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HKICPA QP Exam (Module a) May2005 Answer

HKICPA QP Exam (Module a) May2005 Answer

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Module A (May 2005 Session)
SECTION A CASE QUESTIONS (Total: 50 marks)Answer 1(a)
To: Mr. Peter LIN, Director, FYLFrom: Accounting Manager, FYLc.c.: L.P. LEE, Ricky YUEN, S.Y. LEUNG (Directors)Date: dd/mm/yyyyI refer to your e-mail dated 18 June 2005 regarding your queries about the summaryconsolidated financial statements for FYL for the year ended 31 March 2005.The explanation of the differences between the accounting treatment of the investments inBLL and SGL is as follows:The objective of preparing consolidated financial statements is to give a true and fair viewof the state of affairs and results of the group as if it were a single economic entity.In order to achieve this objective, the financial statements of member companies of ourGroup are combined (or added up, in simple terms) and certain adjustments are made tothe combined statements.FYL, as a parent company, shall present consolidated financial statements in which itconsolidates its investment in subsidiaries in accordance with the accounting standard(HKAS 27).A subsidiary is an entity that is controlled by another entity. In this case, control of SGL ispresumed to exist since FYL owns 100% of the issued shares of SGL.However, FYL holds only 20% of the issued shares of BLL so that FYL has significantinfluence, but not control over BLL.Therefore, BLL should be accounted for as an associate under HKAS 28 since it is anentity over which FYL has significant influence and it is neither a subsidiary nor an interestin joint venture.An investment in an associate shall be accounted for using the equity method. Under theequity method, the investment in an associate is initially recognised at cost and thecarrying amount is increased or decreased to recognise FYL’s share of BLL’s profit or lossafter the date of acquisition. FYL’s share of BLL’s profit or loss is recognised in FYL’sprofit or loss.The carrying amount of the investment in BLL is reduced under equity method reportingwhen a dividend is received from BLL, and when an impairment occurs.Besides, HKAS 28 requires us to make appropriate adjustments to FYL’s share of theprofits or losses after acquisition to account, for example, for depreciation of thedepreciable assets, based on their fair values at the date of acquisition.
Module A (May 2005 Session)
Please refer to the annex for detailed calculation of balance of investment in BLL as shownin the consolidated balance sheet as at 31 March 2005.The method of combining financial results in different currencies and the calculation of thetranslation reserve are as follows:FYL, BLL and SGL have to determine, as an accounting policy, their respective functionalcurrencies. This currency is that of the primary economic environment in which each ofthe entities operates. All currencies other than the functional currency are foreigncurrencies to the entity.Once determined, the functional currency is not changed unless there is a change inunderlying transactions, events and conditions.FYL, BLL and SGL shall each translate foreign currency items or transactions into itsfunctional currency. Any exchange difference arising from such translation is, in general,recognised as a profit or loss.However, FYL, BLL and SGL may present their respective financial statements in anycurrency. If the presentation currency differs from the entity’s functional currency, ittranslates its results and financial position into the presentation currency in accordancewith the procedures set out in HKAS 21.Similarly, the results and financial position of a foreign operation are translated into apresentation currency so that the foreign operation can be included in the financialstatements of the reporting entity by consolidation, proportionate consolidation or the equitymethod.Since we present the consolidated financial statements of FYL Group in HKD, the results ofBLL and SGL must be expressed in HKD so that consolidated financial statements may bepresented.Assets and liabilities for each balance sheet presented (including comparatives) shall betranslated at the closing rate at the date of that balance sheet.Income and expenses for each income statement (including comparatives) shall betranslated at exchange rates at the dates of the transactions.For practical reasons, a rate that approximates the exchange rates at the dates of thetransactions, for example an average rate for the period, is often used to translate incomeand expense items. However, if exchange rates fluctuate significantly, the use of theaverage rate for a period is inappropriate.Any goodwill arising from the acquisition of foreign operations (BLL and SGL) and fair valueadjustments to the carrying amounts of assets and liabilities on the acquisition shall betreated as assets and liabilities of the foreign operation.Thus they shall be expressed in the functional currency of the foreign operation and shallbe translated at the closing rate.All resulting exchange differences shall be recognised as a separate component of equity.In this case, the item translation reserve serves to keep all these resulting exchangedifferences as a separate component of equity.
Module A (May 2005 Session)
The translation reserve essentially results from:(a) translating income and expenses at the exchange rates at the dates of thetransactions and assets and liabilities at the closing rate. Such exchangedifferences arise both on income and expense items recognised in profit or loss andon those recognised directly in equity.(b) translating the opening net assets at a closing rate that differs from the previousclosing rate.These exchange differences (translation reserve) are not recognised in profit or lossbecause the changes in exchange rates have little or no direct effect on present and futurecash flows from operations.Please refer to the annex for detailed workings of the calculation of translation reserve.I hope the above explanation has answered your queries. Please feel free to contact meif you have further queries.Best regardsXXX
Answer 1(b)
Appendix A – Translation from AUD to HKD both the trial balances of BLL and SGL as at31 March 2005
BLL SGL Exchange BLL SGLAUD'000 AUD'000 rate HKD'000 HKD'000
Plant and equipment 24,000 5,000 6.00 144,000 30,000Accumulated depreciation (6,000) (750) 6.00 (36,000) (4,500)Inventory 8,600 500 6.00 51,600 3,000Cash and receivables 11,610 2,425 6.00 69,660 14,550Accounts payable (5,380) (300) 6.00 (32,280) (1,800)Long term loans (11,950) (1,250) 6.00 (71,700) (7,500)Share capital (9,000) (4,000) 5.80 (52,200) (23,200)Retained profits – at 1 April 2004 (4,000) (1,000) 5.80 (23,200) (5,800)Sales (57,900) (5,000) 5.70 (330,030) (28,500)Cost of goods sold 33,000 2,250 5.70 188,100 12,825Depreciation expense 2,400 300 5.70 13,680 1,710Operating expense 13,150 1,150 5.70 74,955 6,555Interest expense 570 675 5.70 3,249 3,848Dividend paid 900 - 5.60 5,040 -- -Translation reserve (4,874) (1,188)- -

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