Paper 2.

5(INT)
Financial
Reporting
(International Stream)

PART 2

THURSDAY 7 DECEMBER 2006

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A This ONE question is compulsory and MUST be

answered

Section B THREE questions ONLY to be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination

hall

The Association of Chartered Certified Accountants

Section A – This ONE question is compulsory and MUST be attempted

1 Hosterling purchased the following equity investments:

On 1 October 2005: 80% of the issued share capital of Sunlee. The acquisition was through a share exchange of
three shares in Hosterling for every five shares in Sunlee. The market price of Hosterling’s shares at 1 October 2005
was $5 per share.
On 1 July 2006: 6 million shares in Amber paying $3 per share in cash and issuing to Amber’s shareholders 6%
(actual and effective rate) loan notes on the basis of $100 loan note for every 100 shares acquired.
The summarised income statements for the three companies for the year ended 30 September 2006 are:
Hosterling Sunlee Amber
$’000 $’000 $’000
Revenue 105,000 62,000 50,000
Cost of sales (68,000) (36,500) (61,000)
–––––––– –––––––– ––––––––
Gross profit/(loss) 37,000 25,500 (11,000)
Other income (note (i)) 400 nil nil
Distribution costs (4,000) (2,000) (4,500)
Administrative expenses (7,500) (7,000) (8,500)
Finance costs (1,200) (900) nil
–––––––– –––––––– ––––––––
Profit/(loss) before tax 24,700 15,600 (24,000)
Income tax (expense)/credit (8,700) (2,600) 4,000
–––––––– –––––––– ––––––––
Profit/(loss) for the period 16,000 13,000 (20,000)
–––––––– –––––––– ––––––––
The following information is relevant:
(i) The other income is a dividend received from Sunlee on 31 March 2006.
(ii) The details of Sunlee’s and Amber’s share capital and reserves at 1 October 2005 were:
Sunlee Amber
$’000 $’000
Equity shares of $1 each 20,000 15,000
Retained earnings 18,000 35,000
(iii) A fair value exercise was carried out at the date of acquisition of Sunlee with the following results:
carrying fair value remaining life (straight line)
amount
$’000 $’000
Intellectual property 18,000 22,000 still in development
Land 17,000 20,000 not applicable
Plant 30,000 35,000 five years
The fair values have not been reflected in Sunlee’s financial statements.
Plant depreciation is included in cost of sales.
No fair value adjustments were required on the acquisition of Amber.
(iv) In the year ended 30 September 2006 Hosterling sold goods to Sunlee at a selling price of $18 million.
Hosterling made a profit of cost plus 25% on these sales. $7·5 million (at cost to Sunlee) of these goods were
still in the inventories of Sunlee at 30 September 2006.
(v) Impairment tests for both Sunlee and Amber were conducted on 30 September 2006. They concluded that the
goodwill of Sunlee should be written down by $1·6 million and, due to its losses since acquisition, the investment
in Amber was worth $21·5 million.
(vi) All trading profits and losses are deemed to accrue evenly throughout the year.

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Required:
(a) Calculate the goodwill arising on the acquisition of Sunlee at 1 October 2005. (5 marks)

(b) Calculate the carrying amount of the investment in Amber at 30 September 2006 under the equity method
prior to the impairment test. (4 marks)

(c) Prepare the consolidated income statement for the Hosterling Group for the year ended 30 September 2006.
(16 marks)

(25 marks)

3 [P.T.O.
Section B – THREE questions ONLY to be attempted

2 The following trial balance relates to Tadeon, a publicly listed company, at 30 September 2006:
$’000 $’000
Revenue 277,800
Cost of sales 118,000
Operating expenses 40,000
Loan interest paid (note (i)) 1,000
Rental of vehicles (note (ii)) 6,200
Investment income 2,000
25 year leasehold property at cost (note (iii)) 225,000
Plant and equipment at cost 181,000
Investments at amortised cost 42,000
Accumulated depreciation at 1 October 2005 – leasehold property 36,000
– plant and equipment 85,000
Equity shares of 20 cents each fully paid 150,000
Retained earnings at 1 October 2005 18,600
2% Loan note (note (i)) 50,000
Deferred tax balance 1 October 2005 (note (iv)) 12,000
Trade receivables 53,500
Inventories at 30 September 2006 33,300
Bank 1,900
Trade payables 18,700
Suspense account (note (v)) 48,000
–––––––– ––––––––
700,000 700,000
–––––––– ––––––––
The following notes are relevant:
(i) The loan note was issued on 1 October 2005. It is redeemable on 30 September 2010 at a large premium (in
order to compensate for the low nominal interest rate). The finance department has calculated that the effective
interest rate on the loan is 5·5% per annum.
(ii) The rental of the vehicles relates to two separate contracts. These have been scrutinised by the finance
department and they have come to the conclusion that $5 million of the rentals relate to a finance lease. The
finance lease was entered into on 1 October 2005 (the date the $5 million was paid) for a four year period. The
vehicles had a fair value of $20 million (straight-line depreciation should be used) at 1 October 2005 and the
lease agreement requires three further annual payments of $6 million each on the anniversary of the lease. The
interest rate implicit in the lease is to be taken as 10% per annum. (Note: you are not required to calculate the
present value of the minimum lease payments.) The other contract is an operating lease and should be charged
to operating expenses.
Other plant and equipment is depreciated at 121/2% per annum on the reducing balance basis.
All depreciation of property, plant and equipment is charged to cost of sales.
(iii) On 30 September 2006 the leasehold property was revalued to $200 million. The directors wish to incorporate
this valuation into the financial statements.
(iv) The directors have estimated the provision for income tax for the year ended 30 September 2006 at $38 million.
At 30 September 2006 there were $74 million of taxable temporary differences, of which $20 million related to
the revaluation of the leasehold property (see (iii) above). The income tax rate is 20%.
(v) The suspense account balance can be reconciled from the following transactions:
The payment of a dividend in October 2005. This was calculated to give a 5% yield on the company’s share
price of 80 cents as at 30 September 2005.
The net receipt in March 2006 of a fully subscribed rights issue of one new share for every three held at a price
of 32 cents each. The expenses of the share issue were $2 million and should be charged to share premium.
Note: the cash entries for these transactions have been correctly accounted for.

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Required:
Prepare for Tadeon:
(a) An income statement for the year ended 30 September 2006; and (8 marks)

(b) A balance sheet as at 30 September 2006. (17 marks)

Note: A statement of changes in equity is not required. Disclosure notes are not required.

(25 marks)

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3 (a) Recording the substance of transactions, rather than their legal form, is an important principle in financial
accounting. Abuse of this principle can lead to profit manipulation, non-recognition of assets and substantial debt
not being recorded on the balance sheet.

Required:
Describe how the use of off balance sheet financing can mislead users of financial statements.
Note: your answer should refer to specific user groups and include examples where recording the legal form
of transactions may mislead them. (9 marks)

(b) Angelino has entered into the following transactions during the year ended 30 September 2006:
(i) In September 2006 Angelino sold (factored) some of its trade receivables to Omar, a finance house. On
selected account balances Omar paid Angelino 80% of their book value. The agreement was that Omar
would administer the collection of the receivables and remit a residual amount to Angelino depending upon
how quickly individual customers paid. Any balance uncollected by Omar after six months will be refunded
to Omar by Angelino. (5 marks)
(ii) On 1 October 2005 Angelino owned a freehold building that had a carrying amount of $7·5 million and had
an estimated remaining life of 20 years. On this date it sold the building to Finaid for a price of $12 million
and entered into an agreement with Finaid to rent back the building for an annual rental of $1·3 million for
a period of five years. The auditors of Angelino have commented that in their opinion the building had a
market value of only $10 million at the date of its sale and to rent an equivalent building under similar terms
to the agreement between Angelino and Finaid would only cost $800,000 per annum. Assume any finance
costs are 10% per annum. (6 marks)
(iii) Angelino is a motor car dealer selling vehicles to the public. Most of its new vehicles are supplied on
consignment by two manufacturers, Monza and Capri, who trade on different terms.
Monza supplies cars on terms that allow Angelino to display the vehicles for a period of three months from
the date of delivery or when Angelino sells the cars on to a retail customer if this is less than three months.
Within this period Angelino can return the cars to Monza or can be asked by Monza to transfer the cars to
another dealership (both at no cost to Angelino). Angelino pays the manufacturer’s list price at the end of
the three month period (or at the date of sale if sooner). In recent years Angelino has returned several cars
to Monza that were not selling very well and has also been required to transfer cars to other dealerships at
Monza’s request.
Capri’s terms of supply are that Angelino pays 10% of the manufacturer’s price at the date of delivery and
1% of the outstanding balance per month as a display charge. After six months (or sooner if Angelino
chooses), Angelino must pay the balance of the purchase price or return the cars to Capri. If the cars are
returned to the manufacturer, Angelino has to pay for the transportation costs and forfeits the 10% deposit.
Because of this Angelino has only returned vehicles to Capri once in the last three years. (5 marks)

Required:
Describe how the above transactions and events should be treated in the financial statements of
Angelino for the year ended 30 September 2006. Your answer should explain, where relevant, the
difference between the legal form of the transactions and their substance.
Note: The mark allocation is shown against each of the three transactions above.

(25 marks)

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 This is a blank page.
Question 4 begins on page 8.

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4 Minster is a publicly listed company. Details of its financial statements for the year ended 30 September 2006,
together with a comparative balance sheet, are:
Balance Sheet at 30 September 2006 30 September 2005
$000 $000 $000 $000
Non-current assets (note (i))
Property, plant and equipment 1,280 940
Software 135 nil
Investments at fair value through profit and loss 150 125
–––––– ––––––
1,565 1,065
Current assets
Inventories 480 510
Trade receivables 270 380
Amounts due from construction contracts 80 55
Bank nil 830 35 980
–––– –––––– –––– ––––––
Total assets 2,395 2,045
–––––– ––––––
Equity and liabilities
Equity shares of 25 cents each 500 300
Reserves
Share premium (note (ii)) 150 85
Revaluation reserve 60 25
Retained earnings 950 1,160 965 1,075
–––– –––––– –––– ––––––
1,660 1,375
Non-current liabilities
9% loan note 120 nil
Environmental provision 162 nil
Deferred tax 18 300 25 25
–––– ––––
Current liabilities
Trade payables 350 555
Bank overdraft 25 40
Current tax payable 60 435 50 645
–––– –––––– –––– ––––––
Total equity and liabilities 2,395 2,045
–––––– ––––––
Income statement for the year ended 30 September 2006
Revenue 1,397
Cost of sales (1,110)
––––––
Gross profit 287
Operating expenses (125)
––––––
162
Finance costs (note (i)) (40)
Investment income and gain on investments 20
––––––
Profit before tax 142
Income tax expense (57)
––––––
Profit for the year 85
––––––
The following supporting information is available:
(i) Included in property, plant and equipment is a coal mine and related plant that Minster purchased on 1 October
2005. Legislation requires that in ten years’ time (the estimated life of the mine) Minster will have to landscape
the area affected by the mining. The future cost of this has been estimated and discounted at a rate of 8% to a

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 present value of $150,000. This cost has been included in the carrying amount of the mine and, together with
the unwinding of the discount, has also been treated as a provision. The unwinding of the discount is included
within finance costs in the income statement.
Other land was revalued (upward) by $35,000 during the year.
Depreciation of property, plant and equipment for the year was $255,000.
There were no disposals of property, plant and equipment during the year.
The software was purchased on 1 April 2006 for $180,000.
The market value of the investments had increased during the year by $15,000. There have been no sales of
these investments during the year.
(ii) On 1 April 2006 there was a bonus (scrip) issue of equity shares of one for every four held utilising the share
premium reserve. A further cash share issue was made on 1 June 2006. No shares were redeemed during the
year.
(iii) A dividend of 5 cents per share was paid on 1 July 2006.

Required:
(a) Prepare a cash flow statement for Minster for the year to 30 September 2006 in accordance with IAS 7 Cash
flow statements. (15 marks)

(b) Comment on the financial performance and position of Minster as revealed by the above financial statements
and your cash flow statement. (10 marks)

(25 marks)

9 [P.T.O.
5 (a) (i) State the definition of both non-current assets held for sale and discontinued operations and explain the
usefulness of information for discontinued operations. (4 marks)
Partway is in the process of preparing its financial statements for the year ended 31 October 2006. The
company’s main activity is in the travel industry mainly selling package holidays (flights and accommodation) to
the general public through the Internet and retail travel agencies. During the current year the number of holidays
sold by travel agencies declined dramatically and the directors decided at a board meeting on 15 October 2006
to cease marketing holidays through its chain of travel agents and sell off the related high-street premises.
Immediately after the meeting the travel agencies’ staff and suppliers were notified of the situation and an
announcement was made in the press. The directors wish to show the travel agencies’ results as a discontinued
operation in the financial statements to 31 October 2006. Due to the declining business of the travel agents, on
1 August 2006 (three months before the year end) Partway expanded its Internet operations to offer car hire
facilities to purchasers of its Internet holidays.
The following are Partway’s summarised income statement results – years ended:
31 October 2006 31 October 2005
Internet travel agencies car hire total total
$’000 $’000 $’000 $’000 $’000
Revenue 23,000 14,000 2,000 39,000 40,000
Cost of sales (18,000) (16,500) (1,500) (36,000) (32,000)
–––––––– ––––––– ––––––– –––––––– ––––––––
Gross profit/(loss) 5,000 (2,500) 500 3,000 8,000
Operating expenses (1,000) (1,500) (100) (2,600) (2,000)
–––––––– ––––––– ––––––– –––––––– ––––––––
Profit/(loss) before tax 4,000 (4,000) 400 400 6,000
–––––––– ––––––– ––––––– –––––––– ––––––––
The results for the travel agencies for the year ended 31 October 2005 were: revenue $18 million, cost of sales
$15 million and operating expenses of $1·5 million.

Required:
(ii) Discuss whether the directors’ wish to show the travel agencies’ results as a discontinued operation is
justifiable. (4 marks)
(iii) Assuming the closure of the travel agencies is a discontinued operation, prepare the (summarised)
income statement of Partway for the year ended 31 October 2006 together with its comparatives.
Note: Partway discloses the analysis of its discontinued operations on the face of its income statement.
(6 marks)

(b) (i) Describe the circumstances in which an entity may change its accounting policies and how a change
should be applied. (5 marks)
The terms under which Partway sells its holidays are that a 10% deposit is required on booking and the balance
of the holiday must be paid six weeks before the travel date. In previous years Partway has recognised revenue
(and profit) from the sale of its holidays at the date the holiday is actually taken. From the beginning of November
2005, Partway has made it a condition of booking that all customers must have holiday cancellation insurance
and as a result it is unlikely that the outstanding balance of any holidays will be unpaid due to cancellation. In
preparing its financial statements to 31 October 2006, the directors are proposing to change to recognising
revenue (and related estimated costs) at the date when a booking is made. The directors also feel that this change
will help to negate the adverse effect of comparison with last year’s results (year ended 31 October 2005) which
were better than the current year’s.

Required:
(ii) Comment on whether Partway’s proposal to change the timing of its recognition of its revenue is
acceptable and whether this would be a change of accounting policy. (6 marks)

(25 marks)

End of Question Paper

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