The Examiner's Answers F1 - Financial Operations

Some of the answers that follow are fuller and more comprehensive than would be expected from a well-prepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike.

SECTION A
Answer to Question One
1.1 B

1.2

A tax base is something that is liable to tax, e.g. income or consumption of goods

1.3

1.4 Accounting profit Add depreciation Add amortisation Less tax depreciation Taxable profit Tax @ 25% Answer D

$000 860 42 15 917 51 866 216.5

1.5

1.6

1.7

Financial Operations

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1.8

An operating segment is defined by IFRS 8 as a component of an entity whose operating results are regularly reviewed by the entitys chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance.

1.9

Four from the following: Significant risks and rewards of ownership of the goods have been transferred to the buyer The seller does not retain any continuing influence or control over the goods Revenue can be measured reliably It is reasonably certain the buyer will pay for the goods The costs to the seller can be measured reliably

March 2012

Financial Operations

SECTION B

Answer to Question Two

(a)
Deferred tax balance at 31 December 2011: Carrying Value $000 440 (55) 385 70 455 (65) 390 Tax base $000 440 (220) 220 0 220 (55) 165

Cost 1 January 2010 Year to 31 December 2010 Revaluation 1 Jan 2011 Year to 31 December 2011

At 31 December 2010: $385,000 - $220,000 = $165,000 At 31 December 2011: $390,000 - $165,000 = $225,000 Change (Increase) $60,000 Tax at 25% = $15,000 Deferred tax movement in year to 31 December 2011: Debit to income statement of $15,000 Deferred tax balance at 31 December 2011: Credit balance $225,000 x 25% = $56,250

(b)
(i) An item that is Zero rated means that no VAT is charged on sales but UYT can reclaim VAT paid on its inputs. An item exempted from VAT means that the revenue earned is exempt VAT, so no VAT is charged but UYT cannot reclaim the portion of input VAT that relates to the exempted goods. If an actual figure cannot be calculated it will be on a proportional basis. Excl VAT $ Inputs: Cost Input VAT claim limited to 450/600 Outputs: Standard rate Exempt Net (ii) Net Vat due to be paid is $22,500 400,000 VAT 15% $ 60,000 45,000

450,000 150,000 600,000

67,500 0 67,500 22,500

Financial Operations

March 2012

(c)
Under the classical system of corporate income tax the entitys profit for the year is taxed and then when a dividend is paid the shareholder is taxed on the full amount received. In this case the dividends have been taxed twice. With an imputation system of corporate income tax the entity pays corporate income tax on all the profits before paying a dividend but then all or part of the underlying corporate income tax that relates to the distribution is imputed to the shareholders as a tax credit. Therefore avoiding the problem of double taxation of dividends. If the personal income tax rate of the shareholder is higher than the rate of tax credit the shareholder may have to apy additional tax on the dividend, however it will still only have been taxed once. With systems using the full imputation system all of the underlying corporate income tax is passed to the shareholder as a tax credit if a partial imputation system is used only part of the tax paid by the entity will be passed to the shareholder. YT has received a dividend from LKJ and will have received a tax credit for the proportion of tax paid by LKJ on the underlying profit. As LKJ is an entity resident in Country X it will have paid corporate income tax at 25% on its taxable profit for the year. This will be passed on to its shareholders as a tax credit as Country X uses the full imputation system.. YT will receive a tax credit and will be able to set this tax credit against any tax due on the dividend leaving additional tax to be paid if YTs personal tax rate is higher than 25%. YT is therefore incorrect in thinking that his dividend has been taxed twice.

(d)
The four main entities involved in developing and implementing IFRS are: IFRS Foundation (formerly known as the International Accounting Standards Committee Foundation (IASCF). Role governance and fund raising International Accounting Standards Board (IASB) Role responsibility for all technical matters including the preparation and publication of international financial reporting standards IFRS Advisory Council (formerly known as the Standards Advisory Council) Role to provide a forum for wider participation. Provides strategic advice to the IASB and informs the IASB of public views on major standard setting projects. IFRS Interpretations Committee (formerly known as the International Financial Reporting Interpretations Committee IFRIC) Role provides timely guidance on the application and interpretation of IFRSs

March 2012

Financial Operations

(e)
(i) According to the International Standard on Auditing (ISA) 200 Objective and General Principles Governing an Audit of Financial Statements the objective of an audit is to enable auditors to express an opinion as to whether the financial statements give a true and fair view of the affairs of the entity at the period end and of its profit or loss for the period then ended and have been properly prepared in accordance with the applicable reporting framework (e.g. relevant legislation and applicable accounting standards). (ii) Three key areas of content of the audit report as required by ISA 700 The Auditors Report on Financial Statements include: Managements responsibility for the financial statements Report should state that management is responsible for the preparation and fair presentation of the financial statements. Auditors responsibility Report should state that the responsibility of the auditor is to express an opinion on the financial statements based on the audit. Description of the audit work done Report should give an overview of the type of work done during the audit, such as obtaining audit evidence, risk assessment, procedures selected and the evaluation of the accounting policies used. Auditors opinion Report should give the auditors opinion on whether the financial statements give a true and fair view or are presented fairly in all material respects, in accordance with the applicable financial reporting framework.

(f)
The ethical problem that XQ faces is that a professional accountant in business should prepare or present information fairly, honestly and in accordance with relevant professional standards so that the information will be understood in its context. A professional accountant is expected to act with integrity and objectivity and not allow any undue influence from others to override his professional judgement. XQ is facing pressure from others to change the results and therefore break the CIMA Code. XQ is being asked to misrepresent the facts of the actual situation which would be contrary to the CIMA Codes fundamental principles of integrity and objectivity. XQ would also be breaking the due care requirement of the CIMA Code. XQ should apply safeguards to eliminate the threats or reduce them to an acceptable level. As other staff are offering incentives XQ will need to decline these and refuse to alter the accounting information. XQ should also consult with his line manager. XQ may also wish to get advice from the CIMA helpline. The situation is unlikely to require XQ to seek legal advice or resign.

Financial Operations

March 2012

SECTION C
Answer to Question Three
RTY - Statement of comprehensive income for the year ended 31 January 2012 $000 $000 Revenue 9,320 Cost of sales (6,059) Gross Profit 3,261 Administrative expenses (1,225) Distribution costs (679) (1,904) Profit from operations 1,357 Finance cost (137) Profit before tax 1,220 Income tax expense (755) Net profit for the period 465 Other Comprehensive Income Revaluation of property (W7) 1,240 1,705

RTY - Statement of Financial Position at 31 January 2012

$000 Non-current assets Property, plant and equipment Deferred development expenditure Current assets Inventory Trade receivables Cash and cash equivalents Total assets Equity and liabilities Equity Share capital Share premium Retained earnings Revaluation reserve Total equity Non-current liabilities Long term borrowings Deferred tax Total non-current liabilities Current liabilities Trade payables Tax payable Interest payable Total current liabilities Total equity and liabilities $000 14,877 272 15,149 330 1,428 142 1,900 17,049

1,375 2,750 3,912 3,340 11,377

2,740 1,019 3,759

1,080 765 68 1,913 17,049

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Financial Operations

RTY Statement of changes in equity for year ended 31 January 2012 Equity Share Retained Shares Premium Earnings $000 $000 $000 Balance at 1 February 2011 1,375 2,750 2,785 Statement of comprehensive 465 income for year Disposal of revalued property (W4) 800 Dividend paid (138) Balance at 31 January 2012 1,375 2,750 3,912 Workings (All figures in $000) (W1) Depreciation Cost/revalued amount Balance b/f Revaluation adjustment Assets sold Depreciation Balance b/f Assets sold Revaluation adjustment Depreciation for year Carrying value 31 Jan 2012 . 5,050

Revaluation Reserve $000 2,900 1,240 (800) 3,340

Total $000 9,810 1,705 0 (138) 11,377

Land 6,220 630 6,850 (1,800) 5,050

Buildings 10,900 (2,000) 8,900 . 8,900 2,610 . 2,610 (2,610) 445 445 8,455

Plant & equipment 5,750 . 5,750 (820) 4,930 3,900 (800) 3,100 458 3,558 1,372

Total 22,870 (1,370) 21,500 (2,620) 18,880 6,510 (800) 5,710 (2,610) 903 4,003 14,877

(W2) Deferred development expenditure Balance b/f Expenditure in year Years amortisation 455 71 526 (254) 272

Years amortisation: Capitalised in previous years Expenditure in 2011 Amortised at 20%

1,199 71 1,270 254

(W3) Trial balance Depreciation (W1) Research Bad debt Development amortisation (W2) Gain on disposal of non-current assets Totals

Cost of sales 4,939 903 163 48 254 (248) 6,059

Administration 1,225

Distribution 679

. 1,225

. 679

Financial Operations

March 2012

(W4) Disposal of non-current assets Land Plant and equipment Carrying value 1,800 (820-800)= 20 2,060 8 Selling price 260 (12) Profit/(loss)

Land Revalued amount 1,800 Cost 1,000 Reversal of revaluation 800

(W5)

Interest Years loan interest Paid Current liability

(2740 x 5%)

137 69 68

(W6)

Tax Balance b/f Year Decrease in deferred tax Income statement 35 765 800 (45) 755

Statement of financial position Current liability tax Provision deferred tax (W7)

765 1,019

Revaluation of Land and buildings

Land (W1) 630 Buildings (W1) (2,610 2,000) 610 1,240

March 2012

Financial Operations

Answer to Question Four

Workings (All workings in $000) (i) Fair value of net assets of Branch at acquisition Equity Shares 790 Retained earnings 380 Fair value adjustment 240 1,410 (ii) Goodwill - Branch Cost Fair value of net assets acquired: Goodwill (iii) Investment in associate - Leaf Cost Add group share of post acquisition profits (220 - 70) = 150 x 40% = Investment at 31 January 2012 (iv) Intra-group trading Mark up on cost 50% = 50/150 or 33.3% margin on selling price. Selling price 180; profit = 180 x 33.3% = 60 2/3 remain in inventory - unrealised profit 60 x 2/3 = 40 Dr. 40 180 180 Cr. 40

1,500 1,410 90

550 60 610

Consolidated cost of sales Consolidated current assets - inventory Consolidated revenue Consolidated cost of sales

Current accounts: Tree current account with Branch Less cheque in transit Branch current account with Tree Loan interest Accrue interest receivable by Tree Interest payable Interest receivable

123 28 95 95

Cancels Cancels

30 Dr 30 Cr 30

Consolidated interest payable = (102 + 59 30) = 131 Consolidated interest receivable (30 30) = 0 (v) Excess depreciation Fair value adjustment 240 Economic life 10 years, straight line basis Excess depreciation = 240/10 = 24

Financial Operations

March 2012

(vi) Consolidated Retained Earnings Balance Tree at 1 Feb 2011 (665 620) Add consolidated profit for year Balance 31 Jan 2012 Alternative calculation: (vi) Consolidated Retained Earnings Balance - Tree (665 + 30) Branch - group share of post acquisition profits (495 - 380) = Associate - Leaf, group share of post acquisition profits (iii) Excess depreciation Cancel unrealised profit in inventory (iv)

45 761 806

695 115 60 (24) (40) 806

(vii) Consolidated Property, plant and equipment Tree Branch Fair value adjustment Excess depreciation

1,535 1,155 240 (24) 2,906

Tree Group Consolidated Statement of Comprehensive Income for year ended 31 January 2012 $000 Revenue(2,200 + 777 -180) 2,797 (1,452) Cost of sales (1,112 + 456 180 + 24 + 40) Gross profit 1,345 Expenses (221 + 115) (336) Profit from operations 1,009 Share of profit of associated entity 60 (131) Finance cost Profit before tax 938 Tax (145 + 32) (177) Profit for the year 761

Tree Group - Consolidated Statement of Financial Position as at 31 January 2012 $000 $000 Non-Current Assets Property, plant and equipment (vii) 2,906 Goodwill (ii) 90 610 Investment in associate (iii) 3,606 Current Assets Inventory (1,360 + 411 - 40) 1,731 Trade receivables (1,540 + 734) 2,274 150 Cash and cash equivalents (47 + 75 + 28) 4,155 Total assets 7,761 Equity and Liabilities Equity Shares Retained Earnings (vi)

3,900 806 4,706

Current Liabilities Trade payables (2,690 + 365)

3,055 7,761

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Financial Operations