SECTION A – CASE QUESTIONS (Total: 50 marks) Answer the following ONE compulsory question which relates to the Case

below. Marks will be awarded for logical argumentation and appropriate presentation of the answers.

CASE Assume that you are the accounting manager of Forever Prosperity Limited (“FPL”), Mr. Raymond Chan. FPL is a listed company in Hong Kong. It is principally engaged in the manufacture of electronic products in Hong Kong. In order to achieve vertical integration, FPL acquired 20 per cent of the issued share capital of Unending Achievement Limited (“UAL”), a retail company incorporated in Hong Kong, on 1 April 2005. The cost of investment was three million Foreign Currency Dollars (FC3,000,000), converted into six million Hong Kong Dollars (HKD6,000,000) on 1 April 2005. This 20 per cent shareholding enables FPL to exercise significant influence on UAL. The book values of UAL’s net identifiable assets approximate to their fair values at the acquisition date. On the same date, i.e. 1 April 2005, FPL acquired 80 per cent of the issued share capital of Everlasting Success Limited (“ESL”), also a retail company incorporated in Hong Kong. The cost of investment was also six million Hong Kong Dollars (HKD6,000,000). The book values of ESL’s net identifiable assets approximate to their fair values at the acquisition date. The difference between the cost of investment and FPL’s share of the book values of ESL’s net identifiable assets is attributed to the goodwill. The details of the acquisitions are as follows: ESL HKD'000 6,000 UAL HKD'000 6,000

HKD'000 Cost of investment Fair value of net assets acquired Property, plant and equipment Inventories Accounts receivable Cash and cash equivalents Accounts payable % acquired Goodwill


5,000 1,000 1,400 200 (1,000) 6,600 80%

5,280 720

24,300 4,400 4,000 800 (3,500) 30,000 20%

6,000 --

To partly finance the acquisition of the 80% interest in ESL, FPL raised HKD4,000,000 by issuing new ordinary shares to an investor. FPL paid FC500,000 (HKD1,000,000) at 1 April 2005 to the vendor of the 20% interest in UAL. The vendor allowed FPL to settle the remaining balance of FC2,500,000 (HKD5,000,000 at the exchange rate at 1 April 2005), on 31 March 2008, on condition that FPL pays the market rate of interest for the loan.

Module A (February 2006 Session)


The consolidated financial statements of FPL group are as follows: Consolidated income statement (extract) for the year ended 31 March 2006 HKD'000 35,700 (19,200) (4,000) (3,400) (400) 1,000 9,700 (1,400) 8,300

Revenue Cost of sales (Note 1) Depreciation expenses Other expenses (Note 2) Interest expenses Share of profit of an associate (Note 3) Profit before tax Income tax expenses Profit for the period Attributable to: Equity holders of the parent company Minority interests

7,700 600 8,300

Consolidated balance sheet as at 31 March 2006 2006 HKD’000 Assets Property, plant and equipment (Note 4) Goodwill Investment in an associate (Note 5) Inventories Accounts receivable Cash and cash equivalents (Note 6) Equity and Liabilities Ordinary shares Share premium Accumulated profits (Note 7) Minority interests (Note 8) Non-current borrowings (Note 9) Accounts payable Interests payable Tax payable 48,000 720 6,400 5,300 2,700 200 63,320 14,000 2,000 35,920 2,600 5,300 1,200 200 2,100 63,320 2005 HKD’000 33,000 --3,900 2,600 6,300 45,800 12,000 -31,220 1,200 -380 -1,000 45,800

The functional currency and presentation currency for FPL, UAL and ESL are the Hong Kong Dollar (HKD).

Module A (February 2006 Session)


Notes: (1) (2) Included employee costs of HK$5,000,000. Included in the other expenses were: (a) employee costs of HK$2,000,000. (b) the exchange loss of HK$300,000 arising on translating the amount due to the vendor of the 20% interest in UAL. This represents the share of UAL’s post-tax profit for the year ended 31 March 2006. During the year, the group has purchased certain property, plant and equipment but has not disposed of any property, plant and equipment. At 1 March 2006, FPL received interim dividends for the six months ended 30 September 2005 of HK$300,000 from UAL. This represents cash on hand and balances with banks. During the year, FPL paid dividends of HK$3,000,000 to its shareholders. Proposed dividends at 31 March 2006 were HK$2,400,000 (2005: HK$3,000,000). Certain subsidiaries of FPL, some of them non-wholly owned, have paid dividends during the year. This represents the amount due to the vendor of the 20% interest in UAL at amortised cost.

(3) (4) (5) (6) (7)

(8) (9)

After you have sent the draft consolidated financial statements to the directors for review, one of the directors, who is not a certified public accountant, sends you an e-mail as follows: To: From: c.c.: Date: Raymond CHAN, Accounting Manager, FPL Ryan WONG (Director) Carmen HE, Ricky LEE, Christopher YUNG (Directors) 18 May 2006

Consolidated financial statements of FPL for the year ended 31 March 2006 Could you please clarify the following points relating to FPL’s draft consolidated financial statements which I have just reviewed. (A) I noticed that the dividends received from UAL have been reported as an item of cash inflows in the consolidated cash flow statement for the year ended 31 March 2006. However, the dividends received from ESL have not been reported in the consolidated cash flow statement accordingly. Why is there such an inconsistency? Moreover, should the dividends be a kind of revenue? Why do they not appear as such in the income statement?

Module A (February 2006 Session)



You told me that the company has assumed a non-current liability of HK$5,000,000 to the vendor of the 20% interest in UAL. However, I notice that the balance of non-current borrowings was HK$5,300,000. I know from the newspapers that a new accounting standard was issued which requires companies to report financial instruments at fair value. Am I right in guessing that it is the changes in fair value that have caused the increase in the carrying amount of the loan?

Best regards, Ryan

Required: Question 1 (50 marks – approximately 90 minutes) (a) Prepare a memorandum in response to the issues raised by Mr. WONG. In your memorandum, you should explain to Mr. WONG: (i) the different accounting treatments generally applied to UAL and ESL in FPL’s consolidated financial statements (ignore the dividends for this part); (8 marks)


the different accounting treatments applied to dividends received from ESL and UAL in FPL’s books and in its consolidated financial statements. Where necessary, show the consolidation adjustments required; and (7 marks)


the reasons for the balance HK$5,300,000 at 31 March 2006.





(10 marks)


Prepare the consolidated cash flow statement of FPL as at 31 March 2006, including all the required notes. You may use either the direct method or the indirect method to present the operating cash flows. (25 marks)


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Module A (February 2006 Session)


SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks) Answer all of the following questions. Marks will be awarded for logical argumentation and appropriate presentation of the answers. Question 2 (10 marks – approximately 18 minutes) “An overseas incorporated company with an annual turnover of less than HK$50 million is no longer required to prepare financial statements that present a true and fair view.” Required: Comment on the validity of this statement by referring to the Companies Ordinance and relevant accounting standards. (10 marks)

Question 3 (12 marks – approximately 22 minutes) Apes Investment Inc. (“APES”) has the following investments as at 31 December 2005: (1) An investment in 300,000 ordinary shares of Silvermine Holding Limited (“SHL”) at a cost of HK$14.5 per share. SHL’s ordinary shares are listed on the Hong Kong Stock Exchange (“HKSE”). The quoted market price (current bid price) per share as at 31 December 2005 is HK$22. APES has considered this investment to be held for trading purposes. (2) On 1 July 2005, APES acquired 250,000 ordinary shares of Top Trend Limited (“TTL”), a privately owned enterprise, at a cost of HK$18 per share from the sole shareholder. TTL has 5,000,000 ordinary shares in issue. APES considers itself a passive investor and has not participated in TTL’s financing and operating policy decisions. APES has not designated this investment as at fair value through profit or loss from the acquisition date. Although TTL has reported a profit and declared dividends continuously in the past year, it is considered that the fair value of these shares cannot be reliably measured as at 31 December 2005. (3) On 1 January 2005, APES purchased a certificate of deposit issued by a bank at HK$2,264,000 in the market. The certificate of deposit carries interest at 4.25% per annum and is due to be redeemed by the bank at the nominal value of HK$2,500,000 on 31 December 2008. Interest is payable annually on 31 December. APES intends to hold this investment up to the redemption date. The effective yield on the investment is approximately 6%. Required: Determine and explain how APES should recognise and measure these investments in the consolidated balance sheet as at 31 December 2005 in accordance with relevant Hong Kong Financial Reporting Standards. (12 marks)

Module A (February 2006 Session)


Question 4 (15 marks – approximately 27 minutes) High Tech Toys Group (“HTT Group”) is engaged in the manufacture and trading of electronic toys with two production plants in Hong Kong and Shenzhen respectively. On 18 November 2005, the board of HTT Group decided to close down the production plant in Hong Kong. On 14 December 2005, a detailed plan for closing down the Hong Kong plant (including the disposal of the leasehold property in which the plant situated) was approved by the board. Prior to the balance sheet of 31 December 2005, redundancy notices were sent to the workers for termination of the employment contract on 28 February 2006 and a property agent was engaged for the disposal of the leasehold property. Also, a transportation contract of HK$800,000 was entered into with a logistics company to ship the machinery acquired after 2002 from Hong Kong to Shenzhen in early February 2006. A deposit of HK$100,000 was paid on 30 December 2005. All the other machinery, equipment and furniture and fixtures will be abandoned. Required: Explain the accounting treatments of the following events/transactions in the balance sheet of 31 December 2005 of HTT Group: (a) leasehold property (HTT Group acquired the leasehold property in lump sum ten years ago. The consideration cannot be allocated reliably between the land element and the building element. Accordingly, the leasehold property has been accounted for as property, plant and equipment and measured at cost model. The property agent has advised you that the market price of the leasehold property is higher than the original cost); machinery, equipment and furniture and fixtures; transportation contract; unused entitlement of annual leave of workers (Each worker is entitled to fifteen working days of paid leave annually. Unused entitlement of paid leave can be carried forward to a future period. Workers are entitled to a cash payment for unused entitlements on leaving the company); and severance payment under the Employment Ordinance for the redundant workers. (15 marks)

(b) (c) (d)


Module A (February 2006 Session)


Question 5 (13 marks – approximately 23 minutes) On 1 January 2005, Excellent Holding Limited (“EHL”) acquired a 100% equity interest of Super Return Limited (“SRL”) at a cash consideration of HK$10,600,000. SRL has four subsidiaries, W, X, Y and Z, each operates independently. The fair values of the assets of W, X, Y and Z acquired by EHL were HK$800,000, HK$1,800,000, HK$2,800,000 and HK$3,800,000 respectively. EHL recognised goodwill of HK$1,400,000 that relates to the acquisition of SRL. SRL is an investment holding company with no assets other than investments in W, X, Y and Z. At the acquisition date, there was no reasonable way to allocate the goodwill arising on the acquisition of SRL to W, X, Y and Z or other cash-generating units of EHL. The whole goodwill was allocated to the group of cash-generating units consisting of W, X, Y and Z. At 31 December 2005, the carrying amounts of the assets of W, X, Y and Z in EHL’s draft consolidated accounts were HK$900,000, HK$1,900,000, HK$2,500,000 and HK$4,400,000 respectively. At 31 December 2005, EHL conducted a review of the carrying amounts of the assets of W, X, Y and Z and the recoverable amounts at 31 December 2005 were estimated to be HK$1,100,000, HK$2,300,000, HK$2,400,000 and HK$5,000,000 respectively. Required: (a) “Goodwill is an asset which is subject to an assessment of impairment under HKAS 36. However, no measurement of the recoverable amount is required if there is no indication that the goodwill may be impaired.” Discuss the statement. (4 marks) (b) Determine any impairment loss that should be recognised in EHL’s consolidated financial statements for the year ended 31 December 2005. (9 marks)


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Module A (February 2006 Session)


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