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Timezone 1


External Programmes

C89AU / C89CI


Semester 2 2013/14

Wednesday 4 June 2014

Duration: Three Hours

1. At the start of the exam ensure that you have completed the information
on the front page of the Answer Book.
2. Read the instructions on page 2.
3. Use both sides of the paper when completing the Answer Book.
4. Start each question on a new left hand page.
5. Show all of your workings in the Answer Book workings/answers in the
Question Paper will not be marked.
6. Cross through (once) anything you dont wish the examiner to mark.
7. The Question Paper and Answer Book must be handed in entire.


Heriot-Watt University C89AU / C89CI
Stage 3 June 2014


The duration of the examination is 3 hours. The marks value of each section is
shown below. You may allocate your time as you see fit.

The paper is in two sections:

SECTION A: 50 marks
SECTION B: 50 marks

Answer BOTH sections.

SECTION A: Answer all parts of Question A1 and Question A2 and either Question
A3(a) or Question A3(b).

SECTION B: Answer all parts of Question B1 and Question B2 and either Question
B3(a) or Question B3(b).

This examination document is in two parts:

Part I is the question paper.

Part II is the answer book.

Please ensure that BOTH PARTS are returned at the end of this examination.

Heriot-Watt University C89AU / C89CI
Stage 3 June 2014


Heriot-Watt University C89AU / C89CI
Stage 3 June 2014

SECTION A (50 marks)

Answer all parts of Question A1 and Question A2 and either Question A3(a) or
Question A3(b).

Question A1

You are an audit partner of Pink and Red, registered auditors. You have responsibility for
the audit of Hill and Dale plc, a listed company which produces bivouac tents that are sold to
specialist mountaineering shops and outlets. You have been in a meeting with Chris
Shelter, the finance director of Hill and Dale, discussing the audit for the year ahead. Your
recording of the conversation includes the following four requests made by Chris Shelter.

This year we have two new non-executive directors. The one continuing non-executive
director will chair the audit committee. You will be meeting them next month but in the
meantime they have asked for an advance summary of the key points of the engagement
letter you will be sending us for next years audit. Could you please give me a short
explanation of the reasons for each of the main sections of your engagement letter, so that I
can explain it to them?

At the annual general meeting last year we had some independent shareholders present
who voted against the reappointment of your audit firm. Their votes were ineffective
because our larger institutional shareholders accepted the directors recommendation.
However, a journalist has been telephoning my office asking what I will say at this years
meeting if the independent shareholders raise the same concerns. These shareholders are
saying that the directors recommend the audit appointment and the directors agree the audit
fee, which calls into question the independence of the audit. I need some wording to answer
the journalist. Please give me your views on audit independence and explain how you can
demonstrate independence while working effectively with the directors, especially the
finance director.

As you know, we discovered a problem in our purchases department last month. One of
the purchase officers had created a fictitious supplier and had authorised payments to a
bank account in the name of the brother of the purchase officer. We have tried to tighten up
procedures but please recommend some key features of internal control relating to
authorisation of payments to suppliers, so that I can discuss your recommendations with the
accounts department.

Finally we agreed last year that you would work with the internal auditor. As you know, we
employ a small local audit firm to carry out our internal audit. Please explain how you can
most usefully work with the internal auditor.


Write replies to the four requests from the finance director.

Total 21 marks

Heriot-Watt University C89AU / C89CI
Stage 3 June 2014

Question A2

Sports Equipment Ltd includes in its non-current assets some specialist equipment which is
used for the manufacture and assembly of cricket bats. The equipment is depreciated on a
straight-line basis over its estimated useful economic life.

The following assertions appear in the financial statements:

1. The net book value of the specialist equipment is 2.1 million.

2. The depreciation charge for the year is 0.4 million.


(a) Explain, with reasons, two internal control procedures that you would expect to observe
in relation to the asset of equipment.
(5 marks)

(b) For each of the two assertions made in the financial statements, describe four
substantive or analytical audit tests that you would carry out.
(8 marks)

(c) Give (i) one example of corroborating evidence, and (ii) one example of inquiry
evidence, as these might be used in the audit of the asset of equipment.
(4 marks)

Total 17 marks

Question A3


(a) In relation to the audit report:

(i) Describe the basic elements of the unqualified audit report.

(4 marks)
(ii) Give a brief explanation of why each basic element is necessary.
(4 marks)
(iii) State two advantages and two disadvantages of free-form audit reporting.
(4 marks)

Total 12 marks


(i) What is meant by the requirement in Company Law for a true and fair view?
(6 marks)

(ii) Who are the various participants in the process of ensuring adherence to the
concept of true and fair?
(6 marks)

Total 12 marks

Heriot-Watt University C89AU / C89CI
Stage 3 June 2014

SECTION B (50 marks)

Answer all parts of Question B1 and Question B2 and either Question B3(a) or
Question B3(b).

Question B1

You are the group accountant of Wool plc ('Wool') in charge of preparing the consolidated
financial statements. Wool has one subsidiary company, Cotton Ltd ('Cotton'). The separate
statements of financial position (balance sheets) of Wool and Cotton at 31 December Year
8, prior to completion of the group audit, are as follows:

Wool Cotton
000 000 000 000
Non-current (fixed) assets: Land 440 212
Other non-current (fixed) assets: cost 790 287
: accumulated depreciation (405) (112)
385 175
Investment in Cotton Ltd 580 ____
1,405 387
Inventories (Stocks) 210 92
Receivables (Debtors) 115 35
Intercompany account - 28
Cash at bank 10 15
335 170
Payables (Creditors) (110) (29)
Intercompany account (28) -
(138) (29)
197 141
1,602 528

Convertible loan stock (210) -

1,392 528

Ordinary share capital 110 207

3% Preference shares, issued 1 Mar Year 8 - 72
Share premium account 85 31
Profit and loss reserve at 31 Dec Year 7 1,117 193
Profit for the year 80 25
Total 1,392 528


1. Wool acquired 80% of the ordinary share capital of Cotton on 1 March Year 8 for a cash
price of 580,000. The ordinary share capital and the share premium account remained
unchanged between 1 March Year 8 and 31 December Year 8. The after-tax profits of
Cotton accrued evenly throughout the year. An annual impairment test is applied to
goodwill. The directors of Wool estimate that the impairment between 1 March Year 8
and 31 December Year 8 amounted to 6,000.

2. At the date of acquisition the directors of Wool were of the opinion that, as at 1 March
Year 8 the fair value of land held by Cotton was 90,000 more than its recorded book
value. No land has been acquired or sold by Cotton between 1 March Year 8 and
31 December Year 8.

Heriot-Watt University C89AU / C89CI
Stage 3 June 2014

3. Other non-current assets of Cotton include a production machine recorded in the ledger
account at 31 December Year 8 at a net book value of 70,000 (original cost 170,000
less accumulated depreciation 100,000). In the opinion of the directors of Wool, this
same production machine had a depreciated replacement cost of 40,000 at 1 March
Year 8 and a remaining estimated useful life of 4 years from that date.

The profit and loss account of Cotton included a depreciation charge of 36,000 for year
8 in respect of this production machine. Depreciation is charged monthly on a straight
line basis.

4. The preference shares issued by Cotton are held by various financial institutions. The
shares issued on 1 March Year 8 are redeemable at par in Year 18. Redemption is
guaranteed by Wool. The preference dividend was paid on 31 December Year 8.

5. Wool sold a plot of land to the Property Bank on 1 January Year 6. The Property Bank
paid 120,000 in cash. It was agreed that Wool would continue to use the plot of land
for parking vehicles and would pay a monthly rent, calculated as three percentage
points above the banks base lending rate. After five years Wool will have the right to
repurchase the land at a fixed price of 120,000. If land values fall during that period
the bank has the right to require Wool to repurchase the land at the end of five years.
The land is not recorded in the draft statements of financial position (balance sheets)
shown above but the auditors have advised that this transaction should be recognised
and recorded in the financial statements of Wool.


Prepare the consolidated statement of financial position (balance sheet) of Wool plc at
31 December Year 8, in a form suitable for publication to shareholders (so far as the
information given permits), together with notes to the finance director explaining the
approach you have taken.

Note that for your answer to this question a suitable format for a statement of
financial position (balance sheet) is set out in the answer book (Part II) for you to
complete by entering the appropriate figures. You should write your working notes on
the pages following that statement of financial position. You are not asked to prepare
a consolidation worksheet. Calculations set out in narrative-form will provide the
figures so that you can proceed directly to completing the statement of financial

Total 21 marks

Heriot-Watt University C89AU / C89CI
Stage 3 June 2014

Question B2

Answer all parts of this question

(a) Explain, with reasons, whether each of the following transactions should be treated as
a financial instrument in the financial statements of AB plc under IAS 39/IFRS 9:

(i) AB plc has placed a deposit of 40,000 in a German bank.

(ii) AB plc has carried out building repair services valued at 10,000 and has sent an
invoice to a credit customer.
(iii) AB plc is holding a legal note in which Y SA has promised to deliver 1m in gold
bullion to AB plc in two months time.
(iv) AB plc has paid 60,000 rent in advance for three months occupation of a storage
(8 marks)

(b) Zeta plc is a company registered in the United Kingdom. It buys and sells electronic
components. Its functional currency is the sterling. The items (1) to (4) below require
attention in the financial statements for the year ended 31 December Year 7. Explain
the accounting treatment of each separate item. Use the exchange rates set out in the
following table:

$ to 1
1 January Year 1 $4.0 = 1
31 December Year 6 $2.5 = 1
30 June Year 7 $2.5 = 1
31 October Year 7 $2.0 = 1
31 December Year 7 $1.6 = 1

1. Sofia Inc is a wholly-owned subsidiary of Zeta plc. The directors of Zeta plc
regard the investment in Sofia as an investment in the overall net worth of the
subsidiary. Sofia Inc owns a fleet of delivery vehicles whose net book value was
$840,000 at 31 December Year 6 and $760,000 at 31 December Year 7. These
delivery vehicles were acquired on 1 January Year 1. They must be translated
into s in preparation for consolidation.

2. Zeta plc purchased a batch of electronic components in the US. The purchase
was agreed on 30 June Year 7 at a price of $160,000 to be paid on that day.
Zeta borrowed $160,000 on 30 June Year 7 to have funds available to purchase
the components. The loan remained owing at 31 December Year 7. The
electronic components were all sold before 31 December Year 7.

3. Zeta plc held cash of $360,000 in a deposit account in a US bank. The amount
held in the bank remained unchanged throughout Year 7.


Explain the accounting treatment in the Year 7 financial statements of each separate item (1)
to (3) above. Where relevant, include in your answer an explanation of how the comparative
balance sheet information at 31 December Year 6 is reported.
(9 marks)

Total 17 marks

Heriot-Watt University C89AU / C89CI
Stage 3 June 2014

Question B3


(a) Explain why accounting for share-based payment for employees service has been a
controversial topic for accounting standard setters.

Total 12 marks


(b) In relation to the IASB, explain and comment on each of the following:

(i) The objectives of the IASB;

(ii) The nature of the geographical spread of membership of the IASB; and
(iii) The role of the Monitoring Board.

Total 12 marks


Timezone 1

Candidates are subject to the regulations governing examinations
which are published by the University. The main points are
summarised below.

1. A candidate shall not bring written, printed or any other material

into the examination room except such as may be authorised by
the examiners. Briefcases and other similar containers, the
main purpose of which is to carry papers, shall not be brought
into the examination room.

2. A candidate shall not communicate with, receive assistance

from or copy from the paper of another candidate during an

3. A candidate shall not leave the examination room less than half
an hour after the start of an examination, except with the
permission of the invigilator and shall not leave the examination
room during the last fifteen minutes of an examination.

4. At the end of the examination a candidate must return the

answer book or books to the invigilator together with any other
material on which he/she has written or drawn during the
examination. Under no circumstances should a candidate
remove an answer book, used or unused, from the examination