SINGAPORE INSTITUTE OF MANAGEMENT

UNIVERSITY OF LONDON
PRELIMINARY EXAM 2015

PROGRAMME : University of London Degree and Diploma Programmes

MODULE CODE : AC3091

MODULE TITLE : FINANCIAL REPORTING

DATE OF EXAM : 04/03/2015

DURATION : 3 hours 15mins (including 15mins reading time)

TOTAL NUMBER : 8
OF PAGES
(INCLUDING
THIS PAGE)
-------------------------------------------------------------------------------------------------------

INSTRUCTIONS TO CANDIDATES: -

Candidates should answer a total of FOUR questions, with at least ONE from each section.
Section A has FOUR questions and Section B has TWO questions. All questions carry
equal marks.

Workings should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated.

Extracts from compound interest tables are given after the final question of this paper. 8-column
accounting paper is provided at the end of this question paper. If used, it must be detached fastened
securely inside the answer book.

A calculator may be used when answering questions on this paper and it must comply in all respects
with the specification given with your Admission Notice. The make and type of machine must be
clearly stated on the front cover of the answer book.

DO NOT TURN OVER THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO.

Candidates are strongly advised to divide their time accordingly.

AC3091 Financial Reporting Page 1 of 8

SECTION A

1. The statements of financial position for Euan Ltd, Mark Ltd and Nathan Ltd as at December 2014
are as follows:

Statement of Financial Position as at 31 December 2014

Euan Ltd Mark Ltd Nathan Ltd
£ £ £
Non-current asset (land) 860,000 260,000 300,000
Investments 380,000
Inventories 140,000 40,000 50,000
Trade Receivables 8,000 30,000 60,000
Dividend receivable from group companies 12,000
Inter-company loans receivable from Mark Ltd 90,000
Inter-company loans receivable from Nathan Ltd 30,000
Cash 130,000 60,000 30,000
1,650,000 390,000 440,000

Share capital (£1 nominal value) 600,000 100,000 200,000

Retained profits 260,000 210,000 160,000
Revaluation reserve 30,000
Trade payables 730,000 30,000 10,000
Inter-company loans payable to Euan Ltd 40,000 20,000
Dividend payable 60,000 10,000 20,000
1,650,000 390,000 440,000

Euan Ltd acquired 70% of Mark Ltd for £290,000 on 1 January 2010 when Mark Ltd’s share capital
and reserves stood at £190,000. At this date the fair value of Mark Ltd's non-current assets was
£280,000 but they were recorded at their historical cost of £260,000. Mark Ltd has not incorporated
this revaluation in its books.

Euan Ltd acquired 25% of Nathan Ltd for £70,000 on 1 January 2011. At this date the fair value of
Nathan Ltd's non-current assets was £300,000 and Nathan Ltd incorporated this revaluation into its
accounts. The share capital and reserves on 1 January 2011 of Nathan Ltd, including the
revaluation reserve, stood at £250,000.

No changes to the share capital of Mark Ltd and Nathan Ltd have occurred since their acquisition by
Euan Ltd.

At the year-end, all group companies declare a dividend of 10p per share. These dividends have
been accounted for correctly.

Euan Ltd's inventory figure includes £10,000 of inventory which had been bought from Mark Ltd.
Mark Ltd had paid £2,000 for these goods. Euan Ltd’s inventory figure also includes £15,000 of
inventory which has been bought from Nathan Ltd. Nathan Ltd had paid £5,000 for these goods.

Goodwill is to be capitalised. Impairment of £50,000 is seen against the value of the goodwill of
Mark Ltd in 2014.

(continued)

AC3091 Financial Reporting Page 2 of 8

Required

(a) Define a subsidiary and an associate company. Outline the differences in how such companies
are accounted for.
(5 marks)

(b) Prepare the group’s consolidated statement of financial position as at 31 December 2014.
(20 marks)

2. On 1 January 2014, Richard Ltd’s long-term budget showed anticipated net receipts of £20,000
for the current year and thereafter £34,000 each year for the foreseeable future. The company’s cost
of capital is 10% per annum and this is not expected to change.

During 2014, the following occurred:

i. General economic conditions suggest that the forward budget for existing activities after
2014 should be revised from £34,000 per annum to £28,500 per annum.

ii. A new three-year contract is undertaken which requires an initial outlay of £6,500 on 31
December 2014 and is expected to produce receipts of £3,400 on 31 December of each of
the following three years.

iii. The company is awarded a prize for its support of the local community and received £3,000
in 2014.

iv. The cost of capital was 10% for 2014 but is now expected to be 15% from 1 January 2015
for the foreseeable future.

Otherwise everything proceeds to plan and other expectations are unchanged. You may assume
that all cash flows arise on 31 December each year. Ignore taxation and inflation. The company
always pays a dividend equal to its income.

Required

(a) Compare and contrast the accountant versus economist’s approach to income and capital.
(9 marks)

(b) Calculate Hicks’ income number 1 ex post version A and Hicks’ income number 1 ex post
version B.
(8 marks)

(c) Calculate Hicks’ income number 2 ex post version A and Hicks’ income number 2 ex post
version B.
(8 marks)

AC3091 Financial Reporting Page 3 of 8

3. Boris Ltd started trading on 1 January 2014. The income statement for the year ended 31
December 2014 and the statement of financial position as at that date are as follows:

Statement of financial performance for the year ended 31 December 2014

£ £
Sales revenue 4,050,000
Less: Cost of sales
Opening inventories 225,000
Purchases 2,700,000
Closing inventories -270,000
2,655,000
Gross profit 1,395,000

Expenses 450,000
Depreciation 126,000
Net profit 819,000

Statement of financial position as at 31 December 2014

£
Non-current assets
Property, Plant & Equipment (PPE) 3,888,000
Inventories 270,000
Other net current assets 1,161,000
Net Assets 5,319,000

Share capital (£1 shares) 4,500,000

Retained profits 819,000
Equity 5,319,000

The price change indices for the year are identified as follows (RPI = retail price index):

RPI PPE Inventories

1 January 2014 200 200 250
30 June 2014 220 240 270
30 November 2014 230 260 280
31 December 2014 240 300 290

Required

(a) Define fully stabilised current value accounts and discuss their advantages and limitations.
(7 marks)

(b) Prepare a statement of financial performance for Boris Ltd for the year ended 31 December
2014 and a statement of financial position as at 31 December 2014 using current value
(replacement cost) accounting and using the financial capital maintenance concept. Base
depreciation on the year-end value of non-current assets.
(9 marks)
(continued)

AC3091 Financial Reporting Page 4 of 8

(c) Calculate the real realised and the real unrealised holding gains and losses on inventory and
non-current assets that would appear in a set of fully stabilised current value accounts, stabilised
in pounds (£) as at 31 December 2014. Where would these items be recorded on the financial
statements for 2014?
(9 marks)

4. Answer all four parts to this question. You can assume they are not connected.

a) Emerald PLC has the following projected information.

Year ended Profit before Capital Depreciation

31 December depreciation £ allowance £ £
2015 15,000 4,800 960
2016 14,400 960 1,920
2017 13,200 2,340 2,880
2018 12,000 6,720 1,920

The tax rate for the company is 33%. There is no deferred tax balance brought forward as at 1
January 2015.

Show the statement of financial performance and statement of financial position entries for deferred
tax for the years 2015 to 2018, under the flow-through and the full provision methods.

Also briefly state reasons in favour and against the provision of deferred taxation.
(10 marks)

b) Rohan Ltd entered into a long-term contract with the following information:

Date commenced 1 January 2014

Expected completion date 31 December 2017
Final contract price £ 2,000,000
Costs to 31 December 2014 £ 600,000
Value of work certified to 31 December 2014 £ 620,000
Progress payments invoiced to 31 December 2014 £ 110,000
Estimated costs to completion £ 500,000

Show how the long-term contract will be treated in the final accounts of Rohan Ltd for the year
ended 31 December 2014 in accordance with standard accounting practice. Justify your treatment in
each case with reference to accounting standards where applicable.
(5 marks)

c) Sian Ltd issued 1 million ordinary shares with nominal value of 10p for £2.50. A further issue of
bonus shares, in respect of all its shares, followed on a 1 for 5 basis. Before the share issue, Sian’s
share capital and reserves were as follows:

Ordinary share capital (nominal value 10p) £ 250,000

Ordinary share premium £ 750,000
Preference share capital £ 200,000
Retained profits £ 8,000,000

(continued)

AC3091 Financial Reporting Page 5 of 8

Show how the share issues will be treated in the final accounts of Sian Ltd for the year ended 31
December 2014 in accordance with standard accounting practice. Justify your treatment in each
case with reference to accounting standards where applicable.
(5 marks)

d) Two lawsuits have been filed against Polly Ltd during 2014. Polly Ltd is fighting both the lawsuits
and the outcomes of both lawsuits are uncertain. The directors of Polly Ltd consider that there is a
5% chance that they will lose lawsuit 1. If they do lose this lawsuit, the expected settlement will be
approximately £300,000. The directors consider that there is a 30% chance of losing lawsuit 2 and
the expected settlement if the lawsuit is lost is expected to be £900,000. Both lawsuits are
considered to be material by Polly Ltd.

Discuss the accounting treatment for these lawsuits in the 2014 financial statements.
(5 marks)

SECTION B

5.
Critically appraise both the traditional and economic arguments for and against accounting
regulation.

OR

Define deprival value and discuss the strengths and limitations of deprival value as the basis of
asset valuation in corporate financial reports.

(25 marks)

6.
Compare and contrast the different methods for translating the financial statements of foreign
subsidiaries. Discuss how the foreign exchange reserves arise under each method, how they should
be accounted for and the situations in which each of the methods should be used.

OR

Discuss the issues in accounting for goodwill and critically assess an accounting standard in this
area.

(25 marks)

- END -

AC3091 Financial Reporting Page 6 of 8

Present Value interest factor per £1.00 due at the end of n years for interest rate of:
% 1 2 3 4 5 6 7 8 9 10
n
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621
6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239
16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218
17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198
18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180
19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164
20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149
21 0.811 0.660 0.538 0.439 0.359 0.294 0.242 0.199 0.164 0.135
22 0.803 0.647 0.522 0.422 0.342 0.278 0.226 0.184 0.150 0.123
23 0.795 0.634 0.507 0.406 0.326 0.262 0.211 0.170 0.138 0.112
24 0.788 0.622 0.492 0.390 0.310 0.247 0.197 0.158 0.126 0.102
25 0.780 0.610 0.478 0.375 0.295 0.233 0.184 0.146 0.116 0.092

% 11 12 13 14 15 16 17 18 19 20
n
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065
16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054
17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045
18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038
19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031
20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026
21 0.112 0.093 0.077 0.064 0.053 0.044 0.037 0.031 0.026 0.022
22 0.101 0.083 0.068 0.056 0.046 0.038 0.032 0.026 0.022 0.018
23 0.091 0.074 0.060 0.049 0.040 0.033 0.027 0.022 0.018 0.015
24 0.082 0.066 0.053 0.043 0.035 0.028 0.023 0.019 0.015 0.013
25 0.074 0.059 0.047 0.038 0.030 0.024 0.020 0.016 0.013 0.010

AC3091 Financial Reporting Page 7 of 8

Present Value interest factor for an annuity of £1.00 for a series of n years for interest rate of :
% 1 2 3 4 5 6 7 8 9 10
n
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145
11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367
15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606
16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824
17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022
18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201
19 17.226 15.678 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365
20 18.046 16.351 14.877 13.590 12.462 11.470 10.594 9.818 9.129 8.514
21 18.857 17.011 15.415 14.029 12.821 11.764 10.836 10.017 9.292 8.649
22 19.660 17.658 15.937 14.451 13.163 12.042 11.061 10.201 9.442 8.772
23 20.456 18.292 16.444 14.857 13.489 12.303 11.272 10.371 9.580 8.883
24 21.243 18.914 16.936 15.247 13.799 12.550 11.469 10.529 9.707 8.985
25 22.023 19.523 17.413 15.622 14.094 12.783 11.654 10.675 9.823 9.077

% 11 12 13 14 15 16 17 18 19 20
n
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675
16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730
17 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775
18 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812
19 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843
20 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870
21 8.075 7.562 7.102 6.687 6.312 5.973 5.665 5.384 5.127 4.891
22 8.176 7.645 7.170 6.743 6.359 6.011 5.696 5.410 5.149 4.909
23 8.266 7.718 7.230 6.792 6.399 6.044 5.723 5.432 5.167 4.925
24 8.348 7.784 7.283 6.835 6.434 6.073 5.746 5.451 5.182 4.937
25 8.422 7.843 7.330 6.873 6.464 6.097 5.766 5.467 5.195 4.948

AC3091 Financial Reporting Page 8 of 8

 Statement of Financial Position as at 31 December 2014 Additional notes
Euan Ltd Mark Ltd Nathan Ltd 1 Jan 2010 £
£ £ £ Parent acquire 70% Subsidiary for 290,000
Non-current asset (land) 860,000 260,000 300,000 Subsidiary Share Cap & Reserves 190,000
Investments 380,000 Fair value non-current assets 280,000
Inventories 140,000 40,000 50,000 Historic cost non-current assets 260,000
Trade Receivables 8,000 30,000 60,000 No change to S/cap & Res
Dividend receivable from group companies 12,000
Inter-company loans receivable from Mark Ltd 90,000 1 Jan 2011 £
Inter-company loans receivable from Nathan Ltd 30,000 Parent acquire 25% Associate for 70,000
Cash 130,000 60,000 30,000 Associate Share Cap & Reserves 250,000
1,650,000 390,000 440,000 Fair value non-current assets 300,000
No change to S/cap & Res
Share capital (£1 nominal value) 600,000 100,000 200,000
Retained profits 260,000 210,000 160,000 Dividend £/share
Revaluation reserve 30,000 Parent 0.1
Trade payables 730,000 30,000 10,000 Subsidiary 0.1
Inter-company loans payable to Euan Ltd 40,000 20,000 Associate 0.1
Dividend payable 60,000 10,000 20,000
1,650,000 390,000 440,000 Inventory £
Sub to Parent 10,000
Parent P Subsidiary S Associate A Sub CoS 2,000
Assoc to Parent 15,000
Assoc CoS 5,000

Part B Goodwill impairment for 2014 £ 50000

(Pre-IAS28): Euan Group: Statement of Consolidated Financial Position as at 31 December 2014
£ Workings
Non-current asset (land) 1,140,000 P+S+Revaluation
Investments 20,000 Net investments at arms length remaining
Goodwill 100,500 see calculation below
Investment in Associate 95,000 P share of A Cap & Reserves
Inventories 172,000 P+S - Unrealised Profit
Trade Receivables 38,000 P+S
Dividend from Associate (Nathan) 5,000 P share of A div
Inter-company loans receivable from Nathan Ltd 30,000 Do not eliminate
Cash 240,000 Includes cash in transit for loan repayment from S to P
Net Assets 1,840,500

Share capital (£1 nominal value) 600,000 P only

Profit & Loss reserves 320,900 see calculation below
Non-controlling interests (NCI) 96,600 NCI share of Adj Capital & Reserves
Trade payables 760,000 P+S
Dividend payable 63,000 P + share of S div payable
Capital, Reserves & Liabilities 1,840,500

(Current - IAS28): Euan Group: Statement of Consolidated Financial Position as at 31 December 2014
£
Non-current asset (land) 1,140,000
Investments 20,000
Goodwill 93,000
Investment in Associate 102,500
Inventories 172,000
Trade Receivables 38,000
Dividend from Associate (Nathan) 5,000
Inter-company loans receivable from Nathan Ltd 30,000
Cash 240,000
Net Assets 1,840,500

Share capital (£1 nominal value) 600,000

Profit & Loss reserves 320,900
Non-controlling interests (NCI) 96,600
Trade payables 760,000
Dividend payable 63,000
Capital, Reserves & Liabilities 1,840,500

Goodwill
Subsidiary 143,000 Price paid - share of fair value net assets
Associate (Under IAS28, do not separate from Investment in Associate) 7,500
Impairment of Subsidiary -50,000
100,500

Reserves £ £ £
Profit & Loss 260,000 210,000 160,000
Provision for unrealised profit 8,000 10,000
Revised Profit & Loss 260,000 202,000 150,000
Share capital 600,000 100,000 200,000
Revaluation 20,000 30,000
Capital & Reserves 860,000 322,000 380,000

Retained Profits (Parent's share) Res. At start Res. At end £

Parent 260,000
Subsidiary 90,000 202,000 78,400
Associate 20,000 150,000 32,500
Impairment of Subsidiary -50,000
Total 320,900

Part A
Define subsidiary: company controlled through ownership >50% or operational control
Define associate: own 20-50% and exert significant influence but not control
Subsidiary: fully consolidated (line by line) but remove non-controlling portion
Associate: Equity method (i.e., single line consol) that only consolidate P's share of investment and profits
University of London: International Programmes

Singapore Institute of Management, Easter 2015

AC3091 Financial Reporting

Commentary on mock examination assessment and performance

By Dr Danny Chow and Professor Jim Haslam

Note: There are two parts to this commentary. This part deals with the general remarks and
comments on the essays. The second part (Excel Sheet) provides suggested solutions to the
numerical components of the assessment.

1
General remarks:

Key steps to improvement

Common mistakes and weaknesses

Advice on which particular skills and abilities the Examiners are looking for.

The exam paper contains six questions, four of which combine numerical and written
components and two of which are essay based. Each of the essay questions has a further
choice of two essays. The combined questions require candidates to prepare calculations on
a variety of topics as well as showing a critical grasp of the theories underlying the techniques.
To do well candidates need to be able both to explain and evaluate the theories and prepare a
range of financial statements and calculations.

For quantitative parts of questions, Examiners are looking for accurate preparation of financial
statements that follow generally accepted formats with clear headings and accurate
application of accounting techniques to specific areas within financial reporting. Workings
should always be provided clearly.

Written components of combined questions require clear and coherent explanations of

theories, techniques and practices and critical evaluation of theories and practices. Good
answers to essay-based questions will be structured coherently and logically, include an
introduction, a main body and conclusion and cover all parts of the essay question.

Typically an essay-based question will require an explanation of an issue within financial

reporting and a critical analysis of the issue. Explanations should be clear and include a
discussion of key definitions with examples if appropriate. The critical analysis should show
critical awareness of both sides of an argument or application of a theory or concept to
financial reporting with an assessment of its appropriateness to financial reporting.

Note that written components now can be as high as 40% of the overall examination mark, so
there has to be a significant refocusing of emphasis in students’ revision effort.

2
Question 1: Consolidation: Statement of Financial Position and Financial Performance

This question required the preparation of both a consolidated balance sheet and a
consolidated profit and loss account including calculations of goodwill, non-controlling interest,
share in associate and investments. It is important that in questions that involve many detailed
calculations candidates show clear workings for each of the figures and that the financial
statements are presented clearly.

Part A:
Euan Group: Statement of Consolidated Financial Position as at 31 December 2014
£
Non-current asset (land) 1,140,000
Investments 20,000
Goodwill 93,000
Investment in Associate 102,500
Inventories 172,000
Trade Receivables 38,000
Dividend from Associate (Nathan) 5,000
Inter-company loans receivable from Nathan Ltd 30,000
Cash 240,000
Net Assets 1,840,500

Share capital (£1 nominal value) 600,000

Profit & Loss reserves 320,900
Non-controlling interests (NCI) 96,600
Trade payables 760,000
Dividend payable 63,000
Capital, Reserves & Liabilities 1,840,500

Part B:
Define subsidiary: company controlled through ownership >50% or operational control
Define associate: own 20-50% and exert significant influence but not control
Subsidiary: fully consolidated (line by line) but remove non-controlling portion
Associate: Equity method (i.e., single line consolidation) that only consolidate Parent's share
of investment and profits

3
Question 2: Hicks’

This question required a clear explanation of the economists approach to income and capital
as proposed by Hicks and a clear explanation of the accountants approach to income and
capital. The two approaches needed to be compared and strengths and limitations of the
approaches could have been discussed.

A: Economists see no use for ex post income, only ex ante; but financial reporting relies on
transactions based info for stewardship

Stewardship requirements different from decision-making (forecasting)

No objective income measurement (including historical cost)

Income measurement based on changes in the value of recorded 'net assets' can only give a
partial picture of the changes in the value of the business as a whole

Income measures ex post not useful for management or shareholder's investment decisions,
but may have some use for management control (but these still are problematic)

Ex ante
Time t 0 1 2 3 4 5 onwards
Net cash flows 20,000 34000 34000 34000 34000 34000
Discount 1.000 0.909 0.826 0.751 0.683
DCF 20,000 30,909 28,099 25,545 23,222

Ex post
Time t 0 1 2 3 4 5 onwards
Revised cash flows 20,000 28500 28500 28500 28500 28500
New contract -6,500 3400 3400 3400
Grant (prize) 3,000
Net cash flow 16,500 31,900 31,900 31,900 28,500 28,500
Revised discount 1.000 0.870 0.756 0.658 0.572
DCF 16,500 27,739 24,121 20,975 16,295

Answers
d1t1 16,500
v1t1 197,763
v0t1 194,785
d1t0 20,000
v1t0 340,000
v0t0 327,273

Income ex ante d1t0 + v1t0 - v0t0 32,727

or r0*v0t0 32,727

Income ex-post 1A d1t1 + v1t1 - v0t0 -113,010

Income ex-post 1B d1t1 + v1t1 - v0t1 19,478

Income ex-post 2A d1t1 + v1t1 - ex ante income/r1 -3,919

Income ex-post 2B v0t1*r1t1*(1+r0t1) / (1+r1t1) 27,947

4
Question 3: Fully Stabilized Current Value Accounting

This question covers both a discussion of fully stabilised current value accounts and the
preparation of current value financial statements and calculations for key components of fully
stabilised financial statements. Candidates should attempt both parts of the question and
answer all the questions set. For the calculations, it is important that candidates show detailed
workings of how they arrive at their answer.

Part A
For the discussion of fully stabilised current value financial statements, it is important that
candidates discuss all parts of the question, provide clear explanations and examples and
assess both the advantages and limitations of the concept in a discursive style. Bullet points
should be avoided if possible.

Part B
Statement of financial performance for the year ended 31 December 2014
£ £ Index
Sales revenue 4,050,000 4,050,000
Less: Cost of sales
Opening inventories 225,000 1.08 243,000
Purchases 2,700,000 2,700,000
Closing inventories -270,000 0.96 -260,357
2,655,000 2,682,643
Gross profit 1,395,000 1,367,357

Expenses 450,000 450,000

Depreciation 126,000 1.50 189,000
Net profit 728,357

Non-current asset: Unrealised 1,944,000

Inventory: Unrealised 9,643
Non-current asset: Realised 63,000
Inventory: Realised 27,643
Retained profit 819,000 2,772,643

Statement of financial position as at 31 December 2014

£ Index
Non-current assets
Property, Plant & Equipment (PPE) 3,888,000 1.50 5,832,000
Inventories 270,000 1.04 279,643
Other net current assets 1,161,000 1,161,000
Net Assets 5,319,000 7,272,643

Share capital (£1 shares) 4,500,000 4,500,000

Retained profits 819,000 2,772,643
Equity 5,319,000 7,272,643

5
Question 3 (continued)

Part C

FSCVA CPP
Non-current asset: Real Unrealised 5,832,000 4,665,600 1,166,400
CVA*CPP HCA*CPP

Inventory: Real Unrealised 279,643 281,739 -2,096

CVA*CPP HCA*CPP

Non-current asset: Real Realised 189,000 151,200 37,800

CVA*CPP HCA*CPP
Note: in the above three calculations, CPP=1 for FSCVA as the CVA are all stated at year end values

Inventory: Real Realised - Method A 2,926,519 2,896,364 30,156

Note: This method assumes we only a single Cost of Sales total and not
individual
constituents (i.e., opening & closing inventory; purchases) making up Cost of
Sales

Inventory Real Realised - Method B 2,926,519 2,933,715 -7,196

Note: We calculate CPP for each constituent figure in the Cost of Sales, and the sum of these
gives the CPP Cost of Sales; We choose this method if we have all the detailed information provided

Inventory Real Realised - Method C 2,926,519 2,920,909 5,610

Strictly speaking if the average (30 June RPI) is affected by the removal of closing inventory
we have to use 30June RPI for closing inventory instead of 30Nov RPI

Holding gains (NCA & Inventories, real realised and real unrealised) all in the Statement of Financial Performance

6
Question 4: Mixed set of shorter questions

Part A:
Flow through 2015 2016 2017 2018
Profit 15,000 14,400 13,200 12,000
Capital Allow. 4,800 960 2,340 6,720
Taxable profit 10,200 13,440 10,860 5,280

Tax at 33% 3,366 4,435 3,584 1,742

Deferred tax 0 0 0 0

Full provision 2015 2016 2017 2018

Capital Allow. 4800 960 2340 6720
Depreciation 960 1,920 2,880 1,920
CA less Dep. 3,840 -960 -540 4,800
Deferred tax 1,267 -317 -178 1,584

Tax at 33% 3,366 4,435 3,584 1,742

Def. tax P&L 1,267 -317 -178 1,584
Def. tax B/S 1,267 950 772 2,356

For deferred tax:

Entity is a going concern so will continue to pay tax
Tax is a business expense; so treat it like any other cost
Apply accruals/matching concept and make it a provision
It is also prudent to recognise this future liability

Against deferred tax:

Tax is not related to the accounting profit but charged to taxable profit so matching does not
apply
Deferred tax approaches are attempts to equalise income over time, but income is not smooth
over time in reality
Tax is not an expense as such (but is not voluntary either)
Deferred tax is only a liability when it becomes due
The actual tax charge is objective and is the best way of judging management's success at
organising tax affairs

Part C:
After issue of New shares
Ordinary share capital (nominal value 10p) £ 350,000
Ordinary share premium £ 3,150,000
Preference share capital £ 200,000
Retained profits £ 8,000,000

After issue of Bonus shares

Ordinary share capital (nominal value 10p) £ 420,000
Ordinary share premium £ 3,080,000
Preference share capital £ 200,000
Retained profits £ 8,000,000

7
Question 4 (continued):

Part B:
Date commenced 1 January 2014
31 December
Expected completion date 2017
Final contract price £ 2,000,000
Costs to 31 December 2014 £ 600,000
Value of work certified to 31 December 2014 £ 620,000
Progress payments invoiced to 31 December 2014 £ 110,000
Estimated costs to completion £ 500,000

Expected profit 900,000

Sales 620,000
Cost of Sales 341,000
Attributable profit (% work completed basis) 279,000

Balance Sheet: Long term contracts 259,000

Balance Sheet: Receivables (amounts recoverable on LT contract) 510,000

Part D:
Likelihood of outcome Approx Prob Accounting treatment
A provision is recognised.
Virtually certain 95% Disclosures
are required for the provision: that
is,
Probably 50-95% this is NOT a contingent liability
No provision recognised.
Possible but not probable 5-50% Disclosures
are required for the contingent liab.
Remote <5% No provision is recognised and no
disclosure is required

Definition: IAS37 contingent liabilities

A possible obligation arising from past events whose existence will be confirmed only by the
occurrence of one or more uncertain future events not wholly within the entity's control or

A present obligation that arises from past events but is not recognised because:
i) it is not probably that an outflow of resource embodying economic benefits will be required
to settle the obligation, or
ii) the amount of the obligation cannot be measured with sufficient reliability

Lawsuit 1: Disclose but do not create provision

Lawsuit 2: Disclose but do not create provision

8
Question 5(a):

OUTLINE SUGGESTED ANSWER

Central in the idea here is the debate over what constitutes ‘stewardship’ versus ‘decision-
making’ as an objective of financial reporting. Hicks’ clearly takes on the decision-making
perspective, where reliability is less of an issue or focus compared with relevance. Students
can therefore bring in the reliability versus relevance debate, first explaining the battle lines
before proceeding to:

Distinguish between traditional and economic e.g. traditional arguments are those
conventionally made by the profession; economic arguments (of varying sophistication) are
academic arguments relying on economics of information/public goods/externalities/imperfect
markets (distinction can be made notwithstanding that traditional arguments are basically
economistic in nature)

Some traditional arguments for: can help improve reports in terms of quality and uniformity,
improving comparability and decisions, force weaker accountants to improve their work,
provide a defence for accountants in court, enhance credibility of accounting

Some traditional arguments against: regulation is costly and bureaucratic; standards are only
suitable for average firm; encourages rule following rather than application of principles;
regulations may be arrived at by consensus and compromise; danger of reducing professional
judgement; may create false sense of security.

Some economic arguments for: benefits outweigh costs; weak accounting has been
evidenced without regulation beyond market; to avoid uneven possession of information
among investors; public good/externalities; information asymmetry and manager incentives;
market processes not speedy enough

Some economic arguments against: there is no need for regulation beyond market processes
either because the market is perfect or near-perfect or functions so that demand and supply
and competition work to effectively ‘regulate’ accounting, similarly there is a market for
managers and possibly ‘contracting’ in the market could work; regulation beyond the market
could distort market processes and users would overstate demands; costs outweigh benefits
[also the view that regulation needs to be balanced – a degree of confidentiality/secrecy
required – so that incentives maintained for R&D, so that monopolistic practice discouraged;
possible usage of game theory to get insights]

9
Question 5(b):

OUTLINE SUGGESTED ANSWER

Central in the idea here is the debate over what constitutes ‘stewardship’ versus ‘decision-
making’ as an objective of financial reporting. Deprival value clearly takes on the decision-
making perspective, and whilst it is not something that is currently in use, nevertheless there
are parallels with contemporary debates over the move from modified historical cost models
towards fair values (with Current Purchasing Power briefly experimented on in between – e.g.,
UK in the 1980s with high inflation). Students should therefore expand on this debate by first
considering definitions of what deprival value is, followed by an evaluation of its constituent
components (PV, NRV, RC etc.)

----

Deprival value is derived as an insurance concept (Bonbright in the 1930s writes it up but you
could trace similar ideas to C18th insurance practice) – if the asset (or asset bundle) is lost
(one is deprived of the asset or asset bundle) how much financial compensation would be
needed? Calculation depends upon an appreciation of economic value if in practice deprival
value usually equals replacement cost.

Consider the case of an asset. If one has an asset one can either sell it or use it. The
economic value of selling it would be the present value derived from sale, which can be very
closely approximated by net realisable value. The economic value from use is the present
value of usage. Normally (assuming rational economic practice justifying having and using the
asset at that point) the latter will be the greater value. But if one is deprived of the asset one
would only replace the asset if the higher of the economic value from sale or use is greater
than replacement cost. Normally, again, this would be the case, so that one can be restored
financially to the status quo ex ante with the replacement cost of the asset, which thus
becomes the deprival value.

Formula: DV is the lower of (i) RC and (ii) the higher of NRV (or strictly the PV from sale) and
PV from use. Bonus marks for approach discussed from p. 96.

Evaluation:
- Up to date value
- Can better link accounts to policy and plans
- Predictive value
- If revenues greater than the amount necessary to justify replacement (i.e. most of the
time), deprival values will be RC and no longer measure the PV of future cash flows (so
inconsistent at this point with Hicks)
- Subjectivity
- DV issue of non-additivity (what does it mean to add RC to PV in use to NRV?)
- May be interdependence problems when assets work as part of a team (the sum of RC
of individual assets may be greater than the RC of total business and/or PV (in use) of total
business; the sum of PV of individual assets may be greater than the PV (in use) of total
business
- Does concept of DV have meaning for all assets e.g. development expenditure?
- Is idea of replacement always appropriate?

10
Question 6(a):
Comments:

Below are some of the key ideas behind the Foreign Currency discussions, which we have
summarised from the discussions we have had in class.

OUTLINE SUGGESTED ANSWER

Conceptual differences in treatment of exchange

Closing rate: differences treated as reserves on balance sheet
Temporal rate: differences treated as part of profits on balance sheet

Closing rate method

Used when the foreign enterprises are quasi-independent entities. The key determinant
appears to be whether or not the foreign enterprise operates primarily in the functional
currency.
If this is the case, the closing rate method applies. This would be true for most foreign
business operations (typically subsidiaries).
Temporal method
If the functional currency is that of the investing company rather than the foreign enterprise,
the temporal method should be used.
Hence the temporal method is to be used where the trade of the foreign enterprise is more
dependent on the economic environment of the investing company's currency than that of its
own reporting currency.
By using the method, the consolidated accounts reflect the transactions of the foreign
enterprise as if they had been carried out by the investing company itself.

While in principle choice may reflect the complexity involved, the particular choice available in
the standard may be questioned.
If a foreign enterprise is quasi-independent should it be treated as a subsidiary, associate or
branch?
The key point in practice is whether the enterprise operates primarily in the local functional
currency. Why is the CR method then more appropriate?
Treatment of exchange differences under IAS 21: somewhat crude?
A more sophisticated approach might take the gain or loss on short-term monetary items to
the income statement? Do they not cast light on actual/prospective cash flow? (see the
treatment in SSAP 20).

Appropriateness of choice of standards is dependent on whether Foreign Currency is an

ordinary part of business and therefore to be included in the profit and loss calculations, or to
be treated as reserves.
This means that judgement is involved on what is the functional currency
But the flexibility is also a strength to avoid volatility of profits that may distort the picture of
ordinary activities.

11
Question 6(b):

Discuss the issues in accounting for goodwill and critically assess an accounting standard in
this area

OUTLINE SUGGESTED ANSWER

The abstract idea of goodwill at a limit is an intangible aggregated construct of intangible

values so that the value of the firm less the aggregate of the separable values of the net
assets is equal to the goodwill.

A recognised variant of the notion of goodwill in accounting, sometimes referred to as

purchased goodwill, arises in group accounts, most typically in the case of consolidation,
when one company acquires another to give rise to a goodwill figure, as follows. The
difference between the purchase consideration and the fair value of the net assets acquired,
whether it is positive or negative, has to be accounted for in consolidation and this difference
is referred to as goodwill. Once this goodwill has arisen the question arises as to its
subsequent treatment in consolidated accounts – Should it be written off immediately or
amortised (and if so how?)? Should it be re-assessed every consolidation and if so how?

Under IFRS 3, any difference between the cost of the business combination and the acquirer’s
interest in the net fair value of the identifiable assets, liabilities and contingent liabilities
recognized shall be accounted for as goodwill.

Goodwill acquired in a business combination represents a payment made by the acquirer in

anticipation of future economic benefits from assets that are not capable of being individually
identified and separately recognized.

Not amortised; test for impairment annually (or more frequently if events/change in
circumstances point to this, see IAS 36, impairment of assets).

Issues include: incoherence – only realized (purchased) goodwill accounted for; different
categories of A/L in consolidated accounts treated differently; conservative valuation bias
(only impairment accounted for); high subjectivity in impairment assessment; reliability of
measurement high in case of purchased goodwill but is one really measuring ‘goodwill’?

12