Financial Reporting (FR)

Solution Pack

Sr. ACCA Exam

Question Syllabus Area Covered
No. Paper
1 Bun Co Sep/Dec 2019 Analysing and interpreting the financial statements
2 Runner Co Sep/Dec 2019 Preparation of consolidated financial statements
3 Pirlo Mar/Jun 2019 Analysing and interpreting the financial statements
4 Vernon Mar/Jun 2019 Preparation of single entity financial statements
5 Perkins Mar/Jun 2018 Analysing and interpreting the financial statements
6 Haverford Mar/Jun 2018 Preparation of single entity financial statements
7 Duke Mar/Jun 2018 Preparation of consolidated financial statements
8 Duggan Mar/Jun 2018 Preparation of single entity financial statements
9 Yogi Jun 2015 Analysing and interpreting the financial statements
10 Cyclip Jun 2015 Preparation of consolidated financial statements
11 Xpand Dec 2014 Analysing and interpreting the financial statements
12 Quincy Dec 2014 Preparation of single entity financial statements
13 Plastik Dec 2014 Preparation of consolidated financial statements
14 Enca Jun 2014 Tangible non-current assets
15 Skeptic Jun 2014 Accounting for transactions in financial statements
16 Woodbank Jun 2014 Analysing and interpreting the financial statements
17 X-tol Jun 2014 Preparing single entity financial statements
18 Penketh Jun 2014 Preparation of consolidated financial statements
19 Polestar Dec 2013 Preparation of consolidated financial statements
20 Kingdom Dec 2013 Statement of cash flows
21 Speculate Jun 2013 Tangible non-current assets
22 Pulsar Jun 2013 Reporting financial performance
23 Monty Jun 2013 Preparation of single entity financial statements
Tangible non-current assets and events after the reporting
24 Shawler Dec 2012
period
25 Viagem Dec 2012 Preparation of consolidated financial statements
Learning
26 N/A Preparing single entity financial statements
Co
 Bun Co

Part (a)
Inventory adjustment

The disposal of the inventory at a discounted price would be classified as an adjusting event in accordance
with IAS 10.

Retail price of the inventory = $1.5 million; GP margin 20% = $0·3 million
Closing inventory (currently credited to SOPL) = $1.2 million

Impact on profit or loss:

Cost of sales will increase by ($1.2 x 50% =) $0.6m to (70m + 0.6m =) $70·6 million.
Profit from operations will reduce to (13.16m – 0.6m =) $12.56 million.

Impact on financial position:

Inventory is written down to (3.96m – 0.6m =) $3.36 million
Equity will be reduced to (32.88m – 0.6m =) $32·28 million

Ratios

Ratio Workings Buns Co Sector average

Return on year-end capital employed 12,560/(32,280 + 14,400) x 100 26·9% 18·6%
Operating profit margin 12,560/100,800 x 100% 12·5% 8·6%
Inventory holding period days 3,360/70,600 x 365 17·4 days 4 days
Debt to equity (debt/equity) 14,400/32,280 x 100 44·6% 80%
2·01
Asset turnover 100,800/46,680 2·16

Part (b)
Analysis of financial performance

Profitability
The primary measure of profitability is the return on capital employed (ROCE) and this shows that Buns
Co (26·9%) is outperforming the sector (18·6%). The ROCE measures the operating profit relative to the
equity employed in the business. As a percentage, it would appear that Buns Co is 31% ((26·9 –
18·6)/26·9) more efficient that its competitors.

However, Bun Co’s capital employed includes its revaluation surplus. If Buns Co’s competitors did not
revalue their property, then the ratio is not directly comparable. Removing the impact of revaluation surplus
would increase ROCE to be even higher than the sector average.

There is little difference between the asset turnover of Buns Co and that of the sector, it would appear that
the main cause of ROCE over-performance is due to a significantly higher operating profit margin (12·5%
compared to 8·6%).

Offering meal deals is advisable, as the company can still afford to reduce its prices and still make a high
operating profit margin compared to the industry sector average. By offering meal deals at reduced prices,
Buns Co would look to increase their sales volume and therefore this may help them to control and reduce
inventory days.

Alternatively, it may be that Buns Co has better control over its costs (either direct or indirect costs or both)
than its competitors; for example, Buns Co may have lower operating costs.
Inventory
Buns Co is taking significantly longer than its competitors to sell its inventory which is being held on
average for 17 days instead of 4 days as per the sector average. The main worry is that the inventory is
largely perishable.

Gearing
Buns Co’s debt to equity at 44·6% is lower than the sector average of 80%. This could be because Buns
Co acquired its property which has no associate finance.

There is a bank loan of $14·4m and, although the bank loan interest rate of 10% might appear quite high,
it is lower than the ROCE of 26·9% (which means shareholders are benefiting from the borrowings).

Buns Co also has sufficient tangible non-current assets to give more than adequate security on any future
borrowings. Therefore there appears to be no adverse issues in relation to gearing.

Conclusion
Buns Co is right to be concerned about its declining profitability compared to previous years, but from the
analysis compared to the industry sector averages, it seems that Buns Co may be in a strong position.

The information shows that Buns Co has a much better profitability compared to the industry, but the
worrying issue is holding inventory (working capital management).

Buns Co should seriously consider the strategy of reducing their prices to enable them to sell more
inventory and reduce wastage.

Should Buns Co wish to raise finance in the future, it seems to be in a strong position to do so.

Part (c)
 It is unlikely that all the companies which have been included in the sector averages will use the
same accounting policies. In the example of Buns Co, it is apparent that it has revalued its property;
this will increase its capital employed and (probably) lower its gearing (compared to if it did not
revalue).

 There could also be differences as Buns Co owns the shop, and yet other companies in the sector
may not own the freehold and may just rent the shop space. Dependent on how the depreciation
compares to the equivalent rate would lead to differences in the profits.

 The accounting dates may not be the same for all the companies.

 If the sector is exposed to seasonal trading (which could be likely if there are cakes made for
Christmas orders, large bread orders for Christmas and New Year parties), this could have a
significant impact on working capital based ratios.

 It may be that the definitions of the ratios have not been consistent across all the companies
included in the sector averages (and for Buns Co). This may be a particular problem with ratios
like gearing.

 Sector averages are just that: averages. Many of the companies included in the sector may not be
a good match to the type of business and strategy of Buns Co. This company not only has bakery
stores but cafés too and this may cause distortions if comparing to companies within the sector
who do not have the same facilities.
 Runner Co

Part (a)
Runner Co consolidated statement of financial position as at 31 March 20X5

$’000 $’000
Assets
Non-current assets
Property plant and equipment (455,800 + 44,700+ 9,000 (w1)) 509,500
Investment 12,500
Goodwill (w2) 20,446
–––––––––
542,446
Current assets
Inventory (22,000 + 16,000 – 720 (w4)) 37,280
Trade receivables (35,300 + 9,000 – 3,000 – 3,400) 37,900
Bank (2,800 + 1,500 + 3,000) 7,300 82,480
––––––– –––––––––
Total assets 624,926
–––––––––
Equity and liabilities
Equity attributable to the owners of the parent
Equity shares of $1 each 202,500
Retained earnings (w5) 290,950
–––––––––
493,450
Non-controlling interest (w3) 14,476
–––––––––
Total equity 507,926
Current liabilities (81,800 + 17,600 – 3,400) 96,000
Deferred consideration (19,446 + 1,554) 21,000 117,000
––––––– –––––––––
Total equity and liabilities 624,926
–––––––––

Workings
(1) Net assets of Jogger Co
Year-end Aquisition Post-aquisition
$’000 $’000 $’000
Share capital 25,000 25,000 0
Retained earnings 28,600 19,500 9,100
Fair value adjustment 9,000 10,000 (1,000)
Unrealised profit (720) 0 (720)
––––––– ––––––– ––––––
61,880 54,500 7,380
––––––– ––––––– ––––––
(2) Goodwill in Jogger Co
$’000 $’000
Cost of investment:
Cash 42,500
Deferred consideration (21,000 x 0·926) 19,446 61,946
–––––––
Non-controlling interest 13,000
–––––––
74,946
Less: Net assets acquired (w1) (54,500)
–––––––
Goodwill 20,446
–––––––

(3) Non-controlling interest

$’000
NCI at acquisition 13,000
NCI share of post-acquisition reserves (7,380 x 20%) 1,476
–––––––
14,476
–––––––

(4) Intercompany transaction

$’000
Inventory held at year end 4,800
Unrealised profit (4,800 x 15%) 720

(5) Retained earnings

$’000
Runner Co 286,600
Runner Co’s share of Jogger Co’s post-acquisition RE (7,380 (w1) x 80%) 5,904
Unwinding discount on deferred consideration (21,000 – 19,446 (w1)) (1,554)
––––––––
290,950
––––––––

Part (b)
Runner Co has significant influence over Walker Co, therefore Walker Co should be treated as an
associate in the consolidated financial statements, using the equity method.

In the consolidated statement of financial position, the interest in the associate should be presented as
‘investment in associate’ as a single line under non-current assets.

The associate should initially be recognised at cost and subsequently adjusted each period for the parent’s
share of the post-acquisition change in net assets (retained earnings).

This figure should be reviewed for impairment at each year end.

Calculation:
$’000
Cost of investment 13,000
Share of post-acquisition change in net assets ((30,000 x 30%) = 9,000) (9,000)
–––––––
4,000
–––––––
 Pirlo

Part (a)

(i) Extract from the Financial Statement of Pirlo.

Consideration received 300,000

Investment at cost (210,000)
Gain on Disposal 90,000

(ii) Consolidated Financial Statements of the Pirlo Group.

Consideration received 300,000

- Goodwill (70,000)
- Net Assets (310,000)
+ NCI 66,000

Loss on the disposal (14,000)

Part (b)

Key Ratios

20X9 20X8

Gross Profit Margin 45.8% 44.9%

(97,860 / 213,480) x 100 (97,310 / 216,820) x 100

Operating Margin 11.9% 13.5%

(25,500 / 213,480) x 100 (28,170 / 216,820) x 100

Interest Cover 1.43 1.8

(25,500 / 17,800) (29,170 / 16,200)

Part (c)

Comment on the Performance:

The revenue of Pirlo group has declined over the past 12 months. The scenario in the question presents
a situation wherein the revenue for the Samba Co has stayed the same in both years. The performance
shown appears to show a decline from the remaining companies in the group.

There was an improvement in 20X9 in the operating profit margin of the group. The performance has
increased from 44.9% to 45.8%. Furthermore there has been an increase in the gross profit margin in
relation to the rest of the group. This furthermore suggests that the other companies in the Prilo group is
operating at a lower gross profit margin.

There has been a decrease in the operating profit margin for the group. This has decreased from 13.5%
down to 11.9%. The operating profit on the other hand has increased which is surprising at first. Two major
changes in the last year may help to account for this:
 - The company recorded a $2M profit on the sale of properties. This is likely to be a one off
income and not likely to be repeated annually.
- Samba Co was also charged a lower rate of rent which may not continue into the future.

There is a concern as well when the profit from the associate is considered. The share of profit from the
associate is $4.6M and this represents 40% of the profit for the year.

There are concerns for the overall profitability of the Pirlo group as they appear to be loss making overall
and this would bring into question the future going concern of the group unless financial performance can
improve.

There appears to be a reduction in the interest cover. This is been driven by the decrease in profit from
Operations and there has also been an increase in finance costs. The reduction in the interest cover raises
further concerns for the future of the company unless performances improve or the finance costs can be
lowered.

The decision to get rid of Samba Co is a little worrying as the company was generating strong financial
concerns. This raises questions around the ability of the management to make such financial decisions.

There may be an alternative strategic decision behind the sale of Salmba Co. The fact that Pirlo Co has
managed to secure the two founding directors may well be seen as a large coup for the company.

Conclusion
The decision to dispose of Samba does not appear to be a good fit for the business. The basis for this is
that Samba Co was a strong former financially. The move by Pirlo Co to start competing against Samba
Co can be seen to be high risk.
 Vernon

Part (a)

Statement of P/L and OCI.

Revenue W1 80,632
Cost of Sales (46,410)

Gross Profit 34,222

Operating Expenses W2 (20,115)

Profit from Operations 14,107

Finance Costs (4,050)
Investment income W3 6,118

Profit before Tax 16,175

Tax Expense W8 (3,330)

Profit for the year 12,845

Other Comprehensive Income

Gain on Revaluation W7 9,000

Total Comprehensive Income 21,845

* Workings

W1: 75,350 + 3,407 (w4) + 1,875 (w5)

W2: 20,640 - 125 (w5) - 400 (w6).

W3: 1,520 + 296 (w4) + 302 (w6) + 4000 (w7)

W4: Initial Revenue = (8M /1.08) $7.407M. $4M has been already recognised. This leaves the final
(7.407 - 4) $3,407M to recognised.
Furthermore the 7,407 should be increased by 8%. This will give rise to the final $8M. This is due in
June 20X9. Vernon has a year end on 21 Dec 20X8. We should recognise 6 months interest.
→ $7,407 x 8% x 6/12 = $296k. This would be added to finance income and receivables.

W5: Overseas Sale. This should be recorded at the historical rate at the date of the transaction. 12m
KR / 6.4 = $1,875. This is the figure to be used in Revenue and Receivables.
At the year end, ) 31 Dec 20X8, the unsettled balance should be retranslated at the new closing rate.
This gives a balance of $2M, The receivable now must be increased by 125k, the increase is reflected
in P/L.

W6: Bonds are assets and not to be expensed.

The Bonds are held at amortised:

Bal brought forward Int @ 8% Payment Bal Carried Forward

9,400 752 (450) 10,602
 752K should be recorded at investment income. 450K has been recorded to date, this a further
302K must be added to the investment income.

W7: Revaluations Gain of $12M must be shown in OCI, net of $3M due to a deferred tax liability.
Gains on the investment property must go through P/L, not via the OCI.

W8: There is $130K in the trial balance. The $3.2m tax estimate should be added to calculate the final
tax expense for the year.

Part (b)

Earnings per Share

12,845,000 / 41,870,689 W1 = 30.7c

W1
Date Number Rights Fraction Period W’ed Average
1/01 30M 3.1/ 2.9 3/12 8,017,241
1/04 35M 3.1/ 2.9 3/12 9,353,448
1/07 49M 6/12 24,500,000
41,870,698

W2
Theoretical ex - rights price

5 at $3.1 $15.50
2 at $2.4 $4.80
7 $20.30

TERP = 20.30 / 7 = $2.90

 Perkins

Part (a)

Gain on disposal in Perkins group consolidated statement of profit or loss

$000
Proceeds 28,640
Less: Goodwill (w1) (4,300)
Less: Net assets at disposal (26,100)
Add: NCI at disposal (w2) 6,160
4,400

(w1) Goodwill $000

Consideration 19,200
NCI at acquisition 4,900
Less: Net assets at acquisition (19,800)
4,300

(w2) NCI at disposal $000

NCI at acquisition 4,900
NCI% x S post acquisition 20% x (26,100 – 19,800) 1,260
6,160

Part (b)

Adjusted P/L extracts:

$000
Revenue (46,220 – 9,000 (S x 8/12) + 1,000 (intra-group)) 38,220
Cost of sales (23,980 – 4,400 (S x 8/12)) [see note] (19,580)
Gross profit 18,640
Operating expenses (3,300 – 1,673 (S x 8/12) + 9,440 profit on disposal) (11,067)
Profit from operations 7,573
Finance costs (960 – 800 (S x 8/12)) (160)

Note: Originally, the intra-group sale resulted in $1m turnover and $0·7m costs of sales. These amounts
were recorded in the individual financial statements of Perkins Co. On consolidation, the $1m turnover
was eliminated – this needs to be added back. The corresponding $1m COS consolidation adjustment is
technically made to Swanson Co’s financial statements and so can be ignored here.

Part (c)

Ratios of Perkins Co, eliminating impact of Swanson Co and the disposal during the year

20X7 Working 20X7 20X6

recalculated (see P/L above) original
Gross profit margin 48·8% 18,640/38,220 48·1% 44·8%
Operating margin 19·8% 7,573/38,220 41% 16·8%
Interest cover 47·3 times 7,573/160 19·7 times 3·5 times
Part (d)

Analysis of Perkins Co

Gross profit margin

In looking at the gross margin of Perkins Co, the underlying margin made by Perkins Co is higher than in
20X6.

After the removal of Swanson Co’s results, this continues to increase, despite Swanson Co having a gross
margin of over 50%.

It is possible that Swanson Co’s gross profit margin was artificially inflated by obtaining cheap supplies
from Perkins Co. Perkins Co makes a margin of 48·8%, but only sold goods to Swanson at 30%.

Operating margin
The operating margin appears to have increased significantly on the prior year. It must be noted that this
contains the profit on disposal of Swanson Co, which increases this significantly.

Removing the impact of the Swanson Co disposal still shows that the margin is improved on the prior year,
but it is much more in line.

Swanson Co’s operating margin is 32·6%, significantly higher than the margin earned by Perkins Co, again
suggesting that a profitable business has been sold. This is likely to be due to the fact that Swanson Co
was able to use Perkins Co’s facilities with no charge, meaning its operating expenses were understated
compared to the market prices.

It is likely that the rental income earned from the new tenant has helped to improve the operating margin,
and this should increase further once the tenant has been in for a full year.

Interest cover
Initially, the interest cover has shown good improvement in 20X7 compared to 20X6, as there has been a
significant increase in profits. Even with the profit on disposal stripped out, the interest cover would still be
very healthy.

Following the removal of Swanson Co, the interest cover is improved further. This may be because the
disposal of Swanson Co has allowed Perkins Co to repay debt and reduce the interest expense incurred

Conclusion
Swanson Co seems to have been a profitable company, which raises questions over the disposal.
However, some of these profits may have been derived from favourable terms with Perkins Co, such as
cheap supplies and free rental. It is worth noting that Perkins Co now has rental income in the year. This
should grow in future periods, as this is likely to be a full year’s income in future periods.
 Haverford

Part (a)

Adjustments to Harverford Co’s profit for the year ended 31 December 20X7

$000
Draft profit 2,250
Convertible loan notes (w1) (135)
Contract revenue (w2) 5,600
Contract cost of sales (w2) (3,600)
Depreciation (w4) (720)
Property impairment (w4) (480)
Closing inventories (w5) 390
Revised profit 3,305

Part (b)

Statement of changes in equity for the year ended 31 December 20X7

Share OCE Retained Revaluation Option

capital earnings surplus
$000 $000 $000 $000 $000
Balance as at 1 January 20X7 20,000 3,000 6,270 800 -
Profit – from (a) 3,305
Revaluation loss (w4) (800)
Bonus issue (w3) 4,000 (3,000) (1,000)
Convertible loan notes issued
(w1) 424
Dividend paid (3,620)
Balance as at 31 Dec 20X7 24,000 - 4,955 - 424
Part (c)

Statement of financial position for Haverford Co as at 31 December 20X7

$000
Assets
Non-current assets:
Property (w3) 16,000
Current assets:
Inventory (w5) 4,700
Trade receivables 5,510
Contract asset (w2) 2,500
Cash 10,320
Total assets 39,030
Equity and liabilities
Equity:
Share capital 24,000
Retained earnings 4,955
Convertible option 424
Total equity 29,379
Non-current liabilities:
Convertible loan notes (w1) 7,711
Current liabilities: 1,940
Total equity and liabilities 39,030

Working 1 – Convertible loan notes

Payment Discount rate Present value
$000 $000 $000
20X7 320 0.943 302
20X8 320 0.890 285
20X9 8,320 0.840 6,989
7,576

As the full amount of $8m has been taken to liabilities, adjustment required is:
Dr Liability $424k
Cr Equity $424k

The liability should then be held at amortised cost, using the effective interest rate.

Balance Interest Payment Balance

b/f 6% Payment c/f
$000 $000 $000 $000
7,576 455 (320) 7,711

As only $320k has been recorded in finance costs:

Dr Finance costs $135k
Cr Liability $135k
Working 2 – Contract with customer

Overall contract:
$000
Price 14,000
Costs to date (1,900)
Costs to complete (7,100)
5,000

Progress: 40%

Statement of profit or loss:

$000
Revenue ($14,000 x 40%) 5,600
Cost of sales ($9,000 x 40%) (3,600)
2,000

Statement of financial position:

$000
Costs to date 1,900
Profit to date 2,000
Amount billed to date (1,400)
2,500

$5.6m should be recorded in revenue, and $3.6m in cost of sales, giving an overall increase to the draft
profit of $2m. $2.5m should then be recorded in the statement of financial position as a current asset.

Working 3 – Bonus issue

The 1 for 5 bonus issue will lead to an increase in share capital of $4m ($20m x 1/5). Of this, $3m will be
debited to other components of equity to take it to zero. The remaining $1m will be deducted from retained
earnings.

Adjustment:
Dr Share premium $3m
Dr Retained earnings $1m
Cr Share capital $4m

Working 4 – Property

The asset should first be depreciated. $18m/25 = $720k. This should be deducted from the draft profit and
the asset, giving a carrying amount of $17,280k.

Dr Draft profit $720k

Cr Property $720k

Then the asset should be revalued from $17,280k to $16,000k, giving a revaluation loss of $1,280k. As
the revaluation surplus is only $800k, only $800k can be debited to this, with the remaining $480k being
debited from the draft profit for the year.

Dr Revaluation surplus $800k

Dr Draft profit $480k
Cr Property $1,280k
Working 5 – Inventories

Closing inventories should be adjusted from $4,310k to $4,700k.

Dr Inventories $390k
Cr Draft profit $390k
 Duke

Solution:
a) Non-controlling interest and Retained earnings

$000
Non-controlling interest (W1) 3,740
Retained earnings (W2) 14,060

Working 1: Non-controlling interest $000

NCI fair value at acquisition 3,400
NCI’s share of Smooth’s post-acquisition profits 700
(20% x $7m x 6/12)
NCI’s share of brand amortisation (60)
(20% x $3m/5 x 6/12)
NCI’s share of unrealised profit from land sale (300)
[20% x ($4m - $2.5m)]
3,740

Working 2: Retained earnings $000

Duke retained earnings 13,200
Adjustment for professional fees (500)
Duke’s share of Smooth’s post-acquisition profit 2,800
(80% x $7m x 6/12)
Duke’s share of brand amortisation (240)
(80% x $3m/5 x 6/12)
Duke’s share of unrealised profit from land sale (1,200)
[80% x ($4m - $2.5m)]
14,060

b) Ratios as at 30 June:
20X8 Working 20X7 Working
1.43 30,400/21,300 1.84 28,750/15,600
Current ratio

31.3% 14,500/(11,000 + 48.1% 12,700/(8,000 + 2,000 +

ROCE
6,000 + 14,060 + 9,400 + 7,000)
3,740 + 11,500)
33.0% 11,500/(11,000 + 36.1% 7,000/(8,000 + 2,000 +
Gearing (debt/equity)
6,000 + 14,060 + 9,400)
3,740)
c) Performance
ROCE has declined from 48.1% for 20X7 to just 31.3% for 20X8. This is primarily due to the increase
in group capital employed (from $26.4 to $46.3m), which was partially caused by the fact that the
acquisition of Smooth was financed by an issue of Duke shares.
What is more, ROCE computed in respect of 20X8 looks especially depressed as only six months’
worth of Smooth’s operating earnings are included in the numerator of the ratio, whereas Smooth’s
year-end liabilities and non-controlling interest feature in full in the denominator.

Position
The current ratio has fallen from 1.84 to 1.43. Possible explanations for this include the fact that
Smooth operates in the provision of training and recruitment services. As such, it is unlikely to hold
significant inventory. This is further supported by the pronounced decrease in inventory holding period.
On the other hand, the receivables collection period has visibly gone up. This may once again be
explained by the nature of Smooth’s industry and its clients – presumably large entities with
preferential, i.e. long, payment terms. Although a longer collection period may put some strain on the
group’s cash flow, the size and financial stability of Smooth’s clients should ensure a high level of debt
recoverability.
The group’s gearing has dropped from a level of just over 36% to 33%. This is despite an increase in
the level of debt held, as the non-current liabilities of Smooth were added to Duke’s existing debt. This
growth was offset by a significant increase in equity, resulting from the issue of shares by Duke.

Conclusion
Smooth is a profitable business and is likely to have boosted Duke’s profits. Smooth may have
increased the group’s level of debt and put some pressure on cash flows but the group’s financial
position remains strong.
 Duggan

Solution:

a) Duggan Co - Statement of profit or loss for y/e 30 June 20X8

$000
Revenue (W1) 45,900
(43,200 + 2,700)
Cost of sales (23,200)
(21,700 + 1,500 (W1))
Gross profit 22,700
Operating expenses (14,532)
(13,520 + 120 (W2) – 8 (W3) + 900 (W4))
Profit from operations 8,168
Finance costs (2,012)
(1,240 + 46 (W2) + 640 (W3) + 86 (W5))
Investment income 120
Profit before tax 6,276
Income tax expense (1,470)
(2,100 – 130 (overprovision from last year) – (2,000 x 25%))
Net profit for the year 4,806

b) Duggan Co - Statement of changes in equity for y/e 30 June 20X8

Share Share Retained Conversion
capital premium earnings option
$000 $000 $000 $000
12,200 - 35,400 -
Opening b/ce as at 1 July 20X7
(1,600)
Prior year error correction (W4)
33,800
Restated opening b/ce
1,500 1,800
Share issue
[Premium = (2.20 – 1.00) x 1,500]
180
Convertible loan note issue
4,806
Profit for the year (from a)
13,700 1,800 38,606 180
Closing b/ce as at at 30 June 20X8
c) Basic earnings per share:
$4,806k (from a) / 13,200k shares (W6) = $0.36 per share

Working 1: Contract
Revenue: (80% - 50%) x $9m = $2.7m
Cost of sales: (80% - 50%) x $5m = $1.5m

Working 2: Provision for court proceedings

Include provision for full $1.012m but discounted by one year at 10%: 1.012 x 0.9091 = $0.92m
The provision already made ($0.8m) must therefore be increased by $0.12m, which is charged to operating
expenses.

The subsequent unwinding of discount on the provision value (for half of the year) is charged to finance
cost: $0.92m x 10% x 6/12 = $46,000.

Working 3: Property construction

Of the $2.56m interest capitalised, only 9/12 should be included in initial asset value. The remaining 3/12
($640,000) should be taken to finance costs.
Initial asset value must therefore be reduced by $640,000, leading to a reduction in depreciation expense
(taken to operating expenses) equal to $640,000 / 20 years x 3/12 = $8,000.

Working 4: Fraudulent accounting discovered

Of the $2.5m error: $1.6m should be taken to opening equity (correction of prior period error), whereas the
remaining $0.9m ought to be charged to operating expenses.

Working 5: Convertible loan notes

The $5m proceeds from the issue of convertible loan notes should have been booked as follows (in $000):
Dr Cash 5,000
Cr Liabilities 4,820 (300 x 0.926 + 5,300 x 0.857)
Cr Equity 180 (5,000 – 4,820)

Interest expense for the year: $4,820k x 8% =$386k

Reported finance costs must therefore be increase by $86k ($386k required - $300k already recorded)

Working 6: Weighted average number of shares

From: To: Fraction of year Number of shares
1 July 20X7 1 November 20X7 4/12 12,200k
1 November 20X7 30 June 20X8 8/12 13,700k

Weighted average: 4/12 x 12,200k + 8/12 x 13,700k = 13,200k

 Yogi

Requirement (a)

Ratios

2014 2015 2014

excluding division (i) as reported (ii) Given

Gross profit 37.5% 33.3%

40.0%
margin (20,000 – 8,000)/(50,000 – 18,000) 12,000/36,000

18.8%
Operating profit 10.3%
(11,000 + 800 – 5,800)/(50,000 – 23.6%
margin (4,300 + 400 – 1,000)/36,000
18,000)

40.0% 21.8%
ROCE (11,000 + 800 – 5,800)/(29,200 – (4,300 + 400 – 1,000)/(22,500 53.6%
7,200 – 7,000*) – 5,500)
2.13 times
Net asset 2.12 times 2.27
(50,000 – 18,000)/(29,200 – 7,200 –
turnover 36,000/(22,500 – 5,500) times
7,000*)

* The $7 million adjustment to capital employed and net asset turnover reflects the capital employed/net
assets of the division sold: $8 million consideration less $1 million profit made on disposal.

Requirement (b)

Discussion

Yogi’s revenue, adjusted for the division sold, has grown from $32 million in 2014 to $36 million, i.e. by $4
million. Despite this, the adjusted gross profit margin fell from 37.5% to 33.3%. It seems that the division
which was sold earned a gross profit margin of 44.4% (8,000 / 18,000) in 2014, so its sale has had a
detrimental effect on Yogi’s profitability. This has also had a knock-on effect on operating profit margin,
which, on an adjusted basis fell from a level of 18.8% in 2014 to just 10.3% in 2015.

Yogi’s performance as measured by ROCE (adjusted) has suffered a sharp fall from 40% in 2014 to 21.8%
in 2015. Given the fact that asset utilisation, as measured by net asset turnover, has remained almost flat,
the drop is attributable to the deterioration in profitability discussed above.
Even though the company seems to have sold the best performing part of the business this does not
explain the deterioration in adjusted profitability ratios, which exclude the performance of the division for
the year 2014. Yogi’s management would be advised to investigate the disappointing performance of the
remaining business and whether this is linked to the sale of the division or other factors.

A controversial issue is the size of the dividend which was offered to Yogi’s shareholders so as to persuade
them to vote in favour of the disposal. The dividend amounted to $4 million (10 million shares x 40 cents)
and was twice the size of Yogi’s 2015 profit for the year if the gain on disposal is excluded. Another effect
of the disposal is that Yogi seems to have used the disposal proceeds, after paying the dividend, to pay
down a significant portion of its loan notes. Given the fact that the cost associated with the notes was just
10% and therefore much lower than the company’s return on capital employed, eliminating this relatively
cheap source of funding may have not been in the best interests of shareholders.
In summary, the decision to sell Yogi’s most profitable division may have been unwise, especially when
we take into account that the sale proceeds were not used to replace lost capacity or improve the
company’s long-term prospects.
 Cyclip

Part (a)
Bycomb: Goodwill on acquisition of Cyclip as at 1 July 2014
$’000 $’000
Investment at cost:
Shares (12,000 x 80% x 2/3 x $3·00) 19,200
Deferred consideration (12,000 x 80% x $1·54/1·1) 13,440
Non-controlling interest (12,000 x 20% x $2·50) 6,000
38,640
Net assets (based on equity) of Cyclip as at 1 July 2014
Equity shares 12,000
Retained earnings b/f at 1 April 2014 13,500
Earnings 1 April to acquisition:
[(2,400 + 100) x 3/12)] – see note below 625
Fair value adjustment to plant 720
Net assets at date of acquisition (26,845)
Consolidated goodwill 11,795

Note: The profit for the year for Cyclip would be increased by $100,000 due to interest capitalised, in
accordance with IAS 23 Borrowing Costs. Alternatively, this could have been calculated as: 2400 x 3/12 +
25. As the interest to be capitalised has accrued evenly throughout the year, $25,000 would relate to pre-
acquisition profits and $75,000 to post-acquisition profits.

Part (b)
Bycomb: Extracts from consolidated statement of profit or loss for the year ended 31 March 2015

$’000
(i) Revenue (24,200 + (10,800 x 9/12) – 3,000 intra-group sales) 29,300
(ii) Cost of sales (w (i)) (20,830)
(iii) Finance costs (w (ii)) (1,558)
(iv) Profit for year attributable to non-controlling interest (1,015 x 20% (w (iii))) 203
Workings in $’000

(i) Cost of sales

Bycomb 17,800
Cyclip (6,800 x 9/12) 5,100
Intra-group purchases (3,000)
URP in inventory (420 x 20/120) 70
Impairment of goodwill per question 500
Additional depreciation of plant (720 x 9/18 months) 360
20,830

(ii) Finance costs

Bycomb per question 400
Unwinding of deferred consideration (13,440 x 10% x 9/12) 1,008
Cyclip ((300 – 100 see below) x 9/12) 150
1,558

The interest capitalised in accordance with IAS 23 of $100,000 would reduce the finance costs of Cyclip
for consolidation purposes.

(iii) Post-acquisition profit of Cyclip

Profit plus interest capitalised and time apportioned
((2,400 + 100) x 9/12) – see note below 1,875
Impairment of goodwill (per question) (500)
Additional depreciation of plant (w (i)) (360)
1,015

Note: This could also have been calculated as (2,400 x 9/12) + 75 (see 1(a) above).
 Xpand

Requirement (a)

The following adjustments to Hydan’s statement of profit or loss would be required to reflect the effects of
the purchase. This is based on the assumption that the buying of inventory on favourable terms would
cease.

$’000
Cost of sales (45,000/0.9) 50,000
Directors’ remuneration 2,500
Loan interest (10% x 10,000) 1,000

Revised statement of profit or loss:

$’000
Revenue 70,000
Cost of sales (50,000)
Gross profit 20,000
Operating costs (7,000)
Directors’ salaries (2,500)
Loan interest (1,000)
Profit before tax 9,500
Income tax expense (3,000)
Profit for the tear 6,500

In the statement of financial position, the following adjustments would be made:

$’000
Equity (replaced by purchase price) 30,000
Director’s loan turned into debt 10,000

Ratios:
Hydan Hydan Sector
Adjusted as reported average
21.7%
Return on equity (ROE) 47.1% 22.0%
6,500/30,000
1.75 times
Net asset turnover 2.36 times 1.67 times
70,000/(30,000 + 10,000)
28.6%
Gross profit margin 35.7% 30.0%
20,000/70,000
9.3%
Net profit margin 20.0% 12.0%
6,500/70,000

Requirement (b)

Discussion:

Hydan’s profitability, as judged on ratios calculated on the basis of reported figures, reveals strong
performance relative to other companies from the same sector. Higher-than-average gross profit and net
profit margins as well as net asset turnover, lead to a return on equity which is more than twice the sector
average. However, when Hydan’s statement of profit or loss is adjusted for the effects of favourable
transactions with other companies owned by the same family, the picture changes significantly. Gross
profit margin drops from 35.7% to a below-sector-average of 28.6%. The effects of the favourable inventory
purchases carry through to the level of net profit. What is more, the existing directors of Hydan seem to
earn a remuneration that is below commercial rates. When the upward adjustment to directors’ salaries is
taken into account, coupled with the interest that would need to be charged on a commercial loan, Hydan’s
net profit margin would drop to just 9.3% (from an existing level of 20%), causing ROE to decrease to
21.7%, which is roughly in-line with the sector average.

A similar convergence to the sector average is observed when net asset turnover is calculated on the
basis of adjusted figures.

In summary, Hydan’s adjusted results are much closer to sector averages and far from the excellent
performance computed on the basis of reported figures.
 Quincy

Requirement (a)

Quincy – Statement of Comprehensive Income for the year ended 30 September 2012

$’000

Revenue (W1) 211,900

Cost of sales (W2) (147,300)

Gross profit 64,600

Distribution costs (12,500)

Administrative expenses (W4) (18,000)

Loss on equity investments (17,000 – 15,700) (1,300)

Investment income 400

Finance costs (W5) (1,920)

Profit before tax 31,280

Income tax expense (W6) (8,300)

Profit for the year 22,980

Other comprehensive income:

Gain on revaluation of land and buildings (W3) 18,000

Total comprehensive income 40,980

Requirement (b)

Quincy – Statement of Changes in Equity for the year ended 30 September 2012

Equity Revaluation Retained Total

shares reserve earnings equity
$’000 $’000 $’000 $’000
Balance at 1 October 2011 60,000 - 18,500 78,500
Total comprehensive income - 18,000 22,980 40,980
Transfer to retained earnings (W3) - (1,000) 1,000 -
Dividend paid (8 cents x 60,000 / 0.25) - (19,200) (19,200)
Balance at 30 September 2012 60,000 17,000 23,280 100,280
Requirement (c)

Quincy – Statement of Financial Position as at 30 September 2012

Assets $’000 $’000

Non-current assets

Property, plant and equipment (57,000 + 42,500) 99,500

Equity investments 15,700

115,200

Current assets

Inventory 24,800

Trade receivables 28,500

Bank 2,900 56,200

Total assets 171,400

Equity and liabilities

Equity

Equity shares 60,000

Revaluation reserve 17,000

Retained earnings 23,280

100,280

Non-current liabilities

Loan note (W5) 24,420

Deferred tax (5,000 x 20%) 1,000

Deferred revenue (1/2 x 1,600) 800 26,220

Current liabilities

Trade payables 36,700

Current tax payable 7,400

Deferred revenue (1/2 x 1,600) 800 44,900

171,400
W1 – Revenue
$’000
Per trial balance 213,500
Less: deferred revenue (incl. 25% profit margin) (1,600)
(600 x 100/75) x 2 years of servicing left
211,900

W2 – Cost of Sales
$’000
Per trial balance 136,800
Depreciation of buildings (W3) 3,000
Depreciation of plant and equipment (W3) 7,500
147,300

W3 – Non-Current Assets

Land and buildings:

The gain on the revaluation performed on 1 October 2012 may be computed as follows:

Carrying amount as at 1 Revalued amount as at 1 Gain on

October 2011 October 2011 revaluation
$’000 $’000 $’000
Land 10,000 12,000 2,000
Buildings 40,000 – 8,000 = 32,000 48,000 16,000
Total 42,000 60,000 18,000

The depreciation expense in respect of buildings for the year ended 30 September 2012 is:
48,000 / 16 years = 3,000

The amount of annual transfer from revaluation reserve to retained earnings is:
16,000 (gain on revaluation of buildings) / 16 years = 1,000

The carrying amount of Land and Buildings as at 30 September 2012 is:

60,000 – 3,000 = 57,000

Plant and equipment:

The depreciation expense in respect of plant and equipment for the year ended 30 September 2012 is:
(83,700 – 33,700) x 15% = 7,500

The carrying amount of Plant and Equipment as at 30 September 2012 is:

83,700 – 33,700 - 7,500 = 42,500
W4 – Administrative Expenses
$’000
Per trial balance 19,000
Less: issue costs (these ought to be recognised as (1,000)
an adjustment to the carrying amount of the loan note
liability)
18,000

W5 – Loan Note
The issue costs of $1 million (originally included in administrative expenses) ought to be deducted from
the loan proceeds, producing an initial carrying amount of $24 million. The effective interest rate of 8%
should be applied to this balance to produce the finance cost for the year: 8% x $24,000 = $1,920.

The carrying amount of the loan note as at 30 September 2012 is the result of increasing its opening
balance by the amount of interest cost incurred in respect of the year (1,920) and reducing it by the amount
of interest actually paid (6% x 25,000 = $1,500), i.e.:

Loan note balance as at 30 Sept 2012 = 24,000 + 1,920 – 1,500 = 24,420

W6 – Income Tax Expense

$’000
Current year income tax charge 7,400
Current tax under provision from previous year 1,100
Deferred tax credit to P&L (200)
(5,000 x 20% - 1,1200)
8,300
 Plastik

(a) Consolidated statement of profit or loss and other comprehensive income for the year ended
30 September 2014
$’000
Revenue (62,600 – 300 x 9 months + 30,000 x 9/12) 82,400
Cost of sales (Working) (61,320)
Gross profit 21,080
Distribution costs (2,000 + 1,200 x 9/12) (2,900)
Administrative expenses (3,500 + 1,800 x 9/12 + 500) (5,350)
Finance costs (200 + [(27.5c x 80% x 9,000)/1.1] x 10% x 9/12) (335)
Profit before tax 12,495
Income tax expense (3,100 + 9/12 x 1,000) (3,850)
Profit for the year 8,645

Other comprehensive income (1,500 + 600) 2,100

Total comprehensive income 10,745

Profit attributable to:

Equity holders of the parent (balancing figure) 8,465
Non-controlling interest [(2,000 x 9/12) – 100 – 500] x 20% 180
8,645
Total comprehensive income attributable to:
Equity holders of the parent (balancing figure) 10,445
Non-controlling interest: 180 + 20% x 600 300
10,745
(b) Consolidated statement of financial position as at 30 September 2014
$’000
Assets
Non-current assets

Property, plant and equipment (18,700 + 13,900 + 4,000 + 600 – 100) 37,100
Goodwill (Working 3) 5,200
42,300

Current assets
Inventory (4,300 + 1,200 – 120) 5,380
Trade receivables (4,700 + 2,500 – 1,200) 6,000
Bank 300
11,680
Total assets 53,980

Equity and liabilities

Equity shares of $1 each (10,000 + 4,800) 14,800
Share premium [4.8 million shares x ($3 - $1) 9,600
Revaluation surplus (2,000 + 80% x 600) 2,480
Retained earnings (Working 5) 6,765
33,645
Non-controlling interest (Working 4) 4,800
Total equity 38,445

Non-current liabilities
10% loan notes 2,500

Current liabilities
Trade payables (3,400 + 3,600 – 800) 6,200
Current tax payable (2,800 + 800) 3,600
Deferred consideration (1,800 + 135) 1,935
Bank (1,700 – 400) 1,300
13,035
Total equity and liabilities 53,980
(c) The recognition of separable intangibles assets is addressed by IFRS 3. The two items identified by
the directors in the acquisition of Dilemma should be recognised as separate intangible assets on the
acquisition of Dilemma. Both IFRS 3 Business Combinations and IAS 38 Intangible Assets require in-
process research in a business combination to be separately recognised at its fair value provided this
can be reliably measured ($1·2 million in this case). The recognition of customer list as an intangible
asset is a specific illustrative example given in IFRS 3 (IE 24) and should also be recognised at its fair
value of $3 million.

Workings (note figure in brackets are in $’000)

W1 - Cost of Sales
$’000

Plastik 45,800

Subtrak (24,000 x 9/12) 18,000

Intra-group transaction (300 x 9 months) (2,700)

Unrealised profit in Subtrak’s inventory (600 x 25/125) 120

Additional depreciation 100

61,320

W2 – Subsidiary Net Assets

Acquisition Consolidation Post-
$’000
date $’000
date $’000
acquisition
Equity shares 9,000 9,000 -
Retained earnings 2,000 3,500 1,500
Fair value adjustments 4,000 4,600 600
Fair value depreciation - (100) (100)
adjustments 15,000 17,000 2,000
W3 – Goodwill
$’000
Investment by Plastik:
Share exchange (9,000 x 80% x 2/3 x $3) 14,400
Deferred consideration 1,800
NCI value at acquisition (1,800 shares x $2.5) 4,500
20,700

Less: Fair value of subsidiary’s net assets at acquisition (Working 2) (15,000)

Goodwill at acquisition 5,700
Impairment as at 30 September 2014 (500)
Goodwill at 30 September 2014 5,200

W4 – NCI
$’000
NCI value at acquisition (working 3) 4,500
NCI’s share of consolidated comprehensive income 300
4,800

Alternatively: $’000
NCI value at acquisition (working 3) 4,500
NCI’s share of post-acquisition reserves 400
(20% x 2,000)
NCI’s share of goodwill impairment (20% x 500) (100)
4,800
W5 - Consolidated Retained Earnings
$’000
Plastik retained earnings at 30 September 2014 6,300
Plastk profit for the year (8,000)
Consolidated profit attributable to equity holders of the parent 8,465
6,765

Alternatively: $’000
Plastik retained earnings at 30 September 2014 6,300
Unrealised profit (120)
Unwinding of discount on deferred consideration (135)
Post-acquisition RE less additional dep: W2 - 80% x (1,500 - 100) 1,120
Group’s share of goodwill impairment (400)
(80% x 500) 6,765
 Enca

Requirement (a)

The requirements of IAS 16 Property, Plant and Equipment may, in part, offer a solution to the director’s
concerns. IAS 16 allows (but does not require) entities to revalue their property, plant and equipment to
fair value; however, it imposes conditions where an entity chooses to do this. First, where an item of
property, plant and equipment is revalued under the revaluation model of IAS 16, the whole class of assets
to which it belongs must also be revalued. This is to prevent what is known as ‘cherry picking’ where an
entity might only wish to revalue items which have increased in value and leave other items at their
(depreciated) cost. Second, where an item of property, plant and equipment has been revalued, its
valuation (fair value) must be kept up-to-date. In practice, this means that, where the carrying amount of
the asset differs significantly from its fair value, a (new) revaluation should be carried out. Even if there are
no significant changes, assets should still be subject to a revaluation every three to five years.

A revaluation surplus (gain) should be credited to a revaluation surplus (reserve), via other comprehensive
income, whereas a revaluation deficit (loss) should be expensed immediately (assuming, in both cases,
no previous revaluation of the asset has taken place). A surplus on one asset cannot be used to offset a
deficit on a different asset (even in the same class of asset).

Subsequent to a revaluation, the asset should be depreciated based on its revalued amount (less any
estimated residual value) over its estimated remaining useful life, which should be reviewed annually
irrespective of whether it has been revalued.

An entity may choose to transfer annually an amount of the revaluation surplus relating to a revalued asset
to retained earnings corresponding to the ‘excess’ depreciation caused by an upwards revaluation.
Alternatively, it may transfer all of the relevant surplus at the time of the asset’s disposal.

The effect of this, on Enca’s financial statements, is that its statement of financial position will be
strengthened by reflecting the fair value of its property, plant and equipment. However, the downside (from
the director’s perspective) is that the depreciation charge will actually increase (as it will be based on the
higher fair value) and profits will be lower than using the cost model. Although the director may not be
happy with the higher depreciation, it is conceptually correct. The director has misunderstood the purpose
of depreciation; it is not meant to reflect the change (increase in this case) in the value of an asset, but
rather the cost of using up part of the asset’s remaining life.
Requirement (b)(i)
Delta – Extracts from statement of profit or loss (see workings):
$’000
Year ended 31 March 2013
Plant impairment loss 20,000
Plant depreciation (32,000 + 22,400) 54,400
Year ended 31 March 2014
Loss on sale 8,000
Plant depreciation (32,000 + 26,000) 58,000

Requirement (b)(ii)
Delta – Extracts from statement of financial position (see workings):

$’000
As at 31 March 2013
Property, plant and equipment (128,000 + 89,600) 217,600
Revaluation surplus
Revaluation of item B (1 April 2012) 32,000
Transfer to retained earnings (32,000/5 years) (6,400)
––––––––
Balance at 31 March 2013 25,600
––––––––
As at 31 March 2014
Property, plant and equipment (item A only) 96,000
Revaluation surplus
Balance at 1 April 2013 25,600
Transfer to retained earnings (asset now sold) (25,600)
–––––––
Balance at 31 March 2014 nil
–––––––
Workings (figures in brackets in $'000)
Item A Item B
$’000 $’000
Carrying amounts at 31 March 2012 180,000 80,000
Balance = loss to statement of profit or loss (20,000)
––––––––
Balance = gain to revaluation surplus 32,000
––––––––
Revaluation on 1 April 2012 160,000 112,000
Depreciation year ended 31 March 2013 (160,000/5 years) (32,000) (22,400)
–––––––– ––––––––
Carrying amount at 31 March 2013 128,000 89,600
Subsequent expenditure capitalised on 1 April 2013 nil 14,400
–––––––– ––––––––
104,000
Depreciation year ended 31 March 2014 (unchanged) (32,000) (26,000)
–––––––– ––––––––
78,000
Sale proceeds on 31 March 2014 (70,000)
––––––––
Loss on sale (8,000)
––––––––
Carrying amount at 31 March 2014 96,000 nil
–––––––– ––––––––
 Skeptic

i. Changing the classification of an item of expense is an example of a change in accounting policy, in

accordance with FRS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Such a
change should only be made where it is required by an FRS or where it would lead to the information
in the financial statements being more reliable and relevant. It may be that this change does represent
an example of the latter, although it is arguable that amortised development costs should continue to
be included in cost of sales as amortisation only occurs when the benefits from the related project(s)
come on-stream. If it is accepted that this change does constitute a change of accounting policy, then
the proposed treatment by the directors is acceptable; however, the comparative results for the year
ended 31 March 2013 must be restated as if the new policy had always been applied (known as
retrospective application).

ii. The two provisions must be calculated on different bases because FRS 37 Provisions, Contingent
Liabilities and Contingent Assets distinguishes between a single obligation (the court case) and a large
population of items (the product warranty claims).

For the court case the most probable single likely outcome is normally considered to be the best
estimate of the liability, i.e. $4 million. This is particularly the case as the possible outcomes are either
side of this amount. The $4 million will be an expense for the year ended 31 March 2014 and
recognised as a provision. The provision for the product warranty claims should be calculated on an
expected value basis at $3.4 million (((75% x nil) + (20% x $25) + (10% x $120)) x 200,000 units). This
will also be an expense for the year ended 31 March 2014 and recognised as a current liability (it is a
one-year warranty scheme) in the statement of financial position as at 31 March 2014.

iii. Government grants related to non-current assets should be credited to the statement of profit or loss
over the life of the asset to which they relate, not in accordance with the schedule of any potential
repayment. The directors’ proposed treatment is implying that the government grant is a liability which
decreases over four years. This is not correct as there would only be a liability if the directors intended
to sell the related plant, which they do not. Thus in the year ended 31 March 2014, $800,000 (8
million/10 years) should be credited to the statement of profit or loss and $7•.2 million should be shown
as deferred income ($800,000 current and $6.4 million non-current) in the statement of financial
position.
 Woodbank

Part (a) Note: Figures in the calculations of the ratios are in $million

2013
(i) 2014 (ii) 2014
From
As reported Excluding Shaw
question
Return on (year end) capital 18/(175 – (18 – 5)/(150 –
12.0% 13.0% 10.5%
employed 25) 50)
1.0 1.2
Net asset turnover 150/150 (150 – 30)/100 1.6 times
times times
(33 – 9)/(150 –
Gross profit margin 22.0% 33/150 20.0% 22.0%
30)
Profit before interest and tax (18 – 5)/(150 –
12.0% 18/150 10.8% 9.1%
margin 30)
Current ratio 1.08:1 27/25 1.67:1
55/(95 +
Gearing (debt/(debt + equity)) 36.7% 5.3%
55)

Part (b) Analysis of the comparative financial performance and position of Woodbank for the year
ended 31 March 2014

Note: References to 2014 and 2013 should be taken as the years ended 31 March 2014 and 2013
respectively.

Introduction
When comparing a company’s current performance and position with the previous year (or years), using
trend analysis, it is necessary to take into account the effect of any circumstances which may create an
inconsistency in the comparison. In the case of Woodbank, the purchase of Shaw is an example of such
an inconsistency. 2014’s figures include, for a three-month period, the operating results of Shaw, and
Woodbank’s statement of financial position includes all of Shaw’s net assets (including goodwill) together
with the additional 10% loan notes used to finance the purchase of Shaw. None of these items were
included in the 2013 financial statements. The net assets of Shaw when purchased were $50 million, which
represents one third of Woodbank’s net assets (capital employed) as at 31 March 2014; thus it represents
a major investment for Woodbank and any analysis necessitates careful consideration of its impact.

Profitability
ROCE is considered by many analysts to be the most important profitability ratio. A ROCE of 12·0% in
2014, compared to 10·5% in 2013, represents a creditable 14·3% (12·0 – 10·5)/10·5) improvement in
profitability. When ROCE is calculated excluding the contribution from Shaw, at 13·0%, it shows an even
more favourable performance. Although this comparison (13·0% from 10·5%) is valid, it would seem to
imply that the purchase of Shaw has had a detrimental effect on Woodbank’s ROCE. However, caution is
needed when interpreting this information as ROCE compares the return (profit for a period) to the capital
employed (equivalent to net assets at a single point in time). In the case of Woodbank, the statement of
profit or loss only includes three months’ results from Shaw whereas the statement of financial position
includes all of Shaw’s net assets; this is a form of inconsistency. It would be fair to speculate that in future
years, when a full year’s results from Shaw are reported, the ROCE effect of Shaw will be favourable.
Indeed, assuming a continuation of Shaw’s current level of performance, profit in a full year could be $20
million. On an investment of $50 million, this represents a ROCE of 40% (based on the initial capital
employed) which is much higher than Woodbank’s pre-existing business.

The cause of the improvement in ROCE is revealed by consideration of the secondary profitability ratios:
asset turnover and profit margins. For Woodbank this reveals a complicated picture. Woodbank’s results,
as reported, show that it is the increase in the profit before interest and tax margin (12·0% from 9·1%)
which is responsible for the improvement in ROCE, as the asset turnover has actually decreased (1·0
times from 1·16 times) and gross profit is exactly the same in both years (at 22·0%). When the effect of
the purchase of Shaw is excluded the position changes; the overall improvement in ROCE (13·0% from
10·5%) is caused by both an increase in profit margin (at the before interest and tax level, at 10·8% from
9·1%), despite a fall in gross profit (20·0% from 22·0%) and a very slight improvement in asset turnover
(1·2 times from 1·16 times). Summarising, this means that the purchase of Shaw has improved
Woodbank’s overall profit margins, but caused a fall in asset turnover. Again, as with the ROCE, this is
misleading because the calculation of asset turnover only includes three months’ revenue from Shaw, but
all of its net assets; when a full year of Shaw’s results are reported, asset turnover will be much improved
(assuming its three-months performance is continued).

Liquidity
The company’s liquidity position, as measured by the current ratio, has fallen considerably in 2014 and is
a cause for concern. At 1·67:1 in 2013, it was within the acceptable range (normally between 1·5:1 and
2·0:1); however, the 2014 ratio of 1·08:1 is very low, indeed it is more like what would be expected for the
quick ratio (acid test). Without needing to calculate the component ratios of the current ratio (for inventory,
receivables and payables), it can be seen from the statements of financial position that the main causes
of the deterioration in the liquidity position are the reduction in the cash (bank) position and the dramatic
increase in trade payables. The bank balance has fallen by $4·5 million (5,000 – 500) and the trade
payables have increased by $8 million.

An analysis of the movement in the retained earnings shows that Woodbank paid a dividend of $5·5 million
(10,000 + 10,500 – 15,000) or 6·88 cents per share. It could be argued that during a period of expansion,
with demands on cash flow, dividends could be suspended or heavily curtailed. Had no dividend been
paid, the 2014 bank balance would be $6·0 million and the current ratio would have been 1·3:1 ((27,000
+ 5,500):25,000). This would be still on the low side, but much more reassuring to credit suppliers than the
reported ratio of 1·08:1.

Gearing
The company has gone from a position of very modest gearing at 5·3% in 2013 to 36·7% in 2014. This
has largely been caused by the issue of the additional 10% loan notes to finance the purchase of Shaw.
Arguably, it might have been better if some of the finance had been raised from a share issue, but the
level of gearing is still acceptable and the financing cost of 10% should be more than covered by the
prospect of future high returns from Shaw, thus benefiting shareholders overall.

Conclusion
The overall operating performance of Woodbank has improved during the period (although the gross profit
margin on sales other than those made by Shaw has fallen) and this should be even more marked next
year when a full year’s results from Shaw will be reported (assuming that Shaw can maintain its current
performance). The changes in the financial position, particularly liquidity, are less favourable and call into
question the current dividend policy. Gearing has increased substantially, due to the financing of the
purchase of Shaw; however, it is still acceptable and has benefited shareholders. It is interesting to note
that of the $50 million purchase price, $30 million of this is represented by goodwill. Although this may
seem high, Shaw is certainly delivering in terms of generating revenue with good profit margins.
 X-tol

Part (a) – Xtol – Statement of profit or loss for the year ended 31 March 2014

$’000

Revenue (490,000 – 20,000 agency sales (w (i))) 470,000

Cost of sales (w (i)) (294,600)

Gross profit 175,400

Distribution costs (33,500)

Administrative expenses (36,800)

Other operating income – agency sales 2,000

Finance costs (900 overdraft + 3,676 (w (ii))) (4,576)

Profit before tax 102,524

Income tax expense (28,000 + 3,200 + 3,700 (w (iii))) (34,900)

Profit for the year 67,624

Part (b) – Xtol – Statement of changes in equity for the year ended 31 March 2014

Share capital Equity options Retained earnings Total equity

$’000 $’000 $’000 $’000
Balance at 1 April 2013 42,600 Nil 26,080 68,680

Rights issue (see below) 38,400 38,400

5% loan note issue (w (ii)) 4,050 4,050

Dividends paid (w (iv)) (10,880) (10,880)

Profit for the year 67,624 67,624

Balance at 31 March 2014 81,000 4,050 82,824 167,874

The number of shares prior to the 2 for 5 rights issue was 160 million (i.e. 224,000 shares x 5/7). Therefore
the rights issue was 64 million shares at 60 cents each, giving additional share capital of $38.4 million.
Part (c) – Xtol – Statement of financial position as at 31 March 2014

$’000 $’000

Assets

Non-current assets

Property, plant and equipment ((100,000 – 30,000) + (155,500 – 57,500)) 168,000

Current assets

Inventory 61,000

Trade receivables 63,000 124,000

Total assets 292,000

Equity and liabilities

Equity (see (b) above)

Equity shares 81,000

Other component of equity – equity option 4,050

Retained earnings 82,824

167,874

Non-current liabilities

Deferred tax 8,300

5% convertible loan note (w (ii)) 47,126 55,426

Current liabilities

Trade payables (32,200 + 3,000 re Francais (w (i))) 35,200

Bank overdraft 5,500

Current tax payable 28,000 68,700

Total equity and liabilities 292,000

Part (d) – Xtol – Basic earnings per share for the year ended 31 March 2014

Profit per statement of profit or loss $67.624 million

Weighted average number of shares (w (v)) 209.7 million

Earnings per share ($67.624m/209.7m) 32.2 cents

Workings (figures in brackets in $’000)

(i) Cost of sales (including the effect of agency sales on cost of sales and trade payables)

$’000

Cost of sales per question 290,600

Remove agency costs (15,000)

Amortisation of leased property (100,000/20 years) 5,000

Depreciation of plant and equipment ((155,500 – 43,500) x
14,000
12½%)
294,600

The agency sales should be removed from revenue (debit $20 million) and their ‘cost’ from cost of
sales (credit $15 million). Instead, Xtol should report the commission earned of $2 million (credit)
as other operating income (or as revenue would be acceptable). This leaves a net amount of $3
million ((20,000 – 15,000) – 2,000) owing to Francais as a trade payable.

(ii) 5% convertible loan note

The convertible loan note is a compound financial instrument having a debt and an equity
component which must be accounted for separately:

Outflow Present value

Year ended 31 March 8%
$’000 $’000
2014 2,500 0.93 2,325

2015 2,500 0.86 2,150

2016 52,500 0.79 41,475

Debt component 45,950

Equity component (= balance) 4,050

Proceeds of issue 50,000

The finance cost for the year will be $3,676,000 (45,950 x 8%) and the carrying amount of the loan
as at 31 March 2014 will be $47,126,000 (45,950 + (3,676 – 2,500)).

(iii) Deferred tax

$’000

Provision at 31 March 2014 8,300

Balance at 1 April 2013 (4,600)

Charge to statement of profit or loss 3,700

(iv) Dividends

The dividend paid on 30 May 2013 was $6.4 million (4 cents on 160 million shares) and the
dividend paid on 30 November 2013 (after the rights issue) was $4.48 million (2 cents on 224
million shares). Total dividends paid in the year were $10.88 million.

(v) Number of shares outstanding (including the effect of the rights issue)

Theoretical ex-rights fair value:

Shares $ $

Holiday (say) 100 1.02 102

Rights issue (2 or 5) 40 0.60 24

140 126

Theoretical ex-rights fair value 0.90 ($126/140)

Weighted average number of shares:

1 April 2013 to 31 July 2013 160 million x $1.02/$0.90 x 4/12 = 60.4 million

1 August 2013 to 31 March 2014 224 million x 8/12 = 149.3 million

Weighted average for year 209.7 million

 Penketh

Requirement (a)

Consolidated goodwill as at 1 October 2013

$’000
Investment by Sphere :
Share exchange 120,000
(90 million shares x 1/3 x $4)
Deferred consideration 126,000
(90 million x $1.54 / 1.1)
NCI value at acquisition 150,000
[(150 – 90) million shares x $2.50] 396,000

Less: fair value of subsidiary’s net assets at acquisition (see Working – Subsidiary net (323,000)
asset below)
Goodwill at acquisition 73,000

Group structure

Penketh 30%
90/150 = 60% Ventor

Sphere
Acquisition date: 1 October 2013
Consolidation date: 31 March 2014 (6 months later)

Subsidiary net assets

Acquisition date
$’000
Equity shares $1 each 150,000
Retained earnings 160,000
[120,000 + (80,000 x 6/12)]
Fair value adjustments 13,000
(2,000 + 6,000 + 5,000)
323,000
Requirement (b)

Penketh – Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year
ended 31 March 2014

$’000
Revenue (Working – Revenue) 755,000
Cost of sales (Working – Cost of Sales) (457,300)
Gross profit 297,700
Distribution costs (40,000 + 20,000 x 6/12) (50,000)
Administrative expenses (Working – Admin expenses) (49,000)
Investment income (Working – Investment income) 4,000
Finance costs (Working – Finance costs) (11,100)
Share of associate’s profit (adjusted for unrealised profit) 600
[(30% x 10,000 x 6/12) – (30% x 15,000 x 25/125)]
Profit before tax 192,200
Income tax expense (45,000 + 6/12 x 31,000) (60,500)
Profit for the year 131,700

Other comprehensive income

Gain / (Loss) on revaluation of land (1,200)
[-2,200 + (3,000 – 2,000)]
Total comprehensive income 130,500

Profit attributable to:

Equity holders of the parent (balancing figure) 116,500
Non-controlling interest (Working – NCI) 15,200
131,700

Total comprehensive income attributable to:

Equity holders of the parent (balancing figure) 114,900
Non-controlling interest: (Working – NCI) 15,600
130,500

Working – Revenue
$’000
Penketh 620,000
Intragroup sales to Sphere (20,000)
Sphere (310,000 x 6/12) 155,000
755,000

Working – Cost of Sales

$’000
Penketh 400,000
Intragroup sales to Sphere (20,000)
Unrealised profit in Sphere’s inventory* 800
Sphere (150,000 x 6/12) 75,000
Additional plant depreciation 1,500
(6,000/2 years x 6/12)
457,300
*The unrealised profit in Sphere’s inventory is computed as (all figures in $’000):

Profit on the sale of goods to Sphere: 20,000 x 25/125 = 4,000

Unrealised profit = 1/5 x 4,000 = 800

The unrealised profit on the sale of goods to Ventor is eliminated against Penketh’s share of the associate’s
profit for the year.

Working – Administrative expenses

$’000
Penketh 36,000
Sphere (25,000 x 6/12) 12,500
Amortisation of customer relationships 500
(5,000/5 years x 6/12)
49,000

Working – Investment income

$’000
Penketh 5,000
Dividend from Ventor (6,000 x 30%) (1,800)
Sphere (1,600 x 6/12) 800
4,000

Working – Finance costs

$’000
Penketh 2,000
Sphere (5,600 x 6/12) 2,800
Unwinding of discount on deferred consideration 6,300
(10% x 126,000 x 6/12)
11,100

Working – Share of associate’s profit

$’000
2,000
Sphere (5,600 x 6/12) 2,800
Unwinding of discount on deferred consideration 6,300
(10% x 126,000 x 6/12)
11,100
Working – NCI

NCI’s share of consolidated profit

$’000
Sphere’s post-acquisition profit (80,000 x 6/12) 40,000
Less: Additional depreciation of plant (1,500)
Less: Additional amortisation of customer (500)
relationships
Adjusted profit 38,000
x 40% = 15,200

NCI’s share of consolidated total comprehensive income

$’000
NCI’s share of consolidated profit (see above) 15,200
NCI’s share of OCI [(3,000 – 2,000) x 40%] 400
15,600
 Polestar

Requirement (a)

Polestar – Consolidated Statement of Profit or Loss for the year ended 30 September 2013

$’000
Revenue (Working - Revenue) 130,000
Cost of sales (Working - Cost of Sales) (109,300)
Gross profit 20,700
Distribution costs (3,000 + 2,000 x 6/12) (4,000)
Administrative expenses (5,250 + 2,400 x 6/12 – 3,400 [W3]) (3,050)
Fall in contingent consideration (1,800 – 1,500) 300
Loss on equity investments (200)
Finance costs (250)
Profit before tax 13,500
Income tax expense (3,500 - 6/12 x 1,000) (3,000)
Profit for the year 10,500

Profit attributable to:

Equity holders of the parent (balancing figure) 11,250
Non-controlling interest (from Working 4): [- 600 – 150] (750)
10,500

Requirement (b)
Polestar – Consolidated Statement of Financial Position as at 30 September 2013
$’000
Assets
Non-current assets
Property, plant and equipment 63,900
(41,000 + 21,000 + 2,000 – 100)
Financial assets 2,300
[16,000 – 13,500 (cash consideration: Working 2) – 200] 66,200

Current assets [16,500 + 4,800 – 600 (unrealised profit)] 20,700

Total assets 86,900

Equity and liabilities

Equity shares of 50c each 30,000
Retained earnings (Working 5) 29,750
59,750
Non-controlling interest (Working 4) 2,850
Total equity 62,600

Current liabilities
Contingent consideration 1,500
Other (15,000 + 7,800) 22,800
24,300
Total equity and liabilities 86,900
Working 1 – Group structure

Polestar

75%

Southstar
Date of acquisition: 1 April 2013
Date of consolidation: 30 September 2013 (6 months after the acquisition)

Working 2 – Subsidiary net assets

Acquisition date Consolidation date Post-

acquisition
$’000 $’000 $’000
Equity shares 6,000 6,000 -
Retained earnings 14,300 12,000 (2,300)
[12,000 + (6/12 x
4,600)]
Fair value adjustments 2,000 2,000 -
- (100) (100)
Fair value depreciation
(2,000/10 years) x
adjustments
6/12
22,300 19,900 (2,400)

Working 3 - Goodwill
$’000
Investment by Polestar:
Cash payment 13,500
[6,000 / 0.5) x $1.50 x 75%]
Contingent consideration 1,800
NCI value at acquisition 3,600
(6,000 / 0.5 x 25% x $1.20)
18,900

Less: fair value of subsidiary’s net assets at acquisition (Working 2) (22,300)

Gain on bargain purchase (to P&L) (3,400)

Working 4 – Non-controlling interest

$’000
NCI value at acquisition (working 3) 3,600
NCI’s share of post-acquisition reserves (25% x 2,400) (600)
NCI’s share of unrealised profit (25% x 600) (150)
2,850
Working 5 – Group retained earnings
$’000
Polestar retained earnings at 30 September 2013 28,500
Polestar profit for the year (10,000)
Consolidated profit attributable to equity holders of 11,250
the parent (from P&L)
29,750

Alternatively: $’000

Polestar retained earnings at 30 September 2013 28,500

Gain on bargain purchase 3,400
Loss on equity investments (200)
Drop in contingent consideration 300
Group’s share of post-acquisition retained earnings less (1,800)
additional depreciation - Working 2
75% x (2,400)
Group’s share of unrealised profit (75% x 600) (450)
29,750

Irrespective of the method adopted for the purposes of computing goodwill, a gain on a bargain purchase
is always fully credited to the equity holders of the parent and accordingly to group retained earnings.

Working – Revenue
$’000
Polestar 110,000
Intragroup sales to Southstar (4,000)
Southstar (66,000 x 6/12) 33,000
Intragroup sales to Polestar (9,000)
130,000

Working – Cost of Sales

$’000
Polestar 88,000
Intragroup sales to Southstar (4,000)
Southstar (67,200 x 6/12) 33,600
Intra-group sales to Polestar (9,000)
Unrealised profit in Polestar’s inventory* 600
Additional depreciation 100
(2,000/10 years x 6/12)
109,300

*The unrealised profit in Polestar’s inventory is computed as (all figures in $’000):

Total profit on the sale of goods back to Polestar: 9,000 – (4,000 + 1,400) = 3,600

Unrealised profit = (1,500 / 9,000) x 3,600 = 600

Kingdom
 Speculate

Requirement (a)(i)

IAS 40 identifies investment property as land or buildings which are held for the purposes of generating
income from rent or for capital appreciation (or both purposes simultaneously) rather than for use in
production or administration. Another perspective is to think of investment properties as generating cash
flows which are largely independent from the remaining assets of the business whereas non-investment
property (classified under property, plant and equipment) will typically generate cash flows in combination
with other assets.

Requirement (a)(ii)

The revaluation and fair value models both require that properties be valued at their fair values. Under the
revaluation model, however, the revalued amount is subsequently adjusted to take account of depreciation
and possible impairment, which do not feature under the fair value approach.

What is more, increases in the revalued amount are reported as gains within other comprehensive income.
Losses are taken to the income statement unless they reverse a previous gain reported within other
comprehensive income.

In the case of investment property carried under the fair value model, all gains and losses are reported
within P&L.

Requirement (b)

Extracts from Speculate’s statement of profit or loss and other comprehensive income for the year
ended 31 March 2013

$’000
Depreciation (expense) (50) Property A: (2,000/20 years x 6/12) to account for the 6
months until reclassification to investment property
Gain on fair value increases 190 Property A: 2,340 – 2,300 = 40
Property B: 1,650 – 1,500 = 150

Other comprehensive income 350 [2,300 – (2,000 – 50)] fair value increase upon
(gain) reclassification to investment property

Extracts from Speculate’s statement of financial position as at 31 March 2013

$’000
Non-current assets
Investment property 3,990 (2,340 + 1,650)

Equity
Revaluation reserve 350 [2,300 – (2,000 – 50)] fair value increase upon
reclassification to investment property

In Speculate’s consolidated financial statements property B would be classified as Property, plant and
equipment and therefore accounted for in accordance with IAS 16.
 Pulsar

Requirement (a)

IFRS 5 defines a discontinued operation as a component of an entity which has either already been
disposed of or is classified as held for sale and:

 represent a separate major line of business or geographical area of operations,

 is part of a coordinated plan to dispose of one of the above, or
 is a subsidiary acquired exclusively with a view to resale.

The separate disclosure of the results generated from a discontinued operation is valuable to users of
financial statements when evaluating past performance and more importantly, when formulating
expectation for the future. For example, if before the year-end, a company disposed of a major loss-making
segment, an analyst should find the split into continued and discontinued operations useful when
generating earnings projections.

Requirement (b)

The decision to dispose of all of the company’s hotels in country A will probably give rise to classification
as a discontinued operation, based on the reasoning that country A represents a separate geographical
area of operation.

On the other hand, the refurbishment of hotels in country B may or may not give rise to treatment as a
discontinued operation. If the shift from business clients to the holiday and tourism market is deemed to
constitute a change in major line of business, then presenting the results previously generated by the
hotels would qualify for separate disclosure as a discontinued operation. On the other hand, if the move is
treated as a mere adaptation of an existing service, then such qualification would not apply.

Requirement (c)

Because a formal plan to close the factory was formulated, details of which were communicated to
interested parties, most notably the employees, a constructive obligation was created which leads to the
creation of a restructuring provision.

In Pulsar’s income statement for the year ended 31 March 2013, the following amounts should be charged
to expenses:
$’000
Redundancy costs 1,000 (5 x 200 employees)
Impairment loss on plant 1,750 [2,200 – (500 – 50)]
Onerous contract 850 (lower of the costs)
Penalty costs 200
3,800

Within the statement of financial position as at 31 March 2013, this amount will be split between a
downward adjustment to the carrying amount of plant ($1.75 million) and provisions recorded within
liabilities ($2.05 million). Furthermore, both the plant and factory should be reported under non-current
assets held for sale. The factory should be carried at its existing carrying amount, whereas the plant ought
to be measured at its fair value less cost to sell ($450,000).

Finally, the $125,000 of costs necessary to retrain the 50 remaining employees do not qualify to be
included within the provision as they relate to a future activity, as opposed to one which is being shut down.
 Monty

Requirement (a)

Monty – Statement of cash flows for the year ended 31 March 2013

$’000 $’000
Cash flows from operating activities
Profit before tax 3,000
Adjustments for:
Depreciation of PPE 900
Amortisation of development expenditure 200
Finance costs 400
4,500
Decrease in inventory (3,800 – 3,300) 500
Increase in trade receivables (2,950 – 2,200) (750)
Increase in trade payables (2,650 – 2,100) 550
Cash generated from operations 4,800
Interest paid (400)
Income tax paid [Working 1] (425)
Net cash from operating activities 3,975

Cash flows from investing activities

Purchase of PPE [Working 2] (2,200)
Deferred development expenditure (1,000 + 200) (1,200)
Net cash used in investing activities (3,400)

Cash flows from financing activities

Redemption of loan notes (3,125 – 1,400) (1,725)
Proceeds from bank loan 1,500
Repayment of bank loan [Working 3] (1,050)
Dividends paid (1,750 + 2,000 – 3,200) (550)
Net cash used in financing activities (1,825)
Net decrease in cash and cash equivalents (1,250)
Cash and cash equivalents at the beginning of the period 1,300
Cash and cash equivalents at the end of the period 50

Working 1: Income tax paid

$’000
Current tax payable (opening b/ce) 725
Deferred tax liability (opening b/ce) 800
Income tax expense (from income statement) 1,000
Deferred tax on revaluation 650
Current tax payable (closing b/ce) (1,250)
Deferred tax liability (closing b/ce) (1,500)
Income tax paid 425
Working 2: Property, plant and equipment

$’000
Opening b/ce 10,700
 Revaluation 2,000
Depreciation (900)
Closing b/ce (14,000)
Cash purchases (incl. PPE acquired from loan proceeds) (2,200)

Working 3: Bank loan

$’000
Opening b/ce (900 + 600) 1,500
New loan proceeds 1,500
Closing b/ce (1,200 + 750) (1,950)
Loan repayment 1,050

Requirement (b)

Ratios

2013 2012

21.4% 16.7%
Return on capital
(3,000 + 400)/(12,550 + 1,400 + 1,200 (2,050 + 350)/(9,750 + 3,125 + 900
employed (ROCE)
+ 750) + 600)
29.7% 25.6%
Gross profit margin
9,200/31,000 6,400/25,000
11.0% 9.6%
Operating profit margin
(3,000 + 400)/31,000 (2,050 + 350)/25,000
1.95 times 1.74 times
Net asset turnover 31,000/(21,300 – 1,250 – 2,650 – 25,000/(18,000 – 725 – 2,100 –
1,500) 800)
26.7% 47.4%
Gearing
(1,400 + 1,200 + 750)/12,550 (3,125 + 900 + 600)/9,750

Monty’s return on capital employed has shown significant improvement, rising by more than 28%
[(21.4/16.7 – 1) x 100]. This growth would have been even bigger had the company not revalued its
property.

The increase in ROCE is mainly driven by improvements in gross profit margin, which also had a knock-
on effect on operating margins. The latter did not, however, exhibit such strong growth, due to the fact that
administrative expenses and distribution costs both increased at rates which were higher than the growth
in revenue.
Another contributor to Monty’s ROCE improvement was the more than 12% [(1.95/1.74 -1) x 100] increase
in asset utilisation as measured by net asset turnover. This is impressive growth, especially considering
the asset revaluation and mid-year investment in additional plant.
Finally, Monty repaid a significant portion of its 8% loan notes, substituting these with new bank loans,
whose balance increased by a net $450,000, leading to an overall drop in the amount of debt outstanding.
Coupled with the increase in equity, of which nearly half was derived from the property revaluation, this
led to a marked drop in the level of gearing.
 Shawler

Requirement (a)(i)

Extracts from Shawler’s statement of financial position as at 30 September 2012

Carrying
amount
$
Non-current assets
Furnace: main body 42,000 48,000 – (60,000/10 years)
replaceable liner 4,000 6,000 – (10,000/5 years)

Current liabilities
Government grant 1,200 Equal to the amount which will be transferred to income
over the upcoming 12 months

Non-current liabilities
Government grant 7,200 8,400 – (12,000/10 years) transferred to current liabilities
Environmental provision 19,440 (18,000 x 1.08) growth to reflect unwinding of discount

Requirement (a)(ii)

Extracts from Shawler’s income statement for the year ended 30 September 2012

$
Depreciation (expense) (8,000) (6,000 + 2,000)
Government grant (income) 1,200
Finance costs (expense) (1,440) (18,000 x 8%) unwinding of discount

Requirement (b)

Although the new legislation has already been passed, there are still two years left until it becomes
mandatory to fit filters. Nevertheless, a provision should not be made even if the company has the intention
of fitting the filters, as the passing of the legislation does not, on its own, constitute an obligating event.
Shawler may still avoid the cost of fitting the filters, for example by pulling out of certain segments of its
operations or shifting to a less-polluting production technology.

Until the filters are actually fitted, there should be no reduction in the amount of environmental provision.
 Viagem

Requirement (a)

Consolidated goodwill at the date of acquisition

$’000
Investment by Viagem:
Share exchange 39,000
(90% x 10,000 shares x 2/3 x $6.50)
Deferred consideration 14,400
(9,000 shares x $1.76 / 1.1)
NCI value at acquisition 2,500
(1,000 shares x $2.50) 55,900

Less: fair value of subsidiary’s net assets at acquisition (see Working – Subsidiary net (47,900)
asset below)
Goodwill at the date of acquisition 8,000

Group structure

Viagem

90%

Greca
Acquisition date: 1 January 2012
Consolidation date: 30 September 2012 (9 months later)

Subsidiary net assets

Acquisition date
$’000
Equity shares $1 each 10,000
Retained earnings 36,550
[35,000 + (6,200 x 3/12)]
Fair value adjustments 1,350
(1,800 - 450)
47,900
Requirement (b)

Viagem – Consolidated Income Statement for the year ended 30 September 2012

$’000
Revenue (Working – Revenue) 85,900
Cost of sales (Working – Cost of Sales) (64,250)
Gross profit 21,650
Distribution costs (1,600 + 1,800 x 9/12) (2,950)
Administrative expenses (Working – Admin expenses) (7,600)
Finance costs (Working – Finance costs) (1,500)
Share of associate’s profit (40% x 2,000) 800
Profit before tax 10,400
Income tax expense (2,800 + 9/12 x 1,600) (4,000)
Profit for the year 6,400

Profit attributable to:

Equity holders of the parent (balancing figure) 6,180
Non-controlling interest (Working – NCI) 220
6,400

Working – Revenue
$’000
Viagem 64,600
Intragroup sales to Greca (9 months x 800) (7,200)
Greca (38,000 x 9/12) 28,500
85,900

Working – Cost of Sales

$’000
Viagem 51,200
Intragroup sales to Greca (7,200)
Unrealised profit in Greca’s inventory* 300
Greca (26,000 x 9/12) 19,500
Additional plant depreciation 450
(1,800/3 years x 9/12)
64,250

*The unrealised profit in Greca’s inventory is computed as (all figures in $’000):

Profit on the sale of goods to Greca: 7,200 x 25/125 = 1,440

Unrealised profit = 1.5/7.2 x 1,440 = 300

Working – Administrative expenses

$’000
Viagem 3,800
Greca (2,400 x 9/12) 1,800
Goodwill impairment 2,000
7,600
Working – Finance costs
$’000
Viagem 420
Unwinding of discount on deferred consideration 1,080
(10% x 14,400 x 9/12)
1,500

Working – NCI

NCI’s share of consolidated profit

$’000
Greca’s post-acquisition profit (6,200 x 9/12) 4,650
Less: Additional depreciation of plant (450)
Less: Impairment of goodwill (2,000)
Adjusted profit 2,200
x 10% = 220

Requirement (c)

IFRS 3 requires that at the time of acquisition, the assets and liabilities of the target, including items of
property, be identified and recognised in the consolidated statement of financial position at their fair values.

When an item of property undergoes a fair value adjustment upon incorporation in the consolidated
financial statements, this also triggers an adjustment to the amount of depreciation expense as charged
to consolidated P&L.

If the group follows a policy of measuring property under the historical cost approach, any subsequent
changes in fair value will not be reflected in the consolidated financial statements. The opposite is true if
the group adopts the revaluation model instead.
 Learning Co.

Remember:
Not all statements may be required to produce in other questions of such type. Also, statement of cash
flow may be asked to figure out in other questions. Required statements will be specified in question
directly.

Remember:
Use standard pro-formas for calculation of income statement and statement of financial position.

Statement of profit or loss and other comprehensive income for the year ended 31 December 2014

Workings:

Working 1 - Cost of sales

$’000
Purchases 2,152
Opening inventory 190
Subsidiary inventory sold during the year 34
Depreciation for the year, buildings $100,000 / 50 2
Depreciation - plant and equipment 36
Less: closing inventory (220)
Cost of sales 2,194

Working 2 - Disposal - Plant and equipment

$’000
Sales proceeds 300
Less: net book value (274)
Gain on sale 26

Working 3 - Administrative expenses

$’000
Wages and salaries 254 + commission 20 274
 Light and heat 31 - commission 20 + accrual 3 14
Sundry expenses 113 - prepayment 6 107
(9 x 8 / 12 months)
Audit fees accrual 4
Administrative expenses 399

Working 4 - Finance costs and % accrual

$’000
Charge for the year 200 x 10% 20
Less: interest paid (10)
Accrual 10

Working 5 - Non-current assets: property, plant and equipment

(i) Land and buildings $’000
Cost at 1.1.2014 430
Accumulated depreciation at 1.1.2014 (20)
Carrying amount at 1.1.2014 410
Depreciation for the year, buildings (Working 1) (2)
Carrying amount at 31.12.2014 408
Revaluation surplus (ß) 800 - 408 392
Revalued amount at 31.12.2014 800

(ii) Plant and machinery $’000

Cost at 1.1.2014 830
Accumulated depreciation at 1.1.2014 (222)
Carrying amount at 1.1.2014 608
Depreciation for the year, plant (Working 1) (36)
Disposal (working 2) (274)
Carrying amount at 31.12.2014 298

Total carrying value at 31.12.2014: 1,098

Statement of financial position at 31 December 2014

Workings:

Working 6 - Goodwill on acquisition of Mary & Co

$’000
Consideration 285
Less: net assets (265)
Goodwill on acquisition 20

The equity instruments totalling $231,000 were still held by Learning at 31.12.2014 as per note (c).

Working 7 - Equity accounts:

(i) Share issue

$’000
Share issue proceeds 120
Less: nominal value (50)
(100,000 ordinary shares 50c each)
Share premium on issue (70)
(ii) Statement of changes in equity for the year ended 31 December 2014

Working 8 - Accruals
$’000
Light and heat (Working 3) 3
Audit fees (Working 3) 4
Finance costs (Working 4) 10
Accruals 17