SECTION A – CASE QUESTIONS (Total: 50 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.

CASE

Assume that you are Mr. John Chan, the accounting manager of Global Resources Limited
(GRL), which is a company incorporated in Hong Kong and listed in the Growth Enterprise
Market of The Stock Exchange of Hong Kong Limited. GRL and its subsidiaries (GRL Group)
are principally engaged in the natural resources business in the People's Republic of
Bangladesh; and the provision of medical equipment services and related accessories, and
the provision of medical research and development services in mainland China. Now, GRL
intends to disinvest its investment in the medical research and development business.

Asia Medical Research Limited (AMR)

On 1 April 2008, GRL acquired 600,000 of the 1,000,000 ordinary shares issued by Asia
Medical Research Limited (AMR) for $7.5 million in cash. On that date, the fair value of the
net identifiable assets of AMR was the same as their carrying amount, and the share capital
and retained earnings of AMR were $1 million and $9 million respectively with no other
components of equity. GRL is entitled to appoint three out of the five directors on the board.
All board decisions are made by simple majority resolution. On 1 April 2011, AMR issued
500,000 shares to a new investor, Simon Firth Limited (SFL), for $8 million. As a result,
GRL’s shareholdings in AMR decreased to 40%. In addition, SFL has the right to appoint
two new directors to the board making a total of seven directors on the board. The fair value
of GRL’s investment in AMR was valued at $9.6 million on 1 April 2011.

China Development Services Limited (CDS)

On 1 April 2010, GRL acquired 2,640,000 ordinary shares in China Development Services
Limited (CDS) for $12 million in cash. Thus GRL owns 2,640,000 out of the 4,000,000
shares of CDS, giving it a 66% interest. On 1 April 2011, CDS issued 400,000 shares to a
new investor, Michael Sun Limited (MSL), for $5.5 million. As a result, GRL’s shareholdings
in CDS decreased to 60%. The carrying amount of CDS’s net identifiable assets in the
consolidated financial statements of GRL, as at 31 March 2011, was $12.9 million.

Other relevant information:

(i) At the date of acquisition, the fair values of CDS’s assets were equal to their carrying
amounts with the exception that the fair value of CDS’s inventory was $500,000 below
its carrying amount; and it was written down by this amount shortly after acquisition as
impairment loss and it has not changed in its fair value since then.

(ii) On 2 April 2010, GRL sold an item of plant to CDS at $2.5 million. Its carrying amount
prior to the sale was $2 million. The estimated remaining useful life of the plant at the
date of sale was five years. GRL, AMR and CDS depreciate their property, plant and
equipment using the straight-line method.
Module A (December 2011 Session) Page 1 of 7
(iii) There were no intra-group payables or receivables at 31 March 2011. No dividends
were paid during the year by any of the said companies.

(iv) It is the group’s policy to measure non-controlling interests at its proportionate share of
the subsidiary’s net identifiable assets at the acquisition date. Goodwill arising from
the acquisition of AMR and CDS has not subsequently been impaired. For the assets
of both AMR and CDS, no gain or loss has been previously recognised in other
comprehensive income.

Ms. Linda Ho, a director of GRL is concerned about the implications of the above transactions
and information. She wondered if it may result in any gain or loss to be recognised and if it
may make any difference in the consolidation process.

The draft statements of financial position of the companies at 31 March 2011 are:

GRL AMR CDS Total

$’000 $’000 $’000 $’000
ASSETS
Non-current assets
Property, plant and equipment 18,400 9,000 10,400 37,800
Investment in AMR 7,500 - - 7,500
Investment in CDS 12,000 - - 12,000
Current assets
Inventory 5,900 3,000 4,200 13,100
Accounts receivable 2,200 2,000 1,500 5,700
Cash 1,000 1,000 2,000 4,000
47,000 15,000 18,100 80,100

EQUITY AND LIABILITIES

Share capital of $1 each 19,000 1,000 4,000 24,000
Retained earnings
At 31 March 2010 16,000 10,000 6,500 32,500
For the year ended 31 March 2011 8,000 1,000 2,400 11,400
43,000 12,000 12,900 67,900
Non-current liability
Debenture - 2,000 1,000 3,000
Current liability
Accounts payable 4,000 1,000 4,200 9,200
47,000 15,000 18,100 80,100

Module A (December 2011 Session) Page 2 of 7

Question 1 (50 marks – approximately 90 minutes)

Assume that you are John Chan, the accounting manager, and you are required to draft a
memorandum to Ms. Linda Ho, a Director of GRL. In your memorandum, you should:

(a) discuss and advise, with calculations, the accounting treatments for the
investment in AMR in the consolidated financial statements of GRL on
1 April 2011;
(14 marks)

(b) discuss and advise, with calculations, the accounting treatments for the
investment in CDS in the consolidated financial statements of GRL on
1 April 2011; and
(10 marks)

(c) prepare an annex to your memorandum showing worksheets for the

consolidated statement of financial position of GRL as at 1 April 2011 after
considering the transactions and other information. Ignore the deferred tax
implications.
(26 marks)

(Consolidation adjustments are to be shown in the form of a worksheet. You have to

show the detailed calculations of each figure, but journal entries are not required.)

* * * * * * * *

Module A (December 2011 Session) Page 3 of 7

End of Section A
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 (17 marks – approximately 31 minutes)

(a) Paper Box Limited (PBL) is a manufacturer of paper-based packaging products. Due
to insufficient production capacity to meet the market demand for its products, PBL
leased two new printing machines from United Machinery Corporation (UMC) for a fixed
term of four years. Monthly rental for the two machines is $200,000 for the first year
and then increased by $10,000 annually. The lease is non-cancellable and there are
no rights to extend the lease term or purchase the machines at the end of the term.
The machines are required to be returned to UMC upon expiry of the lease term. UMC
sells similar machines at a price of $12,000,000 per unit and the estimate useful life of
the each machine is 10 years.

Required:

Discuss PBL’s accounting treatment of the lease arrangement with UMC.

(5 marks)

(b) PBL has three other printing machines which have been used for four years and their
estimated useful life is ten years. The carrying amount and the estimated fair value of
the machines are $15,000,000 and $18,000,000 respectively on 1 October 2011. On
the same date, PBL entered into an agreement with Easy Finance Limited (EFL) to sell
the three machines at $17,000,000 and lease them back for 5 years with an annual
future lease payment of $4,500,000. At the end of the lease term, PBL has an option
to buy the machines from EFL at $50,000.

Required:

“As PBL has sold the machines to EFL, no amount should be reflected in the balance of
plant and equipment on the statement of financial position of PBL” according to PBL’s
Chief Operating Officer.

(i) Do you agree with the Chief Operating Officer? Explain PBL’s accounting
treatment for the lease arrangement with EFL. (Discount rate of 8% is used,
if applicable)
(8 marks)

(ii) Discuss the impact on the accounting treatment of PBL of shortening the
lease term to 3 years with an annual future lease payment of $4,000,000 and
cancellation of PBL’s options to buy the machines from EFL.
(4 marks)

Module A (December 2011 Session) Page 5 of 7

Question 3 (18 marks – approximately 32 minutes)

York Marble Limited (YM) has operated a tile manufacturing plant in the city center for more
than 15 years. Due to a recent change in government policy on environmental protection
and city development, YM was ordered to close the production plant by the end of September
2011 and return the leasehold land to the government early at a consideration based on the
market price of land with a similar remaining lease term and location.

As at 31 May 2011, YM had the following assets related to the production plant:

$ million
Buildings and infrastructure 23.8
Production equipment 48.0
Electricity generator 5.2
Land under operating lease up to 2024 13.0
Inventories – Raw materials 8.4
Inventories – Finished products 6.4

According to the original lease term, YM is required to dismantle the buildings and
infrastructure before returning the bare land to the government. Previously, the company
has recognised a provision for the dismantling to be carried out by the end of the lease term
of the land in the cost of these assets. The carrying amount of the provision at 31 May 2011
is $1.5 million. Based on a quotation from a contractor, it costs $3 million for this exercise to
be carried out by September 2011.

All production equipment will be relocated to another manufacturing plant of YM 60 km away

for continuing usage. The relocation and installation costs are estimated to be $4 million.
YM agreed to sell the electricity generator to another company at $4 million. The relocation
cost will be borne by the buyer.

Although the final consideration of the leasehold land to be paid by the government has yet to
be determined, the government has indicated to YM that the amount would be not less than
$35 million.

YM will continue manufacturing until the end of August and it is expected that all the raw
materials will be consumed for the production of tiles and sold at a profit. Half of the finished
products were made to order with a gross profit of 20% and delivered to customers in early
June 2011. The remaining half is obsolete and old model items which could only be sold at
40% of the cost.

Required:

Discuss the accounting treatment under Hong Kong Financial Reporting Standards
that should be adopted by YM for each individual asset as at 31 May 2011.
(18 marks)

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Question 4 (15 marks – approximately 27 minutes)

Marsh Global Limited (MG) is a company listed on The Stock Exchange of Hong Kong
Limited with an issued capital of 1,000 million ordinary shares of $1 par. The board of
directors is considering the funding needs to finance the expansion of its businesses in
mainland China, and two options are under discussion:

Option 1: A rights issue of 200 million ordinary shares at $5 per rights share.

Option 2: A four-year convertible bond of $1,000 million with semi-annual interest of 2%

payable on 1 April and 1 October. Every $8 bond can be converted into
1 ordinary share of MG from 1 July 2012 until 31 December 2015, the redemption
date of the convertible bond.

The relevant fund raising exercise is planned to be completed by the end of December 2011.

Required:

You are the chief financial officer of MG and you are requested by the board of directors to
prepare an analysis of the impact of these two options on:

(a) the financial position of MG as at 31 December 2011.

(5 marks)

(b) the earnings per share of MG for the year ending 31 December 2012, assuming (i)
the estimated profit before finance expenses is $800 million, and (ii) the funds
raised and the expansion of business in mainland China will only affect the
earnings of MG from 2013 ; and
(6 marks)

(c) the disclosure of financial risks under HKFRS 7.

(4 marks)

(Assume MG’s bank borrowings are carried at an interest rate of 2.5% semi-annually and
ignore the tax effect)

* * * END OF EXAMINATION PAPER * * *

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