Advanced Corporate

Reporting(International Stream)

PART 3

TUESDAY 12 DECEMBER 2006

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A This ONE question is compulsory and MUST beanswered

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

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The Association of Chartered Certified Accountants

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

1 The following draft group financial statements relate to Andash, a public limited company:

Draft Group Balance Sheets at 31 October

2006 2005Assets $m $mNon-current assetsProperty, plant and equipment 5,170 4,110Goodwill 120 130Investment in associate 60 —

––––––– ––––––5,350 4,240

––––––– ––––––Current assetsInventories 2,650 2,300Trade receivables 2,400 1,500Cash and cash equivalents 140 300

––––––– ––––––5,190 4,100

––––––– ––––––Total assets 10,540 8,340

––––––– ––––––Equity and LiabilitiesEquity attributable to equity holders of parentShare capital 400 370Other reserves 120 80Retained earnings 1,250 1,100

––––––– ––––––1,770 1,550

Minority interest 200 180––––––– ––––––

Total equity 1,970 1,730––––––– ––––––

Non-current liabilitiesLong term borrowings 3,100 2,700Deferred tax 400 300

––––––– ––––––Total non-current liabilities 3,500 3,000

––––––– ––––––Current liabilitiesTrade payables 4,700 2,800Interest payable 70 40Current tax payable 300 770

––––––– ––––––Total current liabilities 5,070 3,610

––––––– ––––––Total liabilities 8,570 6,610

––––––– ––––––Total equity and liabilities 10,540 8,340

––––––– ––––––

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Draft Group Income Statementfor the year ended 31 October 2006

$mRevenue 17,500Cost of sales (14,600)

———–Gross profit 2,900Distribution costs (1,870)Administrative expenses (490)Finance costs – interest payable (148)Gain on disposal of subsidiary 8

———–Profit before tax 400Income tax expense (160)

———–Profit after tax 240

———–Attributable to equity holders of parent 200Attributable to minority interest 40

———–240

———–

Draft Statement of changes in equity of the parent for the year ended 31 October 2006.

Share capital Other reserves Retained earnings Total$m $m $m $m

Balance at 31 October 2005 370 80 1,100 1,550Profit for period 200 200Dividends (50) (50)Issue of share capital 30 30 60Share options issued 10 10

––––– –––– –––––– ––––––Balance at 31 October 2006 400 120 1,250 1,770

––––– –––– –––––– ––––––

The following information relates to the draft group financial statements of Andash:

(i) There had been no disposal of property, plant and equipment during the year. The depreciation for the periodincluded in cost of sales was $260 million. Andash had issued share options on 31 October 2006 asconsideration for the purchase of plant. The value of the plant purchased was $9 million at 31 October 2006and the share options issued had a market value of $10 million. The market value had been used to account forthe plant and share options.

(ii) Andash had acquired 25 per cent of Joma on 1 November 2005. The purchase consideration was 25 millionordinary shares of Andash valued at $50 million and cash of $10 million. Andash has significant influence overJoma. The investment is stated at cost in the draft group balance sheet. The reserves of Joma at the date ofacquisition were $20 million and at 31 October 2006 were $32 million. Joma had sold inventory in the periodto Andash at a selling price of $16 million. The cost of the inventory was $8 million and the inventory was stillheld by Andash at 31 October 2006. There was no goodwill arising on the acquisition of Joma.

(iii) Andash owns 60% of a subsidiary Broiler, a public limited company. The goodwill arising on acquisition was$90 million. The carrying value of Broiler’s identifiable net assets (excluding goodwill arising on acquisition) inthe group consolidated financial statements is $240 million at 31 October 2006. The recoverable amount ofBroiler is expected to be $260 million and no impairment loss has been recorded up to 31 October 2005.

[P.T.O.

(iv) On 30 April 2006 a wholly owned subsidiary, Chang, was disposed of. Chang prepared interim financialstatements on that date which are as follows:

$mProperty, plant and equipment 10Inventory 8Trade receivables 4Cash and cash equivalents 5

—27—

Share capital 10Retained earnings 4Trade payables 6Current tax payable 7

—27—

The consolidated carrying values of the assets and liabilities at that date were the same as above. The groupreceived cash proceeds of $32 million and the carrying amount of goodwill was $10 million.

(Ignore the taxation effects of any adjustments required to the group financial statements and round allcalculations to the nearest $million)

Required:

Prepare a group cash flow statement using the indirect method for the Andash Group for the year ended

31 October 2006 in accordance with IAS7 ‘Cash Flow Statements’ after making any necessary adjustments

required to the draft group financial statements of Andash as a result of the information above.

(Candidates are not required to produce the adjusted group financial statements of Andash)

(25 marks)

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Section B – THREE questions ONLY to be attempted

2 Misson, a public limited company, has carried out transactions denominated in foreign currency during the financialyear ended 31 October 2006 and has conducted foreign operations through a foreign entity. Its functional andpresentation currency is the dollar. A summary of the foreign currency activities is set out below:

(a) Misson has a 100% owned foreign subsidiary, Chong, which was formed on 1 November 2004 with a sharecapital of 100 million euros which has been taken as the cost of the investment. The total shareholders’ equityof the subsidiary as at 31 October 2005 and 31 October 2006 was 140 million euros and 160 million eurosrespectively. Chong has not paid any dividends to Misson and has no other reserves than retained earnings in itsfinancial statements. The subsidiary was sold on 31 October 2006 for 195 million euros.

Misson would like to know how to treat the sale of the subsidiary in the parent and group accounts for the yearended 31 October 2006. (8 marks)

(b) Misson has purchased goods from a foreign supplier for 8 million euros on 31 July 2006. At 31 October 2006,the trade payable was still outstanding and the goods were still held by Misson. Similarly Misson has sold goodsto a foreign customer for 4 million euros on 31 July 2006 and it received payment for the goods in euros on 31 October 2006. Additionally Misson had purchased an investment property on 1 November 2005 for 28 million euros. At 31 October 2006, the investment property had a fair value of 24 million euros. The companyuses the fair value model in accounting for investment properties.

Misson would like advice on how to treat these transactions in the financial statements for the year ended 31October 2006. (7 marks)

(c) Misson has further entered into a contract to purchase plant and equipment from a foreign supplier on 30 June2007. The purchase price is 4 million euros. A non-refundable deposit of 1 million euros was paid on signingthe contract on 31 July 2006 with the balance of 3 million euros payable on 30 June 2007. Misson wasuncertain as to whether to purchase a 3 million euro bond on 31 July 2006 which will not mature until 30 June2010, or to enter into a forward contract on the same date to purchase 3 million euros for a fixed price of $2 million on 30 June 2007 and to designate the forward contract as a cash flow hedge of the purchasecommitment. The bond carries interest at 4% per annum payable on 30 June 2007. Current market rates are4% per annum. The company chose to purchase the bond with a view to selling it on 30 June 2007 in orderto purchase the plant and equipment. The bond is not to be classified as a cash flow hedge but at fair valuethrough profit or loss.

Misson would like advice as to whether it made the correct decision and as to the accounting treatment of theitems in (c) above for the current and subsequent year. (10 marks)

Exchange rates Euro:$ Average rate (Euro:$)for year to

1 November 2004 1·131 October 2005 1·4 1·21 November 2005 1·431 July 2006 1·631 October 2006 1·3 1·5

Required:

Discuss the accounting treatment of the above transactions in accordance with the advice required by the

directors.

(Candidates should show detailed workings as well as a discussion of the accounting treatment used.)

(25 marks)

[P.T.O.

3 Seejoy is a famous football club but has significant cash flow problems. The directors and shareholders wish to takesteps to improve the club’s financial position. The following proposals had been drafted in an attempt to improve thecash flow of the club. However, the directors need advice upon their implications.

(a) Sale and leaseback of football stadium (excluding the land element)

The football stadium is currently accounted for using the cost model in IAS16, ‘Property, Plant, and Equipment’.The carrying value of the stadium will be $12 million at 31 December 2006. The stadium will have a remaininglife of 20 years at 31 December 2006, and the club uses straight line depreciation. It is proposed to sell thestadium to a third party institution on 1 January 2007 and lease it back under a 20 year finance lease. The saleprice and fair value are $15 million which is the present value of the minimum lease payments. The agreementtransfers the title of the stadium back to the football club at the end of the lease at nil cost. The rental is $1·2 million per annum in advance commencing on 1 January 2007. The directors do not wish to treat thistransaction as the raising of a secured loan. The implicit interest rate on the finance in the lease is 5·6%.

(9 marks)

(b) Player registrations

The club capitalises the unconditional amounts (transfer fees) paid to acquire players.

The club proposes to amortise the cost of the transfer fees over ten years instead of the current practice which isto amortise the cost over the duration of the player’s contract. The club has sold most of its valuable playersduring the current financial year but still has two valuable players under contract.

Transfer fee Amortisation to Contract ContractPlayer capitalised 31 December 2006 commenced expires

$m $mA. Steel 20 4 1 January 2006 31 December 2010R. Aldo 15 10 1 January 2005 31 December 2007

If Seejoy win the national football league, then a further $5 million will be payable to the two players’ formerclubs. Seejoy are currently performing very poorly in the league. (5 marks)

(c) Issue of bond

The club proposes to issue a 7% bond with a face value of $50 million on 1 January 2007 at a discount of 5%that will be secured on income from future ticket sales and corporate hospitality receipts, which are approximately$20 million per annum. Under the agreement the club cannot use the first $6 million received from corporatehospitality sales and reserved tickets (season tickets) as this will be used to repay the bond. The money from thebond will be used to pay for ground improvements and to pay the wages of players.

The bond will be repayable, both capital and interest, over 15 years with the first payment of $6 million due on31 December 2007. It has an effective interest rate of 7·7%. There will be no active market for the bond andthe company does not wish to use valuation models to value the bond. (6 marks)

(d) Player trading

Another proposal is for the club to sell its two valuable players, Aldo and Steel. It is thought that it will receive atotal of $16 million for both players. The players are to be offered for sale at the end of the current football seasonon 1 May 2007. (5 marks)

Required:

Discuss how the above proposals would be dealt with in the financial statements of Seejoy for the year ending

31 December 2007, setting out their accounting treatment and appropriateness in helping the football club’s

cash flow problems.

(Candidates do not need knowledge of the football finance sector to answer this question.)

(25 marks)

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4 The Gow Group, a public limited company, and Glass, a public limited company, have agreed to create a new entity,York, a limited liability company on 31 October 2006. The companies’ line of business is the generation, distribution,and supply of energy. Gow supplies electricity and Glass supplies gas to customers. Each company has agreed tosubscribe net assets for a 50% share in the equity capital of York. York is to issue 30 million ordinary shares of $1.There was no written agreement signed by Gow and Glass but the minutes of the meeting where the creation of thenew company was discussed have been approved formally by both companies. Each company provides equalnumbers of directors to the Board of Directors. The net assets of York were initially shown at amounts agreed betweenGow and Glass, but their values are to be adjusted so that the carrying amounts at 31 October 2006 are based onInternational Financial Reporting Standards.

Gow had contributed the following assets to the new company in exchange for its share of the equity:

$mCash 1Trade receivables – Race 7Intangible assets – contract with Race 3Property, plant and equipment 9

—20—

The above assets form a cash generating unit (an electricity power station) in its own right. The unit provided powerto a single customer, Race. On 31 October 2006 Race went into administration and the contract to provide power toRace was cancelled. On 1 December 2006, the administrators of the customer provisionally agreed to pay a finalsettlement figure of $5 million on 31 October 2007, including any compensation for the loss of the contract. Gowexpects York will receive 80% of the provisional amount. On hearing of the cancelled contract, an offer was receivedfor the power station of $16 million. York would be required to pay the disposal costs estimated at $1 million.

The power station has an estimated remaining useful life of four years at 31 October 2006. It has been agreed withthe government that it will be dismantled on 31 October 2010. The cost at 31 October 2010 of dismantling the powerstation is estimated to be $5 million.

The directors of Gow and York are currently in the final stages of negotiating a contract to supply electricity to anothercustomer. As a result the future net cash inflows (undiscounted) expected to arise from the cash generating unit(power station) are as follows:

$m31 October 2007 631 October 2008 731 October 2009 831 October 2010 8

—29—

The dismantling cost has not been provided for, and future cash flows are discounted at 6 per cent by the companies.

Glass had agreed to contribute the following net assets to the new company in exchange for its share of the equity:

$mCash 10Intangible asset 2Inventory at cost 6Property-carrying value 4Lease receivable 1Lease payable (3)

—20—

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The property contributed by Glass is held on a 10 year finance lease which was entered into on 31 October 2000.The property is being depreciated over the life of the lease on the straight line basis. As from 31 October 2006, theterms of the lease have been changed and the lease will be terminated early on 31 October 2008 in exchange for apayment of $1 million on 31 October 2006 and a further two annual payments of $600,000. The first annualpayment under the revised terms will be on 31 October 2007. York will vacate the property on 31 October 2008 andthe revised lease qualifies as a finance lease. The cash paid on 31 October 2006 is shown as a lease receivable andthe change in the lease terms is not reflected in the values placed on the net assets above. The effective interest rateof the lease is 7%.

Glass had entered into a contract with an agency whereby for every new domestic customer that the agency gained,the agency received a fixed fee. On the formation of York, the contract was terminated and the agency received$500,000 as compensation for the termination of the contract. This cost is shown as an intangible asset above asthe directors feel that it represents the economic benefits related to the future reduced cost of gaining retail customers.Additionally, on 31 October 2006, a contract was signed whereby York was to supply gas at fair value to a majorretailer situated overseas over a four year period. On signing the contract, the retailer paid a non refundable cashdeposit of $1·5 million which is included in the cash contributed by Glass. The retailer is under no obligation to buygas from York but York cannot supply gas to any other company in that country. The directors intend to show thisdeposit in profit or loss when the first financial statements of York are produced. At present, the deposit is shown asa deduction from intangible assets in the above statement of net assets contributed by Glass.

(All calculations should be made to one decimal place and assume the cash flows relating to the cash generatingunit (electricity power station) arise at the year end.)

Required:

(a) Discuss the nature and accounting treatment of the relationship between Gow, Glass and York. (5 marks)

(b) Prepare the balance sheet of York at 31 October 2006, using International Financial Reporting Standards,

discussing the nature of the accounting treatments selected, the adjustments made and the values placed

on the items in the balance sheet. (20 marks)

(25 marks)

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5 Jones and Cousin, a public quoted company, operate in twenty seven different countries and earn revenue and incurcosts in several currencies. The group develops, manufactures and markets products in the medical sector. The growthof the group has been achieved by investment and acquisition. It is organised into three global business units whichmanage their sales in international markets, and take full responsibility for strategy and business performance. Onlyfive per cent of the business is in the country of incorporation. Competition in the sector is quite fierce.

The group competes across a wide range of geographic and product markets and encourages its subsidiaries toenhance local communities by reinvestment of profits in local educational projects. The group’s share of revenue in amarket sector is often determined by government policy. The markets contain a number of different competitorsincluding specialised and large international corporations. At present the group is awaiting regulatory approval for arange of new products to grow its market share. The group lodges its patents for products and enters into legalproceedings where necessary to protect patents. The products are sourced from a wide range of suppliers, who, onceapproved both from a qualitative and ethical perspective, are generally given a long term contract for the supply ofgoods. Obsolete products are disposed of with concern for the environment and the health of its customers, withreusable materials normally being used. The industry is highly regulated in terms of medical and environmental lawsand regulations. The products normally carry a low health risk.

The Group has developed a set of corporate and social responsibility principles during the period which is theresponsibility of the Board of Directors. The Managing Director manages the risks arising from corporate and socialresponsibility issues. The group wishes to retain and attract employees and follows policies which ensure equalopportunity for all the employees. Employees are informed of management policies, and regularly receive in-housetraining.

The Group enters into contracts for fixed rate currency swaps and uses floating to fixed rate interest rate swaps. Thecash flow effects of these swaps match the cash flows on the underlying financial instruments. All financialinstruments are accounted for as cash flow hedges. A significant amount of trading activity is denominated in theDinar and the Euro. The dollar is its functional currency.

Required:

(a) Describe the principles behind the Management Commentary discussing whether the commentary should be

mandatory or whether directors should be free to use their judgement as to what should be included in such

a commentary. (13 marks)

(b) Draft a report suitable for inclusion in a Management Commentary for Jones and Cousin which deals with:

(i) the key risks and relationships of the business (9 marks)

(ii) the strategy of the business regarding its treasury policies. (3 marks)

(Marks will be awarded in part (b) for the identification and discussion of relevant points and for the style of thereport.)

(25 marks)

End of Question Paper

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