Monitoring Test MT2A

Corporate
Reporting
(International)

P2CR-MT2A-X09-A

Answers & Marking Scheme


Accountancy Tuition Centre Ltd

ATC
INTERNATIONAL

Accountancy Tuition Centre (International Holdings) Ltd 2009 2
1 OLIVER INC
(a) IFRS 3 requirements
(i) Goodwill definition
IFRS 3 defines goodwill as an asset representing the future economic benefits
arising from other assets acquired in a business combination that are not
individually identified and separately recognised.
In essence it is the difference between the cost of the acquisition and the acquirers
interest in the fair value of its identifiable assets, liabilities and contingent liabilities
as at the date of the exchange transaction.
As a result of the 2008 amendment to IFRS 3 goodwill can now be valued in one of
two ways. The first is the same as the previous version of IFRS 3 and recognises
only the Parents share of goodwill whilst the second option now allows the non-
controlling interest share of goodwill to be recognised in the calculation.
(ii) Accounting treatment
It is initially measured at cost, being the excess of the cost of the acquisition over
the acquirers interest in the fair value of the identifiable assets, liabilities and
contingent liabilities acquired as at the date of the acquisition. It is recognised as an
asset.
Subsequent to initial recognition goodwill is carried at cost less any accumulated
impairment losses.
Goodwill is tested annually for impairment, any loss is expensed to profit and loss.
If goodwill only represents the Parents percentage, then the impairment test must
gross up the goodwill to reflect the non-controlling interest share.
If on initial measurement the fair value of the acquirees assets, liabilities and
contingent liabilities exceeds the cost of acquisition (a gain), then the acquirer
reassesses:
the value of net assets acquired;
that all relevant assets, liabilities and contingent liabilities have been
identified; and
that the cost of the combination has been correctly measured.
If there still remains a gain after the reassessment then that gain is recognised
immediately in profit and loss.
Previously this gain was known as negative goodwill.

Accountancy Tuition Centre (International Holdings) Ltd 2009 3
(iii) Treatment of provisions and contingent liabilities
Deferred consideration should be discounted to present value using the companies
cost of capital.
The interest expense (unwinding of the discount) will be charged against profit or
loss till the settlement date. The original cost of investment is not adjusted to reflect
the increase in the liability.
Any contingent consideration is measured at its fair value on the acquisition date.
The fair value will reflect the likely contingent event occurring.
If the contingent consideration is to be paid in cash then the fair value of the liability
will be re-measured each reporting date and any change in fair value will be
reflected in profit or loss
If the settlement is to be made by way of equity instruments then the contingent
consideration is not re-measured. Any difference between the amount of equity
initially recognised and the amount of equity eventually issued will be accounted for
through equity.
(b) Calculation of goodwill
$
Cost of acquisition (W1) 156,322
Fair value of separate net assets acquired
50% 178,723 (W2) (89,362)
_______
66,960
_______
WORKINGS
(1) Consideration
$
Cash
Payable immediately 50,000
Payable 1 July 2011

1 . 1 1 . 1
000 , 50
41,322
______
91,322
Shares (20,000 3.25) 65,000

_______
156,322
_______

Accountancy Tuition Centre (International Holdings) Ltd 2009 4
(2) Net assets summary
At acquisition
$
Share capital 100,000
Revaluation reserve (40,000 35,000) 5,000

Retained earnings (140 80 +50) 110,000
Depreciation policy adjustment
250,000 6/50 (30,000)
FV adjustments
re Doubtful debts (16,472) (W3)
re loan 27,731 (W4)
re Deferred taxation
(30% 58,454 W5) (17,536)
_______
178,723
_______

(3) Adjustment re doubtful debts at acquisition
Over 6-12 3-6
1 year months months Current Total
Age profile as at
31 December 2008 13.3% 5.1% 26.7% 54.9% 100%
$ $ $ $ $
Applied to Receivables as at
1 July 2009 14,763 5,661 29,637 60,939 111,000
______ _____ ______ ______ _______

Correct allowance (following
Olivers accounting policy)
14,763 2,264 2,964 19,991

Actual allowance (following
Heldons accounting policy)
2,953 566 (3,519)

______
Difference 16,472
______

Tutorial note on doubtful debt allowance
To calculate the BS adjustment relating to this allowance it is necessary to
calculate what the allowance is, based on Heldons formula
calculate what the allowance should be, based on Olivers formula
reduce the net assets at acquisition and at the year-end by the extra amount.

Accountancy Tuition Centre (International Holdings) Ltd 2009 5
(4) Loan
$
Fair value
$775,000 1/1.1
3
582,269
Book value 610,000
_______
Adjustment 27,731
_______

(5) Deferred taxation
Carrying Tax Temporary
value base difference
Industrial buildings 220,000 94,286 125,714
Land 285,000 250,000 35,000
Doubtful debts provision (19,991) (19,991)
Loan (582,269) (500,000) (82,269)
______
58,454
______

2 FRAMEWORK
(a)
(i) The accounting choices rest on whether B is considered to have already bought the
car in substance or whether it is merely borrowing it from A.
The factors which point towards treating the cars as inventory of B are:
its obligation to insure the cars.
its obligation to pay for the cars after three months and its obligation to
pay a monthly rental which may be regarded as a finance charge on the
amount outstanding
the fact it cannot be forced to buy the cars for more than their list price at
the date of supply
The factors which point towards treating the cars as inventory of A are:
its ability to demand return or transfer of the cars
Bs right to return them and the fact that A is receiving rental income in
the meantime
On balance it is likely that the deal would be regarded as a sale and the cars would
appear on the statement of financial position of B. However, before a conclusion is
reached it would be necessary to see how the deal worked in practice.

Accountancy Tuition Centre (International Holdings) Ltd 2009 6
(ii) The banks legal ownership of D has little commercial relevance. All the profits of
D go to C and the bank is just in the position of a secured lender.
D should be regarded as a quasi-subsidiary of C and should be consolidated by it.
This would involve elimination of all transactions between the two companies in the
group accounts.
The group statement of financial position would show the properties as assets and
the bank loans as liabilities. The group statement of comprehensive income will
include the full trading results of the properties and any interest on the loans, while
the inter-company management charge will be eliminated on consolidation.
(iii) F plc has arranged a trade loan for its tied houses by arranging advances from banks
which are both guaranteed and subsidised by F plc. It can be argued that the
substance of this arrangement is a subsidised loan made from the brewer to the tied
house. Consequently the brewers position is no different from the situation where
the bank makes a loan to the brewer and the brewer then lends those funds to the
tied house at a subsidised rate. The risks and benefits to the brewer are the same if
the tied house defaults on the loan then the bank has full recourse via the guarantee
to the brewer and the brewer also bears the interest differential. If this is the case the
loan should appear on F plcs statement of financial position.
An alternative argument would be that the substance of the transaction is that F plc
bears a contingent liability for the guarantee which, in accordance with IAS 10
should be disclosed in a note to the accounts. The interest subsidy could just be
regarded as a trade discount to the tied house.
It is difficult to ascertain the substance of this transaction, but on balance, because F
plc bears both the guarantee and the interest subsidy, the transactions would
probably be regarded as a financing arrangement, requiring the loan to be brought
onto F plcs statement of financial position.
(b)
(i) Sale and leaseback (IAS 17)
IAS 17 addresses sale and leaseback transactions. Its key objective is to ensure that
the true substance of such transactions is reflected in the financial statements.
i. Head office
Because the term of the leaseback is only five years and the proceeds of the
compulsory purchase order will go to the purchaser/lessor, this should be accounted
for as an operating leaseback.
However, the selling price is artificially low and this is reflected in future rentals
that are below market value. Therefore, the apparent loss should be deferred and
released over the length of the lease.

Accountancy Tuition Centre (International Holdings) Ltd 2009 7
The correct accounting entries are summarised below.
Dr Cr
On disposal $000 $000

Cash 2,000
Deferred loss 50
Non current asset head office 2,050

Future charges to the statement of comprehensive
income
$000

Total operating lease payment (5 100,000) 500
Release of deferred loss 50

550

Dr Cr
Next year $000 $000

P&L lease rentals 100
Cash 100

P&L lease rentals (50/5) 10
Deferred loss 10

ii. Warehouse
The warehouse is to be leased back for the whole of its remaining useful economic
life and the transaction should therefore be treated as a finance leaseback.
Treat as a sale followed by a leaseback
Dr Cr
On disposal $000 $000

Cash 1,150
Non current assets warehouse 1,003
Deferred profit as no real sale 147

Non current assets warehouse 1,093
Lease creditor fv of asset 1,093
(95% 1,150,000)



Future charges to the statement of
comprehensive income
$000

Total payments (20 85,000) 1,700
Lease creditor (1,093)

607

Total depreciation 1,093
Release of deferred profit (147)

Accountancy Tuition Centre (International Holdings) Ltd 2009 8
Dr Cr
Next year $000 $000

Lease creditor 85
Cash 85

P&L finance interest (W1) 60.7
Accruals 60.7

Deferred profit (W1) 14.7
P&L 14.7

P&L depreciation 54.65
Accumulated depreciation 1,093/20 54.65


(ii) Loans
The key issue is to ensure that the full finance cost is recognised and that it is
allocated to accounting periods on an appropriate basis. There is no existing IAS
rule on this area but the application of substance over form accounting would
suggest that the interest should be charged to profit or loss so as to provide a
constant periodic rate of charge on the outstanding obligation. This follows the
treatment specified by IAS 17 for finance lease interest and the proposed accounting
treatment in the appendix to IAS 39 Financial instruments.
(1) Stepped bonds
Therefore the interest should be spread using the interest rate implicit in the
transaction, i.e. 10.06%.
The correct accounting entries are as follows.
Dr Cr
On receipt of the cash $000 $000

Cash 1,000
Bond 1,000


Future charges to profit and loss $000

Total interest (W2) 1,060

Dr Cr
Next year $000 $000

P&L interest (W3) 100.6
Bond accrued interest (100.6-80) 20.6
Cash (1000 8%) 80



Accountancy Tuition Centre (International Holdings) Ltd 2009 9
(2) Deep discount bond
Such bonds should be initially recorded as the cash received net of interest costs.
The difference between this amount and the total amounts to be repaid is interest.
Dr Cr
On receipt of the cash $000 $000

Cash (470-20) 450
Bond Net proceeds 450


Future charges to profit or loss $000

Total interest
Amounts paid nominal interest (1000 3% 10) 300
Capital 1,000

1,300
Net cash received 450

850

Dr Cr
Next year $ $

P&L interest (W4) 59,535
Bond accrued interest (59.535-30) 29,535
Cash (1000 3%) 30,000

WORKINGS
(1) Interest on warehouse leaseback
Interest
$

Interest 19/190 607,000 60,700

Release of deferred profit
90/190 (147,000) (14,700)

(2) Total interest on stepped bond
Interest
$000

$1 million 8% 3 240
$1 million 10% 3 300
$1 million 13% 4 520

1,060

Accountancy Tuition Centre (International Holdings) Ltd 2009 10
(3) Interest charged on stepped bond
Year B/F Interest Paid C/f
(10.06%)

1 1,000,000 100,600 (80,000) 1,020,600

(4) Interest on deep discount bond
Year B/F Interest Paid C/f
(13.23%)

1 450,000 59,535 (30,000) 479,535

(c)
There have been fundamental changes in international financial markets in recent years.
These have been largely facilitated by improvements in information technology and the
development of a wide range of derivative financial instruments and risk management
strategies.
Financial risks can be managed and transferred separately or in varying combinations. An
entity can instantaneously change its risk profile by using derivative instruments to reduce or
eliminate risk, or multiply the effect of environmental change.
Entities are vulnerable to the volatility of price changes of financial instruments in the
changing economic environment.
Risk management has become a very dynamic activity requiring careful and continuous
monitoring. Traditional accounting principles are not able to provide adequate information for
the appreciation of the consequences of management actions and environmental changes.
Problems of traditional accounting
Traditional accounting practices are based on serving the needs of manufacturing companies.
Accounting for such entities is concerned with accruing costs to be matched with revenues. A
key concept in such a process is revenue recognition.
These traditional cost based concepts are not adequate to deal with the recognition and
measurement of financial assets and liabilities. Specifically:
Traditional accounting bases recognition on the transfer of risks and rewards. The system is
not designed to deal with transactions which divide up the risks and rewards associated with a
particular asset or liability and allocate them to different parties.
Some derivatives have no or little initial cost. These would not be accounted for by traditional
historical cost based systems.
The historical cost of financial assets and liabilities has little relevance to risk management
activities

Accountancy Tuition Centre (International Holdings) Ltd 2009 11
Marking Scheme
1 OLIVER INC
Marks

(a) Definition of goodwill 2
Accounting treatment Positive goodwill 3
Accounting treatment Negative goodwill 2
Treatment of deferred consideration 2
Treatment of contingent consideration 2

(b) Purchase considerations cash 1 deferred 1 shares 3
FV of net assets acquired 11
Depreciation adjustment 2
Receivables 3
Loan 2
Deferred tax 3

Total for question 25



2 FRAMEWORK
Marks
(a) 3 marks per situation 9

(b) Properties held for resale 3 marks each 6
Loans 2 marks per loan 5

(c) 1 mark per point to a max of 5

Total 25