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No. of Questions - 08

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA

MOCK EXAMINATION - DECEMBER 2014

12306 - FINANCIAL REPORTING FRAMEWORK

Instructions to candidates

(1) Time allowed:


Reading and planning : 15 minutes
Writing : 3 hours
(2) Marks : 100 marks
(3) Answer all questions.
(4) Begin each answer on a separate page. Submit all workings.
(5) All answers should be in English Language, in the answer booklets provided.
(6) The examination will be conducted as an open book examination and only the following
publications of CA Sri Lanka will be permitted to be used at the examination hall:
 Sri Lanka Accounting Standards – 2013
 Open Book Referential - Student Edition (Code of Best Practice on Corporate
Governance, Statement of Alternative Treatment, Sri Lanka Statement of Recommended
practice, IFRICs and SICs applicable for financial period beginning on or after
1/1/2012)
 SLFRSs (10-13) - 2014
 Sri Lanka Accounting Standards for Small & Medium sized Entities - 2011
(7) Students are allowed to bring permitted publications which are highlighted, sidelined, or
underlined. Short notes written on the permitted publications will also be allowed. Page tabs may
be used to refer the pages.
(8) Notes, text books (other than permitted publications) or any other materials will not be allowed.
Photocopies/extracts of the above publications will not be allowed.
(9) Answers written on the answer booklets, graph papers and any other stationery, distributed at the
examination hall, only are considered in marking of answer scripts. Any other attached documents
are not taken into account at the time of marking answer scripts.
Question No. 01

(a) You are the finance manager of ABC PLC (ABC).


The following scenarios have taken place during the year ended 31 March 2014.
Comment on the accounting treatment of each of the scenarios in the financial statements
of ABC for the year ended 31 March 2014, and advise how they should be treated under
Sri Lanka Accounting Standards.
(i) ABC spent Rs. 1.2 million sending its staff on training courses during the year. This
has already led to an improvement in the company’s efficiency and resulted in cost
savings. The organiser of the course has stated that the benefits from the training
should last for a minimum of three years. Your assistant accountant has therefore
treated the cost of the training as an intangible asset and charged nine months’
amortisation based on the average date during the year on which the training
courses were completed. (4 marks)
(ii) During the year the company started research work with a view to the eventual
development of a new processor chip. By 31 March 2014 it had spent Rs.
6.5 million on this project. ABC has a past history of being particularly successful
in bringing similar projects to a profitable conclusion. As a consequence the
assistant accountant has treated the expenditure to date on this project as an asset
in the statement of financial position.
The company was also commissioned by a customer to research and, if feasible,
produce a computer system to install in motor vehicles that can automatically stop
the vehicle if it is about to be involved in a collision. By 31 March 2014, the
company had spent Rs. 10.6 million on this project, but at this date it was uncertain
as to whether the project would be successful. As a consequence the assistant
accountant has treated Rs. 10.6 million as an expense in the income statement.
(5 marks)
(iii) One business line of ABC is the construction and renting of luxury apartments.
Upon the request of the residents of its newly built group of luxury apartments
(called Beautiful Homes), ABC entered into a contract with these residents to install
a security system and provide security services. ABC will provide all the security
services to the residents of the apartments and charge a total payment of Rs.
3,000,000 per annum from the residents as the service fee commencing from
September 2014. Installation work commenced on 1 March 2014 and was expected
to be completed by 31 July 2014. The installation expenditure incurred by ABC up
to 31 March 2014 was Rs. 3,800,000. Based on previous experience with a similar
contract (where ABC provided similar security services to residents of another
group of apartments they owned), the assistant accountant of ABC expected (as at
31 March 2014) the company to make a total profit of Rs. 2,800,000 during the
following year ending 31 March 2015 from the security system installed at
Beautiful Homes. The assistant accountant recorded the costs to 31 March 2014 of
Rs. 3,800,000 as a non-current asset, but then on the same date wrote this amount
down to Rs. 2,800,000 because he believed the asset to be impaired.
(5 marks)

DECEMBER 2014 – MOCK EXAMINATION (2) 12306 - FINANCIAL REPORTING FRAMEWORK


(b) Mercury PLC issued a Rs. 1,000 million unsecured loan with a coupon (nominal) interest
rate of 10% on 1 April 2013. The loan is redeemable at a premium which means the loan
has an effective finance cost of 11.5% per annum. The loan was specifically issued to
finance the building of a new housing complex which meets the definition of a qualifying
asset as per LKAS 23. Construction of the housing complex commenced on 1
May 2013 and it was completed and ready for use on 28 February 2014, but did not open
for trading until 1 April 2014. During the year, trading at Mercury PLC’s other housing
complex was below expectations so Mercury PLC suspended the construction of the new
housing complex for a two-month period during July and August 2013, and the proceeds
of the loan were temporarily invested and earned interest of Rs. 18 million.

Calculate the net borrowing cost that should be capitalised as part of the cost of the new
housing complex and the finance cost that should be reported in the income statement of
Mercury PLC for the year ended 31 March 2014.
(5 marks)

(c) Venus PLC is a leading supermarket chain. During the current year it started building a new
store. The directors are aware that in accordance with LKAS 23 Borrowing Costs, certain
borrowing costs have to be capitalised.
Explain the circumstances when, and the amount at which, borrowing costs should be
capitalised in accordance with LKAS 23.
(4 marks)

(d) Neptune PLC owned a 100% subsidiary called Anti Fire (Pvt) Ltd (AFL), which was treated
as a cash generating unit of Neptune PLC. On 31 March 2014, there was an industrial
accident (a fire) that caused damage to some of Neptune PLC’s plant and machinery. The
assets of Neptune PLC immediately before the fire/accident were:
Rs. ‘000
Goodwill 2,300
Patent 4,200
Factory building 6,000
Plant and machinery 4,000
Receivables and cash 2,500
19,000
As a result of the fire, the recoverable amount of the above assets is Rs. 12.7 million. The
fire destroyed (to the point of no further use) an item of plant and machinery that had a
carrying amount of Rs. 1,500,000. Neptune PLC has an open offer of Rs. 4 million from a
competitor for its patent. The receivables and cash are already stated at their fair values
less costs to sell (net realisable values).
Calculate the carrying amounts of the assets at 31 March 2014 after applying any
impairment losses.
(7 marks)

(Total: 30 marks)

DECEMBER 2014 – MOCK EXAMINATION (3) 12306 - FINANCIAL REPORTING FRAMEWORK


Question No. 02
The directors of Always Happy (Pvt) Ltd are disappointed by the draft profit for the year ended 31
March 2014. The company’s assistant accountant has suggested two areas where they believe the
currently recorded profit can be improved.
Comment on the acceptability of the assistant accountant’s suggestions below and explain how
they would affect the financial statements if they were implemented under Sri Lanka Accounting
Standards. (Ignore taxation).
(i) A major item of plant that cost Rs. 20 million to purchase and installed on 1 April 2011 is
being depreciated on a straight-line basis over a five-year period (assuming no residual
value). The plant is wearing well and at the beginning of the current year (1 April 2013)
the production manager believed that the plant was likely to last eight years in total (i.e.
from the date of its purchase). The assistant accountant has calculated the depreciation for
the year ended 31 March 2014 based on an eight-year life (and no residual value).
(5 marks)
(ii) Most of Always Happy (Pvt) Ltd’s competitors value their inventory using the weighted
average cost basis, whereas Always Happy (Pvt) Ltd uses the first in first out (FIFO) basis.
The value of the company’s inventory as at 31 March 2014 (on the FIFO basis) is
Rs. 20 million; however on the weighted average cost basis it would be valued at Rs.
18 million. By adopting the same method (weighted average cost) as its competitors, the
assistant accountant says the company would improve its profit for the year ended 31
March 2014 by Rs. 2 million. The company’s inventory as at 31 March 2013 was reported
as Rs. 15 million; however on the weighted average cost basis it would have been reported
as Rs. 13.4 million. (5 marks)
(Total: 10 marks)

Question No. 03
(a) The objective of LKAS 10 Events after the Reporting Period is to prescribe the treatment
of events that occur after an entity’s reporting period has ended.
Describe the period which LKAS 10 relates to, and differentiate between adjusting and
non-adjusting events. (4 marks)
(b) The following incidents have taken place in relation to Best Traders PLC (BT).
Explain the required treatment as per LKASs of items (i) and (ii) by BT in its financial
statements for the year ended 31 March 2014.
(i) On 12 April 2014 a landslide completely destroyed the company’s warehouse
located in Haputale and the inventory it contained. The carrying amounts of the
warehouse and the inventory were Rs. 7.5 million and Rs. 5 million respectively. It
appears that the company has not updated the value of its insurance cover and it
will be able to recover only a maximum of Rs. 6.5 million from its insurer. BT’s
trading operations have been severely disrupted since the landslide and it expects
large trading losses for some time to come. (3 marks)
(ii) On 18 May 2014 the government announced tax changes which have the effect of
increasing BT’s deferred tax liability by Rs. 750,000 as at 31 March 2014.
(3 marks)
(Total: 10 marks)
DECEMBER 2014 – MOCK EXAMINATION (4) 12306 - FINANCIAL REPORTING FRAMEWORK
Question No. 04

(a) During the year ended 31 March 2014, Ranald (Pvt) Ltd experienced the
transactions/events listed below.

Explain how you would treat them in the company’s financial statements for the year
ended 31 March 2014.

(i) Entered into a finance lease to rent an asset for substantially the whole of its useful
economic life.
(2 marks)

(ii) A decision was made by the board to change the company’s accounting policy from
one of expensing the finance costs on building new beauty advice (BA) outlets to
one of capitalising such costs.
(2 marks)

(iii) The company’s income statement prepared using historical costs showed a loss
from operating its hotels, but the company is aware that the increase in the value of
its properties during the period far outweighs the operating loss.
(2 marks)

(b) A director of Pluto (Pvt) Ltd has expressed concerns about the accounting treatment of
some of the company’s items of property, plant and equipment which have increased in
value. His main concern is that the statement of financial position does not show the true
value of assets which have increased in value and that this ‘undervaluation’ is compounded
by having to charge depreciation on these assets, which also reduces reported profit. He
argues that this does not make economic sense.

Comment on the director’s concerns and state the principal requirements of LKAS 16
Property, Plant and Equipment in relation to the revaluation of property, plant and
equipment, including its subsequent treatment.
(4 marks)

(Total: 10 marks)

DECEMBER 2014 – MOCK EXAMINATION (5) 12306 - FINANCIAL REPORTING FRAMEWORK


Question No. 05

(a) On 1 April 2013, Gamma PLC leased machinery which had an estimated useful life of 5
years. A non-refundable down payment of Rs. 2 million needs to be paid at the inception
of the lease period. Thereafter, a sum of Rs. 2 million will be paid at the end of each year,
for 4 years. Fair value of the asset as at 1 April 2013 is Rs. 7.7 million (implicit rate of
interest – 15%).
Explain how you would determine whether the above lease is a finance or operating lease.
(5 marks)

(b) Gamma PLC operates a dealership for selling machinery. On 1 April 2013, the company
sells machinery to a customer for Rs. 18.6 million, payable either on delivery or by three
annual payments in advance. As 0% finance is offered, the annual payment under the lease
is Rs. 6.2 million. Gamma PLC purchases the model from the manufacturer for Rs.
14 million. Market rate of interest is 15%. The customer chooses the interest free option.
State the amount Gamma PLC would recognise in the income statement for the year ended
31 March 2014. (5 marks)
(Total: 10 marks)

Question No. 06
(a) A housing complex is being constructed by PQR PLC and XYZ PLC under a contractual
agreement which results in the activity being classified as a jointly controlled operation.
Both parties record their own transactions and are entitled to a 50% share of the profit.
The following information is recorded in the accounting records of PQR PLC and XYZ
PLC for the financial year ended 31 March 2014.
Rs. million
PQR PLC XYZ PLC
Amount invoiced to and cash received from customers 600 1,000
Cost incurred and paid 560 840

Calculate and explain how PQR PLC should account for this joint venture in their
financial statements for the year ended 31 March 2014. (5 marks)

(b) Lucky (Pvt) Ltd holds an investment of 30% in the ordinary shares of an associate called
Ranbima (Pvt) Ltd that has net assets of Rs. 400,000 as at 31 March 2014. The associate
has issued 10,000, 9% cumulative preference shares with a nominal value of Rs. 10. The
cumulative preference shares are classified by the entity as equity in accordance with
LKAS 32. The associate has not declared dividends on the cumulative preference shares in
the past two years.
Calculate the investor’s share of the associate’s net assets, and describe how it should be
accounted for in the financial statements of Lucky (Pvt) Ltd for the year ended 31 March
2014. (5 marks)
(Total: 10 marks)

DECEMBER 2014 – MOCK EXAMINATION (6) 12306 - FINANCIAL REPORTING FRAMEWORK


Question No. 07
Once a financial asset has been classified into a particular category on initial recognition,
accounting standards restrict the circumstances in which it is permissible or necessary to transfer
that asset into another category.
State, in the table given below, the possibilities for reclassification of financial assets. Use the
terms “yes” and “no” when completing the table.
To category
From category Held-for Designated Loans and Held-to- Available-
-trading at fair value receivables maturity for-sale
Held-for-trading x
Designated at fair x
value
Loans and receivables x
Held-to-maturity x
Available-for-sale x

(Total: 10 marks)

Question No. 08

(a) Bean PLC is a listed company and its directors’ and non-executive director’s details are as
follows;

(i) Banil – Director


(ii) Ruwan – Director
(iii) Deshan – Non Executive Director

The Audit Committee consists of Deshan and the two other directors on the board, and the
chairman of the committee is Banil.

Explain whether the Audit Committee composition is correct or not. If “not”, determine
the acceptable configuration.
(5 marks)

(b) Explain the circumstances in which a director would not be independent and state five
(05) instances how this could be corrected.
(5 marks)

(Total: 10 marks)

DECEMBER 2014 – MOCK EXAMINATION (7) 12306 - FINANCIAL REPORTING FRAMEWORK