31 March 2011? Yes No No but legislation passed since year end with retrospective effect

No provision for environmental damage has been made in the financial statements. Any appropriate provision should be reported as part of cost of sales. Required: (a) Prepare the consolidated statement of comprehensive income for Alpha for the year ended 31 March 2011; (33 marks) (b) Prepare the summarised consolidated statement of changes in equity for Alpha for the year ended 31 March 2011. Your summarised statement should include a column for the non-controlling interest. (7 marks) Ignore deferred tax. (40 marks)

[P.T.O.

Kappa is a listed entity that prepares financial statements to 31 March each year. Below are details of two transactions of the entity: Transaction one On 31 January 2010 Kappa signed a contract with a fuel company to purchase a large quantity of fuel for its own use. The fuel was delivered and paid for on 30 April 2010. The suppliers functional currency is the Euro and the contracted price was 500,000 euros. Kappas functional currency is the dollar. In order to protect Kappa from exchange fluctuations, on 31 January 2010 the directors entered into a forward contract to purchase 500,000 euros for 700,000 dollars on 30 April 2010. The dollar strengthened against the euro between 31 January 2010 and 31 March 2010 and on 31 March 2010 the contract to purchase 500,000 euros for 700,000 dollars had a value of 20,000 dollars (financial liability). The dollar strengthened further during April 2010 and on 30 April 2010, when the spot exchange rate was 135 dollars = 1 euro, Kappa made a payment of 25,000 dollars to settle the forward contract. The fuel was delivered in accordance with the terms of the contract and used evenly in the 12 month period from 1 May 2010 to 30 April 2011. The directors wish to use cashflow hedge accounting where this is permitted by International Financial Reporting Standards. You can assume that the contract to purchase the euros was a perfectly effective hedge of the potential exchange fluctuations arising out of the contract to purchase the fuel. (10 marks) Transaction two On 1 April 2009 Kappa began to lease an office block on a 20-year lease. The useful economic life of the office buildings was estimated at 40 years on 1 April 2009. The supply of leasehold properties exceeded the demand on 1 April 2009 so as an incentive the lessor paid Kappa $1 million on 1 April 2009 and allowed Kappa a rent-free period for the first two years of the lease, followed by 36 payments of $250,000, the first being due on 1 April 2011. Between 1 April 2009 and 30 September 2009 Kappa carried out alterations to the office block at a total cost of $3 million. The terms of the lease require Kappa to vacate the office block on 31 March 2029 and leave it in exactly the same condition as it was at the start of the lease. The directors of Kappa have consistently estimated that the cost of restoring the office block to its original condition on 31 March 2029 will be $25 million at 31 March 2029 prices. An appropriately risk-adjusted discount rate for use in any discounting calculations is 6% per annum. The present value of $1 payable in 19 years at an annual discount rate of 6% is 32 cents. (10 marks) Required: Prepare extracts from the financial statements for both transactions that show their impact on: (a) The statements of financial position at 31 March 2010 and 2011; (b) The statements of comprehensive income for the years ended 31 March 2010 and 2011. In both cases your extracts should be supported by appropriate explanations and computations. Note: The mark allocation is shown against each of the two issues above. (20 marks)

(a) IAS 38 Intangible assets deals with the recognition and subsequent measurement of intangible assets. Required: Explain the following: (i) The meaning of the term intangible asset and those intangible assets that are within the scope of IAS 38; (ii) The criteria that need to be satisfied before expenditure can be recognised as an intangible asset under IAS 38; (iii) How recognised intangible assets should be subsequently measured. (9 marks) (b) Lambda is a listed entity that prepares consolidated financial statements. Lambda measures assets using the revaluation model wherever this is possible under International Financial Reporting Standards. During its financial year ended 31 March 2011 Lambda entered into the following transactions: (i) On 1 October 2009 Lambda began a project to investigate a more efficient production process. Expenses relating to the project of $2 million were charged in the statement of comprehensive income in the year ended 31 March 2010. Further costs of $15 million were incurred in the three-month period to 30 June 2010. On that date it became apparent that the project was technically feasible and commercially viable. Further expenditure of $3 million was incurred in the six-month period from 1 July 2010 to 31 December 2010. The new process, which began on 1 January 2011, was expected to generate cost savings of at least $600,000 per annum over the 10-year period commencing 1 January 2011.

(ii) On 1 April 2010 Lambda acquired a new subsidiary, Omicron. The directors of Lambda carried out a fair value exercise as required by IFRS 3 Business Combinations and concluded that the brand name of Omicron had a fair value of $10 million and would be likely to generate economic benefits for a ten-year period from 1 April 2010. They further concluded that the expertise of the employees of Omicron contributed $5 million to the overall value of Omicron. The estimated average remaining service lives of the Omicron employees was eight years from 1 April 2010. (iii) On 1 October 2010 Lambda renewed its licence to extract minerals that are needed as part of its production process. The cost of renewal of the licence was $200,000 and the licence is for a five-year period starting on 1 October 2010. There is no active market for this type of licence. However, the directors of Lambda estimated that at 31 March 2011 the fair value less costs to sell of the licence was $175,000. They further estimated that over the remaining 54 months of its duration the licence would generate net cash flows for Lambda that had a present value at 31 March 2011 of $185,000. Requirements: Assuming the Lambda group has no intangible assets other than those mentioned above, compute the carrying value of intangible assets in the consolidated statement of financial position of Lambda as at 31 March 2011. You should provide relevant explanations to support your figures. You are NOT required to compute the goodwill arising on acquisition of Omicron. (11 marks) (20 marks)

[P.T.O.

You are given details of three transactions affecting the financial statements of Omega: Transaction One On 1 April 2009 Omega granted share options to 20 senior executives. The options are due to vest on 31 March 2012 provided the senior executives remain with the company for that period. The number of options vesting to each director depends on the cumulative profits over the three-year period from 1 April 2009 to 31 March 2012: 10,000 options per director if the cumulative profits are between $5 million and $10 million. 15,000 options per director if the cumulative profits are more than $10 million.

On 1 April 2009 and 31 March 2010 the best estimate of the cumulative profits for the three-year period ending on 31 March 2012 was $8 million. However, following very successful results in the year ended 31 March 2011, the latest estimate of the cumulative profits in the relevant three-year period is $14 million. On 1 April 2009 it was estimated that all 20 senior executives would remain with Omega for the three-year period, but on 31 December 2009 one senior executive left unexpectedly. None of the other executives have since left and none are expected to leave before 31 March 2012. A further condition for vesting of the options is that the share price of Omega should be at least $12 on 31 March 2012. The share price of Omega over the last two years has changed as follows: $10 on 1 April 2009. $1175 on 31 March 2010. $1125 on 31 March 2011.

On 1 April 2009 the fair value of the share options granted by Omega was $480 per option. This had increased to $550 by 31 March 2010 and $650 by 31 March 2011. Required: (a) Produce extracts, with supporting explanations, from the statements of financial position at 31 March 2010 and 2011 and from the statements of comprehensive income for the years ended 31 March 2010 and 2011 that show how transaction one will be reflected in the financial statements of Omega. Note: Ignore deferred tax. Transaction Two On 1 April 2009 Omega purchased ten new machines for $12 million each. Each machine had an overall estimated useful economic life of 10 years. The estimated residual value of each machine was zero. Each machine will require a substantial overhaul after five years in order to maintain its operating capacity and the cost of such an overhaul at 1 April 2009 prices was $3 million per machine. In the year ended 31 March 2010 Omega charged total depreciation of $12 million on the machines but the directors have subsequently realised that this may have been an error that could have a material impact on the financial statements. Required: (b) Produce extracts, with supporting explanations, from the statements of comprehensive income for the years ended 31 March 2010 and 2011 and from the statement of changes in equity for the year ended 31 March 2011 that show how transaction two will be reflected in the financial statements of Omega. Note: Ignore deferred tax. (5 marks) (8 marks)

Transaction Three On 1 June 2010 Omega signed a contract to construct a machine for one of its customers and to subsequently provide servicing facilities relating to the machine. Omega commenced construction on 1 July 2010 and the construction took two months to complete. Omega incurred the following costs of construction: Materials $1 million. Other direct costs $2 million. Allocated fixed production overheads $1 million. This allocation was made using Omegas normal overhead allocation model.

On 1 October 2010 the machine was delivered to the customer. The customer paid the full contract price of $75 million on 30 November 2010. The servicing and warranty facilities are for a three-year period from 1 October 2010. This is not considered to be an onerous contract at 31 March 2011. In the six-month period from 1 October 2010 to 31 March 2011 Omega incurred costs of $200,000 relating to the servicing and this rate of expenditure is estimated to continue over the remainder of the three-year period. Omega would normally expect to earn a profit margin of 20% on the provision of servicing facilities of this nature. Required: (c) Produce extracts, with supporting explanations, from the statement of financial position at 31 March 2011 and from the statement of comprehensive income for the year ended 31 March 2011 that show how transaction three will be reflected in the financial statements of Omega. Note: Ignore deferred tax. (7 marks) (20 marks)

End of Question Paper

Answers

Diploma in Financial Reporting

June 2011 Answers Marks

(a)

Consolidated statement of comprehensive income for the year ended 31 March 2011 Revenue (W1) Cost of sales (balancing figure) Gross profit (W2) Distribution costs (18,000 + 17,000) Administrative expenses (19,000 + 16,000) Investment income (W6) Finance cost (W7) Share of losses of associate (W9) Profit before tax Income tax expense (41,000 + 33,000) Net profit for the year Other comprehensive income (W10) Comprehensive income for the year Net profit attributable to Non-controlling interest (W11) Controlling interest Net profit for the year Comprehensive income attributable to Non-controlling interest Controlling interest Comprehensive income for the year $000 886,000 (482,145) 403,855 (35,000) (35,000) 2,800 (139,132) (7,000) 190,523 (74,000) 116,523 5,900 122,423 17,464 99,059 116,523 17,464 104,959 122,423 1 (W1) 16 (W2) 1 (W6) 4 (W7) 2 (W9) 2 (W10)

2 (W11)

33

(b)

Consolidated statement of changes in equity for the year ended 31 March 2011 Controlling interest $000 602,850 104,959 35,850 (52,000) 691,659 Non-controlling interest $000 101,125 17,464 (10,000) 108,589 Total $000 703,975 122,423 35,850 (62,000) 800,248

Balance at 1 April 2010 (W12 & W13) Comprehensive income for the year Equity component of convertible bonds (W14) Dividends Balance at 31 March 2011 WORKINGS Working 1 revenue Alpha + Beta Sales from Alpha Beta (see tutorial note 1)

2 (W12) + 1 (W13) 1 1 (W14) 1 7

$000 904,000 (18,000) 886,000 $000 430,000 (5,000) (375) (270) (11,000) (6,000) (3,500) 403,855

1 1

Working 2 gross profit Alpha + Beta Environmental provision (3,000 + 2,000) Unrealised profit adjustments: Beta: (1/4 (3,600 2,100)) Gamma: (1/4 x 2,700 x 40%) Extra depreciation (W3) Change in the fair value of contingent consideration ($64 million $58 million see tutorial note 2) Impairment of goodwill (W4) 1 1 1 1 (W3) 1 9 (W4) 16

13

Marks Tutorial Note 1 (marks allocated in workings 1 & 2) IAS 28 Investments in associates requires partial elimination of unrealised profits on transactions between associates and group entities. Profits can only be included to the extent that they relate to the non-group share. This means that the group share of such profits is eliminated and an adjustment of $270,000 is required to profit in this case (see working 2 above). The IAS does not specify exactly how such an adjustment should be reported in the consolidated statement of comprehensive income. The approach taken here is to make no adjustment to revenue whatever. Given the required adjustment to gross profit of $270,000, this would alter cost of sales by an equal and opposite amount. An alternative approach would be to reduce consolidated revenue by the group share of the revenue that relates to the inventory that is unsold by Gamma at the year-end. Given the required adjustment to gross profit of $210,000, the adjustment to cost of sales follows as the balancing figure. Either approach would earn full marks. Tutorial note 2 The change in fair value of the contingent consideration could have been shown in other sections of the statement of comprehensive income for example as an administration cost. If the correct figure is shown in another reasonable part of the statement then full marks will be awarded. Working 3 extra depreciation and amortisation Depreciation of PPE x ($280 million $240 million) Amortisation of brand 1/30 x $30 million $000 10,000 1,000 11,000 $000 Carrying value of Beta in the consolidated financial statements at 31 March 2011: Per own financial statements Fair value adjustments: PPE ($280 million $240 million) x (25/4) Brand $30 million x (285/30) Goodwill (W5) Recoverable amount So impairment equals 435,000 25,000 28,500 65,000 553,500 (550,000) 3,500 1 1 6 (W5) 9 (W2) 1 1 (W2)

Working 4 impairment of goodwill on acquisition of Beta

Working 5 goodwill on acquisition of Beta $000 Fair value of consideration given: Share exchange 75,000 x 2/3 x $6 Contingent Acquisition costs Fair value of non-controlling interest 25,000 x $320 Fair value of net assets of Beta at 1 October 2009: Per own financial statements Fair value adjustment PPE ($280 million $240 million) Fair value adjustment brand 300,000 55,000 Nil 355,000 80,000 300,000 40,000 30,000 (370,000) 65,000 $000 37,300 (30,000) (4,500) 2,800 $000 1 1 1 1 6 W4

So goodwill equals Working 6 investment income Alpha + Beta Dividend received from Beta (75% x 40,000) Profit on disposal recorded to be treated in accordance with IFRS 9 (AppB para 5.12) In consolidated statement of comprehensive income

14

Marks Working 7 finance costs Alpha + Beta Finance cost of convertible loan notes incorrectly recorded by Alpha Correct finance cost of convertible loan notes (W8) In consolidated statement of comprehensive income Working 8 finance costs of convertible loan notes $000 Liability element of compound financial instrument at 1 April 2010: (15,000 x $399) + (300,000 x $0681) So finance cost at 8% (264,150 x 008) 264,150 21,132 2 1 3 W7 $000 133,000 (15,000) 21,132 139,132 3 (W8) 4

Working 9 share of losses of associate Loss after tax of Gamma (26,000) x 40% x 6/12 equals Impairment of investment $000 (26,000) (5,200) (1,800) (7,000) $000 1,400 4,500 5,900 $000 85,000 (645) (11,000) (3,500) 69,855 17,464 1 2

Working 10 other comprehensive income Gain on revaluation of investment in Epsilon Profit on disposal recorded to be treated in accordance with IFRS 9 (AppB para 5.12) 1 1 2

Working 11 non-controlling interest in Beta Net profit of Beta Unrealised profit on intercompany sales (375 + 270) (W2) Extra depreciation and amortisation (W3) Impairment of goodwill of Beta (W4)

Non-controlling interest (25%)

Working 12 consolidated equity at 1 April 2010 Alpha Beta post acquisition per own records (390,000 300,000) Extra depreciation and amortisation (11,000 (W3) x 05) 540,000 90,000 (5,500) 84,500 63,375 (525) 602,850 80,000 84,500 21,125 101,125

Group share (75%) Unrealised profit on opening inventory (1/4 x 2,100)

2 1

Working 13 non-controlling interest in opening equity of Beta Fair value of non-controlling interest at date of acquisition (W5) Consolidated post-acquisition increase in equity from date of acquisition to start of the period (W12) Non-controlling interest (25%)

15

Marks Working 14 equity element of convertible bonds Total issue proceeds Liability component (W8) So equity component equals $000 300,000 (264,150) 35,850 1

Transaction one 1. Statement of financial position 31 March 2011 $000 58 Nil 31 March 2010 $000 Nil (20)

Current assets inventory of fuel Current liabilities financial instrument 2. Statement of comprehensive income

1 1

Cost of sales cost of fuel used Other comprehensive income: Losses arising on cash flow hedges Reclassification adjustment 3.

Year ended 31 March 2011 2010 $000 $000 (642) Nil (5) 25 (20) Nil

1 1 1

Explanation The signing of the contract to purchase fuel on 31 January 2010 does not create a liability as it is an executory contract The contract to buy 500,000 euros is a derivative financial instrument that needs to be recognised from 31 January 2010 at fair value, initially zero Since the contract to buy 500,000 euros is designated as a cash flow hedge of the commitment to buy fuel, any gains or losses (in this case losses) on re-measurement are initially recognised as other comprehensive income When the fuel is recognised in the financial statements, the cumulative loss arising on the derivative is added to the carrying value of the inventory or reclassified from other comprehensive income into profit and loss as the inventory is used (see tutorial note below) The initial carrying value of the inventory is $700,000 (500,000 x 135 + 25,000) or $675,000 (see tutorial note below)

1 1

1 1 10

Tutorial note As an alternative to taking the loss of $25,000 on the derivative as a basis adjustment to the carrying value of inventory at 30 April 2010, IAS 39 allows the inventory to be measured using the spot rate at that date. This would mean that the carrying value was $675,000 (500,000 x $135) at 30 April 2010 and $56,000 (675,000 x 1/12) at 31 March 2011. The cost of sales would be $619,000 (675,000 x 11/12) under this approach. A further consequence is that the reclassification adjustment is made as the inventory is recognised as an expense, i.e. when the inventory is sold. In such circumstances the reclassification adjustment for the year ended 31 March 2011 is $23,000 (25,000 x 11/12). The combination of the cost of sales ($619,000) and the reclassification adjustment ($23,000) gives a charge to profit and loss of $642,000, which is the same as the cost of sales under the basis adjustment method. Either approach is acceptable under IAS 39 and either approach would attract full marks. The relative impact of the two approaches on the statement of comprehensive income for the year ended 31 March 2011 is as shown in the table below (there would be no difference between the two approaches for the year ended 31 March 2010):

16

Marks Adopted approach $000 (642) Nil (642) (5) 25 (622) Alternative approach $000 (619) (23) (642) (5) 23 (624)

Cost of sales cost of fuel used Reclassification adjustment Net effect on profit for the year Other comprehensive income: Losses arising on cash flow hedges Reclassification adjustment Net effect on total comprehensive income for the year

The difference of $2,000 (622,000 624,000) between the overall amounts recognised in comprehensive income is equal to the different carrying values of closing inventory under the two approaches of $2,000 (58,000 56,000) under the two approaches. Transaction 2 1. Statement of financial position 31 March 2011 $000 3,508 (100) (1,700) (873) 31 March 2010 $000 3,703 Nil (1,400) (824)

Non-current assets property, plant and equipment Current liabilities operating lease rentals Non-current liabilities: Operating lease rentals Provision for restoration costs 2. Statement of comprehensive income

1 See 3 below

Year ended 31 March 2011 2010 $000 $000 Operating costs: Operating lease rentals Depreciation of leasehold improvements Finance costs unwinding of discount 3. (400) (195) (49) (400) (97) (24) See 3 below (for 2010 figure) See 3 below

Explanation The total operating lease rentals are $8 million ((36 x 250,000) 1 million). Therefore the annual charge is $400,000 (8 million/20) The total lease liability at 31 March 2010 is $1,400,000 (1 million reverse premium plus 400,000 rental). This increases to $1,800,000 by 31 March 2011 (1,400,000 brought forward plus 400,000 rental). The liability is reduced by $100,000 (2 x 250,000 400,000) over the next 18 years The costs of altering the office block are capitalised and depreciated over their useful economic life 19 years from 1 October 2009 The obligation to restore the block needs to be recognised as a provision because the completion of the alterations constitutes an obligating event from 1 October 2009 The initial amount of the provision is $800,000 (25 million x 032) The debit entry for the provision is to PPE since it provides access to future economic benefits The initial carrying value of the PPE is $3,800,000 (3 million + 800,000) and the annual depreciation is $195,000 (38 million/195) The unwinding for the six months to 31 March 2010 is $24,000 (800,000 x 006 x 6/12) and the closing provision $824,000 (800,000 + 24,000) The unwinding for the 12 months to 31 March 2011 is $49,000 (824,000 x 006) and the closing provision $873,000 (824,000 + 49,000)

1 1 1 1 10

17

Marks 3 (a) An intangible asset is an identifiable non-monetary asset without physical substance. Four key factors need to be in place before recognition is appropriate: 1. The asset needs to be identifiable An asset is identifiable either if it is separable (can be sold without disposing of the business as a whole) or if it arises from contractual or other legal rights, irrespective of separability. The entity needs control over the economic benefits derivable from the asset Control involves the power to obtain the future economic benefits flowing from the asset and to restrict the access of others to those benefits. The capacity of an entity to control the future economic benefits would normally, but not necessarily, stem from legal rights that are enforceable in a court of law. A clear probable source of future economic benefits needs to be identified These benefits may include revenue from the sale of products or services, but could also include cost savings or other benefits arising from the use of the asset by the entity. The asset needs to have a cost that can be measured reliably Cost will often be the cost of purchasing or developing the asset. In the case of an asset acquired in a business combination, cost will be the fair value of the asset at the date of acquisition, assuming this fair value can be reliably measured.

2.

3.

4.

Following recognition intangible items can be measured using either the cost model or the revaluation model. However, the revaluation model can only be used if the intangible asset has a readily ascertainable market value. For this to be the case the intangible asset has to be capable of being readily traded in an active market of substantially similar items. Since intangible assets often tend, by their nature, to be fairly unique the revaluation model is rarely used. Intangible assets with a finite useful economic life are amortised over that useful life. Where the useful economic life is estimated to be indefinite no amortisation is charged but the asset is reviewed for impairment on an annual basis. (b) Details Development project Amount $000 2,925 Explanation Only costs incurred after the conditions have been satisfied can be capitalised (3 million in this case) (1 mark). All previous costs must be expensed, even those arising earlier in the same accounting period (1/2 mark). Amortisation of the capitalised costs begins when the process is commercially exploited (1/2 mark) and a full years charge would be 300,000 (3 million/10). The charge in the year ended 31 March 2011 is 75,000 (300,000 x 3/12) (1 mark). Brand name capitalised at fair value and amortised over useful economic life. Per IAS 38 an assembled workforce fails the control test as they could leave and take their expertise elsewhere. Their value is effectively included in the goodwill on acquisition of Omicron. Separately purchased intangibles are recognised at cost, and amortised over their useful economic lives (15 marks). Although the assets net selling price is only $175,000, the value in use is $185,000 so the recoverable amount of the asset is above $185,000 and no impairment has occurred (15 marks). There is no question of revaluing the items recognised as intangible assets as no active market exists (1 mark).

3 2

Brand name Workforce

9,000 Nil

Production licence

180

Revaluation policy relating to all assets

1 11

18

Marks 4 (a) Transaction One 1. Statement of financial position As at 31 March 2011 $000 912 2010 $000 304

In equity 2. Statement of comprehensive income

In operating expenses 3.

Year ending 31 March 2011 2010 $000 $000 608 304

Explanation The total expected cost at 31 March 2010 = $912,000 (19 x 10,000 x $48) 1/3 is recognised in equity as this is an equity settled share based payment The total expected cost at 31 March 2011 = $1,368,000 (19 x 15,000 x $48) 2/3 is recognised in equity at 31 March 2011. Amounts can be shown as a separate component of equity or credited to retained earnings The vesting condition relating to share price is ignored in the estimation of the total expected cost as it is one of the factors that is used to compute the fair value of the share option at the grant date i.e. it is a market related vesting condition The cost recognised in 2010 is the cost to date since this is the first year of the vesting period The cost recognised in 2011 is the difference between cumulative costs carried and brought forward

1 1 1 1

1 1 8

(b)

Transaction Two 1. Statement of comprehensive income Year ended 31 March 2011 2010 $000 $000 15,000 15,000

Depreciation operating expenses 2.

Statement of changes in equity year ended 31 March 2011 Adjustment to retained earnings brought forward $000 (3,000) 1

3.

Explanation IAS 16 Property, plant and equipment recognises that certain assets need a major inspection or overhaul in order to continue to be used. The cost of the overhaul is capitalised separately from the rest of the asset and depreciated over the period to the next overhaul. Therefore, the asset of $120 million should be split into two parts for depreciation purposes. $30 million of the total cost should be depreciated over five years and the remaining balance of $90 million (120m 30m) depreciated over 10 years. Last year Omega should have applied component depreciation to this asset and charged depreciation of $15 million (30m x 1/5 + 90m x 1/10). They only charged $12 million and so undercharged depreciation by $3 million. The impact of this error will not affect the statement of comprehensive income for the year ended 31 March 2011. It will instead be included in the statement of changes in equity as a retrospective adjustment to opening retained earnings. The depreciation charge in the statement of comprehensive income for the year ended 31 March 2011 will be $15 million.

1 5

19

Marks (c) Transaction three 1. Statement of financial position as at 31 March 2011 Non-current liabilities deferred service revenue Current liabilities deferred service revenue 2. Statement of comprehensive income year ended 31 March 2011 Revenue from sale of machine Service revenue Cost of sale of the machine Cost of service element $000 6,000 250 (4,000) (200) 2,050 $000 750 500

3.

Explanation The total revenue arising on the contract is split into a sales element and a service element. The expected total costs of the service element are $1,200,000 (200,000 x 2 x 3). Therefore if a normal gross margin on servicing contracts is 20%, the revenue that is allocated to the servicing element is $1,500,000 (1,200,000 x 100/80). This revenue of $1,500,000 is recognised evenly over the three-year servicing period, with the balance shown as deferred income. $250,000 (500 x 6/36) of the service revenue is recognised in the six months to 31 March 2011. Of the deferred income of $1,250,000 (1,500,000 250,000), $500,000 (1,500,000 x 12/36) is shown in current liabilities and $750,000 (1,250,000 500,000) in non-current liabilities.

2 7

20

Diploma in Financial Reporting

June 2011 Marking Scheme Marks 40

As indicated on model answer

As indicated on model answer

20

(a)

General definition ( each) Discussion of identifiability Discussion of control Discussion of future economic benefits Discussion of cost measurement Subsequent measurement cost or revaluation model Amortisation/impairment issues

1 1 1 1 1 1 1 9 11 20

(b)

As indicated on model answer Total

As indicated on model answer

20

21

Diploma in International Financial Reporting

Tuesday 13 December 2011

Time allowed Reading and planning: Writing:

15 minutes 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

Dip IFR

This is a blank page. The question paper begins on page 3.

ALL FOUR questions are compulsory and MUST be attempted 1 Alpha holds investments in Beta and Gamma. The statements of financial position of the three entities at 30 September 2011 were as follows: Alpha $000 ASSETS Non-current assets: Property, plant and equipment (Note 1) Investments: in Beta (Note 1) in Gamma (Note 3) in Sigma (Note 6) Beta $000 Gamma $000

210,000 180,000 52,000 15,000 457,000 65,000 55,000 12,000 132,000 589,000

165,000 Nil Nil Nil 165,000 36,000 38,000 7,000 81,000 246,000

120,000 Nil Nil Nil 120,000 29,000 35,000 9,000 73,000 193,000

Current assets: Inventories (Note 4) Trade receivables (Note 5) Cash and cash equivalents

Total assets EQUITY AND LIABILITIES Equity Share capital ($1 shares) Retained earnings Other components of equity Total equity Non-current liabilities: Contingent consideration (Note 1) Long-term borrowings (Note 8) Deferred tax Total non-current liabilities Current liabilities: Trade and other payables Short term borrowings Total current liabilities Total equity and liabilities Note 1 Alphas investment in Beta

180,000 183,000 90,000 453,000 20,000 50,000 15,000 85,000 34,000 17,000 51,000 589,000

100,000 67,000 5,000 172,000 Nil 35,000 9,000 44,000 23,000 7,000 30,000 246,000

60,000 64,000 Nil 124,000 Nil 30,000 12,000 42,000 21,000 6,000 27,000 193,000

On 1 April 2010 Alpha acquired 80 million shares in Beta by means of a share exchange. Alpha issued one share for every two shares acquired in Beta. On 1 April 2010 the market value of an Alpha share was $4 and the market value of a Beta share was $180. The terms of the business combination provide for an additional cash payment to the former shareholders of Beta on 30 June 2012 based on its post-acquisition financial performance in the first two years since acquisition. The fair value of this additional payment was $20 million on 1 April 2010. The post acquisition performance of Beta was such that the fair value of this payment had increased to $22 million by 30 September 2011. The investment in Beta and the non-current liabilities of Alpha at 30 September 2010 include $20 million in respect of the additional payment due to be made on 30 June 2012.

[P.T.O.

On 1 April 2010 the individual financial statements of Beta showed the following reserves balances: Retained earnings $41 million. Other components of equity $3 million.

The directors of Alpha carried out a fair value exercise to measure the identifiable assets and liabilities of Beta at 1 April 2010. The following matters emerged: A property, having a carrying amount of $50 million (depreciable amount $30 million), had a fair value of $70 million (depreciable amount $33 million). The estimated future economic life of the depreciable amount of the property at 1 April 2010 was 30 years. This property was still held by Beta at 30 September 2011. Plant and equipment, having a carrying amount of $60 million, had an estimated market value of $64 million. The estimated future economic life of the plant at 1 April 2010 was four years. This plant was still held by Beta at 30 September 2011. Inventory, having a carrying amount of $30 million, had an estimated market value of $31 million. All of this inventory had been sold since 1 April 2010.

The fair value adjustments have not been reflected in the individual financial statements of Beta. In the consolidated financial statements the fair value adjustments will be regarded as temporary differences for the purposes of computing deferred tax. The rate of tax to apply to temporary differences (where required but see notes 3, 4, 6 and 7 below) is 20%. It is the group policy to value the non-controlling interest in subsidiaries at the date of acquisition at fair value. The fair value of an equity share in Beta at 1 April 2010 can be used for this purpose. Note 2 Impairment reviews Beta On 1 April 2010 the directors of Alpha identified that Beta comprised five cash-generating units and allocated the goodwill arising on acquisition equally across each unit. No impairment of goodwill was apparent in the year ended 30 September 2010. During the year ended 30 September 2011 four of the five cash-generating units performed very satisfactorily and no impairment of the goodwill allocated to these units had occurred. However the performance of the other unit was below expectations. During the impairment review carried out at 30 September 2011 assets (excluding goodwill) having a carrying amount in the consolidated financial statements of $50 million were allocated to this unit. The recoverable amount of these assets was estimated at $52 million. Note 3 Alphas investment in Gamma On 1 October 2010 Alpha paid $52 million for 40% of the equity shares of Gamma. The retained earnings of Gamma on 1 October 2010 were $60 million. You can ignore any deferred taxation implications of the investment by Alpha in Gamma. The investment in Gamma has not suffered any impairment since 1 October 2010. Note 4 Inter-company sale of inventories The inventories of Beta and Gamma at 30 September 2011 included components purchased from Alpha during the year at a cost of $16 million to Beta and $10 million to Gamma. Alpha generated a gross profit margin of 25% on the supply of these components. You can ignore any deferred tax implications of the information in this note. Note 5 Trade receivables and payables The trade receivables of Alpha included $5 million receivable from Beta and $4 million receivable from Gamma in respect of the purchase of components (see Note 4). The trade payables of Beta and Gamma included equivalent amounts payable to Alpha. Note 6 Alphas investment in Sigma Alphas investment in Sigma does not give Alpha sole control, joint control or significant influence. The investment was purchased on 1 January 2011 for $15 million. The investment was classified as fair value through other comprehensive income. The fair value of the investment in Sigma on 30 September 2011 was $16 million. In the tax jurisdiction in which Alpha is located unrealised profits on the revaluation of equity investments are not subject to current tax. Any such profits are taxed only when the investment is sold.

Note 7 Employees share option scheme On 1 October 2009 Alpha granted 5,000 share options to 1,000 key employees. The options are due to vest on 30 September 2013 provided the employees remain in employment at 30 September 2013. On 1 October 2009 the directors of Alpha estimated that 90% of the key employees would satisfy the vesting condition. Actual employee turnover was such that this estimate was revised to 92% on 30 September 2010 and 93% on 30 September 2011. At 1 October 2009 the fair value of each share option was estimated to be $120. This estimate was revised to $125 on 30 September 2010 and $128 on 30 September 2011. You can ignore the deferred tax implications of the information in this note. Alpha correctly recognised this transaction in the financial statements for the year ended 30 September 2010. However, they have made no additional adjustments in the financial statements for the year ended 30 September 2011. Note 8 Long-term borrowings On 1 October 2010 Alpha issued 50 million loan notes of $1 each at par. The annual interest payable on these notes is 5 cents per note, payable in arrears. The notes are redeemable at par on 30 September 2015 or convertible (at the option of the note-holders) into equity shares on that date. On 1 October 2010 investors in loan notes with no conversion option would have required an annual rate of return of 8%. On 1 October 2010 the directors of Alpha included $50 million in long-term borrowings in respect of the loan notes. The actual interest paid of $25 million was charged as a finance cost in Alphas income statement for the year ended 30 September 2011. Relevant discount factors are as follows: Present value of $1 payable at the end of year 5 Cumulative present value of $1 payable at the end of years 1-5 Note 9 Modification of vehicles On 1 January 2011 legislation was passed requiring Alpha to carry out modifications to its motor vehicles to enable harmful emissions to be reduced. The modifications should have been completed by 30 June 2011 at an estimated cost to Alpha of $3 million. In fact by 30 September 2011 none of the vehicles had been modified although they continued to be used. It is likely that Alpha will be fined $500,000 per month for the illegal use of the vehicles. The directors of Alpha are uncertain exactly when they will carry out the modifications but they intend to do so sometime during the year ended 30 September 2012. They expect that a fine will become payable very shortly as legal action has commenced against Alpha. Required: Prepare the consolidated statement of financial position of Alpha at 30 September 2011. (40 marks) 5% 784 cents $433 8% 681 cents $399

[P.T.O.

Kappa is an entity that prepares consolidated financial statements to 30 September each year. Below are details of two events ((a) and (b)) that occurred during the year ended 30 September 2011, followed by some questions concerning their treatment in the financial statements for the year. The financial statements are due to be authorised for issue on 20 December 2011. (a) On 31 July 2011, the directors decided to discontinue the business of one of Kappas wholly owned subsidiaries, Lambda. They decided to cease production on 31 October 2011, with a view to disposing of the property, plant and equipment soon after 30 November 2011, the date scheduled for the completion of the sale of all Lambdas inventory and the settlement of all liabilities due to its suppliers and employees. Any amounts still owing by Lambdas customers at 30 November 2011 would be collected by other group companies on Lambdas behalf. On 15 August 2011, the directors made a public announcement of their intentions and offered the employees of Lambda termination payments or alternative employment opportunities elsewhere in the group. Relevant financial details are as follows: On 31 July 2011, the directors estimated that termination payments to employees would total $10 million and, although full details are not yet available, the costs of re-training employees who would remain employed by other group companies is expected total $1 million. Actual termination costs paid out on 30 November 2011 were $105 million and the latest estimate of total re-training costs is $800,000. Lambda was leasing a property under an operating lease that expires on 31 December 2020. On 30 September 2011 the present value of the future lease rentals (using an appropriate discount rate) was $4 million. On 30 November 2011 Lambda made a payment to the lessor of $38 million in return for early termination of the lease. There were no rental payments made in October or November 2011. The loss after tax of Lambda for the year ended 30 September 2011 was $12 million. Lambda made further operating losses totalling $5 million for the two month period 1 October 2011 to 30 November 2011. At 30 September 2011, the property, plant and equipment of Lambda had a carrying amount of $20 million ($12 million for its owned property and $8 million for its plant and equipment) and a recoverable amount of $22 million ($17 million for its owned property and $5 million for its plant and equipment). The carrying amount of $20 million is after deducting a full years depreciation.

A number of questions have arisen from the decision to discontinue. Required: (i) Is any provision for closure costs necessary and if so for what amount?

(ii) How should the decision to discontinue the business of Lambda be presented on the consolidated statement of comprehensive income? (iii) What is the correct carrying amount for the property, plant and equipment? Should it be presented as non-current assets held for sale given that we know it was sold after the year end? Note: You should provide any supporting explanations you consider relevant. The following mark allocation is provided as guidance for this requirement: (i) 6 marks (ii) 4 marks (iii) 2 marks (12 marks)

(b) On 1 July 2011, another wholly-owned subsidiary, Epsilon, signed a contract to manufacture a machine for a customer for a fixed price of $12 million. The customer paid a deposit of $3 million on 1 July 2011 and the balance is payable upon completion and delivery of the machine. This is expected to take place on 31 December 2011. Relevant financial details are as follows: Epsilon has purchased materials costing $5 million for use on the contract. $4 million of these materials had been used by the year end. The manufacture of the machine started on 1 August 2011 and was completed on 30 November 2011. During this period certain property, plant and equipment of Epsilon was used exclusively in the manufacturing process. Annual depreciation on this property, plant and equipment is $3 million. Epsilon incurred direct labour costs and other production overheads totalling $300,000 per month throughout the manufacturing period. General administrative overheads of $150,000 per month were allocated to the contract using Epsilons normal cost allocation model. Epsilon determines the extent of completion of construction contracts by comparing the costs incurred on the contract to date with the total expected contract costs.

There are two key questions that have arisen in relation to the above outlined contract. Required: (i) How much revenue and profit on this contract should be reported in the statement of comprehensive income?

(ii) How should the contract be reported in the statement of financial position? Note: You should provide any supporting explanations you consider relevant. The following mark allocation is provided as guidance for this requirement: (i) 6 marks (ii) 2 marks (8 marks) (20 marks)

[P.T.O.

(a) IAS 19 Employee benefits is a comprehensive standard that deals with the financial reporting of short and long-term employee benefits. The most complex type of employee benefit dealt with in IAS 19 is post-employment benefits. Such benefits are usually provided via a separate plan into which the employer makes contributions. The impact of such arrangements on the financial statements of contributing employers depends on the type of retirement benefit plan. One of the particularly complex aspects of the standard is the treatment of actuarial gains and losses arising on the measurement of obligations relating to post-employment benefits. IAS 19 allows a number of alternative treatments. Required: You are required to provide an explanation of: (i) The difference between a defined contribution and a defined benefit plan. Your explanation should include an analysis of which party bears the risks attaching to the level of benefits.

(ii) The difference, in the financial statements of contributing employers, between the method of accounting for contributions to defined contribution plans and contributions to defined benefit plans. (iii) The two alternative ways other than the corridor method of reporting actuarial gains and losses arising in respect of defined benefit plans. The following mark allocation is provided as guidance for this requirement: (i) 3 marks (ii) 3 marks (iii) 2 marks (8 marks) (b) Omicron prepares financial statements to 30 September each year. Omicron makes contributions to a defined benefit post-employment benefit plan for its employees. Omicron accounts for actuarial gains and losses arising on these arrangements using the corridor method. Relevant data is as follows: (i) At 1 October 2010 the plan obligation was $35 million and the fair value of the plan assets was $30 million. Unrecognised actuarial losses at that date totalled $65 million.

(ii) The actuary advised that the current service cost for the year ended 30 September 2011 was $4 million. Omicron paid contributions of $32 million to the plan on 30 September 2011. These were the only contributions paid in the year. (iii) The expected annual rate of return on plan assets at 1 October 2010 was 5%. The actuary revised this estimate to 4% at 30 September 2011. (iv) The appropriate annual rate at which to discount the plan liabilities was 6% on 1 October 2010 and 55% on 30 September 2011. (v) The plan paid out benefits totalling $2 million to retired members on 30 September 2011. (vi) At 30 September 2011 the plan obligation was $415 million and the fair value of the plan assets was $325 million. (vii) The average remaining service lives of plan members still in employment was estimated to be 20 years. Required: Compute the amounts that will appear in the statement of comprehensive income of Omicron for the year ended 30 September 2011 and the statement of financial position at 30 September 2011 in respect of the post-employment benefit plan. Note: You should indicate where in each statement the relevant amounts will be presented. (12 marks) (20 marks)

You are the financial controller of Omega. Omega has subsidiaries located in a number of different countries. Omega has a strategy of growth by acquisition and regularly evaluates potential acquisition targets from different countries and financial reporting regimes. Omega regularly seeks to raise capital on a number of different markets to fund new acquisitions. All subsidiaries currently prepare financial statements using applicable local accounting standards. The consolidated financial statements have been prepared using local accounting standards that apply in Omegas jurisdiction up to and including the year ended 30 September 2011. Local regulations allow financial statements to be prepared either using local accounting standards or International Financial Reporting Standards (IFRS). The directors are giving serious consideration to using IFRS from the year ending 30 September 2012 onwards. One of the directors is unsure of the wisdom of this proposal and has identified a number of issues about which he is uncertain. Issue (a) Changing from using local standards to using international standards is bound to have short-term cost implications. I need to be convinced that the benefits of a change justify these costs. Please describe three ways we would benefit from a move to IFRS. (6 marks) Issue (b) Before I can agree with a move to IFRS I need to understand how the standard setting process works. Someone told me there are four different bodies involved! Please give me a brief description of each one of these, highlighting their role in the standard setting process. (8 marks) Issue (c) Im unclear about the practicalities of adopting IFRS in the year ending 30 September 2012. Ive heard that we need to start with the opening IFRS statement of financial position. Im unclear what this means and for what date it is prepared. Please explain the process for me, including any additional disclosures we need to make in the first set of financial statements prepared under IFRS. (6 marks) Required: Prepare a response to the three issues raised by the director. Note: The mark allocation is shown against each of the three issues above. (20 marks)

End of Question Paper

Answers

Diploma in Financial Reporting

December 2011 Answers and Marking Scheme Marks

Consolidated statement of financial position of Alpha at 30 September 2011 ASSETS Non-current assets: Property, plant and equipment (210,000 + 165,000 + 19,850 + 2,500 (W1)) Goodwill (W2) Investment in associate (W9) Other investments $000 397,350 43,600 52,600 16,000 509,550 97,000 88,000 19,000 204,000 713,550 + 6 (W2) 1 (W9)

Current assets: Inventories (65,000 + 36,000 4,000 (W5)) Trade receivables (55,000 + 38,000 5,000 (inter-company)) Cash and cash equivalents (12,000 + 7,000)

+ +

Total assets EQUITY AND LIABILITIES Equity attributable to equity holders of the parent Share capital Retained earnings (W5) Other components of equity (W8) Non-controlling interest (W4) Total equity Non-current liabilities: Long-term borrowings (45,047 (W7) + 35,000) Deferred tax (W10) Total non-current liabilities Current liabilities: Trade and other payables (34,000 + 23,000 5,000 (inter-company)) Contingent consideration Provision for fines Short-term borrowings (17,000 + 7,000) Total current liabilities Total equity and liabilities

180,000 186,052 99,785 465,837 39,496 505,333 80,047 28,670 108,717 52,000 22,000 1,500 24,000 99,500 713,550

15 (W5) 4 (W8) 1 (W4)

1 (W7) + 1 (W10)

+ + + 40

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Marks WORKINGS DO NOT DOUBLE COUNT MARKS Working 1 Net assets table Beta: 1 April 2010 $000 100,000 41,000 3,000 20,000 4,000 1,000 (5,000) 164,000 30 September For W2 For W5 2011 $000 100,000 67,000 5,000 19,850 2,500 Nil (4,470) (W11) (W11) 189,880

Share capital Retained earnings Other components of equity Property adjustment see below Plant and equipment adjustment see below Inventory adjustment Deferred tax on fair value adjustments Net assets for the consolidation

The post-acquisition increase in net assets $2588 million ($18988 million $164 million). $2 million of this increase relates to other components of equity, the balance of $2388 million relates to retained earnings.

3 W2

1 4 W5

Note re: post-acquisition depreciation adjustments: For the property this is $150,000 (($33 million $30 million) x 15/30). This makes the closing adjustment $1985 million ($20 million $150,000). For the plant and equipment this is $15 million (($64 million $60 million) x 15/4). This makes the closing adjustment $25 million ($4 million $15 million). Working 2 Goodwill on consolidation (Beta) $000 Cost of investment: Share exchange (80 million x x $4) Contingent consideration Fair value of non-controlling interest at date of acquisition (20 million x $180) Net assets at 1 April 2010 (W1) Goodwill before impairment Impairment (W3) Goodwill after impairment Working 3 Impairment of goodwill: Carrying value of assets in cash generating unit Allocated goodwill (20% x $52 million (W2)) Recoverable amount of assets in cash generating unit So impairment equals 50,000 10,400 60,400 (52,000) 8,400 1 W2 1 160,000 20,000 36,000 216,000 (164,000) 52,000 (8,400) 43,600 3 (W1) 1 (W3) 6

Working 4 Non-controlling interest in Beta: Fair value at date of acquisition (W2) 20% of post-acquisition increase in net assets ($2588 million (W1)) 20% of goodwill impairment ($84 million (W3)) 36,000 5,176 (1,680) 39,496

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Marks Working 5 Retained earnings Alpha Charge for share based payment for the period (W6) Additional finance cost on loan notes (3,522 2,500 (W7)) Provision for fines for illegal operation of vehicles Increase in fair value of contingent consideration ($22 million $20 million) Beta (80% x $2388 million (W1)) Gamma (40% x (64,000 60,000)) Unrealised profits on sales to Beta (16,000 x 25%) Unrealised profits on sales to Gamma (10,000 x 25% x 40%) 80% of impairment of goodwill on acquisition of Beta ($84 million (W3) x 80%) $000 183,000 (1,410) (1,022) (1,500) (2,000) 19,104 1,600 (4,000) (1,000) (6,720) 186,052 5,580 2,790 (1,380) 1,410 3 (W6) 1 1 1 + 4 (W1) 1 1 1 15 2 1 3 W5 1 1 W8 1 1

Working 6 Share based payment charge Expected total cost (5,000 x 1,000 x 93% x $120) Amount that should be recognised to date (2/4) Recognised in draft financial statements (5,000 x 1,000 x 92% x $120 x ) So additional amount to recognise

Working 7 Convertible loan notes Liability element ($25 million x 399 + $50 million x 0681) Equity component (balancing figure) 44,025 5,975 50,000 44,025 3,522 (2,500) 45,047 $000 90,000 800 1,410 5,975 1,600 99,785 52,000 1,600 (1,000) 52,600 24,000 200 4,470 28,670

Opening liability Finance cost for the period (8%) Actual interest paid Closing liability Working 8 Other components of equity Alpha Addition re: revaluation of investment in Sigma (1,000 20% (deferred tax) x 1,000) Addition re: share based payment (W6) Addition re: convertible loan notes (W7) Beta (80% x $2 million (W1))

1 1 (W7) 1 4 1 1

Working 9 Investment in Gamma Cost Share of post-acquisition profits (W5) Unrealised profits (W5)

Working 10 Deferred tax Alpha + Beta On revaluation of investment in Sigma (W8) On fair value adjustments (W11)

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Marks Working 11 Deferred tax on fair value adjustments: Fair value adjustments: 1 April 2010 $000 20,000 4,000 1,000 25,000 5,000 30 September 2011 $000 19,850 2,500 Nil 22,350 4,470 1 W1

Land adjustment Plant and equipment adjustment Inventory adjustment Net taxable temporary differences Related deferred tax (20%)

(a)

By announcing the closure plan on 15 August, the directors have created a valid expectation that the closure will go ahead. In such circumstances, IAS 37 Provisions, contingent liabilities and contingent assets requires that a provision should be made. The provision should be for the direct costs associated with the closure. This includes the costs of terminating the employment of workers who accept termination. The amount provided in respect of this should be $105 million, the actual amount paid. IAS 10 Events after the reporting date requires that events providing additional evidence of conditions existing at the reporting date should be reflected in the financial statements. The re-training costs are associated with the on-going business and should not form any part of the provision. The lease would be regarded as an onerous contract. A provision should be made for the lower of the cost of fulfilling the contract and the cost of early termination. In this case a provision of $38 million should be made. Future operating losses relate to future events and do not form part of any closure provision. Therefore the total provision should be $143 million ($105 million + $38 million). A discontinued operation is one that is discontinued in the period or classified as held for sale at the year end. In this case Lambda was discontinued on 30 November 2011, the following period. Although the decision was made before the year end, this is an abandonment, not a sale, so the held for sale criteria are not relevant for the operation. Given the above, the results of Lambda will be included on a line-by-line basis in the consolidated statement of comprehensive income as part of the profit from continuing operations. For the property, plant and equipment to be classified as held for sale it has to be available for immediate sale in its current condition before the year end. In this case the assets cannot be sold until 30 November 2011 and reclassification as held for sale cannot be made retrospectively. The authority for this treatment is IFRS 5 Non-current assets held for sale and discontinued operations. The recoverable amount of the plant and equipment ($5 million) is lower than its carrying amount ($8 million). Therefore, under the provisions of IAS 36 Impairment of assets an impairment loss of $3 million has occurred and the plant and equipment should be carried at $5 million. The carrying amount of the property remains at $12 million.

1 1

1 1

1 1

1 12

(b)

The costs incurred to date relating to the contract are $51 million ($4 million (materials) + $500,000 (two months depreciation) plus $600,000 (two months direct costs)). General administrative costs are not regarded as costs of the contract. Total expected costs are $72 million ($5 million (materials) + $1 million (depreciation) + $12 million (direct costs)). So the contract is 71% complete (51/72). Contract revenue is $852 million (71% x $12 million). Total expected profit is $48 million ($12 million $72 million). So the profit recognised to date is $341 million ($48 million x 71%).

2 1 1

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Marks The figure in the statement of financial position is $651 million (total costs incurred to date of $61 million ($51 million + $1 million unused material) + profit recognised to date of $341 million progress payments of $3 million). The above figure is presented in current assets as amounts recoverable on contracts.

2 8 20

(a)

A defined contribution retirement benefit plan provides a pension benefit that is based on the value of the plan at retirement date. The risk that the retirement benefit is insufficient to meet the employees financial needs rests with the employee. A defined benefit plan provides a pension benefit that is based on the final salary of the employee and the pensionable service. The risk that the assets in the plan will be insufficient to fund this pension rests initially with the plan but ultimately with the contributing company. Contributions payable to a defined contribution plan are regarded as a direct cost of employment. These costs are shown as expenses in the statement of comprehensive income or as part of the cost of an asset depending on the function of the employee in the business. For defined benefit plans the total retirement benefit obligation less the related assets of the plan is shown in the statement of financial position of the contributing company. Because contributions increase the assets of the plan they are effectively debited to the net retirement benefit liability that appears in the statement of financial position. Other than the corridor method the two methods of accounting for actuarial gains and losses arising on defined benefit retirement benefit plans is to recognise them fully in the income statement or in the other comprehensive income section of the statement of comprehensive income.

2 8

(b) 1. In statement of financial position non-current liabilities Benefit obligation Related asset Unrecognised actuarial losses (W1)

$000 41,500 (32,500) (8,950) 50 (4,000) (2,100) 1,500 (150) 5 (W1)

2. 3.

In statement of comprehensive income operating costs Current service cost In statement of comprehensive income finance costs/income Interest cost (6% x $35 million) Expected return on assets (5% x $30 million) Recognised actuarial losses (W2)

1 1 2 (W2) 12 20

WORKINGS DO NOT DOUBLE COUNT MARKS Working 1 unrecognised actuarial losses At the start of the period Recognised in the period (W2) Arising in the period (W3) At the end of the period Working 2 actuarial losses recognised in the period Corridor limit (10% x $35 million) Excess of opening unrecognised amount over the corridor limit Average remaining service lives So excess recognised ($3 million x 1/20) 3,500 3,000 20 years 150 (6,500) 150 (2,600) (8,950) 4 (W3) 5

1 2

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Marks Working 3 actuarial losses arising in the period Liability $000 35,000 4,000 2,100 Asset $000 (30,000) Net $000 5,000 4,000 2,100 (1,500) (3,200) Nil 2,600 9,000

At start of period Current service cost Interest cost Expected return on assets Contributions Benefits paid out Actuarial (gain)/loss balancing figure At end of period

(2,000) 2,400 41,500

(1,500) (3,200) 2,000 200 (32,500)

4 W1

Issue (a) International financial reporting standards (IFRS) are being used more and more widely on a global basis. If we move to IFRS it will make the appraisal of potential acquisition targets more straightforward since an increasing number of them are likely to be using IFRS for financial reporting purposes. If we move to IFRS across the group it will make the consolidation process easier. Currently the financial statements of foreign subsidiaries need to be restated to our local standards prior to consolidation taking place. If all group companies used IFRS this restatement process would not be necessary. A move to IFRS is likely to make it easier to access global capital markets. Most jurisdictions require multi-national entities to prepare and file financial statements before they can obtain access to capital. It is becoming increasingly common for individual capital markets to accept financial statements prepared under IFRS for this purpose. If we moved to IFRS this would negate the need for costly restatement exercises.

2 6

Tutorial Note: Other relevant comments will also qualify for marks. Issue (b) The first relevant body is the International Financial Reporting Standards Foundation (IFRSF). The IFRSF acts as an overseer of the overall standard setting process and seeks to ensure that the bodies that actually set the standards are properly financed and that their work programmes are appropriate. The second body is the International Financial Reporting Standards Advisory Council (IFRSAC). The IFRSAC gives advice to the IASB (see below) on a range of relevant issues, including priorities for the future and the appropriateness of current projects. The third body is the International Accounting Standards Board (IASB). The IASB has the task of actually developing and promoting the use of IFRS. The standards are based on a Framework that deals with the general principles of general purpose financial reporting. The fourth body is the International Financial Reporting Interpretations Committee (IFRIC). The role of the IFRIC is to assist the IASB in establishing and improving standards of financial reporting. In particular the IFRIC provides timely guidance on newly identified financial reporting issues not specifically addressed in IFRS or on issues where unsatisfactory or conflicting interpretations have developed, or seem likely to develop.

2 8

Issue (c) If we adopt IFRS in the financial statements for the year ended 30 September 2012 then the comparative figures must be prepared under IFRS also. The first step is to prepare an opening statement of financial position at the date of transition to IFRS. This date is the start of the comparative period, i.e. 1 October 2010. The opening statement of financial position needs to be prepared using IFRS that are current at the first reporting date, 30 September 2012. There are a number of exemptions from the requirement to use IFRS current at 30 September 2012 in the opening statement of financial position at the date of transition to IFRS. These exemptions are designed to make the process of transition more manageable in practice. 1 1 1

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Marks In the first set of financial statements prepared under IFRS there must be a reconciliation (between local standards and IFRS) of any amounts that were computed using local standards in previous financial statements but disclosed as comparatives under IFRS in the financial statements for the year ended 30 September 2012. In practice this means providing a reconciliation of: Equity at 1 October 2010 and 30 September 2011. Comprehensive income for the year ended 30 September 2011. 2 6 20

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