Financial Accounting and Reporting

Suggested Answers

1. (a) The term equity includes capital and retained earnings. Profit is linked with retained earnings. Once the
company generate profit retained earnings increase and when the company incurs losses the retained earnings
decrease. Therefore, the statement "Profit is only earned in an accounting period if the equity at the end of the
period is greater than it was at the start" is not necessarily true at all the situations. In some cases, shareholders
inject new capital that increases the total equity and on the other hand when dividend is paid, it reduces equity.
(b) Financial statements are backward-looking whereas most of the users of financial statements base their
decisions on expectations about the future. Financial statements contribute towards this by helping to identify
trends and by confirming the accuracy of previous expectations, but cannot realistically provide the complete
information set required for all economic decisions by all users. Therefore, ''Backward-looking' is called one
of the inherent limitations of financial statements.
(c) "Accounting standards create a common understanding between the users and preparers on how particular
items, for example the valuation of property, are treated. Financial statements should therefore comply with all
applicable accounting standards.

However, there are some situations where there is a conflict between the accounting standards and country
local regulations. In this situation, individual country local regulations should govern, to a greater or lesser
degree, the issue of financial statements. Local laws are prevailed over the accounting standard These local
regulations include accounting standards issued by the national regulatory bodies or professional accountancy
bodies in the country concerned.

2. (a) Notes to the financial statements for the year ended on 31 December 2019 (extracts)
i) Accounting policies

Property, plant and equipment

Freehold land and buildings are stated at a revaluation. Other tangible non-current assets are stated at cost,
together with any incidental expenses of acquisition.

Depreciation is calculated so as to write off the net cost or revaluation of tangible non-current assets over
their expected useful lives. Depreciation charges commence when an asset becomes available for use. The
rates and base methods used are as follows:

Assets % pa BasisMethod
Freehold land and buildings 2% Straight - line
Plant and equipment 10% Straight - line
Office equipment and fixtures 20% Straight - line
Motor vehicles 30% Reducing balance

ii) Profit from operations is stated after charging

Tk
Depreciation of property, plant and equipment 562,000

iii) Property, plant and equipment

Freehold Plant and Motor Office Total
land and equipment vehicles equipment
buildings and fixtures
Tk. '000 Tk. '000 Tk. '000 Tk. '000 Tk. '000
Cost or valuation:
At 1 January 2019 1,440 1,968 449 888 4,745
Additions 500 75 35 22 632
Revaluation (W1) 760 - - - 760
At 31 December 2019 2,700 2,043 484 910 6,137
Depreciation:
At 1 January 2019 144 257 194 583 1,178
Revaluation adj. (W1) (144) - - - (144)
Charge for the year (w) 60 233 87 182 562

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 At 31 December 2019 60 490 281 765 1,596
Carrying amount:

At 31 December 2019 2,640 1,553 203 145 4,541

At 1 January 2019 1,296 1,711 255 305 3,567

(b) Workings: Tk. '000 Tk. '000

W1 Freehold land and buildings revaluation

DR Freehold land and buildings 760

DR Accumulated depreciation (1,440 x 5 /50) 144
CR Revaluation surplus (2,200 - 1,296) 904

W2 Freehold land and buildings depreciation charge

Valuation / cost at 1 January 2019 2,700
Remailing useful life 45 years
Annual depreciation: (2,700 / 45 years) 60

W3 Motor vehicles depreciation charge

Carrying amount at 1 January 2019 255
Additions 35
290
Depreciation - reducing balance method @ 30%: (290 x 30%) 87

W4 Fixtures and fittings depreciation charge

Cost at 31 December 2019 910
Depreciation - straight line method @ 20%: (910 x 20%) 182

W5 Plant and equipment depreciation charge

Cost at 1 January 2019 1,968
Less: Grinding machine (298)
Add: Purchase for factory expansion 75
1,745
Depreciation - straight line method @ 10%: (1,745 x 10%) 175

Grinding machine - cost less residula value (298 - 8) 290

Accumulated depreciation at 1 January 2019 (58)
Carrying amount 232
The carrying amount must be written off over the machine's remaining useful life of 4 years
Depreciation charge: (232 / 4 years) 58

Total depreciation charge for plant and equipment:

Gridning machine 58
Other plant and equipment 175
233

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3. i) Total amount to be charged to profit & loss in the year ended on 31 October 2020:
Amount in Tk.
Formula B (not yet qualifying as development phase) 20,000
Amortisation of development cost (Formula A) working 5,300
Amortisation of patent (2,000 / 10) 200
25,500

ii) Notes to the financial statements as at 31 October 2020 (extracts)

Intangible Assets

Development
Patents (Tk.) Total (Tk.)
cost (Tk.)
Cost:
At 1 November 2019 43,000 - 43,000
Additions 10,000 2,000 12,000
At 31 October 2020 53,000 2,000 55,000
Amortisation
At 1 November 2019 - - -
Charge for the year 5,300 200 5,500
At 31 October 2020 5,300 200 5,500
Carrying amount
At 31 October 2020 47,700 1,800 49,500
At 1 November 2019 43,000 - 43,000
-
Working:
Amortisation of development cost for Formula A
Sales in year / Total sales x Tk. 53,000
50,000 / (50,000 + 150,000 + 200,000 + 100,000) x 53,000
Tk. 5,300

4. i)
Plato Corporation
Projected Income Statement
For the year ended December 31, 2021
Tk Tk
Net Sales 29,000,000
Cost of goods sold 14,000,000
Depreciation* 1,600,000
Operating expenses 6,400,000 22,000,000
Income before income taxes 7,000,000
Unrealised holding gain** 1,700,000
Income before taxes and bonus 8,700,000
President's bonus 1,000,000
Income before income taxes 7,700,000
Income taxes
Current 3,000,000
Deferred*** 850,000 3,850,000
Net income 3,850,000

Conditions met:
1. Net income before taxes and bonus > Tk 8mn
2. Payable for income taxes does not exceed TK 3mn
* Depreciation for the current year includes TK 600,000 for the old equipment and TK 2,000,000 for the
robotic equipment. If the robotic equipment is changed to straight line, its depreciation is only Tk 1mn and
the total is Tk 1.6mn
** By urging the Board of Directors to change the classification of FVOCI Investments to FVTPL investments
as per IFRS 9, at 1 January 2021, income is increased by a Tk (11,900,000-10,200,000)=1,700,000 and the
earlier OCI reserve Tk 200,000 should be reclassified to equity.
*** The unrealized holding gain is not currently taxable until the investments are sold.
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 ii) There is nothing unethical about changing the first-year election of depreciation back to the straight-line
method provided that it meets with the approval of appropriate corporate decision makers. Considering the
immediate needs for cash of Tk 1mn for the Chairman’s bonus and Tk 3mn for income taxes, there may be a
need to sell some of the investments. Therefore, the transfer of Tk 3mn of held for collection investments to
trading investments may also be appropriate.

It is naïve to believe that corporate officers do no planning for year-end or interim financial statements. The
slippery slope arises with manipulation of financial statements. The investment reclassification for the selected
investments clearly manipulates the income to the benefit of the Chairman. While legal and within IFRS
guidelines, the ethics of this situation are borderline. Any auditor would automatically bring this transaction to
the attention of the board of directors.

Some stakeholders and their interests are:

Stakeholders Interests
Chairman Personal gain of Tk 1mn bonus
CFO Placed in ethical delimma between the interests of the Chairman and the Corporation
Board of Directors May be subject to the manipulations of the CEO for his personal gain
Stakeholders Increased income from higher income may increase demand for dividends. Also,
paying a bonus may decrease cash available for dividends.
Employees Chairman takes over 25% of net income for himself. This could have been used to
start a pension plan for all of the employees.
Creditors The increased income represents a 17% inflation of the true net income of the
corporation. This may lead to a misrepresentation of creditworthiness.

5. i) The bond cash flows include a semiannual interest payment of Tk 200,000 (or Tk 5mn at 4%) plus the
principal payment of Tk 5mn at maturity. With an effective (market) interest rate of 5% for each six
months interval, the present value factors are:

20 period ordinary annuity at 5% = 12.46221

20 period single payment = 0.37689
Thus, the issue price is as follows:
(Tk 200,000X 12.46221) + (Tk 5,000,000X0.37689) = Tk 4,376,892
The bond was thus issued at a discount of Tk 623,108 (or Tk 5,000,000 – Tk 4,376,892).

ii) Because the bond was issued on July1, 2019 only six months of interest needs to be recorded for the year.
Interest expense is computed at the effective interest rate of 5%.

So, the interest expense is:

TK4,376,892 X 5% = Tk 218,845

Computed interest expense is more than the required cash payment of Tk 200,000. The Tk 18,845
difference represents amortization of the bond discount i.e. an increase to the book value of the bond. The
year end financial statements of MidLand would show the bond at Tk 4,395,737 ( Tk 4,376,892+Tk
18,845).

iii) The accrual income figure contains interest expense of Tk 218,845, but the cash interest payment is only
Tk 200,000. The additional interest expense of Tk 18,845 does not represent an operating cash outflow for
the year, and so it is added back to net income to arrive at cash flows from operations.

iv) Under the terms of the call option, MidLand can retire the debt by paying bond holders 102% of par value
or:
Tk 5,000,000 X 102%= Tk 5,100,000

However, the current market value of the bonds at an annual yield of 9% is:
(Tk 200,000X 11.23402) + (Tk 5,000,000X0.49447) = Tk 4,719,154

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 The open market purchase is the less expensive way of MidLand to retire its debt.

v) Assume that all interest expense and cash interest payments have been recorded. Then the book value of
the bonds on July 1, 2021 would be TK 4,458,115 as shown in the below amortization table:

Liability at Effective Coupon Increase in recorded Liability at

Period
beginning interest: 5% rate: 4% Book value End of period

7/1/2019 - 4,376,892
1/1/2020 4,376,892 218,845 200,000 18,845 4,395,737
7/1/2020 4,395,737 219,787 200,000 19,787 4,415,524
1/1/2021 4,415,523 220,776 200,000 20,776 4,436,300
7/1/2021 4,436,300 221,815 200,000 21,815 4,458,115
Based on our previous calculation, we find that MidLand would pay Tk 4,719,154 to retire the bonds on
that date, so the entry would be:
Dr Bonds payable Tk 5,000,000
Dr Extraordinary loss on retirement Tk 261,039
Cr Discount on bonds Tk 541,885
Cr Cash Tk 4,719,154

Where Tk 541,885 represents the remaining (unamortized) balance of the original issue discount.

6. i) Consolidated statement of profit & loss for the year ended on 31 March 2019
Tk.
Revenue w2 414,750
Cost of sales w2 (178,900)
Gross Profit 235,850
Distribution cost w2 (110,200)
Administrative expenses w2 (39,530)
Operating profit 86,120
Finance cost w2 (450)
Investment income w2 350
Profit before tax 86,020
Income tax w2 (44,100)
Profit for the year 41,920

Attributable to:
Owners of Dhaka Ltd. 38,270
Non-controlling interest (w3) 3,650
41,920
Retained earnings brought forward
Attributable to owners of Dhaka Limited (w5) 630,280
Non - controlling interest (w5) 14,520

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ii) Adjustment in consolidated schedule
a) Intra-group sales of inventory
As the consolidated accounts treat Dhaka Limited and Khulna Limited as one entity, the total intra-group
trading needs to be eliminated on consolidation. The total of Tk. 37,500 will be in both Khulna Limited's
revenue and Dhaka Limited's cost of sales. The adjustment required is:
DR (Tk. ) CR (Tk. )
Revenue 37,500
Cost of sales 37,500
This has no impact on net consolidated profit.
For the same reason, it is also necessary to eliminate the unrealized profit on the inventory held by Dhaka
Limited at the year end. This adjustment will also reduce inventory to orginal cost to the group.
The adjustment is:
DR (Tk. ) CR (Tk. )
Cost of sales of Khulna Limited 700
Inventory in the consolidated statement of financial position 700
This will reduce consolidated profit.

b) Intra-group sale of plant

For the same reason as given for inventory above, it is necessary to eliminate the unrealized profit and
reduce the plant to its original cost.
The adjustment is:
DR (Tk. ) CR (Tk. )
Cost of sales of Dhaka Limited 3,000
Cost of plant in the consolidated financial position 3,000
This will have a one-off impact on consolidated profit this year.

In current and future years (until the plant has been fully depreciated by Khulan Limited) it will also be
necessary to adjust the depreciation charge by 10% of the PURP, to reflect the gradual realization of the
above profit through the annual depreciation charge. This will require the following:
DR (Tk. ) CR (Tk. )
Accumulated depreciation in the consolidated statement of financial position 300
Cost of sales of Dhaka Limited 300

Therefore, the net impact is to reduce current year consolidated profit by Tk. 2,700.

c) Management charges
As with intra-group trading, this charge must be contra'd out on consolidation to reflect the single entry
concept.
The adjustment required is:
DR (Tk. ) CR (Tk. )
Revenue of Dhaka Limited 3,500
Administrative cost of Khulna Limited 3,500
This has no impact on consolidated profit.

d) Impairment of goodwill
Goodwill only exists in the consolidated accounts and therefore the individual statements of profit or loss
include no impairment of goodwill. The impairment charge for the year is dealt with as follows:
DR (Tk. ) CR (Tk. )
Administrative cost 180
Goodwill in the consolidated statement of financial position 180
This will reduce consolidated profit.

e) Redeemable preference shares

These are in substance liabilities and the net 'dividend' payable outside the group should be included as part
of the consolidated finance cost.
Effectively, the dividend paid by Khulna Limited are contra'd against the dividends received by Dhaka
Limited and the adjustment required is:
DR (Tk. ) CR (Tk. )
Dividend received 150
Dividend paid (25% of Tk. 600) 150
This leaves Tk. 450 payable to third parties

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Workings:
w1 Group structure
Dhaka Limitedholds 80% ordinary shares and25% redeemable preference shares of
Khulna Limited.
w2
Consolidated schedule: Consol.
Dhaka Ltd. Khulna Ltd.
Adjustment
Tk. Tk. Tk. Tk.

Revenue 274,500 181,250 418,250

(37,500)
(3,500) (3,500)
414,750
Cost of sales
Per Q (126,480) (86,520) (175,500)
37,500
Inventory (700) (700)
NCA PURP (3,000) (3,000)
Depreciation (10% x 3,000) 300 300
(178,900)

Distribution Exp (67,315) (110,200)

(42,885)
Administrative Exp (39,350)
Per Q (25,555) (17,295)
3,500
Impairment of goodwill (180) (180)
(39,530)

Preferred dividend received 150 -

(150) (450)
Preferred dividend paid (600) 150
Investment income - interest 250 100 350
Income tax (29,000) (15,100) (44,100)
Profit after tax 18,250

w3 Non-controlling
interest 20% x Tk.
18,250
= Tk. 3,650
w4 Goodwill
Tk.
Consolidation transferred 9,000
Non-controlling interest at acquisition (9,000 x 1,800
20%) Less: net assets at acquisition
Ordinary shares (5,000)
Retained earnings (4,000)
On acquisition 1,800
Carrying amount of goodwill after impairment (1,200)
Impairment loss previously recognized 600

w5 Retained earnings
Tk.
b/f Group:
Dhaka Limited 576,000
Khulna Limited ((72,600 - 4,000) x 80%) 54,880
Less: impairment loss to date (w4) (600)
Attributable to the owners of Dhaka Limited 630,280
Non-controlling interest (72,600 x 20%) 14,520

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