Arm Plc acquired 60% of Leg Ltd on 1 January 2003 for £150,000 when Leg Ltd's retained profits
were £80,000. The share capital of Leg Ltd totalled £50,000 on 1 January 2003. There has been
no change in Leg Ltd‟d share capital since this date.
During 2010 Leg Ltd sold goods costing £4,000 to Arm Plc for £14,000. 20% of this inventory is
included in Arm Plc‟s inventory at the year end.
Arm Plc acquired 30% of Toe Ltd on 1 January 2005 for £200,000 when Toe Ltd‟s share capital
and reserves were £75,000. The share capital of Toe Ltd is made up of 20,000 shares of 50p each.
During 2010 Toe Ltd sold goods costing £6,000 to Arm Plc for £8,000. 50% of this inventory is
still in Arm Plc‟s inventory at the year end.
Goodwill is capitalised. Impairment of £5,000 was seen against the goodwill of Leg Ltd in 2008
and impairment of £10,000 was seen against the goodwill of Toe Ltd in 2010.
At the year end Arm Plc charges both Leg Ltd and Toe Ltd a management fee of 5% of turnover.
None of the companies have accounted for this management fee.
Required
(a) Define the following:
i. subsidiary companies
ii. non controlling interest (minority interest)
iii. goodwill and impairment (6 marks)
(b) Prepare the consolidated income statement (profit and loss account) for Arm Plc for the year
ended 31 December 2010. (19 marks)
UL11/0082 D01 Page 3 of 8
2. Company M owns a manufacturing plant that cost £2,000,000 on 1 January 2009. The plant has
a useful economic life of five years from this date and it is used to manufacture a product called
the spike. There is no second hand market for the plant except as scrap and it is estimated that at
the end of its useful life, or at any other time, it will cost £80,000 net of scrap proceeds, to
dismantle and remove it. Annual operating costs are £800,000. The plant requires an overhaul
costing £60,000 during the third year of its life. It produces a constant annual output, all of
which can be sold, with an annual selling value of £1,600,000.
During February 2010, a new model of the plant used to manufacture the spike is brought out.
The directors of the company now intend to replace the existing spike plant with the new plant at
the end of the existing plant‟s useful life. The new plant costs £2,200,000 and has a six year
useful life at the end of which its scrap value is expected to be £40,000. It incurs constant annul
operating costs of £720,000 and produces a constant annual output, all of which can be sold for
£60,000 per annum higher than the output of the existing plant. When the new plant is installed
for the first time the company will incur one off costs of £100,000 adapting the building housing
the new plant.
Any replacement plant together with the cost of adapting the building would be paid for at the
time of replacement. All other cashflows occur at the end of the years concerned. The
company‟s cost of capital is 10% per annum.
Required
(a) Define deprival value and discuss the strengths and limitations of deprival value as the
basis of asset valuation in corporate financial reports. (12 marks)
(b) Calculate the deprival value of the company‟s spike making plant at 31 December 2010.
(13 marks)
UL11/0082 D01 Page 4 of 8
3. Bear Ltd started trading on 1 January 2010. The income statement for the year ended 31
December 2010 and the statement of financial position as at 31 December 2010 are given as
follows:
Income statement for 2010
£ £
Sales 4,050,000
Cost of sales
Opening inventories 225,000
Purchases 2,700,000
Closing inventories (270,000)
(2,655,000)
Gross profit 1,395,000
Expenses (450,000)
Depreciation (126,000)
Net profit 819,000
Statement of financial position
as at 31 December 2010
£
Non-current assets - plant
and machinery
3,888,000
Inventories 270,000
Other net current assets 1,161,000
Net assets 5,319,000
Share capital (£1 shares) 4,500,000
Retained earnings 819,000
Share capital and reserves 5,319,000
The price change indices for the year were identified as follows:
RPI Plant and
machinery
Inventories
(stock)
1 January 2010 200 200 250
30 June 2010 220 240 270
30 November 2010 230 260 280
31 December 2010 240 300 290
Closing inventory was acquired on 30 November 2010. All non-current assets and opening
inventory were acquired on the first day of trading. Sales and purchases accrue evenly
throughout the year.
Question continues on following page
UL11/0082 D01 Page 5 of 8
Required
(a) Define fully stabilised current value accounts‟ and discuss their advantages and
limitations. (7 marks)
(b) Prepare an income statement for Bear Ltd for the year ended 31 December 2010 and a
statement of financial position for Bear Ltd as at 31 December 2010 using current value
(replacement cost) accounting and using the financial capital maintenance concept. Base
depreciation on the year-end value of non-current assets. (9 marks)
(c) Calculate the real realised and the real unrealised holding gains and losses on inventory
and non-current assets that would appear in a set of fully stabilised current value accounts,
stabilised in pounds (£) as at 31 December 2010. Where would these items be recorded in
the financial statements for 2010? (9 marks)
4. Rhymes Ltd enters into two lease transactions in 2010 as follows:
(1) An asset, asset A, which could be purchased outright for £319,770 is instead leased for
three years. The useful economic life of the asset is three years and at the end of this time,
the asset will have no residual value. Rhymes Ltd is responsible for all maintenance and
repairs and for all insurance costs for asset A. The lease for asset A provides for half-
yearly payments in advance of £60,000, the first payment being made on 1 January 2010.
(2) An asset, asset B, which could be purchased outright for £360,000 is leased for three years
for annual payments of £90,000 per annum payable in advance. The useful economic life
of asset B is eight years. At the end of the three years, Rhymes Ltd intends to return the
asset. Rhymes Ltd is not responsible for maintaining and insuring asset B.
Required
(a) What are operating and finance leases? How are they accounted for? (10 marks)
(b) Show how asset A and asset B should be accounted for by of Rhymes Ltd in 2010 and
2011. (15 marks)
5. Answer all parts of this question.
(a) What is share premium? Discuss the permissible uses for the share premium account.
(5 marks)
(b) XYZ plc is considering whether to (i) issue share capital of £400,000 (£1 nominal value shares) or (ii) issue £200,000 (£1 nominal value shares) and raise £200,000 from a long
term loan with an interest rate of 15% per annum. The future is uncertain and if XYZ plc
has a good year, profit before interest and tax will be £200,000 but if it has a poor year,
profit before interest and tax will be £40,000. Calculate profit after tax and earnings per
share in both scenarios and comment on your results. Assume the tax rate is 35%.
(8 marks)
Question continues on following page
UL11/0082 D01 Page 6 of 8
(c) Prior to IFRS, the pooling of interest method was permissible. Explain the criteria then
laid down for the use of the pooling of interest method and outline the reasons for the
banning of the method. (5 marks)
(d) Technology Ltd entered into the following research and development expenditure in 2010:
£
Research (pure and applied) £600,000
Development £700,000
The development costs relate to a project to develop a new product. The project is
expected to be successful, leading to a new product which will generate substantial
revenues for the company. The company has enough resources to fund the project. Staff
costs of £400,000 have been incurred on the project during 2010. In addition capital
expenditure of £300,000 has been incurred during 2010. The capital expenditure relates to
the acquisition of equipment for final tests on the product and is depreciated using the
straight line method. The equipment has a useful economic life of 3 years and is then
expected to have no residual value
Required
Show how the research and development costs will be treated in the financial statements of
Technology Ltd in 2010. (7 marks)
6. Either
(a) What are “non-current tangible assets” and “investment properties”? Discuss the
differences in the accounting treatment of “non-current tangible assets” and “investment
properties” and discuss how the different accounting treatments affect the financial
statements.
Or
(b) Discus the reasons for initiating standard setting in the 1970‟s and assess the advantages
and limitations of standard setting in the UK.
7. Either
(a) Set out the definitions of well offness and measures of income suggested by Sir John Hicks
and evaluate their usefulness, implications and limitations for financial reporting.
Or
(b) Compare and contrast the different methods for translating the financial statements of
foreign subsidiaries. Discuss how the foreign exchange reserves arise under each method,
how they should be accounted for and the situations in which each of the methods should
be used.
UL11/0082 D01 Page 7 of 8
Compound interest factors over n periods at rate i per period.
Table 1: Present value factors
To determine the present value of a single payment of 1 received „n‟ periods from the present at a
This commentary reflects the examination and assessment arrangements for this course in the academic year 2010–11. The format and structure of the examination may change in future years, and any such changes will be publicised on the virtual learning environment (VLE).
General remarks
Learning outcomesAt the end of this course, and having completed the Essential reading and activities, you should be able to:
• explain and apply a number of theoretical approaches to financial accounting
• record and analyse data
• prepare financial statements under alternative accounting conventions
• describe a number of regulatory issues relating to financial accounting
• critically evaluate theories and practices of, and other matters relating to, financial accounting.
What are the Examiners looking for?The exam paper contains seven questions, five of which combine numerical and written components and two of which are essay based. Each of the essay questions has a choice of two essays. The combined questions require candidates to prepare calculations on a variety of topics as well as showing a critical grasp of the theories underlying the techniques. To do well candidates need to be able both to explain and evaluate the theories and prepare a range of financial statements and calculations.
For quantitative parts of questions, Examiners are looking for accurate preparation of financial statements which follow generally accepted formats with clear headings and accurate application of accounting techniques to specific areas within financial reporting. Workings should always be provided clearly.
Written components of combined questions require clear and coherent explanations of theories, techniques and practices and critical evaluation of theories and practices.
Good answers to essay-based questions will be structured coherently and logically, include an introduction, a main body and conclusion and cover all parts of the essay question.
Typically an essay-based question will require an explanation of an issue within financial reporting and a critical analysis of the issue. Explanations should be clear and include a discussion of key definitions with examples if appropriate. The critical analysis should show critical awareness of both
91 Financial reporting
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sides of an argument or application of a theory or concept to financial reporting with an assessment of its appropriateness to financial reporting.
Planning your time in the examinationAll questions in the paper carry equal marks and equal time should be devoted to each question. It is important that candidates attempt four questions and all parts of each question they answer. Marks for each section are given to each section and should be used by candidates to guide their work and time allocation. Where questions are in parts, candidates should avoid excessively long answers to some parts and missing out other parts.
Key steps to improvementCandidates can improve performance by improving the presentation of their work, providing clear workings, answering the required number of questions and attempting all sections of a question. Often candidates seem to focus attention on the preparation of financial statements and the financial calculations without being able to explain, discuss and evaluate the theories and practices central to financial reporting.
Question spotting
Many candidates are disappointed to find that their examination performance is poorer than they expected. This can be due to a number of different reasons and the Examiners’ commentaries suggest ways of addressing common problems and improving your performance. We want to draw your attention to one particular failing – ‘question spotting’, that is, confining your examination preparation to a few question topics which have come up in past papers for the course. This can have very serious consequences.
We recognise that candidates may not cover all topics in the syllabus in the same depth, but you need to be aware that Examiners are free to set questions on any aspect of the syllabus. This means that you need to study enough of the syllabus to enable you to answer the required number of examination questions.
The syllabus can be found in the ‘course information sheet’ in the section of the VLE dedicated to this course. You should read the syllabus very carefully and ensure that you cover sufficient material in preparation for the examination.
Examiners will vary the topics and questions from year to year and may well set questions that have not appeared in past papers – every topic on the syllabus is a legitimate examination target. So although past papers can be helpful in revision, you cannot assume that topics or specific questions that have come up in past examinations will occur again.
If you rely on a question spotting strategy, it is likely you will find yourself in difficulties when you sit the examination paper. We strongly advise you not to adopt this strategy.
Examiners’ commentaries 2011
1
Examiners’ commentaries 2011
91 Financial reporting – Zone A
Important note
This commentary reflects the examination and assessment arrangements for this course in the academic year 2010–11. The format and structure of the examination may change in future years, and any such changes will be publicised on the virtual learning environment (VLE).
Format of the examination paper
Candidates should answer FOUR of the following SEVEN questions. All questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any necessary assumptions introduced in answering a question are to be stated Extracts from compound interest tables are given after the final question on this paper.
Eight-column accounting paper is provided at the end of this question paper. If used, it must be detached and fastened securely inside the answer book.
A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book.
Comments on specific questions
Question 1
The statements of financial position (balance sheets) for Ear Ltd, Mouth Ltd and Nose Ltd as at 31 December 2010 are given as follows:
Statements of Financial Position as at 31 December 2010
Ear Ltd. Mouth Ltd. Nose Ltd.
£ £ £
Non-current asset (land) 860,000 260,000 300,000
Investment 380,000
Inventories 140,000 40,000 50,000
Trade Receivables 8,000 30,000 60,000
Dividend receivable from group companies 12,000
Inter-company loans receivable from Mouth Ltd 90,000
Inter-company loans receivable from Nose Ltd 30,000
Cash 130,000 60,000 30,000
1,650,000 390,000 440,000
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Share capital (£1 nominal value) 600,000 100,000 200,000
Retained profits 260,000 210,000 160,000
Revaluation reserve 30,000
Trade payables 730,000 30,000 10,000
Inter-company loans payable to Ear Ltd 40,000 20,000
Dividend payable 60,000 10,000 20,000
1,650,000 390,000 440,000
Ear Ltd acquired 70% of Mouth Ltd for £290,000 on 1 January 2006 when Mouth Ltd’s share capital and reserves stood at £190,000. At this date the fair value of Mouth Ltd’s non-current assets was £280,000 but they were recorded at their historical cost of £260,000. Mouth Ltd has not incorporated this revaluation in its books.
[For the full question, please refer to the Examination paper.]
Reading for the question
Subject guide, Chapter 7.
International financial reporting, Chapter 24.
Approaching the question
This question requires a detailed knowledge of preparation of consolidated financial statements, in this case consolidated statements of financial position. Candidates should know what consolidated financial statements are, why they are prepared, what companies are included in consolidated financial statements and the definitions and explanation of key items included in consolidated financial statements. For the preparation of consolidated statements, candidates need to know the formats of these statements and be able to calculate the different components of the statements. It is important that candidates show detailed workings of how they arrive at figures included in the financial statements.
Part (a) full definitions of all terms are required and differences between how they should be accounted for should be clearly explained.
Part b
Solutions to Part b provided below with key workings
Alternative presentations are acceptable (e.g. goodwill of a added to investment in a as follows or calculated as cost of investment + share of post acq reserves – impairment).
Question 2
Company M owns a manufacturing plant that cost £750,000 on 1 January 2009. The plant has a useful economic life of five years from this date and it is used to manufactures a product called the spike. There is no second hand market for the plant except as scrap and it is estimated that at the end of its useful life, or at any other time, it will cost £30,000 net of scrap proceeds, to dismantle and remove it. Annual operating costs are £300,000. The plant requires an overhaul costing £22,500 during the third year of its life. It produces a constant annual output, all of which can be sold, with an annual selling value of £600,000.
[For the full question, please refer to the Examination paper.]
Reading for the question
Subject guide, Chapter 6.
International financial reporting, Chapters 5 and 6.
Approaching the question
This question covers both a discussion of deprival value and calculations relating to deprival value. Candidates should attempt both parts of the question and answer all the questions set. For the calculations, candidates need to be able to apply the concepts of deprival value to an example. It is important that candidates show detailed workings of how they arrive at their answer.
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Part a
A good discussion of deprival value with examples together with the strengths and limitations of the concept is required. A discursive style should be used rather than bullet points.
Pv of difference = cost of replacing services of existing asset = £302,001 = = deprival value
Note Some figures may be included differently in the AEC and have or have not budgets and full credit is given for correct workings if different to the above.
Question 3
Bear Ltd started trading on 1 January 2010. The income statement and the statement of financial position for the first year of trading are given below:
[For the full question, please refer to the Examination paper.]
Reading for the question
Subject guide, Chapter 5.
International financial reporting, Chapter 7.
Approaching the question
This question covers both a discussion of fully stabilised current value accounts and the preparation of current value financial statements and calculations for key components of fully stabilised financial statements. Candidates should attempt both parts of the question and answer all the questions set. For the calculations, it is important that candidates show detailed workings of how they arrive at their answer.
Examiners’ commentaries 2011
5
Part a
For the discussion of fully stabilised current value financial statements, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible.
Part b
Solutions for part b are provided below:
IS £
Sales 1,350,000 1,350,000
Cost of sales
Op invent 75,000 135/100 101,250
Purchases 900,000 900,000
Clo invent (90,000) 135/140 (86,786)
(885,000) (914,464)
GP 465,000 435,536
Exp (150,000) (150,000)
Depreciation (42,000) 150/100 (63,000)
profit 222,536
Nca – unrealised 648,000
Nca realised 21,000
Invent – unrealised 3,214
Invent – realised 29,464
Retained earnings 273,000 924,214
Balance sheet
Non current assets 1,296,000 150/100 1,944,000
Inventories 90,000 145/140 93,214
Other net current assets 387,000 387,000
Net assets 1,773,000 2,424,214
Share capital (£1 shares) 1,500,000 1,500,000
Retained earnings 273,000 924,214
Share capital and reserves
1,773,000 2,424,214
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Part c
Solutions for Part c are given below.
Nca real unrealised 1,944,000 – 1,296,000 * 120/100 = 388,800
Nca real realised 63,000 – 42,000 * 120/100 =12,600
Inventory real realised 894,214 * 120/110 – 977,905 = 19,692
Inventory real unrealised 93,214 – 90,000 * 120/115 = (699)
Question 4
Rhymes Ltd enters into two lease transactions in 2010 as follows:
1. An asset, asset A, which could be purchased outright for £102,004 is instead leased for three years. The useful economic life of the asset is three years and at the end of this time, the asset will have no residual value. Rhymes Ltd is responsible for all maintenance and repairs and for all insurance costs for asset A. The lease for asset A provides for half-yearly payments in advance of £20,000, the first payment being made on 1 January 2010.
2. An asset, asset B, which could be purchased outright for £120,000 is leased for three years for annual payments of £30,000 per annum payable in advance. The useful economic life of asset B is eight years. At the end of the three years, Rhymes Ltd intends to return the asset. Rhymes Ltd is not responsible for maintaining and insuring asset B.
[For the full question, please refer to the examination paper.]
Reading for the question
Subject guide, Chapter 9.
International financial reporting, Chapter 12.
Approaching the question
The question covers both a discussion on operating and finance leases and calculations showing how these would be accounted for in financial statements. For the discussion of operating and finance leases, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible.
For the calculations, it is important that candidates show detailed workings of how they arrive at their answer.
Part a
A discussion of the definition of operating and finance leases with examples is required with discussion of how these different leases are accounted for.
Part b
Solutions for Part b are given below.
Asset a
Recognition that it is finance lease and reasons
Rate implicit in the lease
102,004 = 20,000 + 20,000 a5]?
a5]? = 82,004/20,000
a5]? = 4.1002 which gives a rate of 7% from tables.
2010 finance charge = 5,740 + accrual of 4,742 which relates to prior period
2011 finance charges = 3,674 + accrual of 2,531.
Sfp
Asset: non-current asset at 102,004 – with annual depreciation of 34,001.
2010 net book value = 68,003.
2011 net book value =34,002.
Liability
2010
Accrual of finance charge = 4,742
Lease obligation = 67,744 split between current of 31,584 and non current of 36,160
2011
Accrual of finance charge = 2,531.
Lease obligation = 36,160 (all current).
Asset B
State that it is an operating lease and give the reason why.
Lease payments in income statement = £30,000 in 2010 and 2011.
Question 5
Answer all parts of this question.
a. XYZ plc is considering whether to (i) issue share capital of £200,000 (£1 nominal value shares) or (ii) issue £100,000 (£1 nominal value shares) and raise £100,000 from a long term loan with an interest rate of 15% per annum. The future is uncertain and if XYZ plc has a good year, profit before interest and tax will be £100,000 but if it has a poor year, profit before interest and tax will be £20,000. Calculate profit after tax and earnings per share in both scenarios and comment on your results. Assume the tax rate is 35%. (8 marks)
b. Identify and discuss the factors that influence the determination of the functional currency of an overseas subsidiary? (5 marks)
[For the full question, please refer to the examination paper.]
Reading for the question
Subject guide, Chapters 8, 9, 11 and 14.
International financial reporting, Chapters 12, 15, 25, 26 and 27.
91 Financial reporting
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Approaching the question
This question covers the accounting treatment of several different items, some parts requiring discussion of concepts or key items in financial statements and some parts require calculations. All parts of the question should be attempted with clear workings provided of any required calculations. The marks given to each section are indicated and these should be used as a guide for how long candidates should spend on each section.
Solutions to Parts
Part a
Share capital Good Bad
PBIT 100,000 20,000
Tax (35,000) (7,000)
Pat 65,000 13,000
e/s 0.33 0.07
Share capital + debentures
PBIT 100,000 20,000
interest (15,000) (15,000)
PBT 85,000 5,000
Tax (29,750) (1,750)
Pat 55,250 3,250
e/s 0.55 0.03
Appropriate comments should be made for example relating to variability and risk.
Part b
Up to five factors that influence the functional currency should be discussed.
The definition of LIFO and FIFO should be given and the differences between the methods and the impact of the difference methods on the financial statements should be discussed clearly.
Examiners’ commentaries 2011
9
Question 6
Either
a. What are “non-current tangible assets” and “investment properties”? Discuss the differences in the accounting treatment of “non-current tangible assets” and “investment properties” and discuss how the different accounting treatments affect the financial statements.
or
b. Why do we need a conceptual framework? Discuss the advantages and limitations of conceptual frameworks.
This question related to a key component of financial statements, that of non-current assets and investment properties. Candidates need to be able to discuss the definitions of these items, analyse and discuss professional accounting requirements in these areas, and provide appropriate examples. A comparison of different accounting treatments and their impact on financial statements is important and must be explicitly covered in the answer. A discursive style should be adopted, avoiding bullet points if possible.
Good answers should contain definitions of non-current tangible assets and investment properties and identify the different accounting treatments (depreciation, revaluations) possibly with a numerical example. The impact on the SFP and income statement needs to be discussed, again perhaps referring to a numerical example. Candidates may discuss the economic consequences of the different treatment.
Part a
Reading for the question
Subject guide, Chapter 9.
International financial reporting, Chapter 12.
Approaching the question
Good answers should contain definitions of non current tangible assets and investment properties and identify the different accounting treatments (depreciation, revaluations) possibly with a numerical example. The impact on the SFP and income statement needs to be discussed, again perhaps referring to a numerical example. Candidates may discuss the economic consequences of the different treatment.
Part b
Reading for the question
Subject guide, Chapter 2.
International financial reporting, Chapter 8.
Approaching the question
This question related to an important issue within financial reporting, that of the conceptual framework. Candidates need to be able to define conceptual frameworks and discuss advantages and limitations of conceptual frameworks. The question relates to standard setting in general and not to any specific accounting standard, but candidates may provide some examples of specific standards to illustrate their argument. However, candidates must not write exclusively about specific standards and not address the question set. A discursive style should be adopted, avoiding bullet points if possible.
Good answers would define a conceptual framework and perhaps briefly outline the main contents of a typical conceptual framework. Both the
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advantages and disadvantages (see Chapter 2) should be discussed, with candidates assessing these advantages and disadvantages.
Question 7
Either
a. Set out the definitions of well offness and measures of income suggested by Sir John Hicks and evaluate their usefulness, implications and limitations for financial reporting.
or
b. Critically appraise both the traditional and economic arguments for and against accounting regulation.
Part a
Reading for the question
Subject guide, Chapter 3.
International financial reporting, Chapter 4.
Approaching the question
This question related to Hicks’s concepts of well-offness and income. Candidates need to be able to discuss and explain the concepts clearly using appropriate examples to illustrate their arguments. Equally important is the evaluation of the concepts in relation to financial reporting. A discursive style should be adopted, avoiding bullet points if possible.
Good answers would describe and give examples of the required definitions, possibly referring to a numerical example. All three aspects of usefulness, implications and limitations (see Chapter 3) need to be addressed with some assessment of the issues raised.
Part b
Reading for the question
Subject guide, Chapter 1.
International financial reporting, Chapter 1.
Approaching the question
This question related to accounting regulation in general rather to any specific regulations. Candidates need to be able to define accounting regulation illustrating this with suitable examples. Candidates need to be able to discuss the advantages and disadvantages of accounting regulation form different theoretical perspectives and relate this to issues seen within accounting regulation in practice. A discursive style should be adopted, avoiding bullet points if possible.
Good answers should define accounting regulation and perhaps outline the different types of regulation within accounting. Both traditional and economic arguments (for example, Beaver’s arguments) need to be discussed and assessed and arguments both for and against regulation need to be presented.
Examiners’ commentaries 2011
11
Compound interest factors over n periods at rate i per period.To determine the present value of a single payment of 1 received ‘n’ periods from the present at a constant discount rate of x% per period
Table 2: Cumulative present value factors (‘annuity factors’)
The table gives the present value of ‘n’ annual payments of 1 received for the next ‘n’ years with a constant discount rate of x% per year. For example, with a discount rate of 8% and with six annual payments of £1 the present value is £4.6229
This commentary reflects the examination and assessment arrangements for this course in the academic year 2010–11. The format and structure of the examination may change in future years, and any such changes will be publicised on the virtual learning environment (VLE).
Format of the examination paper
Candidates should answer FOUR of the following SEVEN questions. All questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any necessary assumptions introduced in answering a question are to be stated. Extracts from compound interest tables are given after the final question on this paper.
Eight-column accounting paper is provided at the end of this question paper. If used, it must be detached and fastened securely inside the answer book.
A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book.
Comments on specific questions
Question 1
The income statements (profit and loss accounts) of Arm Plc, Leg Ltd and Toe Ltd for the year ended 31 December 2010 are given as follows:
Arm Plc acquired 60% of Leg Ltd on 1 January 2003 for £150,000 when Leg Ltd’s retained profits were £80,000. The share capital of Leg Ltd totalled £50,000 on 1 January 2003. There has been no change in Leg Ltd’d share capital since this date.
[For the full question, please refer to the Examination paper.]
Reading for the question
Subject guide, Chapter 7.
International financial reporting, Chapter 24.
Approaching the question
This question requires a detailed knowledge of preparation of consolidated financial statements, in this case consolidated income statements. Candidates should know what consolidated financial statements are, why they are prepared, what companies are included in consolidated financial statements and the definitions and explanation of key items included in consolidated financial statements. For the preparation of consolidated statements, candidates need to know the formats of these statements and be able to calculate the different components of the statements. It is important that candidates show detailed workings of how they arrive at figures included in the financial statements.
Part a
All definitions need to be discussed fully.
Part b
Solutions are provided below. All workings in £’000.
Company M owns a manufacturing plant that cost £2,000,000 on 1 January 2009. The plant has a useful economic life of five years from this date and it is used to manufacture a product called the spike. There is no second hand market for the plant except as scrap and it is estimated that at the end of its useful life, or at any other time, it will cost £80,000 net of scrap proceeds, to dismantle and remove it. Annual operating costs are £800,000. The plant requires an overhaul costing £60,000 during the third year of its life. It produces a constant annual output, all of which can be sold, with an annual selling value of £1,600,000.
[For the full question, please refer to the Examination paper.]
Reading for the question
Subject guide, Chapter 6.
International financial reporting, Chapters 5 and 6.
Approaching the question
This question covers both a discussion of deprival value and calculations relating to deprival value. Candidates should attempt both parts of the question and answer all the questions set. For the calculations, candidates need to be able to apply the concepts of deprival value to an example. It is important that candidates show detailed workings of how they arrive at their answer.
Part a
For the discussion of deprival value, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible.
Pv of difference = cost of replacing services of existing asset = £805,336 = deprival value.
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Note: Some figures may be included differently in the AEC and have or have not budgets and full credit is given for correct workings if different to the above.
Question 3
Bear Ltd started trading on 1 January 2010. The income statement for the year ended 31 December 2010 and the statement of financial position as at 31 December 2010 are given as follows:
Income statement for 2010
£ £
Sales 4,050,000
Cost of sales
Opening inventories 225,000
Purchases 2,700,000
Closing inventories (270,000)
(2,655,000)
Gross profit 1,395,000
Expenses (450,000)
Depreciation (126,000)
Net profit 819,000 819,000
Statement of financial position as at 31 December 2010
£
Non-current assets – plant and machinery 3,888,000
Inventories 270,000
Other net current assets 1,161,000
Net assets 5,319,0005,319,000
Share capital (£1 shares) 4,500,000
Retained earnings 819,000
Share capital and reserves 5,319,000
[For the full question, please refer to the Examination paper.]
Reading for the question
Subject guide, Chapter 5.
International financial reporting, Chapter 7.
Approaching the question
This question covers both a discussion of fully stabilised current value accounts and the preparation of current value financial statements and calculations for key components of fully stabilised financial statements. Candidates should attempt both parts of the question and answer all the questions set. For the calculations, it is important that candidates show detailed workings of how they arrive at their answer.
Part a
For the discussion of fully stabilised current value financial statements, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible.
Examiners’ commentaries 2011
5
Part b
Solutions to Part b are given below.
IS £Sales 4,050,000 4,050,000Cost of salesOp invent 225,000 270/250 243,000Purchases 2,700,000 2,700,000Clo invent (270,000) 270/280 (260,357)
Balance sheet SFPNon-current assets 3,888,000 300/200 5832,000Inventories 270,000 290/280 279,642Other net current assets 1,161,000 1,161,000
Net assets 5319,000 7,272,642
Share capital (£1 shares) 4,500,000 4,500,000Retained earnings 819,000 2,772,642
Share capital and reserves 5,319,000 7,272,642
Part c
Nca real unrealised 5,832,000 – 3,888,000 * 120/100 = 1,166,400.
Nca real realised 189,000 – 126,000 * 120/100 = 37,800.
Invent real realised 2,682,643 * 120/110 – 2,933,716 = (7,196).
Invent real unrealised 279,642 – 270,000 * 120/115 = (2,097).
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Question 4
Rhymes Ltd enters into two lease transactions in 2010 as follows:
1. An asset, asset A, which could be purchased outright for £319,770 is instead leased for three years. The useful economic life of the asset is three years and at the end of this time, the asset will have no residual value. Rhymes Ltd is responsible for all maintenance and repairs and for all insurance costs for asset A. The lease for asset A provides for half-yearly payments in advance of £60,000, the first payment being made on 1 January 2010.
2. An asset, asset B, which could be purchased outright for £360,000 is leased for three years for annual payments of £90,000 per annum payable in advance. The useful economic life of asset B is eight years. At the end of the three years, Rhymes Ltd intends to return the asset. Rhymes Ltd is not responsible for maintaining and insuring asset B.
[For the full question, please refer to the Examination paper.]
Reading for the question
Subject guide, Chapter 9.
International financial reporting, Chapter 12.
Approaching the question
The question covers both a discussion on operating and finance leases and calculations showing how these would be accounted for in financial statements. For the discussion of operating and finance leases, it is important that candidates discuss all parts of the question, provide clear explanations and examples and assess both the advantages and limitations of the concept in a discursive style. Bullet points should be avoided if possible.
For the calculations, it is important that candidates show detailed workings of how they arrive at their answer.
Part a
A discussion of the definition of operating and finance leases with examples is required with discussion of how these different leases are accounted for.
Part b
Solutions for Part b are given below.
The answer requires a recognition that it is finance lease, and the reason for this.
Asset a
Rate implicit in the lease:
319,770 = 60,000 +60,000 a5]?
a5]? = 259,770/60,000
a5]? = 4.3295 which gives a rate of 5% from tables.
Examiners’ commentaries 2011
7
Rental payments
Date Rental payment Finance charge Reduction in obligation Balance of obligation under finance lease
2010 finance charge =12,989 + accrual of 10,638 which relates to prior period.
2011 finance charges = 8,170 + accrual of 5,579.
Sfp
Asset: non-current asset at 319,770, with annual depreciation of 106,590.
2010 net book value = 213,180.
2011 net book value =106,590.
Liability
2010
Accrual of finance charge = 10,638.
Lease obligation = 212,759.
Current = 101,192.
Non-current = 111, 567.
2011
Accrual of finance charge = 5,579.
Lease obligation = 111,567 – all current.
Asset B
Operating lease
Operating lease and reason why.
Lease payments in income statement = £90,000 in 2010 and 2011.
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Question 5
Answer all parts of this question.
a. What is share premium? Discuss the permissible uses for the share premium account. (5 marks)
b. XYZ plc is considering whether to (i) issue share capital of £400,000 (£1 nominal value shares) or (ii) issue £200,000 (£1 nominal value shares) and raise £200,000 from a long term loan with an interest rate of 15% per annum. The future is uncertain and if XYZ plc has a good year, profit before interest and tax will be £200,000 but if it has a poor year, profit before interest and tax will be £40,000. Calculate profit after tax and earnings per share in both scenarios and comment on your results. Assume the tax rate is 35%. (8 marks)
[For the full question, please refer to the Examination paper.]
Reading for the question
Subject guide, Chapters 7, 10, 12 and 14.
International financial reporting, Chapters 13, 16, 18, 24, 26 and 27.
Approaching the question
This question covers the accounting treatment of several different items, some parts requiring discussion of concepts or key items in financial statements and some parts require calculations. All parts of the question should be attempted with clear workings provided of any required calculations. The marks given to each section are indicated and these should be used as a guide for how long candidates should spend on each section.
Solutions to parts
a. Definition of share premium and its uses should be fully discussed.
b.
Share capital Good Bad
PBIT 200,000 40,000
Tax (70,000) (14,000)
Pat 130,000 26,000
e/s 0.325 0.065
Share capital + debentures
PBIT 200,000 40,000
Interest (30,000) (30,000)
PBT 170,000 10,000
Tax (59,500) (3,500)
Pat 110,500 6,500
e/s 0.553 0.033
Appropriate comments should be made for example on variability and risk.
c. Both the criteria for merger accounting and the reasons for why it was banned need to be fully discussed.
d. Research will be written off to income statement as an expense.
Development project: Development will be capitalised and amortised if it meets criteria which this project appears to. Identify criteria.
Capitalise staff costs of £400,000 and depreciation of £100,000.
Examiners’ commentaries 2011
9
Note: full marks were given if candidates assumed that the development costs were in addition to staff costs and capital expenditure.
Question 6
Either
a. What are “non-current tangible assets” and “investment properties”? Discuss the differences in the accounting treatment of “non-current tangible assets” and “investment properties” and discuss how the different accounting treatments affect the financial statements.
Or
b. Discuss the reasons for initiating standard setting in the 1970’s and assess the advantages and limitations of standard setting in the UK.
Part a
Reading for the question
Subject guide, Chapter 9.
International financial reporting, Chapter 12.
Approaching the question
This question related to a key component of financial statements, that of non-current assets and investment properties. Candidates need to be able to discuss the definitions of these items, to analyse and discuss professional accounting requirements in these areas, and provide appropriate examples. A comparison of different accounting treatments and their impact on financial statements is important and must be explicitly covered in the answer. A discursive style should be adopted, avoiding bullet points if possible.
Good answers should contain definitions of non-current tangible assets and investment properties and identify the different accounting treatments (depreciation, revaluations) possibly with a numerical example. The impact on the SFP and income statement needs to be discussed, again perhaps referring to a numerical example. Candidates may discuss the economic consequences of the different treatment.
Part b
Reading for the question
Subject guide, Chapter 1.
International financial reporting, Chapter 1.
Approaching the question
This question related to an important issue within financial reporting, that of standard setting in the UK. Candidates need to be able to define standard setting and discuss advantage and limitations of standard setting, a topical subject in financial reporting. The question relates to standard setting in general and not to any specific accounting standard but candidates may provide some examples of specific standards to illustrate their argument. However, candidates must not write exclusively about specific standard and not address the question set. A discursive style should be adopted, avoiding bullet points if possible.
Good answers should outline the process of standard setting in the UK and may provide a definition of what an accounting standard is. Answers should discuss the reasons for standard setting (see Chapter 1) and discuss the advantages and disadvantage of standard setting. Candidates
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may also discuss recent developments in standard setting in the UK and discuss the improvements and advantages and limitations of the recent developments.
Question 7
Either
a. Set out the definitions of well offness and measures of income suggested by Sir John Hicks and evaluate their usefulness, implications and limitations for financial reporting.
Or
b. Compare and contrast the different methods for translating the financial statements of foreign subsidiaries. Discuss how the foreign exchange reserves arise under each method, how they should be accounted for and the situations in which each of the methods should be used.
Part a
Reading for the question
Subject guide, Chapter 3.
International financial reporting, Chapter 4.
Approaching the question
This question related to Hicks’s concepts of well-offness and income. Candidates need to be able to discuss and explain the concepts clearly using appropriate examples to illustrate their arguments. Equally important is the evaluation of the concepts in relation to financial reporting. A discursive style should be adopted, avoiding bullet points if possible.
Good answers would describe and give examples of the required definitions, possibly referring to a numerical example. All three aspects of usefulness, implications and limitations (see Chapter 3) need to be addressed with some assessment of the issues raised.
Part b
Reading for the question
Subject guide, Chapter 8.
International financial reporting, Chapter 25.
Approaching the question
The question related to the topic of foreign exchange within financial reporting. Candidates need to be able to explain the accounting techniques, providing suitable examples to illustrate their answer. Candidates also need to be able to compare and contrast different techniques in this question, identify the key similarities and differences between the different techniques and explain and discuss the impact of different techniques on financial statements. A discursive style should be adopted, avoiding bullet points if possible.
Good answers should outline the temporal and closing rate methods and compare and contrast these methods, for example, the key exchange rates used, where the FX is accounted for, treatment of goodwill, etc., possibly referring to a numerical example. Candidates should describe the situations when the different methods should be used and identify the factors which indicate the functional currency and which method is required.
Examiners’ commentaries 2011
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Compound interest factors over n periods at rate i per period.
To determine the present value of a single payment of 1 received ‘n’ periods from the present at a constant discount rate of x% per period
Table 2: Cumulative present value factors (‘annuity factors’)
The table gives the present value of ‘n’ annual payments of 1 received for the next ‘n’ years with a constant discount rate of x% per year. For example, with a discount rate of 8% and with six annual payments of £1 the present value is £4.6229.
