may 2017 professional examinations corporate …kojach ltd in compliance with the requirements of...
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MAY 2017 PROFESSIONAL EXAMINATIONS CORPORATE REPORTING (PAPER 3.1)
CHIEF EXAMINER’S REPORT, QUESTIONS & MARKING SCHEME
STANDARD OF PAPER The standard of the paper was the same as previously administered ones. The questions were standard for this level of examination. The questions were spread enough to cover all areas of the syllabus. The amount of work (the relevant workings and the final answer) required by question 1 was more than the allotted time and marks. Apart from that the rest were commensurate with the allotted time and marks. GENERAL PERFORMANCE Generally, performance was below average. This could be attributed to lack of adequate preparation by the candidates. Performance at centres in Accra appeared to be higher than outside. There was no similarity of answers to suggest any possible copying. NOTABLE STRENGTHS & WEAKNESS Candidates showed improved understanding of appraisal of financial performance and preparing capital reduction schemes; they scored high marks in those areas. Weaknesses of candidates can be summarized as follows:
Many candidates had difficulties in the treatment of a property which was in use under IAS 16 and later converted to an investment property under IAS 40. It should be noted that investment property is a topic under Level 2.1: Financial Reporting which candidates had already passed.
Some candidates showed lack of effective time management in answering questions. They spent too much time on questions they believed they could handle; this left them with little time to tackle other questions satisfactorily. Candidates should be taught how to allocate time to questions according to the allotted marks and to strictly respect time allocation. They should move to another question when the time allocated is spent.
Some candidates presented themselves for the examination without adequate preparation and as a result scored very low marks. Obviously, they were not ready for the examination.
Several candidates did not attempt all parts of the questions. Also, there were instances where whole questions were not attempted. This attitude reduced candidates’ chances of scoring pass marks. Questions 1 and 2 were the questions which were partially attempted or completely ignored.
Some candidates did not read the questions properly and as a result presented answers which were not required. This was evident in question 5 c). Candidates were required to discuss the “measurement basis” of elements of financial statements in accordance with the IASB Conceptual Framework. Instead many candidates misread the question and wasted time discussing “elements of financial statements”.
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QUESTION ONE
The following draft consolidated financial statements relates to the Baa Koomi Group plc
Consolidated statement of profit or loss for the year ended 31 July 2016
GH¢000 GH¢000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Income from interests in associated undertakings
Operating profit
Profit on disposal of tangible non-current assets
Income from investments
Interest payable
Profit before taxation
Taxation
Profit after tax
Non-controlling interests –equity
Profit attributable to members of parent company
Dividends paid
510
230
5,845
(2,160)
3,685
(740)
2945
990
3,935
300
80
(300)
4,015
(1,345)
2,670
(200)
2,470
(800)
1,670
Consolidated statement of financial positions as at 31 July 2016 2015 GH¢000 GH¢000
Non-current assets
Intangible assets
Tangible assets
Investment in associated undertaking
Other investments
Currents assets
Inventories
Trade receivables
Cash at bank and in hand
Current liabilities
Net current assets
Total assets less current liabilities
Non-current liabilities
Provisions for liabilities: Deferred taxation
200
7,750
2,200
820
10,970
3,930
3700
9,030
16,660
(3,084)
13,576
24,546
4,340
60
20,146
-
5,000
2,000
820
7,820
2,000
2,550
3,640
8,190
(1,854)
6,336
14,156
1,340
26
12,790
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Equity
Share capital
Capital Surplus
Retained earnings
Non-controlling interests -equity
7,880
5,766
6,270
19,916
230
20,146
4,000
4,190
4,600
12,790
-
12,790
The following information is relevant to Baa Koomi Group plc.
i) The Baa Koomi Group plc has two wholly owned subsidiaries. In addition, it acquired a
75% interest in Nyamema Ltd on 1 August 2015. It also holds a 40% interest in Babaa Ltd
which it acquired several years ago. Goodwill has not become impaired.
ii) The following, recorded at fair values, refers to Nyamema Ltd at the date of acquisition.
Statement of financial position as at 1 August 2015
GH¢000 GH¢000
Plant and machinery
Current assets
Inventories
Trade receivables
Cash at bank and in hand
Current liabilities
(including Corporation tax GH¢34,000)
Share capital
Retained earnings
64
56
224
344
(170)
330
174
504
100
404
504
iii) The consideration for the purchase of the shares of Nyamema Ltd comprised 44,000
ordinary shares of GH¢1 of Baa Koomi Group plc at a value of GH¢550,000 and a balance
of GH¢28,000 was paid in cash.
iv) The taxation charge in the consolidated statement of profit or loss is made up of the
following items:
GH¢000
Corporation tax
Deferred taxation
Tax attributable to associated undertakings
782
208
355
1,345
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v) The tangible non-current assets of the Baa Koomi Group plc comprise the following:
Buildings
GH¢000
Plant and
Machinery
GH¢000
Total
GH¢000
Cost at valuation
At 1 August 2015
Additions
Disposals
At 31 July 2016
Depreciation
At 1 August 2015
Provided during year
Disposal
At 31 July 2016
Carrying Amount
At 31 July 2016
At 1 August 2015
5,100
-
-
5,100
700
250
-
950
4,150
4,400
2,800
4,200
1,000
6,000
2,200
400
200
2,400
3,600
600
7,900
4,200
1,000
11,100
2,900
650
200
3,350
7,750
5,000
vi) Included in the additions to plant and machinery are items totaling GH¢1,700,000 acquired
under finance leases. The plant and machinery disposal resulted in a profit of GH¢300,000.
All lease rentals were paid on their due dates.
vii) Non-current liabilities include the following items:
2016
GH¢000
2015
GH¢000
Obligations under finance leases
6% debentures
1,417
2,923
4,340
1,340
-
1,340
There had been an issue of debentures on 1 August 2015. Their par value was GH¢3,000,000
but they were issued at a discount of GH¢100,000. The effective rate of interest was 7%.
Current liabilities comprise the following items
2016
GH¢000
2015
GH¢000
Trade payables
Obligations under finance leases
Corporation tax
Accrued interest
1600
480
924
80
3,084
960
400
434
60
1,854
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Required
Prepare a consolidated statement of cash flow for the Baa Koomi Group plc for the year
ended 31 July 2016, in accordance with the requirements of IAS 7 Statements of Cash
flow. (20 marks)
(Note: use the indirect method to present cash flows from operating activities.)
QUESTION TWO
a) Kantanka Ltd adopts the revaluation model of IAS 16 Property, Plant & Equipment and
the fair value model of IAS 40 Investment Property. Kantanka Ltd chooses to recognise
any fair value gains or losses arising on its equity investments in ‘other comprehensive
income’ as permitted by IFRS 9 Financial Instruments. The following transactions relate
to Kantanka Ltd for the year ended 31 March 2017.
i) Kantanka Ltd owns a piece of property it purchased on 1 April 2014 for GH¢3.7 million.
The land component of the property was estimated to be GH¢1.2 million at the date of
purchase. The useful economic life of the building on this land was estimated to be 25 years
on 1 April 2014. The property was used as the corporate head office for two years from that
date. On 1 April 2016, the company moved its head office to another building and leased
the entire property for five years to an unrelated tenant on an arm’s length basis in order to
benefit from the rental income and future capital appreciation. The fair value of the property
on 1 April 2016 was GH¢4.1 million (land component GH¢1.9 million), and on 31 March
2017, GH¢4.8 million (land component GH¢2.1 million). The estimated useful economic
life remained unchanged throughout the period. Land and buildings are considered to be
two separate assets by the directors of Kantanka Ltd. (5 marks)
ii) Kantanka Ltd holds a portfolio of equity investments the value of which was correctly
recorded at GH¢12 million on 1 April 2016. During the year ended 31 March 2017, the
company received dividends of GH¢0.75 million. Further equity investments were
purchased at a cost of GH¢1.6 million. Shares were disposed of during the year for proceeds
of GH¢1.1 million. These shares had cost GH¢0.4 million a number of years earlier but had
been valued at GH¢0.9 million on 1 April 2016. The fair value of the financial assets held
on 31 March 2017 was GH¢14 million. (5 marks)
Required:
Advise Kantanka Ltd on how to account for the above transactions in accordance with
relevant accounting standards.
b) IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors is applied in
selecting and applying accounting policies, accounting for changes in estimates and
reflecting corrections of prior period errors.
The standard requires compliance with any specific IFRS applying to a transaction, event
or condition, and provides guidance on developing accounting policies for other items that
result in relevant and reliable information.
Required:
i) Discuss the procedure for selecting accounting policies. (3 marks)
ii) Recommend how an entity should account for a change in accounting policy. (2 marks)
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c) Cartier Ltd, a multinational operating in Ghana purchased a plant for GH¢600,000 on 1
January 2015. Cartier Ltd depreciates its plant using the straight line method over 15 years,
assuming a residual value of 10% of original cost. Cartier Ltd claims all available tax
depreciation allowances. On 1 January 2016, Cartier Ltd revalued the plant and increased
its carrying value by GH¢50,000. The asset’s useful life was not affected. Assume there
were no other temporary differences in the period.
Required:
i) Calculate the amount of Cartier Ltd’s deferred tax balance at 31 December 2016 in
accordance with IAS 12 Income Taxes.
ii) Calculate the change in Cartier Ltd’s deferred tax balance for the year ended 31 December
2016 and explain how the change would be treated in Cartier Ltd’s statement of profit or
loss for the year to 31 December 2016.
(Note: Assume an applicable tax rate of 25% and capital allowance of 50% of carrying
amount in the first year and 25% in the second year).
(5 marks)
d) Kojach Ltd is a manufacturing company which prepares its financial statements in
compliance with International Financial Reporting Standards (IFRS). The following
transactions took place for the year ended 31 March, 2017.
i) Kojach Ltd has traditionally repainted its premises every five years. The next painting is
due in a year’s time. The entity proposes to accrue as a provision the expected cost of
repainting the premises. (2 marks)
ii) Kojach Ltd has guaranteed the debts of its associate company up to a maximum amount of
GH¢3 million. The associate is in excellent financial health and the directors are of the
opinion that it is unlikely the guarantee will ever be called in. (3 marks)
Required:
Discuss briefly how each of the above transactions and events should be recorded by
Kojach Ltd in compliance with the requirements of IAS 37 Provisions, Contingent
Liabilities and Contingent Assets
(Total: 25 marks)
QUESTION THREE
Abusua Ltd. has been trading profitably for several years but for the past four years its
operations have resulted in losses. The board of directors has decided to restructure the
company.
The Statement of Financial Position as at 30 September, 2016
GH¢000 GH¢000
Non- current assets
Freehold land and buildings 3,788
Plant and equipment 7,020
Furniture and fixtures 3,080
Investment 2,300
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Deferred development expenditure 7,050
Patent rights 4,200
27,438
Current assets
Inventories 3,510
Trade receivables 1,600
Cash 428
5,538
Current liabilities
Bank loan 5,360
Trade payables 4,650
Sundry creditors 1,060
11,070 (5,532)
Net current liabilities 22% Debentures (7,875)
14,031
Financed by:
Share capital 17,625
Capital surplus 2,250
Income surplus (5,844)
14,031
You have been provided with the following additional information.
i) Abusua Ltd’s share capital consists of GH¢000
Ordinary shares 13,500
20% Cumulative Preference shares 4,125
ii) No dividend was declared on the Preference shares for the year ended 30 September, 2016.
iii) The following assets have net realizable values as indicated below:
GH¢000
Freehold land and buildings 4,005
Plant and equipment 3,750
Furniture and fixtures 2,800
iv) The investment in Abusua Ltd. is 55% holding in Obi Ltd. An offer of GH¢ 1,350,000 has
been made for it and it has been accepted by the directors.
v) Following further feasibility study carried out on the project which gave rise to the deferred
development expenditure, the directors have decided to discontinue the project. The project
is not patented.
vi) The directors have decided to sell the patent rights for a net realizable value of GH¢
1,800,000.
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vii) Inventories were written down by GH¢ 2,232,000.
viii) The 22% debentures are secured on the freehold land and buildings.
ix) The bank has a fixed and floating charge over the assets in respect of the loan.
x) It is considered that a proposed reconstruction of the company should result in net profit
after tax of GH¢1,500,000 in the year ending 30 September, 2017 and GH¢1,800,000 or
more in each of the years thereafter.
xi) The company will require a ratio of accounts receivable and cash to current liabilities of
0.80:1 in future to trade satisfactory.
Required:
As a Director of Finance of Abusua Ltd, recommend a scheme of reconstruction for
consideration by the board of directors of the company and prepare a summarized statement
of a financial position (15 marks)
QUESTION FOUR
a) In 2012, the management team of Sawaleh Ltd, a manufacturer of motorcycle parts,
acquired the company from its parent company in a management buyout deal. The
managers of the company are considering the possibility of listing on the Ghana Stock
Exchange. The following financial statements relates to the company:
Sawaleh Ltd
Statement of financial position as at June 30 2016
Non-current assets GH¢000 GH¢000
Land and buildings 3,600
Plant and machinery 9,900
13,500
Current assets:
Inventories 4,400
Trade receivables 4,700
Cash in hand and at bank 1,000 10,100
23,600
Equity and Liabilities
Ordinary share capital issued at Gh¢1 each
Voting 1,800
“A” Shares (Non-voting) 900
Retained earnings 9,700
Shareholders’ funds 12,400
Non-Current Liabilities
12% Debenture loan (2018) 2,200
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Current Liabilities
Bank Overdraft 2000
Trade payables 7,000
23,600
Statement of profit or loss for the year ended June 30 2016
Gh¢000
Revenue 36,500
Cost of sales (31,600)
Profit before interest and taxes 4,900
Interest (1,300)
Profit before taxes 3,600
Taxation expense (500)
Profit attributable to ordinary shareholders 3,100
Dividends (300)
Retained profit 2,800
The industry performance average ratios in which Sawaleh Ltd operates are stated below.
Industry sector ratios
Price/earnings ratio 10.0
Interest cover 4.5
Dividend cover 4.0
Total debt: equity 24%
Quick (acid test) ratio 1.0:1
Current ratio 1.6:1
Operating profit as percentage of sales 11%
Return after tax on equity 16%
Return before interest and tax on long-term capital employed 24%
Required:
As a newly qualified accountant working with Sawaleh Limited, you are to write a memo
to the CEO of the company evaluating the financial position and performance of Sawaleh
Limited by comparing it with that of its industry sector given above. (10 marks)
b) There has been widespread debate for several years concerning the declining value of
traditional methods of measuring corporate performance and the ability to predict corporate
failure. Earnings per share, return on capital employed and other investment ratios are
seemingly out of step with the needs of investors. The analysis of financial ratios is to a
large extent concerned with the efficiency and effectiveness of management’s use of
resources and also with the financial stability of the company. Researchers have developed
models which attempt to predict business failure.
Altman’s ‘Z score’ and Argenti’s failure models are examples of such research. However
many analysts feel that financial statements require several adjustments before any
meaningful evaluation of corporate performance can be made. Analysts often make
amendments to corporate profit and net assets before calculating even the most basic of
ratios because of their disapproval of certain generally accepted accounting principles and
in an attempt to obtain comparability.
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Required:
Discuss any FIVE reasons in general terms why the comparison of the a company’s ratios
with the ratios of previous years and other companies might be misleading. (5 marks)
(Total: 15 marks)
QUESTION FIVE
a) Historically, financial reporting throughout the world has differed widely. The IFRS
Foundation (formerly the International Accounting Standards Committee Foundation
(IASCF)) is committed to developing, in the public interest, a single set of high quality,
understandable and enforceable global accounting standards that require transparent and
comparable information in general purpose financial statements. The various
pronouncements of the IFRS Foundation are sometimes collectively referred to as
International Financial Reporting Standards (IFRS).
Required:
Discuss the IFRS Foundation’s standard setting process including how standards are
promulgated and revised. (6 marks)
b) According to Bob Massie, co-founder of the Global Reporting Initiative,'Integrated
reporting advances the proposition that sustainability reporting and financial reporting are
inherently linked and thus would benefit from merging.'
Required:
Discuss how integrated reporting has developed from social and environmental reporting.
(7 marks)
c) Measurement is the process of determining the monetary amounts at which the elements of
financial statements are to be recognized and carried in the statement of financial position and
statements of profit or loss and other comprehensive income (Conceptual Framework). This
involve the selection of a particular basis of measurement. A number of these are used to
different degrees and in varying combinations in financial statements.
Required:
Discuss the measurement basis of elements of financial statements in accordance with the
IASB Conceptual Framework. (7 marks)
d) You work for a large company as the assistant financial controller. One of your duties is to
reconcile the sales ledger each month. The ledger has failed to agree month after month. You
strongly believe that it is associated with bad debts being written off on the individual
customer account but not included in the nominal ledger. You consider the differences to be
material and have brought this to the attention of the financial controller but he seems
unwilling to act.
Required:
What action would you take in this situation? (2 marks)
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e) Good ethical behavior may require acting beyond the requirement of the law. In a highly
competitive complex business world, it is essential that professional accountants maintain their
integrity and remember the trust and confidence which is placed in them by whosoever relies
on their objectivity and professionalism.
Required:
Explain why the code of ethics is important to professional accountants in Ghana. (3 marks)
(Total: 25 marks)
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MARKING SCHEME QUESTION ONE
Baa Koomi Group Plc Consolidated statement of cash flow for the your ended 31/7/2016
Operating cash flows GH¢000
GH¢000
Profit before tax (GH¢4,015- GH¢990) Adjustments for: Depreciation Profit and disposal of tangible Investment income Interest payable Profit before working capital changes Changes in working capital: increase in inventories W5 Increase in trade receivable W5 Increase in trade payables Cash generated from operations Interest paid W8 Taxation paid W7 Net cash inflows from operations Cash flows from investing activities Acquisition of subsidiary net of cash acquired(-28+224) Payment for tangible assets W3 Proceeds for disposal W3 Net cash outflows from investing activities Cash Flows from financing activities Proceeds from sale of shares W8 Proceeds of loan issue Payment of finance lease obligation W6 Dividends from associates W4 Other investment income Dividend paid: Group Non-controlling interest Net cash inflows from financing activities W9 Net increase in cash and cash equivalent W1 Cash and cash equivalent at start Cash and cash equivalent at end
3,025
650 (300) (80) 300
3,595
(1,866) (1,094) 504 1,139 (257) (500)
196 (2,170)
1,100
4,906 2,900
(1,543) 435 80
(800)
(96)
382
(874)
5,882 5,390
3,640 9,030
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Workings W1 Cash and cash equivalent
2015 2016
3,640 9,030 5,390
W2 Intangible movements
2015 2016
- 200 200
Goodwill? This is not a cash flow
2015 2016
578 (378) 200
(550 +28) 75%@ 504
W3 Tangibles: Plant and Machinery
Additions Given per question Subsidiary Finance lease obligation
GH¢000 4,200 (330)
(3,870) (1,700)
2,170
Cash outflows
Disposals of plant and machinery
Given per question Depreciation Profit on disposal Proceeds from disposals
GH¢000 1,000 (200) 800 300 1100
Cash inflows
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W4 Dividend Received From Associate Company
2015 CIS Taxation (Asso)
GH¢000 2,000 990 2,990 ( 355) 2,635
2016 2,200 435
W5 working capital changes
Inventories GH¢000
Trade receivables GH¢000
Trade payable GH¢000
2015 Subsidiary 2016
2,000 64
2,064 3,930
(1,866)
2,550 56
2,606 3,700
(1,094)
960 136
1,096 1,600
504
W6 Finance Lease Obligation GH¢000
2015 New finance lease acquired 2016
1,740 1,700 3,440
(1,897)
1,543
(400+ 1340) (480 + 1417) Cash paid
W7 Taxation GH¢000 Opening balances: 460 (GH¢434+GH¢26 Subsidiary 34 Profit or loss 990 (GH¢1,345- GH¢355) [or 782 + 208] 1,484 Closing balances 984 (GH¢924+60) Cash paid 500
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W8 Analysis of proceeds from issue of shares Share Capital Share premium Total GH¢000 GH¢000 GH¢000 2015 4,000 4,190 Subsidiary 440 110 4,440 4,300 2016 7,880 5,766 proceeds 3,440 1,466 4,906
W8 Interest Payable Analysis GH¢000 2015 (opening balance) 60 Consolidated statement of profit or loss 300 360 2016 (closing balance) 80 280 However, the debenture loan or liability is measured at amortised cost in accordance with the provisions of IAS 39 Financial Instruments: Recognition and Measurement. See calculations in the table below:
Year Liability at start GH¢000
EIR@7% Coupon payment@6%
Liability at End GH¢000
2016 3,000-100= 2,900 203 (180) 2,923
The net interest (203-180 = 23) is deducted from GH¢280,000 above given actual interest of GH¢257,000 (GH¢280,000-GH¢23,000).
W9 Dividend Paid to Non-controlling Interest GH¢000 Opening balance (2015) nil Subsidiary acquired 126 (GH¢504,000@25%) Consolidated income statement 200 326 Closing balance (2016) 230 96 Dividend paid
(20 marks spread evenly using ticks) EXAMINER’S COMMENTS Question 1 tested the preparation of Consolidated Statement of Cash Flow. Although this is a standard question at this level, it was poorly attempted. Many candidates were not well prepared for this question and either ignored it or attempted it as the last question. Candidates had difficulty in computing relevant figures for the
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statement. Some of them wasted time calculating goodwill on consolidation and preparing structure of control with diagrams and explanations which were irrelevant in the statement of cash flow. Others placed items anywhere in the statement without regard to the standard format for Statement of Cash Flow. Strangely a candidate gave an elaborate write up on the advantages of a Cash Flow Statement which was not required by the examiner. Generally, candidates did not demonstrate sufficient understanding of principles underlying consolidated cash flows. QUESTION TWO
a) (i) This property was an IAS 16 property until 1 April 2016 and an IAS 40 investment property after this date. The accounting treatment therefore changes on the date it became an investment property. Any revaluation gains or losses up to that date are accounted for under IAS 16, and any arising since are accounted for under IAS 40. The carrying value of the property at 1 April 2016 was as follows:
Land Building GH¢m GH¢m
Cost 1.2 2.5 Depreciation to 31 March 2015 (3.5 – 1.0)/25 (0.1) Depreciation to 31 March 2016 (same) (0.1) Carrying value (before revaluation) 1.2 2.3 Fair value at 1 April 2016 1.9 2.2 Revaluation gain (loss) 0.7 (0.1) The revaluation gain would be taken to OCI and the revaluation loss to profit or loss as they were recognised in the financial year ended 31 March 2017. The depreciation relates to previous years, so its recording is not the subject of the requirement. Journal entry 1 April 2016: DR CR GH¢m GH¢m Dr Accumulated depreciation 0.2 Dr Profit or loss 0.1 Cr Buildings 0.3 Dr Land 0.7 Cr OCI / Revaluation surplus 0.7 From 1 April 2016 the property is considered an investment property. Journal entry 1 April 2016: DR GH¢m CR GH¢m Dr Investment property 4.1 Cr Land 1.9 Cr Buildings 2.2
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Under IAS 40, investment property is not depreciated and is revalued to fair value at each reporting date. Any gains or losses are taken to profit or loss. Investment property
GH¢m Fair value 1 April 2016 4.1 Fair value 31 March 2017 4.8 Fair value gain 0.7 Journal entry 31 March 2017: DR GH¢m CR GH¢m Dr Investment property 0.7 Cr Profit or loss 0.7 (5 marks) (ii) Dividends received are recognised as income regardless of the treatment of the financial assets. Journal entry to record dividends received: DR GH¢m CR GH¢m Dr Cash 0.75 Cr Profit or loss 0.75 Journal entry to record purchase of investments: DR GH¢m CR GH¢m Dr Financial assets 1.6 Cr Cash 1.6 Remeasurements are treated in accordance with the policy of the entity. We must assume that the irrevocable election required by IFRS 9 was made as this is the policy of Kantanka Ltd. Journal entry to record remeasurement and disposal: DR GH¢m CR GH¢m Dr Financial assets (1.1 – 0.9) 0.2 Cr Other comprehensive income 0.2 Dr Cash 1.1 Cr Financial assets 1.1 The assets held at the period end must be remeasured to GH¢14 million. These are already carried at GH¢12.7 million (12.0 – 0.9 + 1.6). The original carrying value included GH¢0.9 relating to the investments sold, so these are no longer there. In addition, new assets costing GH¢1.6 million were purchased. The fair value of these remaining assets on 31 March 2017 was 14 million, hence a gain of GH¢1.3 million (14 – 12.7) must be recognised.
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Journal entry to record remeasurement at 31 March 2017: DR GH¢m CRGH¢m Dr Financial assets 1.3 Cr Other comprehensive income 1.3
(5 marks) b) i) Selection and application of accounting policies
When a Standard or an Interpretation specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item must be determined by applying the Standard or Interpretation and considering any relevant Implementation Guidance issued by the IASB for the Standard or Interpretation. [IAS 8.7]
In the absence of a Standard or an Interpretation that specifically applies to a transaction, other event or condition, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. [IAS 8.10]. In making that judgement, management must refer to, and consider the applicability of, the following sources in descending order:
the requirements and guidance in IASB standards and interpretations dealing with similar and related issues; and the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework. [IAS 8.11]
Management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources in paragraph 11. [IAS 8.12]
(Any 3 points for 3 marks)
ii) How an entity should account for a change in accounting policy
If a change in accounting policy is required by a new IASB standard or interpretation, the change is accounted for as required by that new pronouncement or, if the new pronouncement does not include specific transition provisions, then the change in accounting policy is applied retrospectively. [IAS 8.19]
Retrospective application means adjusting the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied. [IAS 8.22]
However, if it is impracticable to determine either the period-specific effects or the cumulative effect of the change for one or more prior periods presented, the entity shall apply the new accounting policy to the carrying amounts of assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable, which may be the current period, and shall make a
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corresponding adjustment to the opening balance of each affected component of equity for that period. [IAS 8.24] Also, if it is impracticable to determine the cumulative effect, at the beginning of the current period, of applying a new accounting policy to all prior periods, the entity shall adjust the comparative information to apply the new accounting policy prospectively from the earliest date practicable. [IAS 8.2
(2 marks) c) Accounting Capital Temporary
Depreciation Allowance difference GH¢000 GH¢000 GH¢000 Cost 1 January 2015 600 600 First year (36) (300) Balance 31 December 2015 564 300 264 x 25% = 66 Revaluation 50 614 Second year (39.6) (75) Balance 31 December 2016 574.4 225 349.4 x 25% = 87.4 Change since 31 December 2015 85.4 x 25% = 21.4 Accounting depreciation: 2015 – (600 – 60) / 15 = 36 2016 – (614 – 60) / 14 = 39.6 Note: Assume an applicable tax rate of 25% and capital allowance of 50% of carrying amount in the first year and 25% in the second year. (i) Deferred tax balance at 31 December 2016 = GH¢87,400 (3 marks) (ii) Deferred tax increase during year ended 31 December 2016 = GH¢21,400 GH¢21,400 will be added to the tax charge in Cartier Ltd’s statement of profit or loss for the year ended 31 December 2016. (2 marks)
d) (i) No present obligation exists to paint the premises, hence the accrual of a provision is not permitted by IAS 37. No contingent liability exists either, unless a commitment has been made to a supplier to carry out the work. (2 marks)
(ii) There is a present obligation, as the entity has undertaken to guarantee the debts of another party. However it seems unlikely that this guarantee will be called in. Hence it is not probable at the reporting date that an outflow of resources will be required to settle the obligation. Therefore the second condition has not been met, and no provision should be recognised in the financial statements. If an outflow of resources is judged possible but not remote, disclosure of a contingent liability of GH¢3 million should be made in the notes. (3 marks)
(Total: 25 marks)
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EXAMINER’S COMMENTS Question 2 was in four (4) parts. Part a) examined how to account for given transactions in accordance with relevant accounting standards. This part was poorly answered. Candidates were not able to apply the general principles in the standards to the facts given. Many candidates simply explained the principles in the standards. Others simply did calculations without explaining the calculations. The relevant standards were IAS 16 Property, Plant & Equipment, IAS 40 Investment Property and IFRS 9 Financial Instrument. Part b) examined procedure for selecting accounting policies and how an entity should account for a change in accounting policy. The answers were generally satisfactory. Part c) examined calculation of deferred tax. Two key items were missing in the question. They were initial allowance and corporate tax rate. Candidates were assessed according to how they demonstrated their understanding of the principles of deferred tax in spite of the omission. Not many candidates were able to make assumptions and produce relevant answer. Part d) examined how given transactions and events should be recorded in compliance with the requirements of IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Candidates were unable to apply the general principles in the standard to the facts given. Many candidates simply explained the principles in the standards. Others simply did calculations without explaining the calculations. This part was poorly
answered.
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QUESTION THREE
ABUSUA LTD Determination of maximum amount available if the company were to be liquidated.
Assets Realizable Value GH¢ 000 Freehold Property 4005 Plant & Equipment 3750 Fixtures & Fittings 2800 Investment 1350 Patents 1800 Stock (3510-2232) 1278 Debtors 1600 Cash 428 Cash available if the company is liquidated 17011 Distributed as follows: Debenture 4005 13006 Bank loan (5360) Available to unsecured creditors and shareholders 7646 Payment to unsecured creditors Debenture balance (7875-4005) 3870 3089 Trade creditors 4650 3710 Sundry creditors 1060 846 9580 7,646 Since the amount available is GH¢7,646,000 as against creditors of GH¢9,580,000. Each ordinary creditor would receive for every GH¢1 as capital. GH¢ 0.798=GH¢0.80 PER The shareholders would receive nothing if their company liquidates.
Calculation of maximum possible loss if the company re-constructs. Assets Book Value Going Concern (Loss)/Gain GH¢000 GH¢000 GH¢000 Freehold property 3788 4005 217 Plant & equipment 7020 3750 (3270) Fixtures & fittings 3080 2800 (280) Investments 2300 1350 (950) Def. Dev.Exp. 7050 - (7050) Patent 4200 1800 (2400) Stock 3510 1278 (2232) Debtors 1600 1600 - Income surplus (5844) Capital surplus 2250 Preference Div. (20% ×4,125) (825) Maximum possible loss on reconstruction 20,384
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The loss should be shared as follows: Ordinary shares They would suffer most because they are the owners and if the company liquidates they will receive nothing. They should sacrifice GH¢13, 400,000 of their capital and leave GH¢100, 000 as capital. Preference shareholders They will also suffer the same fate as ordinary shareholders under liquidation. They should therefore suffer a loss of GH¢4,000,000 leaving a capital of GH¢125,000. Debenture holders They would suffer 20 per cedi of the remaining balance after they have been paid GH¢4,005,000. I recommend that they should suffer GH¢1,005,000 leaving debentures of GH¢6,870,000. Creditors The trade creditors and sundry creditors should be made to suffer the maximum loss they would have lost under liquidation, which is GH¢940,000 and GH¢214,000 respectively. Preference dividends in arrears The preference dividend in arrears of GH¢825,000 is to be waived. Note: alternative recommendations are acceptable provided they are logical reasonable and in accordance with best practice. Working capital requirements Ratio of debtors to current liabilities is 0.80:1 After the capital reduction, current liabilities are: GH¢000 Bank Loan 5360 Trade creditors 3710 Sundry creditors 846 9916 Debtors and cash should be 0.8 of the new current liabilities. This is GH¢ 7,933,000. But existing debtors and cash is made up as follows: GH¢000 Debtors 1600 Cash 428 Sale of investments 1350 Sale of patents 1800 5178
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Additional cash of the difference of GH¢7,933,000 and GH¢5,178,000 is required to maintain the desired ratio. This amounts to GH¢ 2,755,000 and should be raised by the old shareholders as ordinary share capital. PROPOSED SCHEME Ordinary share: Reduce the ordinary share capital by GH¢13,400,000 and convert the balance to new ordinary share capital. Eliminate the negative income surplus and capital surplus balances Preference shares Reduce the preference share capital by GH¢4,000,000 and convert the balance to new ordinary share capital. Preference dividend Write off the preference dividend of GH¢ 825,000 in arrears. 22% Debentures: I recommend that they should suffer GH¢ 1,005,000 and be compensated by raising their interest rate to 25%. Creditors: Creditors should be made to suffer 20% of the amounts owed to them by the company. The investments and patents to be realized to GH¢1, 350,000 and GH¢ 1,800,000 respectively. In order to have a ratio of debtors and cash to current liabilities of 0.80:1 additional cash of GH¢ 2,755,000 will have to be sourced (see workings). The existing ordinary shareholders and existing preference shareholders will be required to introduce cash of GH¢2, 155,000 and GH¢600, 000 respectively for the purchase of new ordinary shares.
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ABUSUA LTD. SUMMARISED BALANCE SHEETAFTER EFFECTING THE RECONSTRUCTION
GH¢000 GH¢000 Long term assets Freehold land & buildings 4005 Plant & equipment 3750 Fixtures and fittings 2800 10,555 Current assets Stock 1278 Debtors 1600 Cash (428+1,350+1,800+2,155+600) 6333 9211 Current liabilities Bank loan 5360 Trade creditors 3710 Sundry creditors 846 9916 Net current liabilities (705) 25% Debentures (6870) 2980 Financed by: Stated Capital 2980
(15 marks evenly spread using ticks) EXAMINER’S COMMENTS Question 3 asked candidates to recommend a scheme of reconstruction and prepare a summarised Statement of Financial Position. It was generally well answered; many candidates scored pass mark. However, some candidates only provided workings without providing recommendations. One candidate wrote extensively on the conditions to be satisfied before proceeding on a capital reconstruction scheme. Such an effort was not required by the question and the time spent on it was wasted.
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QUESTION FOUR (a) To: CEO, Sawaleh Limited From: Accountant Subject: Evaluation of the performance of Sawaleh Limited Date: November 11, 2016 Introduction The assessment of the performance of Sawaleh Limited is based on the areas of profitability, liquidity, and financial security of the company. Profitability Sawaleh’s returns on capital employed, return on equity and operating profit margin are all significantly above the industry averages. Although the first two measures could be inflated due to assets being shown at the low book values, the profit margin indicates that Sawaleh Ltd is managing to make good profits, which could be due to successful marketing, a low cost base or to its occupation of a particularly profitable niche in the market. Liquidity Both the current and the quick (acid test) ratios are well below the industry averages (see appendix A attached). This suggests that Sawaleh Ltd is either short of liquid resources or is managing its working capital poorly. However, the three key working capital ratios modify this impression (appendix A refers). Although the industry averages are not known, these ratios appear to be very good by general standards. It therefore appears that Sawaleh Ltd has become under-capitalized, perhaps through the use of working capital to finance growth. Financial security Gearing is high in comparison with the rest of the industry, and 48% of the debt is in the form of overdraft which is generally repayable on demand. This is therefore a risky form of debt to use in large amounts. The debenture is repayable in two years and will need to be refinanced since Sawaleh Ltd cannot redeem it out of existing resources. Interest cover is also poor, and this together with the poor liquidity probably account for the low payout ratio (the inverse of the dividend cover). Appendix A attached for calculations. Conclusion In summary, profit performance is strong, but there are significant weaknesses in both the liquidity and the financial structure. These problems need to be addressed if Sawaleh Ltd is to be able to maintain its record of strong and consistent growth in order to compete favourably in the industry. The whole capital needs to be restructured possibly eliminating the non-voting shares as the Ghana Stock Exchange will not permit such shares to be listed. Also, surplus assets must be disposed of
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among others this will improve performance and possibly increase the dividend payout ratio. Signature Name of Accountant Appendix in support of memo
Ratios Formula Substitutions Ratios Industry Averages
Interest cover
Profit before interest and tax (PBIT): Interest
GH¢4,900: GH¢1,300
3.77 times
4.5
Dividend cover
profit attributable to equity: Dividends
GH¢3,100: GH¢300
10.3 times
4.0
Acid test
Current assets excluding inventories: current liabilities
GH¢5,700: GH¢9,000
0.63:1 1.0:1
Gearing Debt: Equity (GH¢2,000 + GH¢2,200): GH¢12,400
33.9% 24%
Current ratio
Current assets: current liabilities
GH¢10,100: GH¢9,000
1.12:1 1.6:1
Operating profit margin
Operating profit: sales
GH¢4,900: GH¢36,500
13.4% 11%
Return on equity
Profit attributable to ordinary shareholders: Equity
GH¢3,100: GH¢12,400
25% 16%
Return on (long-term) capital employed
Operating profit (PBIT):Equity + long-term debt
GH¢4,900: (GH¢12,400 + GH¢2,200)
33.6% 24%
Inventory days
Inventories: Cost of salesx365
365 × 4,400/31,600
51days nil
Trade receivable days
Trade receivables: credit sales x 365
365 × 4,700/36,500
47days nil
Trade payable days
Trade payables : cost of sale x 365
365 × 7,000/31,600
81 days
nil
b)
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Limitations of inter-period and inter-company comparisons
The data might need to be adjusted to for inflation if valid comparisons are to be made over time.
The financial statements might have been prepared using different accounting policies e.g. choice of depreciation and stock valuation policies
Accounts may be made up to a different date which can significantly affect ratios if the business is seasonal
Traditional analysis tends to focus on profitability. Greater attention is needed to be paid to assessing liquidity and the capacity to adapt by reference to cash flow statement
The statement of financial position is prepared at a single point in time. This means it is possible to practice window dressing and this can affect ratios.
The industry average does not indicate the distribution of results around the average. It would be helpful to have quartile and decile figures.
(Any 5 points for 5 marks)
(Total: 15 marks)
EXAMINER’S COMMENTS Question 4 was in two parts, a) and b): Part a) examined the evaluation of the financial position and performance of a company by comparing it with that of its industry. It was generally well answered. Many candidates got the calculation of the relevant ratios right. However, some candidates wasted time trying to compute price/earnings ratio even though there was not sufficient information available. A number of candidates simply stated the variances between the Company’s ratios and those of the Industry without adducing possible reasons for performing above or below the Industry nor suggesting strategies to redress or overcome the weakness. Part b) examined reasons why the comparison of a company’s ratios with the ratios of previous years and other companies might be misleading. This part was well answered. However, some candidates dwelt extensively on comparing Altman’s Z-Score and Argenti’s failure models. They lost marks because that comparison was not a requirement.
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QUESTION FIVE a) International Financial Reporting Standards (IFRS Standards) are developed through an international consultation process, the "due process", which involves interested individuals and organisations from around the world. The due process comprises six stages, with the Trustees of the IFRS Foundation having the opportunity to ensure compliance at various points throughout:
Setting the agenda The IASB evaluates the merits of adding a potential item to its agenda, also know as the work plan, mainly by reference to the needs of investors. The IASB considers: the relevance to users of the information and the reliability of information that could be provided; whether existing guidance is available; the possibility of increasing convergence; the quality of the standard to be developed; and resource constraints.
Planning the project When adding an item to its active agenda, the IASB also decides whether to: conduct the project alone; or jointly with another standard-setter. due process is followed under both approaches. After considering the nature of the issues and the level of interest among constituents, the IASB may establish a Consultative group at this stage. A team is selected for the project by the two most senior members of the technical staff: The Director of Technical Activities; and The Director of Research.
Developing and publishing the Discussion Paper, including public consultation Although a Discussion Paper is not mandatory, the IASB normally publishes it as its first publication on any major new topic to explain the issue and solicit early comment from constituents. If the IASB decides to omit this step, it will state why. Typically, a Discussion Paper includes a comprehensive overview of the issue; possible approaches in addressing the issue; the preliminary views of its authors or the IASB; and an invitation to comment.
Developing and publishing the Exposure Draft, including public consultation Publication of an Exposure Draft is a mandatory step in due process. Irrespective of whether the IASB has published a Discussion Paper, an Exposure Draft is the IASB’s main vehicle for consulting the public. Unlike a Discussion Paper, an Exposure Draft sets out a specific proposal in the form of a proposed Standard (or amendment to an existing Standard). The development of an Exposure Draft begins with the IASB considering: issues on the basis of staff research and recommendations; comments received on any Discussion Paper; and suggestions made by the IFRS Advisory Council, Consultative groups and accounting standard-setters, and arising from public education sessions.
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Developing and publishing the Standard The development of an IFRS Standard is carried out during IASB meetings, when the IASB considers the comments received on the Exposure Draft. After resolving issues arising from the Exposure Draft, the IASB considers whether it should expose its revised proposals for public comment, for example by publishing a second Exposure Draft.
Procedures after a Standard is issued The development of an IFRS Standard is carried out during IASB meetings, when the IASB considers the comments received on the Exposure Draft. After resolving issues arising from the Exposure Draft, the IASB considers whether it should expose its revised proposals for public comment, for example by publishing a second Exposure Draft.
(6 marks)
b) How integrated reporting has developed from social and environmental
reporting. It first emerged as social and environmental reporting whereby companies disclose the impact of their operations, both positive and negative, on the community and environment in which they operate. Typical social disclosures might include details of community support programmes, charitable fundraising activities and educational and social programmes for employees. Typical environmental disclosures might include activities to reduce levels of emissions, recycling programmes and pollution controls. More recently, these types of basic social and environmental disclosures have developed into sustainability reporting. This form of reporting particularly focuses on the issue of sustainable development and whether the operations of an organisation are sustainable into the future. The ability of an organization’s performance to be sustainable into the future is said to be based on its economic, environmental, social and governance performance. For example in order to be sustainable, a company must limit its use of non-renewable energy sources (an environmental issue); it must also treat its staff well and reward them adequately to ensure their continued support (economic and social issues). Therefore sustainability reporting discloses environmental and social issues but also expands disclosure to integrate the economic impact of a company, for example through wages, taxes and purchasing policy, and governance i.e. how the company is run. Integrated reporting develops the concept of sustainability reporting further by linking sustainability issues to financial strategy and results, sometimes referred to as 'triple bottom line' or PPP reporting ('Profit, Planet and People'). This form of reporting is based on the idea that companies that achieve success in the future will be those that have an integrated strategy that achieves financial results whilst also creating lasting value for the company itself, its stakeholders and the wider society. (7 marks)
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c) Measurement basis of elements of Financial Statement (i) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business. (ii) Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently. (iii) Realisable (settlement) value. Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business. (iv) Present value. Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.
(1.75 marks each for every point =7 marks) d) The possible actions could be
Informing the financial controller audit committee or board of directors and formerly asking the financial controller to address it.
Informing the financial controller that you are going to bring the matter to the attention of the financial director or the audit committee.
It would not be advisable to report externally until legal advise has been taken, hopefully this situation can be resolved with one of the above actions.
(2 marks)
d) Importance code of ethics of to professional accountants
The Code of ethics relate to fairness, honesty and responsibility.
Ethics are a set of moral principles to guide behaviour.
They guide accountants to perform their work properly.
Ethics describe how an accountant does his work and not what he does. If an accountant carries out his work with bad faith, it can affect the accountant who may be disciplined by ICAG. Improper conduct can also have an effect on the business as a whole e.g. Financial viability and if in the public sector, the tax payer’s money could be wasted.
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The main ethical issue is integrity. It would not be appropriate for an accountant to assist someone with the potentially fraudulent act or to allow misleading information to be presented to others.
There is also the potential issue of objectivity. if you are placed under pressure by the financial controller as this will mean you have a conflict of interest between a conflict of interest on the requirement to behave with integrity.
(Any 3 points for 3 marks)
(Total: 25 marks) EXAMINER’S COMMENTS Question 5 was in five parts. Part a) tested the IFRS Foundation’s standard setting process. It was generally well answered. Part b) tested how integrated reporting has developed from social and environmental reporting. Although the answers were generally satisfactory, some candidates could not explain appropriately the link between integrated reporting and social and environmental reporting. Part c) tested the measurement basis of elements of financial statements in accordance with the IASB Conceptual Framework. Many candidates misread this question and wrote generally about elements of financial statements. Consequently, they lost valuable marks. Part d) tested ethical conduct between a subordinate and his supervisor. It was generally well answered. Part e) tested why the code of ethics is important for professional accountants in Ghana. It was generally well answered. CONCLUSION Candidates should be educated to prepare adequately before presenting themselves for the examination. The Institute should consider organising classes for prospective candidates outside Accra.