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Financial Reporting

(Hong Kong)

QUESTION PAPER Time allowed 3 hours This paper is divided into two sections Section A This ONE question is compulsory and MUST be answered THREE questions ONLY to be answered

Section B

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

The Association of Chartered Certified Accountants

Paper 2.5(HKG)

Section A This ONE question is compulsory and MUST be attempted 1 Parentis, a public listed company, acquired 600 million equity shares in Offspring on 1 April 2006. The purchase consideration was made up of: a share exchange of one share in Parentis for two shares in Offspring the issue of $100 10% loan note for every 500 shares acquired; and a deferred cash payment of 11 cents per share acquired payable on 1 April 2007. Parentis has only recorded the issue of the loan notes. The value of each Parentis share at the date of acquisition was 75 cents and Parentis has a cost of capital of 10% per annum. The balance sheets of the two companies at 31 March 2007 are shown below: Parentis $ million $ million Assets Property, plant and equipment (note (i)) Investments Intellectual property (note (ii)) Current assets Inventory (note (iii)) Trade receivables (note (iii)) Bank Total assets Equity and liabilities Equity shares of 25 cents each Retained earnings 1 April 2006 year ended 31 March 2007 Non-current liabilities 10% loan notes Current liabilities Trade payables (note (iii)) Current tax payable Overdraft Total equity and liabilities The following information is relevant: (i) At the date of acquisition the fair values of Offsprings net assets were approximately equal to their carrying amounts with the exception of its properties. These properties had a fair value of $40 million in excess of their carrying amounts which would create additional depreciation of $2 million in the post acquisition period to 31 March 2007. The fair values have not been reflected in Offsprings balance sheet. 130 45 25 640 120 nil 760 76 84 nil 22 44 4 Offspring $ million $ million 340 nil 30 370

160 920 300

70 440 200

210 90

300 600 120

120 20

140 340 20

200 920

57 23 nil

80 440

(ii) The intellectual property is a system of encryption designed for internet use. Offspring has been advised that government legislation (passed since acquisition) has now made this type of encryption illegal. Offspring will receive $10 million in compensation from the government. (iii) Offspring sold Parentis goods for $15 million in the post acquisition period. $5 million of these goods are included in the inventory of Parentis at 31 March 2007. The profit made by Offspring on these sales was $6 million. Offsprings trade payable account (in the records of Parentis) of $7 million does not agree with Parentiss trade receivable account (in the records of Offspring) due to cash in transit of $4 million paid by Parentis. (iv) Due to the impact of the above legislation, Parentis has concluded that the consolidated goodwill has been impaired by $27 million.

Required: Prepare the consolidated balance sheet of Parentis as at 31 March 2007. (25 marks)


Section B THREE questions ONLY to be attempted 2 The summarised draft financial statements of Wellmay are shown below. Income statement year ended 31 March 2007: Revenue (note (i)) Cost of sales (note (ii)) Gross profit Operating expenses Investment property rental income Finance costs Profit before tax Income tax Profit for the period Balance sheet as at 31 March 2007: $000 Assets Non-current assets Property, plant and equipment (note (iii)) Investment property (note (iii)) Current assets Total assets Equity and liabilities Equity Equity shares of 50 cents each (note (vii)) Reserves: Revaluation reserve Retained earnings (note (iv)) Non-current liabilities 8% Convertible loan note (2010) (note (v)) Deferred tax (note (vi)) Current liabilities Total equity and liabilities The following information is relevant to the draft financial statements: (i) Revenue includes $500,000 for the sale on 1 April 2006 of maturing goods to Westwood. The goods had a cost of $200,000 at the date of sale. Wellmay can repurchase the goods on 31 March 2008 for $605,000 (based on achieving a lenders return of 10% per annum) at which time the goods are estimated to have a value of $750,000. $000 $000 4,200 (2,700) 1,500 (470) 20 (55) 995 (360) 635

4,200 400 4,600 1,400 6,000

1,200 350 2,850

3,200 4,400

600 180

780 820 6,000

(ii) Past experience shows that in the post balance sheet period the company often receives unrecorded invoices for materials relating to the previous year. As a result of this an accrued charge of $75,000 for contingent costs has been included in cost of sales and as a current liability.

(iii) Non-current assets: Wellmay owns two properties. One is a factory (with office accommodation) used by Wellmay as a production facility and the other is an investment property that is leased to a third party under an operating lease. Wellmay revalues all its properties to current value at the end of each year and uses the fair value model in HKAS 40 Investment property. Relevant details of the fair values of the properties are: Factory $000 1,200 1,350 Investment property $000 400 375

Valuation 31 March 2006 Valuation 31 March 2007

The valuations at 31 March 2007 have not yet been incorporated into the financial statements. Factory depreciation for the year ended 31 March 2007 of $40,000 was charged to cost of sales. As the factory includes some office accommodation, 20% of this depreciation should have been charged to operating expenses. (iv) The balance of retained earnings is made up of: balance b/f 1 April 2006 profit for the period dividends paid during year ended 31 March 2007 $000 2,615 635 (400) 2,850

(v) 8% Convertible loan note (2010) On 1 April 2006 an 8% convertible loan note with a nominal value of $600,000 was issued at par. It is redeemable on 31 March 2010 at par or it may be converted into equity shares of Wellmay on the basis of 100 new shares for each $200 of loan note. An equivalent loan note without the conversion option would have carried an interest rate of 10%. Interest of $48,000 has been paid on the loan and charged as a finance cost. The present value of $1 receivable at the end of each year, based on discount rates of 8% and 10% are: End of year 1 2 3 4 8% 093 086 079 073 10% 091 083 075 068

(vi) The carrying amounts of Wellmays net assets at 31 March 2007 are $600,000 higher than their tax base. The rate of taxation is 35%. The income tax charge of $360,000 does not include the adjustment required to the deferred tax provision which should be charged in full to the income statement. (vii) Bonus/scrip issue: On 15 March 2007, Wellmay made a bonus issue from retained earnings of one share for every four held. The issue has not been recorded in the draft financial statements. Required: Redraft the financial statements of Wellmay, including a statement of changes in equity, for the year ended 31 March 2007 reflecting the adjustments required by notes (i) to (vii) above. Note: Calculations should be made to the nearest $000. (25 marks)


(a) A trainee accountant has been assisting in the preparation of the financial statements of Toogood for the year ended 31 March 2007. He has observed that the corresponding figures (i.e. for the year ended 31 March 2006) in the financial statements for the year ended 31 March 2007 do not agree in several instances with the equivalent figures that were published in the companys financial statements for year ended 31 March 2006. In particular: consolidated goodwill (gross figure before impairment) appears to have been recalculated, several other non-current assets have been revised, the brought forward retained earnings have been restated and; several income statement line items are also different. The trainee accountant has also noted that even when the revised earnings figure for the year ended 31 March 2006 is divided by the weighted average number of shares in issue during that year, it still does not agree with the comparative earnings per share figure (i.e. for the year ended 31 March 2006) reported in the financial statements for the year ended 31 March 2007. Required: Explain three circumstances where accounting standards require previously reported financial statement figures to be amended when they are reproduced as corresponding amounts. Note: It may help to consider, among other things, the items mentioned by the trainee accountant. (12 marks) (b) The trainee accountant has been reading some literature written by a qualified surveyor on the values of leasehold property located in the area where Toogood owns leasehold property. The main thrust is that historically, annual increases in property prices more than compensate for the fall in the carrying amount caused by annual amortisation until a leasehold property has less than 10 years of remaining life. Therefore the trainee accountant suggests that the company should adopt a policy of carrying its leasehold properties at cost until their remaining lives are 10 years and then amortising them on a straight-line basis over 10 years. This would improve the companys reported profit and cash flows as well as showing a faithful representation of the value of the leasehold properties. Required: Comment on the validity and acceptability of the trainee accountants suggestion. (7 marks)

(c) The trainee accountant notes that Toogood acquired the Trilogy group during the year ended 31 March 2007. The Trilogy group consists of Trilogy itself and two wholly owned subsidiaries. Toogood has only consolidated Trilogy and one subsidiary with the other subsidiary being shown as a current asset. The trainee accountant wonders if this is because the non-consolidated subsidiary is making losses. Required: Explain why the two subsidiaries may require the different treatments that Toogood has applied. (6 marks) (25 marks)

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


Greenwood is a public listed company. During the year ended 31 March 2007 the directors decided to cease operations of one of its activities and put the assets of the operation up for sale (the discontinued activity has no associated liabilities). The directors have been advised that the cessation qualifies as a discontinued operation and has been accounted for accordingly. Extracts from Greenwoods financial statements are set out below. Note: the income statement figures down to the profit for the period from continuing operations are those of the continuing operations only. Income statements for the year ended 31 March: Revenue Cost of sales Gross profit Operating expenses Finance costs Profit before taxation Income tax expense Profit for the period from continuing operations Profit/(Loss) from discontinued operations Profit for the period Analysis of discontinued operations: Revenue Cost of sales Gross profit/(loss) Operating expenses Profit/(loss) before tax Tax (expense)/relief Loss on measurement to fair value of disposal group Tax relief on disposal group Profit/(Loss) from discontinued operations 2007 $000 27,500 (19,500) 8,000 (2,900) 5,100 (600) 4,500 (1,000) 3,500 (1,500) 2,000 7,500 (8,500) (1,000) (400) (1,400) 300 (1,100) (500) 100 (1,500) 2006 $000 21,200 (15,000) 6,200 (2,450) 3,750 (250) 3,500 (800) 2,700 320 3,020 9,000 (8,000) 1,000 (550) 450 (130) 320 320

Balance Sheets as at 31 March $000 Non-current assets Current assets Inventory Trade receivables Bank Assets held for sale (at fair value) Total assets Equity and liabilities Equity shares of $1 each Retained earnings Non-current liabilities 5% loan notes Current liabilities Bank overdraft Trade payables Current tax payable Total equity and liabilities 1,150 2,400 950 1,500 2,000 nil 6,000

2007 $000 17,500 $000

2006 $000 17,600

9,500 27,000 10,000 4,500 14,500 8,000

1,350 2,300 50 nil

3,700 21,300 10,000 2,500 12,500 5,000

4,500 27,000

nil 2,800 1,000

3,800 21,300

Note: the carrying amount of the assets of the discontinued operation at 31 March 2006 was $63 million. Required: Analyse the financial performance and position of Greenwood for the two years ended 31 March 2007. Note: Your analysis should be supported by appropriate ratios (up to 10 marks available) and refer to the effects of the discontinued operation. (25 marks)


(a) The following is an extract of Errseas balances of property, plant and equipment and related government grants at 1 April 2006. cost $000 240 accumulated depreciation $000 180 carrying amount $000 60 30 10

Property, plant and equipment Non-current liabilities Government grants Current liabilities Government grants

Details including purchases and disposals of plant and related government grants during the year are: (i) Included in the above figures is an item of plant that was disposed of on 1 April 2006 for $12,000 which had cost $90,000 on 1 April 2003. The plant was being depreciated on a straight-line basis over four years assuming a residual value of $10,000. A government grant was received on its purchase and was being recognised in the income statement in equal amounts over four years. In accordance with the terms of the grant, Errsea repaid $3,000 of the grant on the disposal of the related plant.

(ii) An item of plant was acquired on 1 July 2006 with the following costs: Base cost Modifications specified by Errsea Transport and installation $ 192,000 12,000 6,000

The plant qualified for a government grant of 25% of the base cost of the plant, but it had not been received by 31 March 2007. The plant is to be depreciated on a straight-line basis over three years with a nil estimated residual value. (iii) All other plant is depreciated by 15% per annum on cost (iv) $11,000 of the $30,000 non-current liability for government grants at 1 April 2006 should be reclassified as a current liability as at 31 March 2007. (v) Depreciation is calculated on a time apportioned basis. Required: Prepare extracts of Errseas income statement and balance sheet in respect of the property, plant and equipment and government grants for the year ended 31 March 2007. Note: Disclosure notes are not required. (10 marks) (b) In the post balance sheet period, prior to authorising for issue the financial statements of Tentacle for the year ended 31 March 2007, the following material information has arisen. (i) The notification of the bankruptcy of a customer. The balance of the trade receivable due from the customer at 31 March 2007 was $23,000 and at the date of the notification it was $25,000. No payment is expected from the bankruptcy proceedings. (3 marks)

(ii) Sales of some items of product W32 were made at a price of $540 each in April and May 2007. Sales staff receive a commission of 15% of the sales price on this product. At 31 March 2007 Tentacle had 12,000 units of product W32 in inventory included at cost of $6 each. (4 marks) (iii) Tentacle is being sued by an employee who lost a limb in an accident while at work on 15 March 2007. The company is contesting the claim as the employee was not following the safety procedures that he had been instructed to use. Accordingly the financial statements include a note of a contingent liability of $500,000 for personal injury damages. In a recently decided case where a similar injury was sustained, a settlement figure of $750,000 was awarded by the court. Although the injury was similar, the circumstances of the accident in the decided case are different from those of Tentacles case. (4 marks) 10

(iv) Tentacle is involved in the construction of a residential apartment building. It is being accounted for using the percentage of completion basis in HKAS 11 Construction contracts. The recognised profit at 31 March 2007 was $12 million based on costs to date of $3 million as a percentage of the total estimated costs of $6 million. Early in May 2007 Tentacle was informed that due to very recent industry shortages, building materials will cost $15 million more than the estimate of total cost used in the calculation of the percentage of completion. Tentacle cannot pass on any additional costs to the customer. (4 marks) Required: State and quantify how items (i) to (iv) above should be treated when finalising the financial statements of Tentacle for the year ended 31 March 2007. Note: The mark allocation is shown against each of the four items above. (25 marks)

End of Question Paper