CIMA F1 - Ningapi.ning.com/.../CIMAF1StudentNotesfinalversion.pdf.ld.pdf · | CIMA F1 5 The Verb Hierarchy Learning Objective Verbs Used Definition 1 Knowledge What are you expected

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CIMA F1 Financial Reporting and Taxation

Student Notes

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Contents

CIMA F1 ................................................................................................................................................................. 1

Syllabus Structure .................................................................................................................................................. 1

Exam Structure ...................................................................................................................................................... 1

Topic 1: Principles of Business Taxation ................................................................................................................. 1

The modern tax system ...................................................................................................................................... 1

Types of Tax........................................................................................................................................................... 1

Trading income .................................................................................................................................................. 1

Capital taxes ...................................................................................................................................................... 1

Indirect taxes ..................................................................................................................................................... 1

VAT .................................................................................................................................................................... 1

Employee Taxation ................................................................................................................................................ 1

International tax ................................................................................................................................................ 1

Administration ................................................................................................................................................... 1

Topic 2: Investments in Subsidiaries and Associates ............................................................................................... 1

Topic 3: The Consolidated statement of financial position ..................................................................................... 1

Topic 4: Consolidated Statement of profit or loss ................................................................................................... 1

Topic 5: Associates -CSOFP .................................................................................................................................... 1

Topic 6 – The Regulatory Environment ................................................................................................................... 1

International Financial Reporting Standards (IFRSs) ........................................................................................... 1

Topic 7: The Conceptual Framework ...................................................................................................................... 1

Topic 8: External Audit ........................................................................................................................................... 1

Topic 9: Code of ethics ........................................................................................................................................... 1

Topic 10: Corporate Governance ........................................................................................................................... 1

Topic 11: An introduction to published accounts ................................................................................................... 1

Topic 12: The Statement of cash flows ................................................................................................................... 1

Topic 13: Non current assets – Property, plant and equipment .............................................................................. 1

Intangible non-current assets ................................................................................................................................ 1

IAS 36: Impairment Testing .................................................................................................................................... 1

Topic 14: Non- current assets held for sale and discontinued operations ............................................................... 1

Topic 15: IAS 20 government grants and IAS 40 investment properties .................................................................. 1

IAS 40 Investment Properties ................................................................................................................................. 1

Topic 16: IAS 2, 8, 10, 34 and IFRS 8 ....................................................................................................................... 1

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IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.................................................................. 1

IAS 10 Events after the reporting date ................................................................................................................... 1

IFRS 8 Operating segments .................................................................................................................................... 1

Topic 17: IAS 12: Income Taxes .............................................................................................................................. 1

IAS 21: The effects of changes in foreign exchange rates........................................................................................ 1

Topic 19: IAS 19: Employee benefits ...................................................................................................................... 1

Topic 20: WCM – short-term finance and investments ........................................................................................... 1

Topic 21: Working Capital Management (WCM) .................................................................................................... 1

Investment in working capital ................................................................................................................................ 1

Topic 22: Working Capital Management – accounts receivable and payable .......................................................... 1

Topic 23: Working Capital Management – inventory control .................................................................................. 1

Topic 24: Working Capital Management – cash control .......................................................................................... 1

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A Regulatory environment for financial reporting and

corporate governance

10%

B Financial Accounting and Reporting 45%

C Management of working capital, cash and sources of short

term finance

20%

D Fundamentals of business taxation 25%

Maths Tables and formulae are also provided (see following page)

Syllabus Structure

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The exam will comprise of 60 questions covering all the learning outcomes for the syllabus. The time for each

exam is 90 minutes.

The types of questions that will be required to answer are:

Multiple choice

Multiple response

Fill the gap

Pull down list

Drag and drop

Item set

Exam Structure

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The Verb Hierarchy

Learning Objective Verbs Used Definition

1 Knowledge

What are you expected to

know

List

State

Define

Make a list of

Express, fully or clearly, the details of/facts of

Give the exact meaning of

2 Comprehension

What you are expected to

understand

Describe

Distinguish

Explain

Identify

Illustrate

Communicate the features of

Highlight the differences between

Make clear or intelligible / State the meaning of

Recognise, establish or select after consideration

Use an example to describe or explain something

3 Application

How you are expected to

apply the knowledge

Apply

Calculate / compute

Demonstrate

Prepare

Reconcile

Solve

Tabulate

Put to practical use

Ascertain or reckon mathematically

Prove with certainty or to exhibit by practical

means

Make or get ready for use

Make or prove consistent/compatible

Find an answer to

Arrange in a table

4 Analysis


analyse the detail of what

you have learned

Analyse

Categorise

Compare and contrast

Construct

Discuss

Interpret

Produce

Examine in detail the structure of

Place into a defined class or division

Show the similarities and/or differences between

Build up or compile

Examine in detail by argument

Translate into intelligible or familiar terms

Create or bring into existence

5 Evaluation


use your learning to

evaluate, make decision or

recommendations

Advise

Evaluate

Recommend

Counsel, inform or notify

Appraise or assess the value of

Advise on a course of action

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Learning outcome D1a – discuss the features of the types of indirect and direct taxation that typically apply to

an incorporated entity.

The principles of a modern tax system are:

Equity – to be fairly levied between one taxpayer and another

Efficiency – cheap and easy to collect

Economic impact – considers the way in which a tax should be collected

In Wealth of Nations, Adam Smith proposed that a good tax system should have the following characteristics:

Fair

Absolute

Convenient

Efficient

Topic 1: Principles of Business Taxation

The modern tax system

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Tax is either a direct or indirect tax

Direct taxes

Definition:

Tax imposed directly on the person or enterprise

required to pay the tax.

Indirect tax

Definition:

Tax is imposed on one part of the economy with the

intention that the burden is passed on to another.

Tax is imposed on the final consumer of the goods or

services

Examples:

Wages – income tax, usually deducted at source

Profits – trading income / business tax

Gains – tax on profits generated by the disposal of

an asset

Examples:

Unit taxes –excise duties A levy is $10 per litre

Ad valorem taxes –e.g sales tax

Property taxes on rental profits

Wealth taxes –on pension funds, insurance policies

and works of art

Consumption taxes – taxes imposed on the

consumption of goods and added to the purchase

price.

Taxable person is the person who is accountable for the tax payment.

However the person who pays the tax over maybe different. This is referred to as incidence.

Incidence is who is paying the tax. This can be split in to two categories:

Formal incidence

This is the individual who has direct contact with the

tax authorities.

- Legally obliged to pay the tax.

- VAT – the entity making the sale and charging

VAT on its sales and paying its net VAT to the tax

authority, through submitting a vat return

Actual / effective incidence

This is the person who actually ends up bearing the

cost of the tax.

- VAT – the consumer who bears the cost of the

tax when they purchase the goods

- CT – an entity being assessed for corporate

income tax by the tax authority

- An employee having tax deducted from salary

trough the PAYE system.

Types of Tax

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Terminology

Competent jurisdiction

The tax authority that has the legal power to assess and collect the taxes.

This is usually the responsibility of the central government and local authorities in that country. The tax law is

enforceable by sanction (fines and imprisonment)

Hypothecation

Certain taxes are devoted entirely to certain types of expenditure.

Tax gap

The difference between the total amount of tax due to be paid and the amount actually collected by the tax

authority. The tax authorities will aim to minimise this gap.

Tax rate structure

There are three types of taxes

1. Progressive taxes

These take an increasing proportion of income as income rises. The more you earn the higher the rate of

tax.

2. Proportional taxes

These take the same proportion of income as income rises. The rate will stay the same regardless of the

level of income

3. Regressive taxes

These take decreasing proportion of income as income rises. The rate decrease when income exceeds a

threshold.

Tax base

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

Tax bases regularly used by governments are:

income – for example, income taxes and taxes on an entity’s profits;

capital or wealth – for example, taxes on capital gains and taxes on inherited wealth;

consumption – for example, excise duties and sales taxes/VAT.

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Scheduler system

Most countries separate different types of income into categories and have a set of rules to determine how that

income will be taxed. This is referred to as a scheduler system.

A scheduler system of taxation is a system that has a number of schedules that sets out how the different types of

income should be treated for tax purposes.

Different types of income being, trade, property interest etc...

Apply Your Knowledge 1

A customer purchases goods for $200, inclusive of VAT. From the customer’s point of view the VAT could be

said to be:

A: a direct tax with formal incidence.

B: an indirect tax with formal incidence.

C: a direct tax with effective incidence.

D: an indirect tax with effective incidence.


Complete the following sentence.

A scheduler system of tax is ................................................................................... .


Which ONE of the following defines the meaning of “hypothecation”?

A: a new tax law has to be passed each year to allow taxes to be legally collected.

B: the difference between the total amount of tax due to be paid and the amount actually collected by

the tax authority.

C: tax is deducted from amounts due before they are paid to the recipient.

D: the products of certain taxes are devoted to specific types of public expenditure.

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Learning outcome D3a – produce a corporate income tax computations from a given set of rules

The accounting profit needs to be adjusted for tax purposes as in many countries there are differences between

what the accounting standards allow and what the tax system allow.

To calculate the taxable trading profit there is a set proforma

Accounting profit x

Less income exempt from tax or taxed under other rules1

Add disallowable expenditure2

Depreciation3 x

Amortisation x

Entertaining x

Taxes x

Donation to political parties x

Loss on disposal of asset (SP – CV)3 x

Less Tax depreciation (x)

Taxable profit/(loss) x/(x)

The profits will then be charged at the appropriate rate for that accounting period. This rate will always be given

in the question.

1 is any income included in the accounting profit which does not relate to the main trading activity.

2 are expenses that have been deducted from the accounting profit, but for tax purposes are not allowed

3 The calculation is too subjective; this is replaced with tax deprecation.

Trading income

This detail is given in the

exam question

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Tax depreciation

An example of tax depreciation could be:

50% of additions to property, plant and equipment in the accounting period in

which they are recorded;

25% per year of the written-down value (i.e. cost minus previous allowances) in

subsequent accounting periods except that in which the asset is disposed of;

When an asset is disposed of a balancing charge or allowance will occur

This is calculated by taking

Proceeds x

Less: tax written down value (TWDV) (x)

Balancing allowance/ charge x

If proceeds greater than the TWDV = balancing charge (ADD)

If proceed are less than TWDV = balancing allowance (DEDUCT)

No tax depreciation is allowed on land.

Trading losses

When a company makes a trading loss the assessment for the tax year will be nil.

The company can claim loss relief based on the rules of the country’s tax regime.

The four methods that a Country can choose from when relieving trading losses of an entity are:

i. Carry forward against future trading profits of the same trade

ii. Offset against other income and chargeable gains of the same period

iii. Offset against other income and chargeable gains of the previous period

iv. Group relief

A company would transfer its loss to another group entity, so that entity could then offset the loss against taxable

profits. As a result the total group tax payable would be reduced for the year.

The question may tell you what to do with the losses.

Cessation of a business

Trading losses in the last period of trade can be carried back against profits of previous years to generate a tax

refund.

This detail is

given the

question

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For the year ended 30 June 20X2 QC’s statement of profit or loss included a profit before tax of $131,000. QC’s

expenses included political donations of $7,000 and entertaining expenses of $5,000.

QC’s statement of financial position at 30 June 20X2 included plant and machinery with a carrying value of

$151,500. This is comprised of plant purchased on 1 July 20X0 at a cost of $180,000 and machinery purchased

on 1 October 20X1 at a cost of $50,000.

QC depreciates all plant and machinery on the straight line basis at 25% per year.

For QC the following information is relevant:

All expenses other than depreciation, amortisation, entertaining, taxes paid to other public bodies and

donations to political parties are tax deductible.

Tax depreciation is deductible as follows:

o 50% of additions to property, plant and equipment in the accounting period in which they are

recorded;

o 25% per year of the written-down value (i.e. cost minus previous allowances) in subsequent

accounting periods except that in which the asset is disposed of;

o No tax depreciation is allowed on land.

The corporate tax on profits is at a rate of 25%.

Required:

Calculate the tax payable by QC for the year to 30 June 20X2.


BMX sold an asset on 31 March 20X3 for $20,000. The asset cost $180,000 and at 31 March 20X3 had

accumulated depreciation of $170,000.

The asset was eligible for tax depreciation and at 31 March 20X3 its accumulated tax depreciation was

$151,520.

What was the balancing charge on the disposal of the asset?

A: $8,480

B: $10,000

C: $18,480

D: $28,480

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SMT is a small local corporate entity that delivers products to local businesses. The following is a summary of

SMT’s statement of profit or loss for the year ended 31 March 20X3:

$

Revenue 210,000

Expenses 167,000

Profit before tax 43,000

Expenses include depreciation charges of $17,500 for property. These properties qualified for tax depreciation

allowances of $20,600 in the year ended 31 March 20X3.

On 1 April 20X2 SMT had to replace its only delivery vehicle. The vehicle was sold for $2,000. At the date of

disposal the vehicle had a carrying value of $3,000 and a tax written down value of $2,000.

SMT’s replacement vehicle cost $37,000, has an expected useful life of 5 years with a residual value of $7,000.

The appropriate accounting entries for these vehicles have been included in the accounts.

SMT’s expenses include $5,400 for entertainment costs.

For SMT the following information is relevant:



Tax depreciation is deductible as follows:

o 50% of additions to property, plant and equipment in the accounting period in which they are

recorded;

o 25% per year of the written-down value (i.e. cost minus previous allowances) in subsequent

accounting periods except that in which the asset is disposed of;

o No tax depreciation is allowed on land.


Required:

Calculate the amount of tax that SMT is due to pay for the year ended 31 March 20X3.

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CF, an entity resident in Country Y, had an accounting profit for the year ended 31 December 20X2 of

$840,000. The accounting profit was after charging depreciation of $62,000 and amortisation of development

costs of $25,000.

CF was entitled to a tax depreciation allowance of $61,000 for the year to 31 December 20X2.

For CF the following information is relevant:




CF’s tax payable for the year ended 31 December 20X2 is:

A: $202,250

B: $206,500

C: $212,750

D: $216,500


Arnold Ltd has an accounting period ending 31/12/X2 and a taxable profit of £1,000,000.

The rates are as follows

01/04/X1 – 31/03/X2 25%

01/04/X2 – 31/03/X3 20%

Required:

Calculate the tax liability for the period ending 31/12/X2.

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Capital losses

Most countries keep capital losses separate from trading activities.

Possible ways of relieving capital losses are:

Carry forward against future capital gains;

Carry back against previous capital gains;

Offset against trading income in the current period.

The examiner will tell you the treatment in the exam.

Group loss relief

Trading losses

Tax consolidation enables a tax group to be recognised, allowing

Trading losses to be surrendered to companies in the group, to save tax for the group as a whole

Surrendered only between resident companies

Maybe restricted to current accounting period losses only

Each company in the group will still

Produce their own individual accounts

Taxed individually

Capital losses

Usually cannot be surrendered between group companies

Can transfer ownership of assets under a nil gain/nil loss transfer

Gains and losses can then be matched when disposed to a third party, utilising the offset rules of gains

against capital losses

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Learning outcome D3b - produce a capital tax computations from a given set of rules

Capital tax gain is triggered when an entity sells and makes profits (gains) or losses on the disposal of investments

or other assets.

Examples

Properties, listed stocks and shares

To calculate the gain you would use the following proforma:

Notes

Selling price x Sale proceeds

Less selling costs x Legal fees, estate agent fees

Less allowable costs

Purchase x Original cost

Purchase costs x Legal fees, estate agent fees

Enhancement / improvement x

Import duties x

(x)

Less indexation allowance

(Cost X %) (x) Indexation % will be given to you in exam

Taxable Gain x

Tax at tax rate (Gain X %) x

The chargeable gain will be charged at the appropriate tax rate for that accounting period.

Some countries will allow an Annual exemption, which is an amount of the gain that will be tax free, so only the

amount in excess will be taxable. You will be told this amount if applicable.

Capital taxes

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EHH is resident in Country Y. EHH purchased an asset on 1 April 20X1 for $620,000, incurring additional import

duties of $50,000. The relevant index increased by 30% in the period from 1 April 20X1 to 31 March 20X7.

EHH sold the asset on 31 March 20X7 for $900,000, incurring selling costs of $20,000.


Assume all purchase and selling costs are allowable for tax purposes.

Required:

How much tax was due from EHH on disposal of its asset?

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Interaction of corporate tax system with the personal tax system

Learning outcome D1a – discuss the features of the types of indirect and direct taxation that typically apply to

an incorporated entity.

Shareholder Business making profits

Dividends being paid to S/H

Classical system – The shareholder is treated as an independent entity from the company and therefore the

dividend is taxed twice

Imputation system – The shareholder receives a tax credit equal to the underlying corporate income tax paid by

the company. This will result in the dividends only being taxed once.

Partial imputation system – a tax credit to the shareholder but only for part of the underlying corporate income

tax paid by the company. (This is what happens in the UK)

Split rate system – These systems distinguish between distributed profits and retained profits and charge a lower

rate of corporate income tax on distributed profits to avoid the double taxation of dividends.

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Re-characterising debt

As a general rule interest is an allowable deduction and dividends are not. It is therefore advantageous from a tax

point of view to obtain funds via loans instead of shares.

Governments have anti avoidance legislation in place to deter this from happening, called thin capitalisation.

The interest allowable will be capped, and the excess interest will be classified as a dividend and therefore not

allowable.

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COR is resident in Country X. COR makes a taxable profit of $750,000 and pays an equity dividend of

$350,000.

Equity shareholders pay tax on their dividend income at a rate of 30%.

If COR and its equity shareholders pay a total of $205,000 tax between them, what method of corporate

income tax is being used in Country X?

A: The classical system

B: The imputation system

C: The partial imputation system

D: The split rate system

(2 marks)


JY, an entity resident in Country X, reported a taxable profit for the year to 31 June 20X2 and declared a

dividend for the year.

BM, a director and shareholder of JY, received a dividend payment from JY and is certain that the dividend he

received will have been taxed twice.

Country X applies a full imputation system to corporate income taxes.

Required:

Explain to BM how the imputation system of corporate income tax works AND whether his dividend will have

been taxed twice.

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D1a – discuss the features of the types of indirect and direct taxation that typically apply to an incorporated

entity.

Unit taxes – this is a tax based on the number or weight of items e.g. excise duties a levy is $10 per litre

Characteristics of commodities

Few large producers

Inelastic demand with no close substitutes

Large sales volumes

Easy to define products covered by the duty

Ad valorem taxes – this is based on the value of items e.g. sales tax

Property taxes on rental profits

Wealth taxes – these are taxes on pension funds, insurance policies and works of art

Consumption taxes – taxes imposed on the consumption of goods and added to the purchase price.

Two types

Single stage taxes

Single stage sales tax is payable on sales at a specific

part of the trade cycle, e.g. retail sales. There is no

credit given to an entity for sales tax paid on

purchases.

Multi-stage sales tax

Tax charged each time a component or product is

sold

Two types

Cascade tax

Value added tax

Indirect taxes

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Cascade tax

This is where tax is taken at each stage of production and is a business cost. An entity cannot claim the tax back.

Example

A peddle manufacturer sell peddles to a wholesaler who then sells it to a bike retailer. The bike retailer then

sells it to a consumer (James).

Peddle manufacture sells to the wholesaler for $100, the wholesaler sells to the bike retailer for $150, the

retailer then sells to James for $200. The tax rate is 15%

Calculate the total sales tax due.

Answer

100 x 15% = 15

150 x 15% = 22.5

200 x 15% = 30

Total vat on sales $67.50

Each business has to charge tax and pay over to the tax authorities. The $67.50 is not recoverable.


An entity earns a profit of $60,000 for the year to 31 March 20X3. The entity is assessed as owing $15,000 tax

for the year. Which ONE of the following types of tax would best describe the tax due?

A: Capital tax.

B: Income tax.

C: Wealth tax.

D: Consumption tax.


(i) Explain the difference between an excise duty and a single stage sales tax.

| CIMA F1 23


entity.

This is a tax based on the value of the items.

A taxable person making a taxable supply of goods or services must register for VAT in most countries once their taxable turnover reaches a certain limit.

VAT is charged each time a component or product is sold but the government allows businesses to claim back all the tax they have paid.

The entire tax burden is passed on to the final consumer.

Taxable supplies are standard rated and zero rated supplies. This results in Input VAT being reclaimed

If a company sell exempt supplies this is not an example of a taxable supply, therefore the entity cannot claim the VAT back on goods purchased for these exempt supplies.

Business Process

VAT

To calculate the VAT amount

Buzz words:

Exclusive (net of VAT)

Net x % = VAT

Inclusive (Gross) including VAT

Gross / (100 + Tax Rate) x Tax

Rate

Income statement if the company is VAT

registered;

Sales (net) Std/ zero x

Exempt supplies (gross) x

Less Taxable expenses (net) (x)

Exempt supplies (gross) (x)

Profit x

Goods being purchased (Input VAT)

Standard rated – 15% Rates table

Zero Rated – 0% Rates table

Higher Rate - Rates table

Exempt – Not subject to VAT (therefore no VAT)

Goods being sold (Output / sales tax)

Standard rated – 15% Rates table

Zero Rated – 0% Rates table

Exempt – Not subject to VAT (therefore no VAT)

| CIMA F1 24

Once registered for VAT the regulations will normally require an entity to:

Issue VAT invoices

Keep appropriate VAT records

Charge VAT on taxable supplies to customers

Complete a quarterly VAT return

Make payments to VAT authority and be able to claim back VAT when due


HB is registered for VAT in Country X. HB is partially exempt for VAT purposes.

During the latest VAT period HB purchased materials and services costing $890,000 including VAT at standard

rate. These goods and services were used to produce standard rated, zero rated and exempt goods.

Goods supplied to customers (excluding VAT) were:

$

Goods at standard rate 920,000

Goods at zero rate 100,000

Exempt goods 250,000

The VAT rate is 20%

Assume HB had no other VAT related transactions.

Required:

(i) Once registered for VAT an entity must abide by the VAT regulations.

Identify FOUR typical requirements of VAT regulations.

(ii) Calculate the net VAT balance shown on HB’s VAT return for the period.

| CIMA F1 25


JG sells two types of product, A and B. A is standard rated for VAT purposes and B is zero rated. All purchases

have incurred VAT at standard rate.

JG’s sales (inclusive of VAT where applicable) for the three months to 31 March 20X3 were:

$

A 68,750

B 24,150

92,900

JG’s purchases for the three months to 31 March 20X3 were $37,833 exclusive of VAT.

The VAT rate is 15%

Calculate the amount of VAT that JG is due to pay for the three months to 31 March 20X3.

(2 marks)


JJ is registered for VAT in Country X.

JJ purchased a consignment of goods for $90,000 plus VAT at the standard rate and then sold the goods for

$161,000 inclusive of VAT at the standard rate.

The VAT rate is 15%

How much profit should JJ record in its statement of comprehensive income for this consignment?

A: $50,000

B: $57,500

C: $68,000

D: $77,130

(2 marks)

| CIMA F1 26


T is an entity supplying goods and services to other businesses. T is registered for Value Added Tax (VAT) in

Country X. T is partially exempt for VAT purposes.

During the last VAT period T purchased materials and services costing $600,000 excluding VAT. T used these

goods and services to produce both standard and exempt supplies. VAT was payable at standard rate on all

purchases.

T supplied goods and services to its customers, some of these were at standard rate VAT and some were

exempt VAT.

Excluding VAT: $

Standard rate goods and services 650,000

Exempt supplies 150,000

At the end of the period T prepared a VAT return. Assume T had no other VAT related transactions.

The VAT rate is 22%

Required:

(i) Explain the difference between the treatment of items that are zero rated and items that are exempted

from VAT.

(ii) Calculate the net VAT balance shown on T’s VAT return.


LM imports luxury goods in bulk. LM repackages the products and sells them to retailers. LM is registered for

Value Added Tax (VAT) in Country X.

LM imported a consignment of perfume costing $50,000, paying excise duty of 20% of cost. The consignment

was subject to VAT on the total (including duty). LM paid $9,775 repackaging costs, including VAT and sold the

perfume for $105,800 including VAT.

LM had not paid or received any VAT payments to or from the VAT authorities for this consignment.

The VAT rate is 15%

Required:

(i) Calculate the net VAT due to be paid by LM on the perfume consignment.

(ii) Calculate LM’s net profit on the perfume consignment.

| CIMA F1 27


F is a business in Country X, that uses locally grown grapes to make country wines.

During 20X3 F paid $50,000 plus VAT for the ingredients and other running costs.

When the wine is bottled F pays $1 tax per bottle to the tax authority. During 20X3 F produced 12,000 bottles.

F sold all the wine to retailers for an average price of $9.05 per bottle, including VAT at standard rate.

The VAT rate is 15%

Required:

(i) Explain the difference between unit taxes and ad valorem taxes, using the scenario above to illustrate your

answer.

(3 marks)

(ii) Calculate the amounts of indirect tax payable by F for the year ended 31 December 20X3.

(2 marks)

Total for sub-question = (5 marks)

| CIMA F1 28


entity.

Employees are taxed on their earning under income tax:

The basis of assessment is based on the individual country; the examiner will state the basis.

Employees will be able to deduct allowable expenditure, which are wholly, exclusively and necessary for

employment.

Proforma for calculating the taxable employment income

Earnings

Salaries x

Bonuses x

Commissions x

Benefits – company cars, accommodation, medical insurance etc. x

Less allowable expenses

Business travel (x)

Contributions to company pension schemes (x)

Donations to charities under a payroll giving scheme (x)

Professional subscriptions (x)

Less personal allowance 1 (x)

Taxable employment income x

1 Personal allowance is an amount of an individual’s income that is tax free.

The entity pay the income tax on behalf of the employee, referred to as Pay As You Earn (PAYE).

The entity also pays social security taxes based on the salaries paid to the employees and on behalf of the

employee (in the UK this is national insurance).

Employee Taxation

| CIMA F1 29

The taxable income will be charged at the appropriate tax rate for the tax year. The tax year is the time frame that

is taxable.

Advantages of this type of collection for the government

Most of the administration costs are borne by the employer.

Government receives a higher proportion of the tax due as defaults and late payments are fewer.

Tax collected at source, making it less likely for the tax payer to default on payment

Tax authorities receive regular payments helps to budget cash flows for the government


Danielle is a 22 year old accounts assistant and earns $20,000 per annum.

During the tax year, she also received a bonus of $5,000, and has a taxable benefit made up of a company car

and medical insurance worth $3, 500.

She also pays her accounting subscriptions of $200 which her company will not pay for.

Required:

Calculate the income tax liability for Danielle assuming the following:

a) The personal allowance is $10,000

b) The tax rates are as follows based on taxable earnings:

- 10% on the first 2,000

- 20% after that.

| CIMA F1 30

Learning outcome D1c – Explain the taxation issues that may apply to an incorporated entity that operates

internationally.

A company will pay tax on their worldwide income in the country they are resident in.

Resident status

An entity is deemed to be resident for tax purposes either

In the place of incorporation or

Place of control / central management

Under the OECD model tax convention an entity will generally have residence for tax purposes in the country of

its effective management

For example, where the decisions have been made, board meetings held, head office located.

The OECD model states that business profits of an entity will only be taxable in a state if an enterprise has a

permanent establishment in that country. A permanent establishment could include the following

A factory

An office

A branch

A place of management

The problem with the worldwide approach is that it leads to double taxation as income will usually be taxed in the

country where it is earned and again in the country where the holding entity is resident.

Double tax relief exists to reduce the total amount of tax payable on income earned in other countries. The effect

of double tax relief is to reduce the total tax payable to the higher of the two, the home country or overseas tax

rate.

Most countries applying the worldwide approach grant some form of relief from double taxation. Double tax

relief is given according to double tax agreements that a country has entered into.

The three main methods of giving double taxation relief are:

1. Exemption – the countries involved agree the types of income that will be exempt in one country or the

other.

International tax

| CIMA F1 31

2. Deduction – the foreign tax is deducted from the foreign income and the net amount is taxable in the

country of residence.

3. Tax credit – the tax paid in one country is allowed as a tax credit, at the lower tax rate (lower of the

foreign tax rate and country of residence tax rate) in another country.

Types of overseas operations

Subsidiary

Definition: a company incorporated and managed

overseas owned by a UK company.

Tax implication:-

Holding company will only pay tax on any

dividends received from the subsidiary

Loss relief is NOT available for the group

Assets transferred from holding company

may result in capital gains tax

The overseas subsidiary can NOT claim tax

depreciation on assets

Branch

Definition: an extension of the UK activity, for

example a factory

Tax implication:-

All profits will be subject to UK tax

Loss relief is available

Assets can be transferred between the

branch and holding company at a no gain/

no loss

The branch can claim tax depreciation on all

assets

Types of foreign tax

Withholding tax

This is overseas tax on income such as

Interest

Royalties

Rent

Gains

Dividends

The net income (gross payment less tax) is then received by the beneficiary in the foreign country.

The gross income (plus withholding and underlying tax) will be taxed at the relevant rate in the accounting period.

Which will result in the income being tax twice and triggering double taxation relief.

| CIMA F1 32

Underlying tax

Underlying tax is tax on the profits out of which an overseas entity has paid a dividend to its holding entity. E.g. A

subsidiary or associated entity pays a dividend out of its taxed profits. The underlying tax is the tax on its profits.

This is because the company’s profits have been taxed, and then the dividends which have been paid out of those

profits will also be taxed in the country of receipt.

This is known as underlying tax. It is calculated as follows:

Note : You will not be assessed on the calculation of foreign taxation but you should have a general appreciation

what it represents.


Assume that Countries M; N; O and P each has a double tax treaty with each other based on the OECD model

tax convention.

JZ is incorporated in Country M

JZ earns the majority of its revenue from Country N

JZ holds its management board meetings in Country O

JZ raises most of its finance and operating capital in Country P

In which country will JZ be deemed to be resident for tax purposes?

A. Country M

B. Country N

C. Country O

D. Country P

(2 marks)

Tax on foreign profits

Foreign Profit after tax

X Gross dividends

| CIMA F1 33


HND acquired an 80% holding in SUD on 1 April 20X2.

HND received a dividend from SUD of $156,000, the amount received is after deduction of withholding tax of

20%. SUD profit before tax was $650,000 and it paid corporate income tax of $130,000 in respect of these

profits.

Required:

(i) Explain the meaning of “underlying tax”.

(ii) Calculate the amount of underlying tax that HND can claim for double tax relief.


HOC, resident in Country X for tax purposes, owns 100% of shares in a foreign entity, OC.

OC operates in a country that has a double taxation treaty with Country X that provides for the use of the tax

credit method of double taxation relief.

OC reported profits before tax of $800,000 with corporate income tax of $176,000 for the year ended 31

March 20X3.

OC paid HOC a dividend for the year ended 31 March 2013 of $250,000 gross which was subject to withholding

tax of 10%.

Required:

(i) Calculate the total foreign tax suffered on the dividend.

| CIMA F1 34

Learning outcome D1b – discuss the regulatory environment for taxation, including the distinction between tax

evasion and tax avoidance.

Record keeping

Corporate income tax

Must retain:

all records required to support the financial statement,

working papers to support the tax workings.

Sales tax

Must retain all the sales and purchases records

Orders and delivery notes

Purchase and sales invoices (UK and overseas)

Credit and debit notes

Purchase, sales, cash day books

Bank statements

VAT accounts

Overseas subsidiaries

Transfer pricing1 policy

1 Transfer pricing occurs when a connected company sells goods or services under market value. The tax authorities will want

an adjustment to go through the accounts to represent the same price as it would be charged to a third party.

Employee tax

Must retain

Detailed records of employee tax

Social security contributions

Year end returns

Details of the employees

Administration

| CIMA F1 35

Tax authorities set deadline for the payment of tax and submission of the tax return. The tax authorities will then

check the tax return to confirm if the correct tax has been paid.

Minimum retention of records

There will be a minimum length of time for retention of records (in the UK 6 years)

The purpose of this is to enable the tax authorities to question or challenge records earlier or later. Interest will

be charged on late payments of tax.

Powers of tax authorities

Tax authorities may be given various powers to enable them to enforce the tax regulations. These powers may

include:

Power to impose penalties and charge interest on late payments of tax.

Power to review and query tax returns filed by entities.

Power to request special reports from an entity if they believe the entity has given incorrect information.

Power to enter an entity’s premises and to search for and seize documents

Power to examine documents of previous years

Power to give information to foreign tax authorities

Tax evasion

Tax evasion is the illegal manipulation of the tax system to avoid paying tax.

Tax avoidance

Tax avoidance is tax planning to arrange tax affairs, within the scope of the law, to minimise the tax liability.

Imprecise and vague tax laws and very high tax rates are most likely to encourage an increase in the incidence of

tax avoidance or tax evasion.

The tax authorities use various methods to prevent both tax avoidance and tax evasion:

Reducing the opportunity

Simplifying tax structure

Auditing tax returns and payments

Developing good communication between tax authorities and enterprises

Changing social attitudes towards evasion and avoidance

Reducing lost revenue by reviewing the penalty structure

| CIMA F1 36

Source of tax rules

Legislation produced by a national government of the country

Precedents based on previous legislation, interpretations

Directives from international bodies

Agreements with different countries


Maggie has reduced her tax bill by taking advice from a tax expert and investing her surplus cash in

government securities. The income from government securities is free of tax.

Steve works as a carer for a local entity and also has a job working in a garden centre during the day. Steve has

reduced his tax bill by declaring only his day job income on his annual tax return.

Required:

Explain the difference between tax evasion and tax avoidance, using Maggie and Steve to illustrate your answer.

| CIMA F1 37

B3a – Explain whether an investment in another entity constitutes a subsidiary or an associate relationship in

accordance with relevant international financial reporting standards

Purchase of shares in other companies

When one company purchases shares in another the basic accounting in their individual company accounts is

straightforward:

DR Investment in XX

CR Cash

(Assuming cash is used to finance the investment, as when one company buys shares in another it is relatively

common for one company to use another form of consideration, such as a share issue to finance the purchase).

The issue of group accounts

If the purchase of shares gives the investor no influence at all over the investee company then the issue of group

accounts will not arise. The investment is treated per IFRS 9 as a basic investment in shares. However if the

investment in shares is enough to give influence over the investee company then in addition to preparing

individual company accounts the investor company has a second set of accounts to prepare- the group accounts.

Group accounts are also known as consolidated financial statements.

Influence

Sometimes one company owns enough shares in another company that they actually control the investee

company. You will have control if you have power of the investee including the ability to direct its activities and

use that power to affect the amount of returns.

Control

IFRS 10 Consolidated financial statements adopts a principles based approach to determining control but the

clearest indicator is when the investor exercises the majority of the voting rights in an investee.

When control exists we refer to the investor as the parent and the investee as the subsidiary and we will need to

apply IFRS 3 Business combinations in preparing our consolidated financial statements.

Topic 2: Investments in Subsidiaries and Associates

| CIMA F1 38

Exemption from preparing financial statements

A parent need not present consolidated financial statements if and only if:

the parent itself is a wholly owned subsidiary or a partially owned subsidiary and all its other owners,

(including those not otherwise entitled to vote) have been informed about and do not object to the parent

not preparing consolidated financial statements.

the parent's debt or equity instruments are not traded in a public market.

the parent did not file its financial statements with a securities commission or other regulatory organisation.

the ultimate or any immediate parent of the parent produces consolidated financial statements available for

public use that comply with International Financial Reporting Standards.

| CIMA F1 39

Learning outcome B3c – produce consolidated statement of financial positon in accordance with relevant IFRS

for a group comprising of one or more subsidiaries (being wholly partially directly owned) including interest

acquired part way through the year

A group

A group exists where one entity controls another. Control is usually achieved by the purchase of more than 50%

of a company’s equity share capital (ESC).

This is because the first company, that is referred to as the holding or parent company (P say), has enough voting

power to appoint all the directors of the second company that we call the subsidiary (S say). P is, in effect, able to

manage S as if it were merely a department of P, rather than a separate entity. In strict legal terms P and S remain

distinct, but in economic substance (commercial reality) they can be regarded as a single unit (a ‘group’).

Topic 3: The Consolidated statement of financial position

P (Parent)

100%

S (Subsidiary)

| CIMA F1 40

Economic substance

The key principle underlying group accounts is the need to reflect the economic substance of the relationship. This

issue of control is much more than just owning 50%+ of the shares and IFRS 10 Consolidated Financial Statements

covers the issue of 'control' in full. For this session though we will assume that once a company has purchased at

least 51% of another company that 'control' exists.

To reflect the true economic substance of a group of companies we need to produce group accounts in addition to

the individual accounts prepared for each company within the group. One of the main methods of doing this is to

prepare ‘consolidated’ accounts using the ‘acquisition’ method.

The single entity concept

Business combinations consolidate the results and net assets of group members so as to display the group’s

affairs as those of a single economic entity. As already mentioned, this conflicts with the strict legal position that

each company is a distinct entity. Applying the single entity concept is a good example of the accounting principle

of showing economic substance over legal form.

| CIMA F1 41

Mechanics of Consolidation

When one company buys shares in another company the cash paid is recorded as an investment in the acquiring

company’s statement of financial position*.

A standard group accounting question will present you with the accounts of the parent company and the

accounts of the subsidiary and will require you to prepare consolidated accounts. Consolidated statement of

financial position* questions should be approached using the following set of standard workings.

Workings Required

(W1) Group structure and PURP

P

S

S

| CIMA F1 42

PURP – Provision for unrealised profit

We will be considering this in later questions. We always need to know if either the parent sold goods to the

subsidiary or the subsidiary sold goods to the parent.

If any of these goods are still held in inventory at the year end we will have an unrealised profit situation against

which we must make a provision.

(W2) Net assets of subsidiary

At date of acquisition At reporting date

$ $

Share Capital X X

Reserves:

Share Premium X X

Revaluation Reserve X X

Retained earnings X X

X X

(W3) (W4)

| CIMA F1 43

(W3) Goodwill

$

Cost of Parent holding (investment) at fair

value

X

Fair value of non-controlling interest X

Less

Fair value of net assets at acquisition (W2) (X)

Goodwill on acquisition X

Impairment (X)

Carrying value of Goodwill in SOFP X

(W4) Non-controlling interest

$

Fair value of NCI at date of acquisition (W3) X

Add

NCI % of subsidiary’s post acquisition

retained earnings

X

Less NCI % of impairment (Fair value method

only)

(X)

Carrying value of NCI in SOFP X

| CIMA F1 44

(W5) Group retained earnings

$

100% Parent retained earnings X

Parent’s % of subsidiary’s post acquisition retained

earnings

Less parent’s share of impairment (W3)

X

(X)

X

Other reserves (other components of equity):

Each reserve has a separate calculation still based on ownership so the calculation is the same as for retained

earnings

Having completed these core workings we then consolidate the statement of financial position itself – based on control and representing the single economic entity

IFRS 3 Business Combinations - Goodwill

Purchased goodwill is the difference between the purchase consideration and the fair value of the identifiable

assets, liabilities and contingent liabilities.

The group recognises goodwill at cost at the date of acquisition as an intangible non-current asset. Goodwill is

reviewed annually for any impairment.

Negative goodwill arises when the purchase consideration is less than the fair value of the net assets acquired.

The first step is to check the accuracy of the calculation. If it proved accurate it should be credited directly to the

income statement.

Inherent goodwill or non-purchased goodwill should never be included in the statement of financial position.

Goodwill methods

IFRS 3 allows two methods to be used to calculate the value of NCI's holding at the date of acquisition:

Fair value

Proportion of net assets

| CIMA F1 45

Fair value method

The fair value of the NCI's interests may be calculated using the market value of the subsidiary's shares at the

date of acquisition or other valuation techniques if the subsidiary's shares are not traded in an active market. You

will be given the fair value of the NCI in the assessment if you are asked to use this method.

Proportion of net assets method

Under this method, the NCI's holding is measured by calculating their share of the fair value of the subsidiary's

net assets at acquisition (W2).

| CIMA F1 46

Consolidated Statement of Financial Position at 31 December 20X4

$’000

Non Current Assets

Goodwill (W3) X

Tangible (100% P + S) X

Current Assets

Inventory (100% P + S) X

Receivables (100% P + S) X

Bank & cash (100% P + S) X

X

Share Capital (Parent only) X

Share Premium (Parent Only) X

Group retained earnings (W5)

Non controlling Interest (W4)

X

X

Non-current liabilities (100% P + S) X

Current liabilities (100% P + S) X

X

| CIMA F1 47


Summarised statements of financial position for the year to 31 December 20X8 Paula Sophie $ $ Non Current Assets PPE 2,000 1.000 Investment in Sophie 1,200 -

Current Assets 1,600 1,200

4,800 2,200

Equity Shares of $1 each 1,000 400 Retained earnings 1,600 800 Current liabilities 2,200 1,000

4,800 2,200

1) Paula purchased 80% of the ordinary shares of Sophie for $1,200 two years ago when Sophie had

retained earnings of $200.

2) Goodwill arising on acquisition of Sophie has suffered no impairment to date.

3) NCI should be valued using proportion of net assets method. Required:

a) Prepare the consolidated statement of financial position for the Paula Group as at 31 December 20X8. b) Prepare the consolidated statement of financial position for Paula groups as at 31 December 20X8 using

the fair value method assuming goodwill was valued at a fair value method assuming NCI was valued at $300,000 at acquisition.

| CIMA F1 48

Impairment of goodwill

IFRS 3 requires that goodwill is tested at each reporting date for impairment. This means that goodwill is

reviewed to ensure that its value is not overstated in the consolidated statement of financial position.

Fair value method

When valuing NCI at the fair value method we should record the impairment loss by:

Dr NCI to reduce NCI (W4) by the NCI % of the impairment loss

DR GRE to reduce retained earnings for the group (W5) by the parent's % of the impairment loss

Cr goodwill to reduce goodwill (W3) by the full impairment loss

Proportion of net assets method

When valuing NCI at the proportion of net assets method we should record the impairment loss by:

Dr GRE to reduce retained earnings for the group (W5) by the full impairment loss

Cr Goodwill to reduce goodwill (W3) by the full impairment loss

Intra group transactions

IFRS 10 requires all transaction and balances between group companies to be eliminated on consolidation.

Consolidated financial statements treat the two companies as if they are one. If the parent has sold goods to the

subsidiary there could be receivable and payable balances between them at the end of the year.

If this is the case, ask yourself this – will the parent receive cash from outside the group and, will the subsidiary

pay cash outside the group?

NO! Therefore these balances are not true outstanding balances from a group point of view and need to be

cancelled otherwise receivables and payables would be overstated. The same is true for any balance between

parent and subsidiary.

When goods are sold by one company in a group to another in the same group a cancellation would be required to

remove, in accordance with IFRS 10’s single entity concept, the receivable/payable amount on the group statement

of financial position.

| CIMA F1 49

Unrealised Profit – Inventory

If, for example, a parent sells to a subsidiary and the subsidiary has not sold on the goods by the year end an extra

adjustment is required to remove the ‘profit’ on the transaction.

STEP 1 Calculate the PURP (Provision for unrealised profit)

STEP 2 Make the adjustment

Seller Buyer

Cancel profit Reduce inventory

cost to the group


P sells $100,000 (selling price) worth of goods to S (an 80% subsidiary) at cost plus 25% (25% mark-up).

S had not sold any of the goods outside the group by the end of the year.

Required:

Calculate the PUP and show the double entry for this transaction


In the post acquisition period A’s sales to B were $50 million on which A had made a margin of 10% on these

sales. Of these goods, $7 million (at selling price to A) were still in the inventory of B at its year-end of 30

September 20X1. A holds a controlling interest of 70% in B.

Required:

Calculate the PUP and show the double entry for this transaction.

upMark

upMarkinventoryunsold

100

| CIMA F1 50


Summarised statements of financial position as at 31 December 20X8 Mike Susan $ $ Non Current Assets PPE 1,800 1,000 Investment in Susan 1,600 -

Current Assets 1,400 1,200

4,800 2,200

Equity shares of $1 each 1,000 400 Retained earnings 1,600 800 Current liabilities 2,200 1,000

4,800 2,200

1) Mike purchased 75% of the ordinary shares of Susan for $1,600 two years ago when Susan retained earnings showed a balance of $400.

2) The fair value of non controlling interest at the date of acquisition was $600

3) Mike and Susan traded with each other during the year. At the end of the year Susan owed Mike $300. This is included in both sets of individual company figures. Also included in the inventory of Mike was $60 of goods purchased from Susan at mark up on cost of 25%.

Required:

Prepare the consolidated statement of financial position for the Mike Group as at 31 December 20X8 where impairment is $400.

| CIMA F1 51

Unrealised Profit – Non-current assets

It’s not just inventory that can be sold between group companies. It’s possible that non-current assets could also be transferred between group companies. Exactly the same principles apply – any profit made on the transfer should be cancelled and the non-current asset reduced to cost to the group.

The additional consideration would be depreciation. You must remember that the depreciation needs to be based on cost to the group. An adjustment to the NBV of the asset and profit may be necessary.


On 1 July 2007 Max acquired 100% of the ordinary share capital of Paddy. The Max Group are now preparing group financial statements for the year ended 30 June 2008.

On the acquisition date Max sold an item of equipment to Paddy for $84,000. The asset originally cost $96,000 and has been written down to $64,000 as at 30 June 2007. Both companies depreciate plant and equipment on a straight line basis over 6 years. Paddy depreciated the cost of the asset over it’s remaining useful life of 4 years.

Required:

Show the journal adjustment that would be made for this intra-group transaction when preparing the group accounts for the year ended 30 June 2008.


Club purchased 75% of the share capital of Green on the 1 April 20X2. Green sold a piece of machinery to Club

on 1 April 20X2 for $115,000. The machinery had previously been used in Green’s business and had been

included in green’s property, plant and equipment at a carrying value of $90,000. Green had recognised the

profit on disposal in revenue. The machinery had a remaining useful life of 5 years on 1 April 20X2.

Club’s year end is the 31st March 20X3

Required:

What adjustment is required for the 31 March 20X3 in reaction to the above transaction?

| CIMA F1 52


Summarised statements of financial position as at 31 December 20X8 Bree Orson $ $ Non Current Assets PPE 4,000 1,600 Investment in Orson 1,800 -

Current Assets Inventory 500 360 Receivables 600 400 Bank 180 100

7,080 2,460

Equity shares of $1 each 2,000 400 Retained earnings 1,800 700 Non-current liabilities 1,000 200 Current liabilities 2,280 1,160

7,080 2,460

1) Bree purchased 70% of Orson for $1,800 three years ago when Orson’s retained earnings showed a

balance of $200.

2) Bree and Orson traded with each other during the year. At the year end Orson owed Bree $100. This is

included in both sets of individual company accounts. Also included in the inventory of Orson is goods

purchased from Bree for $100 at a mark up on cost of 25%.

3) Goodwill arising on acquisition of Orson has been impaired by $600.

4) NCI should be valued using the proportion of net assets method

Required:

Prepare the consolidated statement of financial position for the Bree Group as at 31 December 20X8.

| CIMA F1 53


Summarised statements of financial position as at 31 May 20X9

Brooke Lucas

$ $ Non Current Assets PPE 20,000 12,000 Investments 12,000 -

Current Assets Inventory 12,000 2,000 Receivables 10,000 12,000 Bank 2,000 4,000

56,000 30,000

Equity shares of $1 each

24,000 8,000

Retained earnings 26,000 16,000 Current liabilities 6,000 6,000

56,000 30,000

1) Brooke acquired 80% of the ordinary shares of Lucas for $10,000 two years ago when retained earnings

of Lucas were $1,000. Brooke owed Lucas $1,500 in respect of group trading that had occurred during

the year. This balance is reflected in both companies’ statements of financial position.

2) Goodwill on acquisition has been impaired by a total of $150.

3) During the year Lucas sold $1,000 goods to Brooke at a mark-up of 25% on cost. Three quarters of these

goods had been sold by Brooke by the year end.

4) The fair value of non controlling interest at the date of acquisition was $2.50 per share of Lucas.

Required:

Prepare the consolidated statement of financial position as at 31 May 20X9

| CIMA F1 54

Learning outcome B3c – produce the statement of profit or loss and other comprehensive income in

accordance with relevant IFRS for a group comprising of one or more subsidiaries (being wholly partially

directly owned) including interest acquired part way through the year

Proforma CSOPL for a group with a 100% subsidiary.

Consolidated statement of profit or loss for the year ended …….....

$000 $000

Revenue (100% of P and S), less inter-company sales

Cost of sales (100% of P and S), less inter-company purchases, add unrealised profit in inventory

Gross profit (cast down)

Distribution costs (100% of P and S)

Administrative expenses (100% of P and S)

Profit from operations

Investment income (external only)

Finance cost (external only)

Profit before tax (cast down)

Income tax expense (100% P and S)

Profit for the year

OTHER COMPREHENSIVE INCOME

Revaluation gains (100% P and S)

Total comprehensive income

Amount attributable to:

Non-controlling interest

Group

Topic 4: Consolidated Statement of profit or loss

| CIMA F1 55


Statements of profit or loss for the year ended 30 September 20X7

Peter Sasha

$ $

Revenue 200,000 160,000

Cost of sales (100,000) (60,000)

Gross profit 100,000 100,000

Operating expenses (40,000) (70,000)

Operating profit 60,000 30,000

Investment income

Finance costs

20,000

(8,000)

-

(9,000)

Profit before tax 72,000 21,000

Income tax expense (20,000) (10,000)

Profit for the year 52,000 11,000

1) Peter acquired 80% of Sasha on 1 October 20X6. The goodwill on acquisition of Sasha was $8,000 and

has been impaired by a total of $1,000 during the year. Impairment should be charged to operating expenses.

2) During the year Sasha sold $10,000 goods to Peter at a mark-up of 25% on cost, ¼ of those goods are

in inventory at the year end. 3) Sasha paid a dividend of $5,000 during the year which is included in the investment income of Peter.

4) Peter purchased 100,000 of Sasha’s 6% $1 loan notes on 1 October 20X6. Required:

a) Prepare the consolidated statement of profit or loss for the year to 30 September 20X7.

| CIMA F1 56

Mid year acquisition

If a subsidiary is acquired during the year then the results need to be time apportioned when preparing the group statement of profit or loss.

i.e. With a year end of December a subsidiary acquired on 1 October is only controlled by the group for 3 months

so only 3/12 of the results would go in the group statement of profit or loss.


Statements of profit or loss for the year ended 31 December 20X8

Posh Spice

$m $m

Revenue 100 80

Cost of sales (60) (20)

Gross profit 40 60

Operating Expenses (25) (5)

Profit from operations 15 55

Investment income 12 -

Profit before tax 27 55

Income tax expense (5) (10)

Profit after tax 22 45

Retained earnings bfwd

30

10

Profit for the year

Dividend paid

Retained earnings cfwd

22

(5)

47

45

(10)

45

1) Posh acquired 80% of Spice on 1 October 20X8. Goodwill on the acquisition was $12m of which $4m has been impaired during this year.

2) Posh sold goods to Spice invoiced at $2m, including a mark up of 50%, half the goods remain in Spices’ inventory at the year end.

3) Spice paid a dividend of $10 million on 31 December 20X8

Required:

Prepare the consolidated statement of profit or loss for the Posh group for the year ended 31 December 20X8.

| CIMA F1 57

Learning outcome B3c – produce consolidated statement of financial positon and the statement of profit or loss

and other comprehensive income in accordance with relevant IFRS for a group comprising of one or more

subsidiaries (being wholly partially directly owned) or associates, including interest acquired part way through

the year

A shareholding of between 20% and 50% is assumed to give the investing company significant influence over its

investment.

This means it is treated as an associate and equity is accounted for in accordance with IAS 28 (no line by line

consolidation).

IAS 28 states that significant influence can be shown by:

Representation on the board of directors

Participation in the policy making processes

Material transactions between the investor and investee

Interchange of managerial personnel

Provision of essential technical information

The Mechanics of Equity accounting

Group Statement of financial position

Group structure, net assets and goodwill calculations are all calculated in the same way as they would be for a

subsidiary. No non-controlling interest calculation is needed. Group reserves are required as normal.

An extra working (W6) is required. This is entitled investment in associate and is calculated as follows:

Cost of investment in A

X

ADD post acquisition reserves (W5)

LESS impairment of associates goodwill

X

(X)

X

In non-current assets section of the Group

Statement of Financial Position

Topic 5: Associates -CSOFP

| CIMA F1 58


Statements of Financial Position at 30 September 20X2:

AZ PQ SY

$000 $000 $000

Non-Current Assets

PPE (note vii) 400 297 380

Investments:

100,000 Equity shares

in PQ at cost(i) to (iii)

500 - -

80,000 Equity shares

in SY at cost (iv)

125 - -

1,025 297 380

Current Assets

Inventory (vi) 190 60 160

Trade Receivables 144 63 88

Cash and cash equivalents

48 21 73

382 144 321

Total Assets 1,407 441 701

Equity and Liabilities

Equity shares of $1 each 900 100 400

Share premium 300 50 100

Retained earnings 111 112 95

Revaluation Reserve 60

1,311 322 595

Current liabilities

Trade payables 96 119 106

Total Equity and Liabilities 1,407 441 701

Additional information:

(i) AZ acquired 75% of PQ’s equity shares on 1 October 20X0 for $500,000. PQ’s retained earnings at 1 October 20X0 were $38,000.

| CIMA F1 59

(ii) AZ carried out an impairment review of the goodwill arising on acquisition of PQ and found that as at 30 September 20X2 the goodwill had been impaired by $20,000.

(iii) AZ purchased its shareholding in SY on 1 October 20X1for $125,000. The fair value of all SY’s net assets was the same as their carrying value at that date. AZ exercises significant influence over all aspects of SY’s financial and operating policies.

(iv) The Statements of profit or loss for the year ended 30 September 20X2 showed the following amounts for the profit for the year for each entity:

$000

AZ 67

PQ 49

SY 55

(v) During August 20X2 PQ sold goods to AZ for $52,000 at a mark up of 331/3 on cost. At 30 September 20X2 all of the goods remained in AZ’s closing inventory & AZ had not paid for the goods.

(vi) AZ sold a piece of machinery to PQ on 1 October 20X1 for $74,000. The machinery had previously been used in AZ’s business and had been included in AZ’s property, plant and equipment at a carrying value of $50,000. The machine had a remaining useful life of 4 years at that date. Profit on disposal was included in revenue.

(vii) AZ made a payment to PQ for $60,000 on 30September 20X2 which was not recorded by PQ until 5 October 20X2.

(viii) NCI should be calculated using the fair value method assuming a value at acquisition of $125,000 Required: Prepare the consolidated statement of financial position for AZ as at 30 September 20X2, in accordance with the requirements of IFRS.

| CIMA F1 60

Associates in a Consolidate statement of profit or loss

The income from associate goes under operating profit on the group statement of profit or loss.

A proforma CSPL- 100% Sub and 30% Associate

$000 $000

Sales revenue (100% of P and S), less inter-company sales

Cost of sales (100% of P and S), less inter-company purchases , add unrealised profit in inventory

Gross profit

Administrative expenses (100% of P and S)

Distribution costs (100% of P and S)

Profit from operations

Share of profits of associates(30% of Assoc PAT) – impairment of associates goodwill

Investment income (external only)

Interest payable (100% P and S)

Profit before tax (cast down)

Taxation

Group (100% P and S)

Profit for the year

OTHER COMPREHENSIVE INCOME

Revaluation gains

Total comprehensive income

Amount attributable to:

Equity holders of the parent

Non-controlling interests (20% of S’s profit after tax)

| CIMA F1 61

Unrealised profit in inventory

Although the associate is not in the group the equity method introduces part of the results and balances of the

associate into the group. If there has been trading between the group and the associate, then inventory balances

may mean adjustments are necessary.

However, it will only ever be the groups share of the associate that is introduced so the unrealised profit

calculation is

x GROUP SHARE

Examples:

Parent sells to the associate – the parent has recognised profits on inventory that will be brought back into the

group within the share of net assets of the associate.

CSOFP

Dr Group retained earnings (cancel profit on goods still in the group)

Cr Investment in associate (reduce goods to cost to the group)

Associate sells to the parent – the associate has recognised profits on inventory that are still in the group, within

the inventory of the parent.

Dr Group retained earnings (cancel profit on goods still in the group)

Cr Group inventory (reduce goods to cost to the group)

upMark

upMarkinventoryunsold

100

| CIMA F1 62


The draft statements of financial position at 30 September 20X4 and statements of profit or loss for the year

ended 30 September 20X4 for three entities, HC, SU and AS are given below:

Statements of Financial Position as at 30 September 20X4:

Notes HC SU AS

Statements of profit or loss for the year ended 30 September 20X4

HC SU AS

$000 $000 $000

Revenue 1,925 480 285 Cost of sales (925) (230) (119) Gross profit 1,000 250 166 Expenses (240) (54) (42)

760 196 124

Interest received 25 0 0 Finance cost (27) (45) 0

758 151 124

Income tax expense (147) (38) (27) Profit for the year 611 113 97

Notes: (i) HC acquired 80% of SU’s equity shares on 1 October 20X3 by issuing 600,000 new HC shares. The

agreed purchase consideration was $1,356,000, however HC has not yet recorded the acquisition in its accounting records. SU’s retained earnings were $319,000 on 1 October 20X3.

(ii) HC carried out an impairment review of goodwill arising on acquisition of SU and found that as at

$000 $000 $000

Non-current Assets Property, plant and equipment

2,192 920 684

Investments: (i) Loan to SU (iii) 250 0 0

Investment in AS (ii) 384 0 0

2,826 920 684

Current Assets Inventory (iv) 1,810 782 52 Trade and other receivables

2,292 686 57

Cash and cash equivalents (iv) 113 70 19

4,215 1,538 128

Total Assets

7,041 2,458 812

Equity and Liabilities Equity Equity shares of $1 each

5,520 720 320

Retained earnings

796 457 229

6,316 1,177 549

Non-current liabilities Long term loans (iii) 0 650 0

Current liabilities Payables and accruals

725 631 263

Total Equity and Liabilities

7,041 2,458 812

| CIMA F1 63

30 September 20X4 the goodwill had been impaired by 15%. (iii) HC purchased 96,000 $1 equity shares in AS on 1 October 20X3 for

$384,000 when AS’s retained earnings were $132,000. The fair value of AS’s net assets was the same as its carrying value at that date. HC exercises significant influence over all aspects of AS’s financial and operating policies.

(iv) On 1 October 20X3 HC advanced SU a 10 year loan of $250,000 at 10% interest per year. SU paid the interest due on 25 September 20X4.

(v) HC occasionally trades with SU. During September 20X4 HC sold SU goods for $170,000. HC uses a mark-up of 25% on cost. At 30 September 20X4 50% of the goods remained in SU’s inventory. SU paid $90,000 to HC on 29 September 20X4. HC did not receive the payment until 2 October 20X4.

Required: Prepare the consolidated statement of profit or loss for HC for the year ended 30 September 20X4 AND a consolidated statement of financial position for HC as at 30 September 20X4, in accordance with the requirements of International Financial Reporting Standards.

| CIMA F1 64

Learning outcome A1a: Explain the need for the regulation of the financial reporting information of incorporated entities and the key elements of an ethical regulatory environment for such information

Learning outcome A1b: Explain the roles and structures of the key bodies involved in the regulation of financial reporting information.

Need for regulation

Because of the importance of published accounts giving a fair presentation to the users of these accounts, they

need to be regulated. Without such regulation consistency of accounts preparation is undermined.

Regulatory bodies

The IFRS Foundation 22 Trustees

IFRS Advisory Council

International Accounting

Standards Board

IFRS Interpretations

Committee

Appoints members

Advises

Reports

Topic 6 – The Regulatory Environment

| CIMA F1 65

IFRS Advisory Council

The IFRS Advisory Council (formally called the SAC) provides a forum for organisations and individuals to participate in the standard-setting process. It is way the IASB consults with the outside world. The objectives of the IFRS Advisory Council Care:

To give advice to the IASB on agenda decisions and priorities in its work;

To inform the IASB of the views of organisations and individuals on the Council on major standard-setting

projects;

To give other advice to the Board or to the Trustees.

| CIMA F1 66

IFRS Interpretations Committee (IFRS IC)

The IFRS Interpretations Committee (formally known as the International Financial Reporting Interpretations committee or IFRIC) was originally established in 2002. They provide guidance on specific practical issues in the interpretation of IFRS. Note that despite the name change. Interpretations issued by the IFRS Interpretations Committee are still known as IFRIC interpretations. In your exam, you may see the IFRS Interpretations Committee referred to as the IFRS IC.

The responsibilities of the IFRS IC:

1. To review on a timely basis , newly identified financial reporting issues not specifically addressed in IFRSs

2. To clarify issues where unsatisfactory or conflicting interpretations have developed, or seem likely to

develop in the absence of authoritative guidance, with a view to reaching a consensus on the appropriate

treatment.


What is the role of the IFRS Interpretations committee?

A. To develop and issue a set of globally accepted international financial reporting standards

B. To clarify issues in the application of IFRS s where unsatisfactory or conflicting interpretations has

developed

C. To take account of the financial reporting needs of small and medium sized entities

D. To provide a forum for the IASB to consult with the national accounting standard setters, academics

and other interested parties


Which of the following is responsible for developing and issuing IFRSs (International Financial Reporting

Standards)?

A. IFRS Foundation

B. IFRS Interpretations committee

C. International Accounting Standards Board (IASB)

D. IFRS Advisory Council

| CIMA F1 67

Learning outcome A1c: Explain the scope of IFRS and how they are developed.

There are currently 41 IASs and 13 IFRSs in issue.

The use and application of FRSs

PLEASE NOTE THROUGHOUT THIS COURSE WE WILL USE THE ABBREVIATION IFRSs TO INCLUDE BOTH IFRSs

AND IASs.

The IFRSs have helped to improve and harmonise financial reporting around the world. The standards are used in

the following ways:

1. As national requirements

2. As the basis for all or some national requirements

3. As an international benchmark for those counties which develop their own requirements

4. By regulatory authorities for domestic and foreign companies

5. By companies themselves

In the UK the consolidated accounts of listed companies have had to be produced in accordance with IFRSs since

January 2005.

Standard-setting process

The IASB prepares IFRSs in accordance with due process.

Establishment of a consultative group to give advice on the issues arising on the project. The IASB will consult

with this committee and IFRS advisory council throughout the process.

On acceptance of a project a steering committee is set up (chaired by board members);

On major projects, the IASB develops and publishes a Discussion Document for public comment;

Following the receipt and review of comments, an Exposure Draft is produced for public comment;

Following the receipt and review of comments, the final IFRS will be issued.

International Financial Reporting Standards (IFRSs)

| CIMA F1 68

Scope and application of IFRSs

Any limitation of the applicability of a specific IFRS is made clear within that standard. IFRSs are not intended to be applied to immaterial items, nor are they retrospective. Within each individual country local regulations will govern, to a greater or lesser degree.

| CIMA F1 69

Learning outcome A1a: Explain the need for the regulation of the financial reporting information of incorporated entities and the key elements of an ethical regulatory environment for such information

Purpose and status of the conceptual Framework

The IASB’s Framework for the Preparation and Presentation of Financial Statements sets out the concepts underlying the preparation and presentation of financial statements for external users. In detail, the intended role of the Framework is to:

assist the IASB in its development of future accounting standards and in its review of existing accounting standards

assist the IASB by providing a basis for reducing the number of alternative accounting treatments permitted by law and accounting standards

assist preparers of financial statements in applying accounting standards and in dealing with topics that do not form the subject of an accounting standard

assist auditors in forming an opinion as to whether financial statements conform with accounting standards

help users of financial statements to interpret the information contained in financial statements prepared in conformity with accounting standards

provide those who are interested in the work of the IASB with information about its approach to the formulation of accounting standards.

The Framework is not itself an accounting standard nor can it override the requirements of any existing accounting standard.

The objective general purpose financial reporting

You must learn the objective of financial statements, the qualitative characteristics of financial statements and

the underlying assumptions. These are a ‘need to learn’.

At the user

The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

These decisions involve buying, selling or holding investments in shares or debt instruments, and providing or settling loans and other forms of credit.

Topic 7: The Conceptual Framework

| CIMA F1 70

Decisions made by users depend upon the returns that they expect to receive, for example dividend income, principal and interest payments or market price increases. Consequently users need information that helps them assess the prospects for future net cash inflows to an entity.

To assess the entity's prospects for future net cash inflows users need information about:

the resources of the entity

claims against the entity

how efficiently and effectively the entity's management and governing board have discharged their responsibilities to use the entity's resources.

Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely upon general purpose financial reports for much of the financial information they need. Consequently they are the primary users to whom general purpose financial reports are directed.

Underlying assumption

Going concern

Going concern is the underlying assumption adopted whenever we are preparing financial statements. You will

have learnt about this from your first introduction to double-entry bookkeeping.

Although the accruals concept is no longer considered to be an underlying assumption it is still covered by the

Conceptual Framework as an important concept of financial accounting. The accruals concept states events

should be dealt with in the accounting period they occur, rather than the period they are paid.

Fundamental qualitative characteristics of financial statements

The framework splits qualitative characteristics into two categories:

(i) Fundamental qualitative characteristics

- Relevance

- Faithfull representation

(ii) Enhancing qualitative characteristics:

- Comparability

- Verifiability

- Timeliness

- Understandability

| CIMA F1 71

Relevance

Relevance – to be useful, information must be relevant to the decision making needs of the user. Information is

relevant when it influences the economic decisions of users by helping them to evaluate past, present or future

events or confirming or correcting their past evaluations.

The relevance of information is affected by its nature and materiality. (Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements)

Faithful representation

Faithful representation – a transaction or other event is faithfully represented if the way in which it is recognised,

measured or presented in the financial statements corresponds closely to the effect of that transaction or event.

Substance over form – the economic substance of a transaction should be recorded rather than simply its legal

form.

Example: A company acquired a non-current asset under a hire purchase agreement; the legal position is that

ownership does not pass until the final instalment has been paid. However, substance of the transaction is that

the company is purchasing an asset and taking out a loan to pay for it. Therefore, the asset and the loan are

recorded in the accounts.

Neutrality (objectivity) – information is not neutral if it has been selected or presented in such a way as to

influence the making of a decision or judgement in order to achieve a predetermined result or outcome.

Free from error – Within the bounds of materiality information must be free from error. This does not mean

perfectly accurate. Estimates are acceptable but must be described clearly as such.

Completeness- Financial information must be complete, within the restrictions of materiality and cost, to be

reliable. Omission may cause information to be misleading.

Enhancing qualitative characteristics of financial statements

Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the

usefulness of information that is relevant and faithfully represented. The enhancing qualitative characteristics

may also help determine which of two ways should be used to depict a phenomenon if both are considered

equally relevant and faithfully represented.

| CIMA F1 72

Comparability

Users must be able to compare financial statements over a period of time in order to identify trends in financial

position and performance. Users must also be able to compare financial statements of different entities to be

able to assess their relative financial position and performance.

In order to achieve comparability, similar items should be treated in a consistent manner from one period to the

next and from one entity to another. However, it is not appropriate for an entity to continue accounting for

transactions in a certain manner if alternative treatments exist that would be more relevant and reliable.

Disclosure of accounting policies should also be made so that users can identify any changes in these policies or

differences between the policies of different entities.

Verifiability

Verification can be direct or indirect. Direct verification means verifying an amount or other representation

through direct observation i.e. counting cash. Indirect verification means checking the inputs to a model, formula

or other technique and recalculating the outputs using the same methodology i.e. recalculating inventory

amounts using the same cost flow assumption such as first-in, first-out method.

Timeliness

Timeliness means having information available to decision makers in time to be capable of influencing their

decisions. Generally, the older the information is the less useful it becomes.

Understandability

Information needs to be readily understandable by users. Information that may be relevant to decision making

should not be excluded on the grounds that it may be too difficult for certain users to understand.

| CIMA F1 73

The elements of financial statements

Asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

Liabilities are an entity’s obligations to transfer economic benefits as a result of past transactions or events.

Equity is the residual amount found by deducting all liabilities of the entity from all of the entity’s assets.

Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from equity participants.

Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

| CIMA F1 74

Recognition of the elements of financial statements

In order to recognise anything in the statement of financial position and income statement it must meet all three of the following criteria:

Meet the definition of the element (as above)

Probable future economic benefit will flow to or from the entity

The item can be measured reliably

Measurement of the elements of financial statements

Historical cost - cash price or fair value at acquisition or obligation. Most commonly used but widely criticised

Current cost – what would be the cash price today

Realisable value - what could be realised/satisfied today

Present value – discounted future cash flows

The Framework does not state which of the four should be used

Concepts of capital and capital maintenance.

The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to maintain.

It provides the linkage between the concepts of capital and the concepts of profit because it provides the point

of reference by which profit is measured; it is a prerequisite for distinguishing between an entity’s return on

capital and its return of capital; only inflows of assets in excess of amounts needed to maintain capital may be

regarded as profit and therefore as a return on capital. Hence, profit is the residual amount that remains after

expenses (including capital maintenance adjustments, where appropriate) have been deducted from income. If

expenses exceed income the residual amount is a loss.

Financial capital maintenance is measured in either nominal monetary units or units of constant purchasing power.

Physical capital maintenance requires the adoption of the current cost basis of measurement – an appreciation of

what it would cost to replace assets at current prices.

The main difference between the two is how they treat the effects of increases in prices of assets and liabilities.

| CIMA F1 75


Under the IASB’s Framework for the preparation and presentation of financial statements which of the

following is the ‘threshold quality’ of useful information.

A. Relevance

B. Reliability

C. Materiality

D. Understandability


THE IASB’s Framework identifies qualitative characteristics

i. Relevance

ii. Comparability

iii. Verifiability

iv. Understandability

v. Faithful Representation

Which of the above are not listed as an enhancing characteristic?

A. (i), (iv) and (v)

B. (ii), (iii) and (iv)

C. (ii) and (iii)

D. (i) and (v)


According to ‘The Framework’ what is the main objective of financial reporting?

Providing useful information to:

A. The government

B. The employees

C. The customers

D. The investors

| CIMA F1 76


Which THREE of the following are uses of financial statements as identified by ‘The Framework’?

A. The general public

B. Trade unions

C. Lenders

D. Analyst/ advisors

E. The European Union

F. Competitors


Which are the THREE main financial statements as identified by ‘The Framework’?

A. The statement of liabilities

B. The statement of expenses

C. The income statement

D. The statement of financial position

E. The statement of cash flows

F. The statement of Obligations


According to ’The Framework’ which qualitative characteristics enhance the usefulness of information that

is:

A. Comparability, understandability, timeliness, verifiability

B. Consistency, prudence, measureability, verifiability

C. Consistency, reliability, measurability, timeliness

D. Materiality, understandability, measureability, reliability

| CIMA F1 77


Which THREE of the following are qualitative characteristics of financial statements as identified by

A. Relevance

B. Materiality

C. Reliability

D. Timeliness

E. Measurability

F. Prudence


Which THREE of the following are elements of financial statements as identified by ‘The Framework’

A. Revenue

B. Expenses

C. Profits

D. Losses

E. Capital

F. Obligations

| CIMA F1 78

Learning outcome A1d: Describe the role of the external auditor in the context of the financial reporting

information of incorporated entities and the content and significance of the audit report.

What is an External audit?

An external audit is when an independent person examines and checks the financial statements. The auditor will

then prepare a report to present to the shareholders.

The objective of an audit is for the auditor to express an opinion as to whether the financial statements are fairly

presented, i.e. that they

show a true (accurate) and fair (unbiased) view;

have been prepared in accordance with ‘specific legislation’ (this will vary internationally).

materially correct.

(This implies that either accounting standards have been complied with or that non-compliance with the

accounting standards was necessary in order to show a true and fair view.)

Materiality

Materiality is an error or misstatement that will influence the user’s decision.

Purpose

To give users confidence in the financial statements and reduce the risk of fraud and error.

This is not 100% guarantee, but reasonable assurance.

Topic 8: External Audit

| CIMA F1 79

Duties of directors

Duties of directors can vary from country to country. Typically the legal duties of the directors will include a

requirement to:

safeguard the company's assets and to prevent fraud and errors in the company;

ensure that the company keeps proper accounting records;

prepare annual financial statements showing the financial position, financial performance and changes in

the financial position during the reporting period;

deliver to the relevant national regulatory authority a copy of the company's audited financial statements

within a defined time limit;

set up an internal control system in the company to ensure that all of the above requirements are met.

| CIMA F1 80

Duties of auditors

To report to the shareholders of the entity on whether or not the financial statements show a true and fair

view and have been prepared in accordance with the applicable reporting framework.

Auditors also have a duty to report by exception, which means they have a duty to report any problems to

shareholders. Again, their duties will vary from country to country but typically they would report on the

following matters:

R returns from branches have been received

A accounts are in agreement with underlying accounting records

P proper accounting records have been kept

I information and explanations has been received

D directors report is consistent with the financial statements, e.g. director's emoluments, related party

transactions.

Rights of auditors

In order to carry out their duties, auditors are given certain rights:

access to accounting records;

require information and explanations as necessary;

receive notice of, attend and speak at general meetings of shareholders;

rights relating to their removal, resignation and retirement.

Benefits Disadvantages

Independent confirmation to directors of profits Cost of the audit fee

Assurance of compliance with accounting standards Time consuming and may disrupt management and

staff time

Can make recommendations on systems In a small company the directors and shareholders are

likely to be the same, so no real benefit.

Adds credibility to financial information

| CIMA F1 81

Audit Process

Auditors appointed

Auditor agrees terms with client

Auditor will plan what tests to do

Auditor will gather the evidence

Review

Audit opinion

Audit report

Auditor attends AGM

| CIMA F1 82

The Audit report

Title

Addressee

Introductory paragraph

Statement of responsibilities

- Management

- Auditors

Scope paragraph

Opinion

Signature

Date

| CIMA F1 83

Types of audit reports

Audit Report

UNMODIFIED REPORT

FS are materially misstated

MODIFIED REPORT

Auditor unable to obtain sufficient

appropriate evidence

‘Fair Presentation’ or

‘True and Fair’

MODIFIED OPINION

Other Matter

Emphasis of Matter

DISCLAIMER OF OPINION

QUALIFIED OPINION

ADVERSE OPINION

QUALIFIED OPINION

material not pervasive

material not pervasive

material and pervasive

material and pervasive

| CIMA F1 84

Pervasive

Pervasive effects on the financial statements are those that, in the auditor’s judgement:

I. Are not confined to specific elements. Accounts or items of the financial statements;

II. If so confined, represent or could represent a substantial proportion of the financial statements; or

III. In relation to disclosures, are fundamental to users’ understanding of the financial statements.


You are a trainee accountant working for DDD, which is listed on the local stock exchange. A new chief

executive has recently been appointed and has queried the benefits to DDD of having an external audit carried

out each year.

Required:

Prepare a short briefing note that highlights the benefits of an external audit to DDD.

| CIMA F1 85


AT’s profits have suffered due to a slow-down in the economy of the country in which it operates. AT’s draft

financial statements show revenue of $35 million and profit before tax of $4 million for the year ended 31

March 2012.

AT’s external auditors have identified a significant quantity of inventory that is either obsolete or seriously

impaired in value. The audit senior has calculated the inventory write-down of $2 million. AT’s directors have

been asked by the audit senior to record this in the financial statements for the year ended 31 March 2012.

AT’s directors are refusing to write-down the inventory at 31 March 2012, claiming that they were not aware of

any problems at that date and furthermore do not agree with the auditor that there is a problem now. The

directors are proposing to carry out a stock-take at 31 July 2013 and to calculate their own inventory

adjustment, if required. If necessary the newly calculated figure will be used to adjust inventory values in the

year to 31 December 2013.

Required:

(i) Explain the objective of an external audit.

(ii) Assuming that AT’s directors continue to refuse to amend the financial statements, explain the type of audit

report that would be appropriate for the auditors to issue.

| CIMA F1 86


An external auditor has completed an audit and is satisfied that proper records have been maintained and that the financial statements reflect those transactions.

However the auditor has one disagreement with the management of the entity. The disagreement involves the treatment of one large item of expenditure that has been classified by management as an increase in non-current assets.

The auditor is of the opinion that the item should have been classified as maintenance and charged as an expense to the statement of profit or loss. The amount is material in the context of the reported profit for the year.

Assuming that the management refuse to change their approach, which ONE of the following modified audit reports should the auditor use?

A: Emphasis of matter

B: “Except for” qualification

C: Adverse opinion

D: Disclaimer of opinion

| CIMA F1 87

Learning outcome A1a Explain the need for the regulation of the financial reporting information of incorporated entities and the key elements of an ethical regulatory environment for such information

Importance

Ethics is more a guide to behaviour, principals instead of rules; ethics describes “how” an entity does its business

not what it does.

Sources of ethical guidance

IFAC Code of Ethics – governs audits carried out under ISAs.

CIMA Code of Ethics – to be followed by CIMAs, but is practically identical to the IFAC code.

Enforcement; Discipline members through a process of disciplinary hearings which can result in:

Fines

Suspension of membership

Withdrawal of membership

To ensure that CIMA members protect the good standing and reputation of the profession, members must inform

the institute if they are convicted or disqualified from acting as an officer of a company, or if they are subject to

any sanction resulting from disciplinary action taken by another professional body.

Conceptual Framework Approach

Identify

Evaluate

Mitigate / Address

Issues

Topic 9: Code of ethics

| CIMA F1 88

The Fundamental ethical principles for CIMA members are:

Principles

Objectivity Members should not allow bias, conflict of interest or

undue influence to over-ride professional or business

judgements

Professional Competence & Due Care Members have a continuing duty to maintain professional

knowledge and skills at a level required to ensure that a

client receives competent professional services.

Act in accordance with applicable technical and professional

standards when providing professional services.

Professional Behaviour Members should comply with relevant laws and regulations

and should avoid any action that discredits the profession.

Integrity Members should be straightforward and honest in all

professional and business relationships.

Confidentiality Members should not disclose information to third parties

without proper and specific authority unless there is a legal

or professional right or duty to disclose, and information

should not be used to personal advantage.

OPPIC

Conflicts of interest

Definition: Difficult situations to manage, with no obvious “correct” solution. If you are under pressure to do

something that you think is unethical, or against your principles.

CIMA members should be constantly conscious of, and be alert to factors which give rise to conflicts of interest.

Avoid conflicts of interest wherever possible.

| CIMA F1 89

General threats to objectivity

Self-interest threats – can occur as a result of your own or your close family interests, financial or

otherwise

Self-review threats – occur when you are required to evaluate your own previous work or judgement

Familiarity threats – can be present when you become so sympathetic to interests of others

Intimidation threats – occur when you are deterred from acting objectively by actual or perceived threats

Advocacy – threats occur when you are promoting or been seen to represent someone or something

| CIMA F1 90

Examples

Specific

threats

Why Safeguards/ recommendations / how do we mitigate

Not declaring

information

Lack of integrity, maybe a conflict

of interest if you report to the

individual not disclosing

Inform manager about concerns and if not addressed

the director or audit committee

Trainee has

lied about the

attempts of

exam papers.

Lack of integrity

Trainee disciplined through the formal disciplinary

channels

Depending on the severity the trainee could be

dismissed

Hospitality or

other benefits

Could be perceived as a bribe,

and we need to be seen to be

independent

Lose professional scepticism

Company should have a policy

Basic idea is that they should be modest

Should not accept, so politely decline the offer

Represent a

client in court

Being perceived as taking the

viewpoint of the client –

therefore losing professional

scepticism and integrity

Individual should resign from that appointment or not

accept the offer of representing them in court

Advised on the

systems that

should be in

place and then

reviewing the

effectiveness

of the systems

Self-review threat as if we as the

individual review our work and

we find an error we may hide

those errors to save face, or lose

professional scepticism.

Get someone else to do the work

| CIMA F1 91

General Safeguards

Safeguards

Professional, legal and

regulation

Work environment

Individual's actions

Education and training

Corporate governance

requirements

Disciplinary procedures

External reviews

Internal control systems

Recruit the right staff

Whistle blowing procedures

Disciplinary process

Leadership that drives ethical behaviour

Grievance procedures

Maintaining records of

contentious issues

Ethical conflict resolution

Seek legal advice

| CIMA F1 92

Ethical Conflict Resolution

Raise your concerns internally

Manager

Trusted colleague

Director

Board

Non-executive director

Audit committee

Internal whistle blowing procedure

If not being addressed seek advice externally

Auditors

Trade or industry regulator

Seek legal advice regarding confidentiality

Finally

Remove yourself from the situation

Team / client / refuse to be associated with a report

Resign

Check factsEscalate

internallyEscalate

externally

Refuse to remain

associated with the conflict

Document the issue

Seek professional or legal advice

| CIMA F1 93


Which ONE of the following is NOT a fundamental ethical principle identified in CIMA’s code of ethics?

A. Professional competence.

B. Professional behaviour.

C. Integrity.

D. Independence


Which ONE of the following is NOT a common threat identified in CIMA’s code of ethics?

A. Self interest

B. Bias

C. Self review

D. Familiarity


JT an employee, prepares monthly management accounting information for BBB which includes detailed

performance data that is used to calculate staff bonuses. Based on information prepared by JT this year’s

bonuses will be lower than expected.

JT has had approaches from other staff offering various incentives to make accruals for additional revenue and

other reversible adjustments, to enable all staff (including JT) to receive increased or higher bonuses.

Required:

Explain the requirements of the CIMA Code of Ethics for Professional Accountants in relation to the

preparation and reporting of information AND the ethical problems that JT faces.

| CIMA F1 94


CP, a professional accountant, is facing a dilemma. She is working on the preparation of a long term profit

forecast required by the local stock market listing regulations prior to a new issue of equity shares.

At a previous management board meeting, her projections had been criticised by board members as being too

pessimistic. She was asked to review her assumptions and increase the profit projections.

She revised her assumptions, but this had only marginally increased the forecast profits.

At yesterday’s management board meeting the board members had discussed her assumptions and specified

new values to be used to prepare a revised forecast. In her view the new values grossly overestimate the

forecast profits.

The management board intends to publish the final revised forecasts.

Required:

Explain the ethical problems that CP faces and identify her possible options. You should refer to CIMA’s Code

of ethics for professional accountants

| CIMA F1 95

Learning outcome A2a Discuss the need form and scope of corporate governance regulation

Learning outcome A2b Compare and contrast the approach to corporate governance in different markets.

The purpose of corporate governance is to control the board of a listed company to ensure that they act in the

best interests of that company.

“Corporate governance is the system by which companies are directed and controlled”

The separation of ownership and control

Systems of corporate governance

Principles based approaches

Rules based approaches

Topic 10: Corporate Governance

| CIMA F1 96

Principles of Corporate Governance

The UK Combined Code has issued principles in relation to

Leadership

Effectiveness

Accountability

Remuneration

Relations with Shareholders

Corporate Governance in action

| CIMA F1 97

Corporate

governance in action

Segregation of roles Committees Internal audit

Audit

Chairman CEO

Remuneration

Nomination

Risk

| CIMA F1 98

Features of governance codes

Leadership

Effective board responsible for the long-term success of the company

Chairman/CEO

Non-executive directors

Committees

Nomination

Remuneration

Effectiveness

Formal, rigorous, transparent appointments

Induction, CPD, board performance

Timely information

Retirement by rotation – re-election at regular intervals

Accountability and Audit

Balanced and understandable assessment of company’s current and future prospects

Sound system of control

Risk based approach

Independent external auditors

Audit committee

| CIMA F1 99

Directors remuneration

Sufficient to attract, retain and motivate, but not excessive

Significant proportion should be linked to performance

Align interest

No director should influence or set own salary

Unethical to pay poor performance

Relations with shareholders

Use of the AGM

| CIMA F1 100

Benefits of corporate governance

Reduces risk

Stimulates performance

Improves access to capital markets

Enhances the marketability of goods and services

Improves leadership

Demonstrates transparency and social accountability

Failures of corporate governance:

Domination by a single individual

Lack of board involvement

Ineffective internal control

Poor supervision

Lack of independent scrutiny

Poor communication with shareholders

Emphasis on short-term profitability

Misleading accounts

OECD Framework

The OECD consists of 34 countries who want a free market economy with one set of rules for corporate

governance.

6 Principles

1. Effective corporate governance framework

2. Shareholders right of ownership

3. Fair treatment for shareholders

4. Stakeholders role and rights

5. Disclosure and transparency

6. Responsibilities of the board

| CIMA F1 101

The US Sarbanes –Oxley Act 2002 (SOX)

In 2002, following a number of corporate governance scandals such as Enron and WorldCom, tough new

corporate governance regulations were introduced in the US by SOX.

SOX Key Points:

Auditor independence

Audit committee

Internal control report

Increased financial disclosures

US stock exchange regulations

| CIMA F1 102

Learning outcome: B1a - describe the main elements of financial statements prepared in accordance with IFRS

Learning outcome B2a – produce the primary financial statements from a trial balance for an individual entity

in accordance with IFRS

IAS 1 PRESENTATION OF FINANCIAL STATEMENTS

The objective of this Standard is to outline the basis for presentation of general purpose financial statements, to

ensure comparability both with the entity’s financial statements of previous periods and with the financial

statements of all other entities. IAS 1 sets out overall requirements for the presentation of financial statements,

guidelines for their structure and minimum requirements for their content.

A complete set of financial statements comprises:

a statement of financial position

a comprehensive income statement

a statement showing changes in equity

a statement of cash flows

notes for accounting policies and other explanatory notes.

IAS 1 provides the following formats within its Implementation Guidance for the first three statements. These are

shown below for a basic incorporated company only. The statement of cash flow will be considered later in the

chapter under IAS 7.

Fair presentation and compliance with IFRS’s

Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in

accordance with the definitions and recognition criteria set out in the Framework.

Topic 11: An introduction to published accounts

| CIMA F1 103

THE STATEMENT OF FINANCIAL POSITION

Statement of Financial Position as at 31 December 2008

ASSETS $ $

Non-current assets

Property, plant and equipment X

Goodwill X

Other intangible assets X

Available-for-sale investments X

––

X

Current assets

Inventories X

Trade receivables X

Other current assets X

Cash and cash equivalents X

––

X

––

Total assets X

––

EQUITY AND LIABILITIES

Capital and reserves

Share capital X

Other reserves X

Retained earnings X

––

X

––

Total equity X

Non-current liabilities

Long-term borrowings X

Long-term provisions X

––

X

Current liabilities

Trade and other payables X

Short-term borrowings X

Current portion of long term borrowings X

Current tax payable X

Short-term provisions X

––

X

––

Total equity and liabilities X

| CIMA F1 104

THE STATEMENT OF PROFIT OR LOSS

Two formats are provided by IAS 1 but we shall consider the most likely to be examined.

Classification of expenses by function

Statement of profit or loss for the year ended 31 December 2008

$

Revenue X

Cost of sales (X)

––

Gross profit X

Distribution costs (X)

Administrative expenses (X)

––

Profit from operations* X

Investment income

Finance costs (X)

––

Profit before tax X

Income tax expense (X)

––

Profit or loss for the period X

OTHER

* There is no requirement to show profit from operations in IAS1 but it is often beneficial for you to do so.

| CIMA F1 105

STATEMENT OF CHANGES IN EQUITY

The statement of changes in equity provides a comprehensive summary of all movements in the share capital and

reserves during the year.

Statement of Changes in Equity for the year ended 31 December 2008

Share

capital

Share

premium

Revln

reserve

Retained

earnings

Total

$ $ $ $ $

Balance at 31 December 2007 X X X X X

Changes in accounting policy (X)

(X)

–– –– –– –– ––

Restated balance X X X X X

Surplus on revaluation of properties X X

Deficit on revaluation of

investments

(X) (X)

–– –– –– –– ––

Net gains and losses not

recognised in the income

statement

X X

Net profit for the period X X

Dividends (X) (X)

Issue of share capital X X X

–– –– –– –– ––

Balance at 31 December 2008 X X X X X

NOTES TO THE FINANCIAL STATEMENTS

It is unlikely full sets of notes would be requested. It is more likely that specific notes would be requested. Many

disclosures are laid out in the standard itself e.g. IAS 16 property, plant & equipment.

| CIMA F1 106


Alexandra Ltd- trial balance as at 30 September 20X9

DR CR

$000 $000

Revenue 103,500

Inventories at 1October 20X8 5,460

Purchases 67,206

Distribution costs 8,000

Salespeople commission 2,920

Administrative salaries 2,280

Manufacturing wages 2,000

Finance costs 540

Administrative expenses 5,000

3% Debenture loans 18,000

Equity share capital 60,000

Retained earnings at 1st October 20X8 8,495

Cash 2,685

Dividends paid 2,820

Revaluation reserve @1st October 20X8 6,000

Trade Payables 5,861

Land and buildings –value/cost 92,578

Accumulated depreciation 25,000

Plant and equipment 35,000

Accumulated depreciation 15,313

Trade receivables 16,395

Accruals 715

242,884 242,884

Further Information (a) Inventories were valued at $7,850,000 on 30 September 20X9.

(b) Depreciation is to be provided for the year to 30 September 20X9 as follows:

Buildings 10% per annum straight line basis

Plant and Equipment 25% per annum reducing balance basis

Depreciation is to be apportioned as follows:

Cost of Sales 55%

| CIMA F1 107

Distribution costs 30%

Administrative expenses 15%

Land and buildings in the trial balance includes a value for land at $42,578. It is be be revalued at $61,000 and this revaluation is to be included in the financial statements for 30 September 20X9.

(c) An irrecoverable debt of $21,000 which is included in trade receivables is to be written off.

(d) Administrative expenses of $85,000 owing at 30 September 20X9 are to be provided for.

(e) The company’s tax charge for the year has been estimated as $1,500,000.

Required:

Prepare a statement of profit or loss and a statement of changes in equity for Alexandra Ltd for the year ended 30 September 20X9 and also a statement of financial position as at that date.

They must comply with IAS 1 – Presentation of financial statements.

| CIMA F1 108

IAS 7 STATEMENT OF CASH FLOWS

The statement of cash flow is a primary statement that will be produced by a company alongside the statement of profit or loss, statement of financial position and statement of changes in equity.

Definitions:

Cash

Cash on hand and demand deposits

Cash equivalents

Short term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value

Statement of cash flows

Inflows and outflows of cash and cash equivalents

HEADINGS OF THE STATEMENT OF CASH FLOWS

Operating activities

The principal revenue producing activities of the entity and other activities that are not investing or financing activities.

Investing activities

The acquisition and disposal of long term assets and other investments not included in cash equivalents.

Financing activities

Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity

Some examples of what would be included under these headings are shown in the pro forma. This pro forma follows the indirect method approach. The direct method approach is considered later.

Topic 12: The Statement of cash flows

| CIMA F1 109

Statement of cash flows for the year ended 31 December 2008

$ $

Cash flows from operating activities

Net profit before tax X Adjustments for: Interest expense X Investment income (X) Depreciation X Amortisation X Impairment X Increase/Decrease in provisions X/(X) Profit/loss on disposal (X)/X ––––

Operating profit before working capital changes X Increase in trade receivables (X) Increase in inventories (X) Increase in trade payables X ––––

Cash generated from operations X Interest paid (X) Income taxes paid (X) ––––

Net cash from operating activities X

Cash flows from investing activities

Purchases of property, plant and equipment (X) Proceeds of sale of property, plant and equipment X Purchase of intangibles (X) Purchase of investments (X) Interest received X Investment income received X

––––

Net cash used in investing activities (X)

| CIMA F1 110

Cash flows from financing activities

Proceeds from issue of shares X Proceeds from issue of debt X Redemption of debt (X) Dividends paid (X) ––––

Net cash used in financing activities (X)

Net increase in cash and cash equivalents X Cash and cash equivalents at beginning of period X –––

Cash and cash equivalents at end of period X –––

| CIMA F1 111

DIRECT AND INDIRECT METHOD

IAS 7 allows the statement of cash flows to be prepared using either of the two methods below. It is important to

note that both methods should give the same overall outcome.

Direct method Indirect method $000 $000 Cash received from customers X Profit before taxation X Cash payments to suppliers and employees

X Depreciation X

Investment income (X) Interest expense X Increase in inventories (X) Increase in receivables (X)

_____ Increase in payables

X _____

Cash flow from operating activities SAME _____

Cash flow from operating activities SAME _____

| CIMA F1 112


The financial statements of Moma at 31 August 2008 and 2009 are given below:

Statement of profit or loss for the year ended 31 August 2009

$’000

Revenue 10,050

Cost of sales (6,040)

Gross profit 4,010

Operating expenses (2,300)

Profit from operations 1,710

Finance costs (150)

Profit from operations before tax 1,560

Income tax expense (500)

Profit from operations after tax 1,060

Continued over page

| CIMA F1 113

Statement of Financial Position

Note 31.8.2008 31.8.2009

$000 $000 $000 $000

Non-current assets 1 6,400 8,500

Current assets

Inventories 1,200 1,400

Trade receivables 1,500 1,400

Cash at bank 200 300

2,900 3,100

9,300 11,600

Capital and reserves

Called up share capital 2,000 2,200

Share premium account 2,340 2,540

Revaluation reserve

Retained earnings

–

2,400

1,000

2,960

Non-current liabilities

Loan notes

Current Liabilities

3

6,740

800

8,700

1,000

Trade payables 800 700

Taxation 600 1,000

Bank overdraft 360 200

1,760

9,300

1,900

11,600

Continued over page

| CIMA F1 114

Notes 1. Movements in non-current assets:

LAND BUILDINGS PLANT AND

EQUIPMENT

TOTAL

$000 $000 $000 $000

Cost or valuation

At 1 September 2008 2,000 3,000 3,400 8,400

Additions 2,500 2,500

Disposals (1,000) (1,000)

Revaluation 1,000 1,000

____

____

____

____

At 31 August 2009 3,000 3,000 4,900 10,900

____

____

____

____

ACCUMULATED DEPRECIATION

At 1 September 2008 400

1,600

2,000

Charge for year 60

1,140

1,200

Disposals (800) (800)

____

____

____

At 31 August 2009 460 1,940 2,400

____

____

____

Net book value 3,000

2,540 2,960 8,500

At 31 August 2009 ____ ____

____

____

At 1 September 2008 2,000

2,600

1,800

6,400

2. Dividends paid during the year amounted to $500,000. 3. Issue of loan notes – a further $500,000 of 10% loan notes was issued at par on 1 September 2008.

Interest on all loan notes is paid on 28 February and 31 August each year. 4. Plant sold during the year realised $250,000.

Required:

Prepare a statement of cash flows for Moma for the year ended 31 August 2009, complying as far as possible with IAS 7, using the indirect method.

| CIMA F1 115


The following is an extract from the statement of financial position of KJB at 31 July 20X7 and 20X8

20X8 20X7

$000 $000

Receivables 14,500 17,800

Inventory 28,700 26,300

Payables 19,900 20,100

What is the net effect on the calculation of cash generated from operations?

A. Positive $700,000

B. Negative $700,000

C. Positive $1,100,000

D. Negative $1,100,000


Extracts from the statement of financial position for honeycomb at 30 June 20X8 and 20X9

$ $

Net book value 435,000 405,000

Revaluation reserve 89,000 64,000

An asset was disposed of in the year, raising proceeds of $12,000. The asset had originally cost $40,000 and

made a profit on disposal of $2,000.

Accumulated depreciation at the start of the year was $110,000 and at 30 June 20X8 was $125,000.

What was the amount of cash paid to acquire new PPE for the year ending 30 June 20X8?

A. $45,000

B. $60,000

C. $85,000

D. $105,000

| CIMA F1 116

Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of

accounting for non-current assets.

IAS 16 Property, plant and equipment

Tangible assets that:

Are held by an entity for use in the production or supply of goods and services, for rental to others, or for

administrative purposes; and

Are expected to be used during more than one period

Cost

Fair value

Carrying amount

DEBIT Non-current asset – cost $X

CREDIT Cash (or payable, if a credit transaction) $X

Purchase price, including any import duties paid, but excluding any trade discount and sales tax paid

Initial estimate of costs of dismantling and removing the item and restoring the site on which it is located

Directly attributable costs of bringing the asset to working condition for its intended use, e.g.:

The cost of site preparation, e.g. levelling the floor of the factory so that the machine can be installed

Initial delivery and handling costs

Installation and assembly costs

Professional fees (lawyers, architects, engineers)

Cost of testing whether the asset is working properly, after deducting the net proceeds from selling

samples produced when testing equipment

Only staff costs arising directly from the construction or acquisition of the asset can be capitalised.

Topic 13: Non current assets – Property, plant and

equipment

| CIMA F1 117

Subsequent expenditure

Improves

Modification

Upgrade

Adoption of a new production process

| CIMA F1 118

Depreciation accounting

Method must be found of spreading the cost of the asset over its useful life

Depreciation is the allocation of the depreciable amount of an asset over its estimated useful life. Depreciation

for the accounting period is charged to net profit or loss for the period either directly, or indirectly

Useful life

Useful life is either:

The period which a depreciable asset is expected to be used by the enterprise; or

The number of production or similar units expected to be obtained from the asset by the enterprise

Should be reviewed at least annually

The assessment of useful life requires judgement

The residual value is the net amount which the entity expects to obtain for an assets at the end of its useful life

after deducting the expected costs of disposal

| CIMA F1 119

Depreciation methods

Depreciation is a means of spreading the cost of a non-current asset over its useful life, in order to match the cost

of the asset with the profits it earns for the business

The straight line method

The annual depreciation charge is calculated as: Cost of asset – residual value

Expected useful life of asset

The straight line method is a fair allocation of the total depreciable amount between the different accounting

periods provided that it is reasonable to assume that the business enjoys equal benefits from the use of an asset

in every period throughout its life.

A non-current asset costing $20,000 with an estimated life of 10 years and no residual value would be

depreciated at the rate of:

$20,000 = $2,000 per annum

10 years

A non-current asset costing $60,000 has an estimated life of 5 years and a residual value of $7,000. The

annual depreciation charge using the straight line method would be:

$(60,000 – 7,000) = $10,600 per annum

5 years

| CIMA F1 120

The reducing balance method

The reduced balance method of depreciation calculates the annual depreciation charge as a fixed percentage of

the carrying amount of the asset, as at the end of the previous accounting period.

A non-current asset costing $10,000 with an estimated life of 10 years and an estimated residual value of

$2,160. The business uses the reducing balance method to depreciate the asset, and calculates that the

rate of depreciation should be 40% of the reducing (carrying) amount of the asset.

| CIMA F1 121

Change in method of depreciation

Depreciation should be applied consistently from year to year


Genius Co purchased an asset for $100,000 on 1.1.x1. It had an estimated useful life of 5 years and it was

depreciated using the reduced balance method at a rate of 40%. On 1.1.x3 it was decided to change the

method to straight line.

Required

Show the depreciation charge for each year (to 31 December) of the asset’s life.

| CIMA F1 122

Change in expected useful life or residual value of an asset

The depreciation charge on a non-current asset depends not only on the cost (or value) of the asset and its

estimated residual value, but also on its estimated useful life.

Carrying amount at time of life readjustment – residual value

New estimate of remaining useful life


A business purchased a non-current asset costing $12,000 with an estimated life of 4 years and no residual

value. The business uses the straight line method to depreciate the asset.

After two years the business decides the useful life of the asset has been underestimated and it still has five more years in use to come (making its total life 7 years).

NEED TO LEARN

New depreciation = Carrying amount – residual value

Revised useful life of asset

DEBIT Depreciation expense (income statement)

CREDIT Accumulated depreciation account (statement of financial position)

With the depreciation charge for the period

| CIMA F1 123

Revaluation of non-current assets

IAS 16 allows entities to revalue non-current assets to fair value

When a non-curent asset is revalued, depreciation is charged on the revalued amount

IAS 16 requires that when an item of property, plant and equipment is revalued, the whole class of assets to

which it belongs should be revalued.


Andrew Inc, which makes up its accounts to 31 December each year, buys an asset on 1 January 20X1 for $10,000. The asset has an estimated useful economic life of ten years with no residual value. Therefore, straight-line depreciation will be $1,000 pa and, on 31 December 20X2, the asset will be included in the statement of financial position* as follows:

$

Non-current assets at cost 10,000

Accumulated depreciation (2,000)

8,000

On 1st January 20X3, Andrew revalues the asset to $16,000. The total useful economic life remains at ten years

from 1st January 20X1.

Required:

A. Show the journal to record the revaluation.

B. Show the journal to record the revised depreciation charge and reserves transfer.

| CIMA F1 124

Revaluation downwards

If after a year it becomes clear that Andrews asset is now overvalued , it will need to be revalued downwards

DR Revaluation Surplus (revaluation reserve)

CR Asset account

Non-current asset disposal

When a non-current asset is sold, there is likely to be a profit or loss on disposal. This is the difference between

the net sale price of the asset and its carrying amount at the time of disposal.


A business purchased a non-current asset on 1 January 20X1 for $25,000 with an estimated life of 6 years and

an estimated residual value of $17,000. The business uses the straight line method to depreciate the asset.

After three years the asset was eventually sold to another trader who paid $17,500 for it.

| CIMA F1 125

Non-current asset disposal – Disposal of a revalued asset

Apply Your Knowledge 5: Andrew, revisited

Andrew Inc, which makes up its accounts to 31 December each year, buys an asset on 1 January 20X1 for

$10,000. The asset has an estimated useful economic life of ten years with no residual value. Therefore,

straight-line depreciation will be $1,000 pa and, on 31 December 20X2, the asset will be included in the

statement of financial position* as follows:

$

Non-current assets at cost 10,000

Accumulated depreciation (2,000)

8,000

On 1st January 20X3, Andrew revalues the asset to $16,000. The total useful economic life remains at ten years

from 1st January 20X1.

Required:

Andrew sells the asset on 1 January 20X4 for $15,000. Show how the disposal is recorded.

| CIMA F1 126

Disclosure note

IAS 16 requires a reconciliation of the opening and closing carrying amounts of non-current assets to be given

in the financial statements.

The main disclosure required for property, plant and equipment is shown below:

Land and buildings

$’000

Plant

$’000

Motor Vehicles

$’000

Total

$’000

Cost or valuation: At (b.fwd date) X X X X Additions 1 X X X X Disposals (X) (X) (X) (X) Revaluation 1 X X X X –––– –––– –––– –––– At (c/fwd date) X X X X –––– –––– –––– –––– Accumulated depreciation: At (b/fwd date) X X X X Charge for year 11 X X X X Disposal (X) (X) (X) (X) Revaluation 1 (X) (X) (X) (X) –––– –––– –––– –––– At (c/fwd date) X X X X –––– –––– –––– –––– Carrying value (b/fwd date) X X X X –––– –––– –––– –––– Carrying value (c/fwd date) X X X X –––– –––– –––– ––––

| CIMA F1 127


Which of the following items should be capitalised within the initial carrying amount of an item of plant?

i. Cost of transporting the plant to the factory

ii. Cost of installing a new power supply required to operate the plant

iii. A deduction to reflect the estimated realisable value

iv. Cost of a three-year maintenance agreement

v. Cost of a three-week training course for staff to operate the plant

A. (i) and (ii) only

B. (i), (ii) and (iii)

C. (ii), (iii) and (iv)

D. (i), (iv) and (v)


Lucas has an accounting year end of 31 January 20X7. Property costing $100,000 and a useful life of 20 years

was purchased on 1 February 20X2. The property was revalued to its market value of $120,000 on 31 January

20X6 with no changes to its remaining useful economic life.

If Lucas elects to make the annual transfer for excess depreciation to retained earnings what amounts should

be shown in the financial statements at 31 January 20X7?

Property, plant and equipment Revaluation reserve

$ $

A 112,000 45,000

B 114,000 44,000

C 120,000 45,000

D 112,000 42,000

| CIMA F1 128


Pompidou incurred the following expenditure on improving and maintaining its property plant and equipment

in the year.

$

Expenditure to increase the operating capacity of its machinery 250,000

Expenditure to redecorate the reception area of its building 20,000

Expenditure to extend the warehouse to increase storage capacity 145,000

Expenditure to repair the roof of a warehouse caused by storm damage 55,000

What total amount can be capitalised as part of subsequent expenditure in the year on property, plant and

equipment?

A. $75,000

B. $215,000

C. $395,000

D. $415,000

| CIMA F1 129

IAS 23 BORROWING COSTS

Definitions:

Borrowing cost

Interest and other costs incurred by an entity in connection with the borrowing of funds.

Qualifying asset

An asset that necessarily takes a substantial period of time to get ready for its intended use or sale

Accounting:

Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset

shall be capitalised as part of the cost of that asset.

Amount to be capitalised

The borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset are

those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been

made.

Specific Borrowings:

To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the amount of

borrowing costs eligible for capitalisation on that are the actual borrowing costs incurred less any investment

income on the temporary investment of those borrowings.

Commencement,

Capitalisation commences when;

Expenditures for the asset are being incurred;

Borrowing costs are being incurred; and

Activities that are necessary to prepare the asset for its intended use or sale are in progress

Suspension

Suspension of capitalisation of borrowing costs shall occur during extended periods in which active development

is interrupted.

| CIMA F1 130

Cessation

Capitalisation of borrowing costs shall cease when substantially all the activities necessary to prepare the

qualifying asset for its use or sale are complete.


Wooden constructed a golf course at a cost of $200 million over eight months from 1 January to 31 August. In

order to finance the project Wooden took out a $160 million 10% loan on 1 January. The loan was repaid on 31

December. The golf course did not open until the following year.

Required:

Calculate the initial cost of the golf course.

| CIMA F1 131



An identifiable non-monetary asset without physical substance.

Accounting treatment

Capitalise and amortise over useful economic life

Cost- residual value

Estimated useful economic life

Amorisation?

To Amortise literally means ‘to spread’ , so amortisation is exactly the same as depreciation, but by

convention we depreciated tangibles and amortise intangibles

Intangible non-current assets

| CIMA F1 132

IAS 38 Intangible assets

Initial recognition of an intangible asset

An intangible asset is recognised if, and only if;

It is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and

The cost of the asset can be measured reliably

An intangible asset shall be measured initially at cost.

DEBIT Non-current asset (intangible) – cost $X


Purchase price,

import duties and

non-refundable purchase taxes less any trade discounts

Any directly attributable costs of preparing the asset for its intended use e.g. professional fees, testing,

costs of employee benefits arising directly from bringing the asset to its working condition

Internal expenditure – internally generated intangibles

Internally generated goodwill shall not be recognised.

Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance should not

be recognised as intangible assets.

| CIMA F1 133

Research and Development costs

IAS 38 All costs incurred in research are written off directly to the statement of profit or

loss.

DEBIT Income statement – research cost $X


An intangible asset arising from development shall be recognised if, and only if, an entity can demonstrate ALL of

the following:

The technical feasibility of completing the intangible asset so that it will be available for use or sale.

Its intention to complete the intangible asset and use or sell it.

Its ability to use or sell the intangible asset.

How the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.

The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.

Its ability to measure reliably the expenditure attributable to the intangible asset during its development.

DEBIT Non-current asset (intangible- development asset $X


| CIMA F1 134

Method must be found of spreading the cost of the asset over its useful life

If an intangible has a finite life then it should be amortised on a systematic basis over its useful economic life.

Residual value is normally assumed to be zero unless there is a commitment from a buyer to purchase at the end

of its useful life or an active market exists.

Amortisation begins when the asset is available for use.

An intangible could be considered to have an indefinite useful life if there is no foreseeable limit to the period

over which the asset is expected to generate net cash flows for the entity. An intangible asset with an indefinite

useful life shall not be amortised. It will need to be tested for impairment every year

If no active market exists the intangible must be carried at cost less any accumulated amortisation and impairment

losses.


Proudfoot Co is a pharmaceutical company and has incurred development expenditure of $500,000 and

research expenditure of $400.000 in the year ended 31 December 20X1. The development expenditure has

been capitalised in accordance with IAS 38. The asset developed is now available for use. Proudfoot Co have a

policy of amortising capitalised development expenditure over 25 years.

What balances related to research and development would appear in the financial statements of Proudfoot

for the year ended 31 December 20X1?

SOFP Statement of P/L

A $900,000 $nil

B $500,000 $400,000

C $864,000 $436,000

D $480,000 $420,000

| CIMA F1 135

Revaluation of an Intangible asset

Intangible assets may be revalued to their fair value. The fair value should be determined by an active market.

An active market exists where all of the following conditions are met:

items traded in the market are homogenous

willing buyers and sellers can be found at any time

prices are available to the public.

IAS 38 states it is ‘uncommon’ for an active market to exist for intangible assets.

IAS 38 requires the following disclosure requirements:

For each class of intangible assets:

The useful lives or amortisation rates used.

The amortisation methods used.

The gross carrying amount and accumulated amortisation at the beginning and end of the period.

The amount of amortisation charged for the period to the statement of profit or loss.

A reconciliation between the beginning and end of the year balances, i.e. additions, disposals, changes

due to impairments or revaluations, amortisation during the period.

| CIMA F1 136

The intangible note (IAS 38) shows the movements in the year for each category of asset.

Development Patents Trademarks Total

$000 $000 $000 $000

Cost

At 1 January 20X4 X X X X

Additions X X X X

Disposals (X) (X) (X) (X)

–– –– –– ––

At 31 December 20X4 X X X X

–– –– –– ––

Accumulated amortisation/impairment:


Charged during the year X X X X

Disposals (X) (X) (X) (X)

–– –– –– ––


–– –– –– ––

Carrying amount


–– –– –– ––


–– –– –– ––

| CIMA F1 137


Dempsey’s year end is 30 September 2014. Dempsey commenced the development stage of a project to

produce a new pharmaceutical drug on 1 January 2014. Expenditure of $40,000 per month was incurred until

the project was completed on 30 June 2014 when the drug went into immediate production. The directors

became confident of the project’s success on 1 March 2014. The drug has an estimated life span of five years;

time apportionment is used by Dempsey where applicable.

What amount will Dempsey charge to profit or loss for development costs, including any amortisation, for the

year ended 30 September 2014?

A. $12,000

B. $98,667

C. $48,000

D. $88,000


Which of the following items below can be classified as intangible assets according to IAS 38 Intangible assets?

i. market knowledge e.g. customer lists, relationship and loyalty

ii. scientific/technical knowledge

iii. investment properties

iv. licenses and quotas

v. plant and equipment

A. i, ii and iii

B. i, ii and v

C. ii, iii and iv

D. i, ii and iv

| CIMA F1 138


A whisky distiller incurs the following costs: $38,000 developing new distilling techniques that will be put in

place shortly to cut the production cost of making malt whisky; $27,000 researching a new process to improve

the quality of standard whisky and $8,000 on market research into the commercial viability of a new type of

malt whisky. It is company policy to capitalise costs whenever permitted by IAS 38.

How much should be charged as research and development expenditure in profit or loss ? (ignore

amortisation)

A. $73,000

B. $35,000

C. $27,000

D. $38,000

| CIMA F1 139


accounting for impairments.

THE KEY RULE

An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.

Recoverable amount

Is the Higher is

Fair value less costs to sell Value in use

(present value of future

cash flows arising from

use and disposal of

asset)

WHEN TO TEST FOR IMPAIRMENT

The following situations may indicate that an asset has been impaired:

decline in market value

technological, legal or economic changes

physical damage

plans to dispose of asset.

IAS 36: Impairment Testing

| CIMA F1 140


Mary Inc is a manufacturer of cardboard boxes. However a change in the market means that the inventory

produced by the machine that makes small gift boxes is being sold below its cost. Due to this impairment

circumstance an impairment test needs to be carried out.

The following information is relevant:

The carrying value of the productive machinery at depreciated historical cost is $290,000 and its net selling price

is estimated at $120,000. The anticipated net cash inflows from the machines are now $100,000 per annum for

the next three years. The current cost of capital is 10%. An annuity factor for this rate over this period is 2.487

Required:

Advise the directors of Mary on how to treat the above item in the financial statements

| CIMA F1 141

Impairment of a previously revalued assets


Lock holds a non-current asset, which was purchased for $10 million on 1 December 2006 with an expected

useful life of 10 years. On 1 December 2008, it was revalued to $8· 8 million. At 30 November 2009, the asset

was reviewed for impairment and written down to its recoverable amount of $5·5 million.

Required:

Advise the directors of Lock on how to treat the above items in the financial statements for the year ended 3o

November 2009.

| CIMA F1 142

THE CASH GENERATING UNIT


Path owns a company called Taylor. Extracts from Path’s Statement of Financial Position relating to Taylor:

$000

Goodwill 160,000

Franchise costs 100,000

Restored furniture (at cost) 180,000

Buildings 200,000

Other net assets 100,000

–––––––

740,000

–––––––

The restored furniture has an estimated realisable value of $230 million. The franchise agreement contains a ‘sell back’ clause, which allows Taylor to relinquish the franchise and gain a repayment of $60 million from the franchisor. An impairment review at 31 March 2013 has estimated that the value of Taylor as a going concern is only $480 million. Required: Show how the impairment would be dealt with.

Disclosures

IAS 36 requires the following disclosure requirements:

For each class of property, plant and equipment:

The amount of impairment losses recognised in the statement of profit or loss during the period and

where it has been included, i.e. which expense category.

The amount of reversals for impairment losses recognised in the statement of profit or loss during the

period and where it has been included.

The amount of impairment losses recognised directly in equity during the period.

The amount of reversals of impairment losses recognised directly in equity during the period.

| CIMA F1 143


The net assets of Fyngle, a cash generating unit (CGU), are:

$

Property, plant and equipment 200,000

Allocated goodwill 50,000

Product patent 20,000

Net current assets (at net realisable value) 30,000

––––––––

300,000

––––––––

As a result of adverse publicity, Fyngle has a recoverable amount of only $200,000.

What would be the value of Fyngle’s property, plant and equipment after the allocation of the impairment loss?

A. $154,545

B. $170,000

C. $160,000

D. $133,333


Riley acquired a non-current asset on 1 October 2009 at a cost of $100,000 which had a useful economic life of

ten years and a nil residual value. The asset had been correctly depreciated up to 30 September 2014. At that date

the asset was damaged and an impairment review was performed. On 30 September 2014, the fair value of the

asset less costs to sell was $30,000 and the expected future cash flows were $8,500 per annum for the next five

years. The current cost of capital is 10% and a five year annuity of $1 per annum at 10% would have a present

value of $3.79

What amount would be charged to profit or loss for the impairment of this asset for the year ended 30 September

2014?

A. $17,785

B. $20,000

C. $30,000

D. $32,215

| CIMA F1 144


Which of the following is NOT an indicator of impairment?

A. Advances in the technological environment in which an asset is employed have an adverse impact on its

future use

B. An increase in interest rates which increases the discount rate an entity uses

C. The carrying amount of an entity’s net assets is higher than the entity’s number of shares in issue

multiplied by its share price

D. The estimated net realisable value of inventory has been reduced due to fire damage although this value

is greater than its carrying amount

| CIMA F1 145

Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of reporting

of performance.

IFRS 5 NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS The objective of IFRS 5 is to specify the accounting for assets held for sale and the presentation and disclosure of discontinued operations.

Assets held for sale

An asset is classified as held for sale if its carrying amount will be recovered principally through a sale transaction

rather than through continuing use.

For this to be the case the asset must be available for immediate sale and its sale highly probable i.e.:

Management commitment to the sale

Available for immediate sale in its present condition

Actively marketed

Sale is highly probable- i.e offered at a reasonable price

Sale must be expected to complete with one year

Accounting

The non-current asset should be held at the lower of its carrying value and fair value less costs to sell. The asset or

group of assets are removed from Non-current assets in the statement of financial position and moved into the

current assets section as a Non-current asset held for sale:

Statement of financial position as at xx/xx/xxx

$000 $000

Current Assets

Inventory xx

Trade receivables xx

Cash and cash equivalents xx

xx

Non-current asset held for sale xx

Total Assets xx

Topic 14: Non- current assets held for sale and

discontinued operations

| CIMA F1 146

An asset classified as held for sale will not be depreciated.

Discontinued operation

A component of an entity that either has been disposed of or is classified as held for sale and;

Represents a separate major line of business or geographical area of operations,

Is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations

Is a subsidiary acquired exclusively with a view to resale.

If it needs to be adjusted to comply with the measurement rule of lower of its carrying value and fair value less

costs to sell this is treated as an impairment loss and it will need to be expensed via profit in the normal way (but

the presentation is radically different) :

Proforma statement of profit or loss presentation

$ Continuing operations Revenue x Cost of sales (x) ____

Gross profit x Distribution costs (x) Administration expenses (x) ____

Operating profit x Finance costs (x) ____

Profit before tax x Income tax expenses (x) ____

Profit for the period from continuing operations x

Discontinued operations Profit for the period from discontinued operations*

x

____

Total profit for the period x

* detail given in the notes

| CIMA F1 147

Presentation in the statement of profit or loss

An enterprise must disclose a single amount on the face of the statement of profit or loss, comprising the total of:

The post-tax profit or loss of discontinued operations; and

The post-tax gain or loss recognised on the measurement to fair value less costs to sell, or on the disposal, of the assets constituting the discontinued operation.


On 1 January 2007 Rolf introduced a new production line at a cost of $500,000. It has an expected useful life of

10 years but will realise nothing on final disposal. On 31 December 2008, after just two years of using the asset,

it was decided to upgrade again so the production must be sold.

A plan was put in place and instructions given to locate a buyer. The plant is in great demand so Rolf is confident

that the machine will be sold quickly. Its current market value is $300,000. As the production line is a

considerable size dismantling costs to make it available for sale will be incurred at $10,000.

Required:

Show how the asset should be presented in the statement of financial position for the year ended 31 December

2008.

| CIMA F1 148

IFRS 5 and published accounts questions

IFRS 5 will be frequently examined in published accounts questions. These can be the trickiest of the published

accounts questions


As at 30 September 2013 Dune’s property in its statement of financial position was:

Property at cost (useful life 15 years) $45 million

Accumulated depreciation $6 million

On 1 April 2014, Dune decided to sell the property. The property is being marketed by a property agent at a price

of $42 million, which was considered a reasonably achievable price at that date. The expected costs to sell have

been agreed at $1 million. Recent market transactions suggest that actual selling prices achieved for this type of

property in the current market conditions are 10% less than the price at which they are marketed.

At 30 September 2014 the property has not been sold.

At what amount should the property be reported in Dune’s statement of financial position as at 30 September

2014?

A. $36 million

B. $37·5 million

C. $36·8 million

D. $42 million

| CIMA F1 149


GZ is a small mining entity, which operated a single gold mine for many years. The gold mine ceased operations on 31 October 20X7 and was closed on 1 January 20X8.

On 1 November 20X7, GZ commenced operating a new silver mine.

The trial balance for GZ at 31 October 20X8 was as follows:

$000 $000 4% Loan notes (redeemable 1 April 20X9) 1,900 Administrative expenses 1,131 FVTOCI investments at market value 31 October 20X7 2,177 Cash and cash equivalents 2,025 Direct operating expenses (excluding depreciation) 6,253 Distribution costs 879 Dividend paid 1 March 20X8 550 Equity shares $1 each, fully paid 5,900 Government operating licence, silver mine at cost (see note (ii)) 100 Income tax 13 Interest paid on loan notes – half year to 30 April 20X8 38 Inventory at 31 October 20X8 2,410 Investment income received 218 Mine properties at cost (see note (iv)) 6,719 Plant acquired during the year 900 Plant and equipment at 31 October 20X7 3,025 Provision for depreciation at 31 October 20X7: Mine properties (see note (iv)) 2,123 Plant and equipment 370 Receipt from sale of plant (see note (iii)) 2 Retained earnings at 31 October 20X7 4,491 Revaluation reserve at 31 October 20X7 80 Revenue 9,600 Suspense account (see note (xii)) 1,820 Trade payables 2,431

Additional information provided:

i. Each mine requires a government operating licence for 20 years and is expected to be productive for that time. After 20 years, the mine will be closed and decommissioned.

ii. On 1 November 20X7, GZ received a government operating licence to operate the new silver mine. The licence cost $100,000 and is for 20 years. Included in the licence is a condition that, on closure of the mine, all above-ground structures must be removed and the ground landscaped. GZ has estimated this cost and discounted it to a present value of $3,230,000 at 31 October 20X8. The trial balance excludes this decommissioning provision.

iii. GZ sold old plant and equipment from the gold mine for $2,000 (original cost $200,000, net book value $5,000). The gold mine property is now surplus to GZ’s requirements. At 31 October 20X8, the gold mine property had a market value of $520,000 with estimated selling and legal costs of $27,000.

iv. (The mine property balances in the trial balance comprised:

| CIMA F1 150

Mine property Gold Mine Silver Mine Total

$000 $000 $000

Cost 2,623 4,096 6,719

Provision for depreciation 2,123 0 2,123

––––– ––––– –––––

500 4,096 4,596

v. The market value of the available for sale investments at 31 October 20X8 was $2,311,000. vi. There were no sales or purchases of available for sale investments during the year ended 31 October

20X8 and no acquisitions of other non-current assets, except for those in note (ix) below. vii. Income tax due for the year ended 31 October 20X8 is estimated at $375,000.

viii. Depreciation is charged on mining property using the straight-line basis at 5% per annum. Plant and equipment is depreciated using the reducing balance method at 25%. The depreciation policy is to charge a full year’s depreciation in the year of acquisition and no depreciation in the year of disposal. Depreciation is regarded as a cost of production.

ix. The 4% loan notes are ten-year loans due for repayment 1 April 20X9. GZ incurred no other interest charges in the year to 31 October 20X8.

x. The final dividend for the year to 31 October 20X7 was paid on 1 March 20X8. xi. GZ made a new issue of 1,400 equity shares on 31 October 20X8 at a premium of 30%. The cash

received was debited to the bank account and credited to the suspense account.

Required:

(a) Prepare GZ’s Property, Plant and Equipment note to the financial statements for the year to 31 October 20X8.

(b) Prepare GZ’s Statement of profit or loss and other comprehensive income and a statement of changes in equity for the year to 31 October 20X8 and a statement of financial position at that date, in a form suitable for presentation to the shareholders and in accordance with the requirements of International Financial Reporting Standards. (All workings should be to the nearest $000).

Notes to the financial statements, except as indicated in part (a) above, are NOT required, but all workings must be clearly shown. Do NOT prepare a statement of accounting policies.

| CIMA F1 151


accounting for government grants.

IAS 20 ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF GOVERNMENT

ASSISTANCE

Definitions:

Government

Government, government agencies and similar bodies whether local, national or international

Government grants

Assistance by government in the form of transfers of resources to an entity in return for past or future

compliance with certain conditions relating to the operating activities of the entity.

Government assistance

Action by government designed to provide an economic benefit specific to an entity or range of entities qualifying

under certain criteria. Government assistance for the purpose of this standard does not include benefits provided

only indirectly through action affecting general trading conditions.

General principles

IAS 20 follows two general principles when determining the treatment of grants:

Prudence: grants should not be recognised until the conditions for receipt have been complied with and there is

reasonable assurance the grant will be received.

Accruals: grants should be matched with the expenditure towards which they were intended to contribute.

Recognition – general principles

A grant should not be recognised until there is reasonable assurance that:

a) The entity will comply with the conditions attaching to them; and

b) The grants will be received

Topic 15: IAS 20 government grants and IAS 40

investment properties

| CIMA F1 152

Capital grants- accounting

Statement of financial position

Two methods of presentation in the financial statements of capital grants;

a) Set up the grant as deferred income and recognise income on a systematic basis over the useful life of the

asset

b) Deduct the grant from the cost of the asset and recognise as part of the depreciation charge

Revenue grants- accounting

Statement of profit or loss

Government grants shall be recognised as income over the periods necessary to match them with the related

costs which they are intended to compensate, on a systematic basis.

Two presentation approaches are acceptable:

Present as a credit in the statement of profit or loss

Present as a deduction from the related expense

| CIMA F1 153


Star buys an item of plant for a total cost of $200,000. They applied for a government grant and, having

complied with all relevant conditions, have just received $20,000 towards the cost of the plant.

The useful economic life of the plant is estimated at ten years.

Required:

Prepare extracts from the statement of profit or loss and statement of financial position if Star adopts;

A. deferred income approach B. off-set grant against asset approach


Gloria received a government grant towards purchasing a new building. The building has a useful life of 25

years and had a total cost of $250,000 on 1 July 20X5 and Gloria received a grant of $100,000on the same date.

Assuming Gloria uses the deferred income method for government grants, what is the total impact on the

statement of profit or loss for the year ended 30 June 20X6 and what is the value of the non-current asset as at

30 June 20X6?

A. SPL $6,000 expenses, Asset value $240,000

B. SPL $6,000 expenses, Asset value $144,000

C. SPL $10,000 expense, Asset Value $240,000

D. SPL $10,000 expenses, Asset value $144,000


Manny received a government grant of $10,000 for the purchase of a new property costing $80,000 on 1 April

20X5. The asset has a life of 10 years and Manny adopts the deferred income method permitted in IAS 20

Government Grants.

What amounts would appear in the statement of financial position as at 31 March 20X6?

Deferred income Current liability Deferred income non current liability

A $1,000 $9,000

B $1,000 $8,000

C $700 $6,300

D $700 $5,600

| CIMA F1 154


Phil received a government grant of $4,500 against the purchase of a piece of equipment costing $30,000 on 1

July 20X4. The assets has a useful life of 6 years and Phil adopts the deferred income method permitted in IAS

20 Government grants.

What amounts will appear in the statement of cash flow for the year ended 30 June 20X5?

Operating activities- Investing activities-

Amortisation of government grant Grant income received

A $500 $4,500

B $750 $4,500

C $500 $nil

D $750 $nil

| CIMA F1 155



Definitions

Investment property

Land or building or part of a building, or both held to earn rentals or for capital appreciation or both, rather than

for:

a) Use in the production or supply of goods or services or for administrative purposes; or; b) Sale in the ordinary course of business

Owner occupied

Property held for use in the production or supply of goods or services or for administrative purposes.

Accounting

Initial Recognition

An investment property is initially measured at cost including transaction costs.

Subsequent measurement

An entity can choose from the following policies but must apply the policy consistently

Cost model

The property is accounted for in accordance with IAS 16.

Fair value model

Carry the property at its fair value with any gains or losses recognised in the statement of profit or loss in the

period that it arises. It should be carried at fair value until disposal.

Fair value should reflect market conditions at each statement of financial position date.

If a fair value cannot be established then the cost model must be used.

IAS 40 Investment Properties

| CIMA F1 156


Penny purchases an office block for $50m on 1 January 2007 with a view to earning rentals and for its capital

appreciation. The property is expected to have a useful life of 50 years. At 31 December 2008, market

conditions indicated that the fair value of the property has risen to $72m.

Required:

Show how the property would be presented in the financial statements as at 31 December 2008 if Warrior

follows the:

(a) cost model

(b) fair value model

| CIMA F1 157


accounting for inventories.

IAS 2 Inventory

Definition:

Assets:

Held for sale in the ordinary course of business;

In the process of production for such sale; or

In the form of materials or supplies to be consumed in the production process or in the rendering of

services

Types of inventory held

Goods for resale Finished goods Work in progress Raw materials

Cost of sales

Goods might be unsold at the end of an accounting period and so still be held in inventory. The purchase cost of

these goods should not be included therefore in the cost of sales of the period.

Topic 16: IAS 2, 8, 10, 34 and IFRS 8

| CIMA F1 158

Counting inventories

The quantity of inventories held at the year end is established by means of a physical count of inventory in an

annual accounting exercise, or by a ‘continuous’ inventory count.

Valuing inventories

IAS 2 INVENTORIES

“Inventories should be measured at the lower of cost and net realisable value.”

Lower of

Cost Historical cost - purchase price FIFO – first in first out AVCO – average weighted cost

Net realisable value Expected sale price – costs incurred in getting the items ready for sale

The value of inventories is calculated at the lower of cost and net realisable value for each separate item or

group of items.

FIFO (first in, first out)

FIFO assumes that materials are issued out of inventory in the order in which they were delivered into

inventory. This happens a lot with food beacuse of the sell by dates.

AVCO (average cost)

The cumulative weighted average pricing method calculates a weighted average price for all units in inventory.

Issues are priced at this average cost, and the balance of inventory remaining would have the same unit

valuation.

| CIMA F1 159

A new weighted average price is calculated whenever a new delivery of materials into store is received. This is the

key feature of cumulative weighted average pricing.

Cost

The cost of inventories shall comprise all costs of purchase, costs of conversion and other cost incurred in bringing

the inventories to their present location and condition

Cost of purchase comprises of:

Purchase price, import duties, irrecoverable taxes, transport, handling and other costs directly attributable to the

acquisition of finished goods, materials and services.

Trade discounts are deducted but cash or settlement discounts are not.

Costs of conversion comprises of:

Costs directly related to the units of production, such as direct labour.

Exclusions: abnormal costs, storage costs, administration costs and selling costs.

Net realisable value

The estimated selling price in the ordinary course of business less the estimated costs of completion and the

estimated costs necessary to make the sale

Apply your knowledge 1

Daisy paid $3 per unit for the raw materials of its products. To complete each unit incurred $2 per unit in direct labour.

Production overheads for the year based on normal output of 12,000 units was $72,000.

Due to industrial action only 10,000 units were produced and 1,000 units were in inventory at the end of the year.

As a result of the industrial action some units were badly stored and became damaged. It’s is estimated that 200 of the units will now only be sold for $12 each after minor repairs of $2 each

Required:

What figure for closing inventory would be shown in the statement of financial position?

| CIMA F1 160


The following figures relate to inventory held at the year end.

A B C

$ $ $

Cost 20 9 12

Selling price 30 12 22

Modification cost to enable sale - 2 8

Marketing costs 7 2 2

Units held 200 150 300

Required:

Calculate the value of inventory held.

E.g. if we buy and sell tyres we may get to a 31 December year end with 200 tyres in our warehouse but our

transactions in December were as follows:

1st December – Warehouse empty

2nd December –Purchase 200 tyres costing $15 each

10th December – Purchase 100 tyres costing $18 each

16th December- Sell 250 tyres at $30 each

20th December – Purchase 150 units at $20 per unit

So with costs ranging from $15- $20 how will we value the 200 tyres in the warehouse at the year end?

| CIMA F1 161


On the 1 October 2012 a company held 300 units of finished goods, these were valued at £12 per unit. During

October 2012 the following transactions occurred:

Date Activity Cost per unit

10 October Purchased 400 $12.50

14 October Sold 500

20 October Purchased 400 $14

21 October Sold 500

25 October Purchased 400 $15

28 October Sold 100

Units were sold for $20 each

Required:

Calculate the profit for October and the closing inventory if valued under

a. FIFO

b. AVCO (using cumulative weighted average costing)


On 30 September 2014, Razor’s closing inventory was counted and valued at its cost of $1 million. Some items

of inventory which had cost $210,000 had been damaged in a flood (on 15 September 2014) and are not

expected to achieve their normal selling price which is calculated to achieve a gross profit margin of 30%. The

sale of these goods will be handled by an agent who sells them at 80% of the normal selling price and charges

Razor a commission of 25%.

At what value will the closing inventory of Razor be reported in its statement of financial position as at 30

September 2014?

A. $1 million

B. $790,000

C. $180,000

D. $970,000

| CIMA F1 162

Learning outcome: B1a Describe the main elements of financial statements prepared in accordance with IFRS

Accounting policies

The specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting the

financial statements.

Selecting accounting policies

In selecting accounting policies an entity must firstly consider the requirements of the applicable accounting

standards.

In all other situations policies should be selected so as to result in information that is relevant and reliable in line

with the framework.

Relevant – to the economic decision making needs of users; and

Reliable

Faithful representation

Reflect the substance

Neutral, free from bias

Prudent

Complete in all material respect.

Changing accounting policies

Once chosen accounting policies should be applied consistently unless changing the policy would result in fairer

presentation. Policies may also need amending where changes in standards take place.

This change should be applied retrospectively. This will result in the restatement of opening balances and

comparatives. The retrospective adjustment is referred to as a prior period adjustment and shown in the statement

of changes in equity.

For a change to be truly a change in accounting policy it must affect any one of the following; recognition,

presentation or measurement. Otherwise it will be a change in an accounting estimate.

IAS 8 Accounting Policies, Changes in Accounting

Estimates and Errors Apply Your Knowledge 4

| CIMA F1 163


Paddy construction incurs considerable finance costs on its financing for the construction of motorway bridges. Its accounting policy to date has been expense the finance costs as incurred. The final accounts for the year ended 31 December 2007, and the 2008 draft accounts, reflect this policy and show the following.

2008 2007 $000 $000 Profit from operations 9,000 6,000 Finance costs (3,000)

______ (2,000)

______ Profit before tax Income tax expense Profit for the year

6,000 (2,000) ______

4,000

4,000 (1,500) ______

2,500 Retained earnings brought forward 24,500

______ 22,000

______ Retained earnings carried forward 28,500

====== 24,500

======

The directors have now decided to change the accounting policy to one of capitalisation of finance costs to give a fairer presentation. This decision has been supported by paddy’s auditors. The finance costs above all relate to the construction of the bridges.

Paddy had 5m $1 ordinary shares.

Required:

Show how the change in accounting policy will be reflected in the financial statements for the year ended 31 December 2008. Assume there are no tax implications

| CIMA F1 164

Changes in accounting estimates

As a result of inherent uncertainties in a business many estimates will be made. As estimates revisions will obviously

need to be made.

Changes in estimates are adjusted prospectively in the current years statement of profit or loss but not retrospectively

as with changes in accounting policy.

Prior period errors


Material prior period errors should be corrected retrospectively by adjustment against the opening balance of retained earnings in the statement of changes in equity.

Required:

According to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, which ONE of the following is a change in accounting policy?

A. The depreciation method of vehicles being changed from straight line to reducing balance. B. The provision for warranty claims being recalculated using a different method. C. Recognising a provision for a legal claim which had been disclosed as a contingent liability in the previous

year’s financial statements. D. Presenting depreciation in cost of sales which had previously been presented in administrative expenses.


Which of the following would be a change in accounting policy in accordance with IAS 8 Accounting Policies,

Changes in Accounting Estimates and Errors?

A. Adjusting the financial statements of a subsidiary prior to consolidation as its accounting policies differ from those of its parent

B. A change in reporting depreciation charges as cost of sales rather than as administrative expenses C. Depreciation charged on reducing balance method rather than straight line D. Reducing the value of inventory from cost to net realisable value due to a valid adjusting event after the

reporting period

| CIMA F1 165


Which of the following is a change of accounting policy under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors?

A. Classifying commission earned as revenue in the statement of profit or loss, having previously classified it as other operating income

B. Switching to purchasing plant using finance leases from a previous policy of purchasing plant for cash C. Changing the value of a subsidiary’s inventory in line with the group policy for inventory valuation when

preparing the consolidated financial statements D. Revising the remaining useful life of a depreciable asset

| CIMA F1 166

Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of events

after the reporting period.

Events after the reporting date

Those events, favourable and unfavourable, that occurred between the end of the reporting period and the date

when the financial statements are authorised for issue.

Adjusting events

Those events that provide additional evidence of conditions that existed at the end of the reporting period.

Non-adjusting events

Those that are indicative of conditions that arose after the reporting period.

These events will be disclosed when material.

Nature of the event

Estimate of the financial effect, or a statement that such an estimate cannot be made.

Dividends

If an entity declares dividends to holders of equity instruments (IAS32) after reporting period, the entity shall not

recognise those dividends as a liability at the end of the reporting


Should each of the following be treated as an adjusting or non-adjusting event?

(i) the company makes an issue of 100,000 shares which raises $200,000 shortly after the reporting date.

(ii) a legal action had brought against the company for breach of contract prior to the year end. The outcome was decided shortly after the reporting date, and as a result the company will have to pay costs and damages totalling $80,000. No provision has currently been made for this event.

(iii) inventory included in the accounts at the year end at cost $30,000 was subsequently sold for $10,000.

IAS 10 Events after the reporting date

| CIMA F1 167


A company has a year end 31 December 20X1. The accounts were then signed on the 4 April 20X2. The following events took place between the year end and the date of signing.

According to IAS 10 ‘Events After the Reporting Period’, which events should have been adjusted for in the 20X1 accounts?

1. The directors decided on the 25 March 20X2 to cease trading at the end of 20X2.

2. A legal dispute arising in 20X1, previously not provided for, has been settled on 25 February 20X2 resulting in the company being ordered to pay damages of $3,000.

3. After a successful year in 20X1 the directors have decided that, based on the 20X1 draft accounts, sufficient profits have arisen and declared a dividend on 1 January 20X2.

A. None of the above

B. All of the above

C. 1 & 2 only

D. 2 & 3 only


Which TWO of the following events which occur after the reporting date of a company but before the financial statements are authorised for issue are classified as ADJUSTING events in accordance with IAS 10 Events after the Reporting Period?

(i) A change in tax rate announced after the reporting date, but affecting the current tax liability

(ii) The discovery of a fraud which had occurred during the year

(iii) The determination of the sale proceeds of an item of plant sold before the year end

(iv) The destruction of a factory by fire

A. (i) and (ii) B. (i) and (iii) C. (ii) and (iii) D. (iii) and (iv)

| CIMA F1 168

Learning outcome: B1a Describe the main elements of financial statements prepared in accordance with IFRS

IFRS 8 sets out requirements for disclosure of information about an entity’s operating segments, the entity’s

products and services, the geographical areas in which it operates and its major customers.

An operating segment is a component of an entity:

a) that engages in business activities from which it may earn revenue and incur expenses

b) whose operating results are regularly reviewed by the entity’s chief operating decision maker

c) for which discrete financial information is available.

A segment should be classified as a reportable segment if it contributes more than 10% of the total of any of the

following:

revenue (internal and external)

profitable segments

loss making segments

assets

If, after allocating segments according to the 10% rule, the external revenue of reportable segments is less than

75% of the total revenue of the entity, additional segments will be classified as reportable segments even though

they do not meet the 10% rule.

Disclosure

IFRS 8 requires the disclosure of the following:

factors used to identify the entity’s reportable segments, including the basis of segmentation (for

example, whether operating segments are based on products or services or geographical areas)

types of products and services from which each segment derives its revenue

For each reportable segment an entity should report:

profit or loss

revenues

total assets

total liabilities

IFRS 8 Operating segments

| CIMA F1 169


Which of the following is a feature of an operating in accordance with IFRS 8 operating segments?

A. a component for which financial information is available

B. it is a significant area of the entity’s operations

C. a part of the operations that is expected to be discontinued within the next twelve months

D. it is a loss making area of the business

| CIMA F1 170


accounting for taxation.

IAS 12 INCOME TAXES

Definitions

Accounting profit

The profit or loss for a period before deducting tax expense.

Taxable profit

The profit or loss for a period determined in accordance with the rules established by the taxation authorities,

upon which income taxes are payable (recoverable)

Current tax

The amount of income taxes payable (recoverable) in respect of the taxable profit/( tax loss) for a period

Topic 17: IAS 12: Income Taxes

| CIMA F1 171

Current tax

At the end of the financial year a company will estimate the amount of tax payable on profits for the period. This

amount is charged to the statement or profit or loss and shown as a current liability in the statement of financial

position.

DR Income tax expense (SOPL)

CR Income tax liability (SOFP)

Often this estimate is not the exact amount that is actually paid resulting in an over or under provision of income

taxes.

This balance will then be incorporated to the current year’s tax charge as you cannot go back and restate last year’s

figures.

Income tax expense:

Current tax charge for the year x

Under/over provision from previous year x/(x)

_____

Total tax charge for the year x

_____


At 31 December 2007 Terry estimates that its current tax liability for the year will be $200,000.

In August 2008 Terry pays its tax liability for the year ended 31 December 2007 at $170,000.

At 31 December 2008 Terry again estimates it income tax liability, this time at $210,000.

Required:

Show the statement of profit or loss and statement of financial position extracts to reflect the above for the

two years ended 31 December 2008.

| CIMA F1 172


At 31 December 2007 Mckay estimates that its current tax liability for the year will be $100,000. In August

2008 Mckay pays its tax liability for the year ended 31 December 2007 at $120,000.

At 31 December 2008 Mckay again estimates it income tax liability, this time at $130,000.

Required:

Show the statement of profit or loss and statement of financial position extracts to reflect the above for the

two years ended 31 December 2008.

| CIMA F1 173


TYV is a manufacturing entity and produces a range of products in several factories. TYV’s trial balance at 30

September 2014 is shown below:

Notes $000 $000 Accumulated depreciation at 30 September 2013:

Buildings (i)

1,700 Plant and equipment (iv)

4,510

Administrative expenses

1,820 Cash and cash equivalents

272

Cost of sales

10,200 Distribution costs

1,110

Equity dividend paid

350 Equity shares $1 each, fully paid at 30 September 2014

6,625

Finance charges for new factory building

113 Income tax (v) 80 Inventory at 30 September 2014

575

Land and buildings at cost at 30 September 2013 (ii)&(iii) 17,386 Long term borrowings (vi)

5,000

Long term borrowings loan interest (vi) 233 New factory building cost

1,014

Plant and equipment at cost at 30 September 2013 (iv) 7,750 Receipt from disposal of plant and equipment (iv)

7

Retained earnings at 30 September 2013

491 Sales revenue

19,460

Share premium at 30 September 2014

850 Short term loan (iii)

1,500

Suspense account (ii)

1,130 Trade payables

1,880

Trade receivables

2,250 .

43,153 43,153

Notes:

i. On 1 October 2013 two of TYV’s factories, factory A and factory B, were deemed obsolete and no

longer suitable for TYV’s use. On 1 June 2014 both factories were closed and production moved to

a new facility. TYV disposed of factory B with all legal formalities completed and cash received on

31 August 2014. Factory A was not sold by the financial year end, however at 30 September 2014

negotiations for the sale of factory A were well advanced and TYV’s management expected to

conclude the sale by 31 December 2014. The cost and accumulated depreciation included in land

and buildings along with the fair value of each factory is shown below:

Factory Cost Depreciation at 30 September 2013

Fair value less cost of disposal at 30 Sept. 2014

Land Buildings

A $1,375,000 $455,000 $364,000 $1,420,000 B $1,120,000 $325,000 $286,000 $1,130,000

| CIMA F1 174

ii. The suspense account is the cash received from the disposal of factory B. The only entries made in

the ledgers for this item was in cash and cash equivalents and suspense account.

iii. The cost of land included in land and buildings was $11,000,000 on 1 October 2013. TYV built the

new factory on land it already owned, commencing on 1 October 2013 and completing it on 30

June 2014. To fund the project TYV raised a short term loan on 1 October 2013, repayable on 30

September 2015.

iv. Plant and equipment in factories A and B was relocated to the new factory, except for plant and

equipment with a carrying value of $55,000 (cost $175,000) that was sold as scrap, realising

$7,000. Buildings are depreciated at 2% per annum on the straight line basis. Buildings

depreciation is treated as an administrative expense. Plant and equipment is depreciated at 25%

per annum using the reducing balance method and is charged to cost of sales. TYV’s accounting

policy for depreciation is to charge a full year in the year of acquisition and none in the year of

disposal.

v. The director estimate the income tax charge on the year’s profits at $940,000. The balance on the

income tax account represents the under-provision for the previous year’s tax charge.

vi. The long term borrowings consist of one loan issued in 2000 for 20 years at 7% interest per year.

Interest is paid half yearly on 1 June and 1 December.

Required:

Prepare TYV’s statement of profit or loss and a statement of changes in equity for the year ended 30

September 2014 and a statement of financial position at that date, in accordance with the requirements of

international financial reporting standards.

(All workings should be to the nearest $000).

Notes to the financial statements are not required but all workings must be clearly shown. Do not prepare a

statement of accounting policies.

| CIMA F1 175

Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of reporting

of performance.

Introduction Foreign currency transactions and financial statements should be translated at rates that are both compatible

with the impact of their rate changes on cash flows and which also maintain the true and fair view of results

required.

Functional currency

This is the main currency in which an entity operates (ie the currency of their primary economic environment). It

is used for measurement in the financial statements. Any other currencies are treated as foreign currencies.

Presentation currency

This can be any currency that the entity chooses, there are specific rules which apply when translating from

functional currency to presentation currency. The translation of foreign operations is the same as for functional

currency.

FUNCTIONAL CURRENCY

Definition: As per IAS 21, this is the currency of the primary economic environment in which the entity operates.

Identifying an entity’s functional currency

Key indicators of an entity’s functional currency are as follows:

main influence on sales prices for goods and services (i.e. used to state prices)

is the currency of the country where the regulations and markets mainly determine the sales prices

main influence on labour, material and other costs (i.e. used to pay costs)

is the currency in which finances are generated

is the currency in which receipts from operating activities are usually retained.

IAS 21: The effects of changes in foreign exchange rates

| CIMA F1 176

Impact on reporting in functional currency

At transaction date: using the spot exchange rate at the date of transaction

At SOFP date:

Monetary assets and liabilities Restate at closing rate

Non-monetary assets and liabilities Do not restate

Non-monetary assets at FV Use rate when FV was determined

Recognition of exchange differences

Differences are recognised in profit and loss in the period that they are incurred. Differences arising from trading

transactions are usually recognised in “Other income/expense” and differences from financing transactions are

usually recognised in “Finance income/costs”.


Aston plc (who use the dollar as their functional currency) have an year end of 31 December 20X1 entered into

the following transaction:

25-10-X1 Purchased goods from a Swedish supplier for 286,000 euros

31-12-X1 Not yet paid at year-end

31-01-X2 Pay for the goods

The exchange rates are as follows:

SwK/$

25-10-X1 11.16

31-12-X1 11.02

31-01-X2 10.87

Required:

Show how this would be accounted for in the records of Aston for the year ended 31-12-X1 and the year ended

31-12-X2.

| CIMA F1 177

Changes to the functional currency

Usually there is no change to this currency, it would only be changed if there was a change to the currency which

impacted on the transactions of the entity.

Presentation currency

Definition: As per IAS 21, this is the currency in which the financial statements are presented.


An entity based in the EU sells goods to the UK on 10 March 20X5 when the exchange rates was €1 = £0.65. The

customer pays in May 20X5 then the rate was €1 = £0.60.

What is the gain or loss on exchange when the payment is made in May 20X5?

A. Gain of €102,564

B. Loss of €102,564

C. Gain of €40,000

D. Loss of €40,000


A French entity buys a noncurrent asset from a US entity for $200,000 when the exchange rate was $/EUR 0.76.

At the year end the French entity has not paid its US $ payable. The exchange rate at the year end is $/EUR 0.82.

Prepare the journal entries to record the initial acquisition of the noncurrent asset and any journal entries

required at the year end.


An entity based in the Europe sells goods to the UK for £800,000 on 20 April 20X5 when the exchange rate was

€1 = £0.65. The customer pays in May 20X5 when the rate was €1 = £0.60.

How does the entity account for the sale on 20 April 20X5?

A. Dr Receivables €480,000 Cr Sales €480,000

B. Dr Receivables €1,333,334 Cr sales €1,333,334

C. Dr Receivables € 520,000 Cr sales €520,000

D. Dr Receivables €1,203,769 Cr sales €1,203,769

| CIMA F1 178

NB The entity can choose its presentation currency


accounting for employee benefits.

A pension plan (sometimes called a post-employment benefit scheme) consists of a pool of assets and a liability

for pensions owed to employees. Pension plan assets normally consist of investments, cash and (sometimes)

properties. The return earned on the assets is used to pay pensions.

There are two main types of pension plan:

defined contribution plans

defined benefit plans

Defined contribution plans

The pension payable on retirement depends on the contributions paid into the plan by the employee and the

employer.

The employer’s contribution is usually a fixed percentage of the employee’s salary. The employer has no

further obligation after this amount is paid.

Therefore, the annual cost to the employer is reasonably predictable.

Defined contribution plans present few accounting problems.

Topic 19: IAS 19: Employee

benefits

| CIMA F1 179

Defined benefit plans

The pension payable on retirement normally depends on either the final salary or the average salary of the

employee during their career.

The employer undertakes to finance a pension income of a certain amount, e.g.

2/3 × final salary × (years of service/40 years)

The employer has an ongoing obligation to make sufficient contributions to the plan to fund the pensions.

An actuary calculates the amount that must be paid into the plan each year in order to provide the

promised pension. The calculation is based on various estimates and assumptions including:

o life expectancy

o expected length of service to retirement/employee turnover

o investment returns

o wage inflation.

Therefore, the cost of providing pensions is not certain and varies from year to year.

| CIMA F1 180

Accounting for Defined contribution plans

The expense of providing pensions in the period is normally the same as the amount of contributions paid.

The entity should charge the agreed pension contribution to profit or loss as an employment expense in

each period.

An asset (prepayment) or liability (accrual) for pensions only arises if the cash paid does not equal the

amount of contributions due.

IAS 19 requires disclosure of the amount recognised as an expense in the period.


Max Co agrees to contribute 6% of employee’s total remuneration into a post-employment plan each period.

For the year ended 31-12-07 the company paid total salaries of $20 million and a bonus of $4 million based on the income for the period was paid to the employees in February.

The company had paid $480,000 into the plan by 31-12-X7.

Required:

What will the impact of these transactions be on the financial statements as at 31-12-X7?

Defined benefit plans

An entity will set up a defined benefit pension plan on behalf of its employees. Both employees and the employer

(the entity), will pay into the plan. It is important to note that the pension plan is separate from the entity.

The entity recognises the net defined benefit liability (or asset) in the statement of financial position.

If the pension plan liability exceeds its assets, there is a deficit (the usual situation) and a liability is reported in

the statement of financial position of the entity.

If the pension plan assets exceeds its liability, there is a surplus and an asset is reported in the statement of

financial position of the entity.

| CIMA F1 181

Measuring the pension plan assets and liabilities.

Defined Benefit Scheme Assets should be measured at fair value i.e. market value. Defined Benefit Scheme Liabilities should be measured in the same way, at fair value which will be discounted to present value.

Presentation in the statement of profit or loss and other comprehensive income

Profit or loss

Service costs component

Net interest component

Other comprehensive income

remeasurement component

Service Cost Component

Current service cost – the additional costs of an employee working for an extra year meaning that they

are now entitled to an extra year of benefit from the plan. This increases the obligations of the plan, but

needs to be discounted to present value.

Past service cost- is the increase in the present value of the scheme liabilities related to employee service

in prior periods arising in the current period as a result of the introduction of, or improvement to,

retirement benefits.

Curtailment and settlement gains/losses - arise when significant reductions are made to the number of

employees covered by the plan or the benefits promised to them.

Net interest component

Interest costs – the liabilities of the plan must be compounded back up each year to account for the fact

that the plan is now one year nearer to settlement.

Remeasurement component - principally comprises actuarial gains and losses and also includes any

return on plan assets not already recognised in the net interest component.

Actuarial gains and losses result from increases or decreases in the pension asset or liability that

occur either because the actuarial assumptions have changed or because of differences between the

previous actuarial assumptions and what has actually happened (experience adjustments).

| CIMA F1 182

Presentation in the statement of financial position

Present value of the plan liability

Fair value of the plan assets


Harry has a defined benefit pension plan and makes up financial statements to 31 March each year. The net

pension liability (i.e. obligation less plan assets) at 31 March 20X3, was $100 million ($90 million at 31 March

20X2). The following additional information is relevant for the year ended 31 March 20X3:

The discount rate relevant to the net liability at the start of the year was 10%.

The current service cost was $65 million.

At the end of the year the entity granted additional benefits to existing pensioners that have a present

value of $23 million. These were not allowed for in the original actuarial assumptions.

The entity paid pension contributions of $65 million.

Required:

Calculate the re-measurement component gains/losses arising in the year ended 31 March 20X3.

Prepare extracts from the statement of profit or loss and other comprehensive income for the year ended 31 March 20X3 and the statement of financial position at 31 March 20X3 showing how the defined benefit scheme would be presented.

| CIMA F1 183


The following data relates to a defined benefit scheme for the year ended 31 July 20X9.

$000

Discount rate 10% per annum

Pension liabilities at start of year 2,575

Pension asset at start of year 2,525

Current service costs 350

Past service costs 88

Curtailment costs 38

Benefits paid out 263

Contributions paid in 275

Pension liability at year end 3,200

Pension asset at year end 3,100

Required:

Prepare extracts from the statement of profit or loss and other comprehensive income for the year ended 31

July 20X9 and the statement of financial position at 31 July 20X9 showing how the defined benefit scheme

would be presented.

| CIMA F1 184


Let us assume that Bowser makes up its financial statements to 31 December each year. The company offers its

staff a defined benefit (final salary pension scheme). It employs the services of an actuary to model the liability

and advise upon contributions to an asset fund. To keep the computations simple, all transactions are assumed

to occur at the year-end. The present value of the obligation and the market value of the plan assets were both

$1,000 at 1 January 20X1. The following information is available from the actuary re the model:

20X1 20X2

Discount rate at the start of the year 10% 9%

$ $

Current service cost 180 140

Benefits paid 150 180

Contributions paid 90 100

Present value of obligations at31 December 1,100 1,380

Market value of plan assets at 31 December 1,190 1,372

Required:

Prepare extracts from Bowsers accounts to show how this pension scheme will be accounted for

| CIMA F1 185


Fenton operates a defined pension plan for its employees. At 1 January 20X5 the fair value of the pension plan

was $5.4 million and the present value of the plan liabilities were $6 million. The discount rate on the assets

and liabilities was estimated at 7%.

The actuary estimates that the current service cost for the year ended 31 December 20X5 is $750,000. Fenton

made contributions into the pension plan of $850,000 in the year.

The pension plan paid $480,000 to retired member in the year 31 December 20X5.

At 31 December 20X5 the fair value of the pension plan assets was $5.2 million and the present value of the

plan liabilities was $6.3 million.

Calculate the net expense that will be included in Fenton’s statement of profit or loss for the year ended 31

December 20X5 in accordance with IAS 19 Employee Benefits.

Calculate your answer to the nearest $000


Jay operates a defined pension plan for its employees. At 1 January 20X5 the fair value of the pension plan was

$22 million and the present value of the plan liabilities were $23.5 million. The discount rate on the assets and

liabilities was estimated at 5%.

The actuary estimates that the current service cost for the year ended 31 December 20X5 is $3 million. Jay

made contributions into the pension plan of $5 million in the year.

The pension plan paid $2.5 million to retired member in the year 31 December 20X5.

At 31 December 20X5 the fair value of the pension plan assets was $22.8 million and the present value of the

plan liabilities was $25 million.

Calculate the re-measurement component gains/losses on pension plan assets and liabilities that will be

included in other comprehensive income for the year ended 31 December 20X5 in accordance with IAS 19

Employee Benefits.

Calculate your answer to the nearest $000

| CIMA F1 186

Learning outcome C1a – describe the sources of short term finance and methods of short term cash investment

available to an entity

Short-term finance

Trade payable

Bank overdrafts and short-term loans

Factoring

Trade payables

Advantages

alleviates cash flow difficulties

cash can earn a return whilst still in the

paying company's account

No interest charges

Disadvantages

loss of any settlement discount

could obtain a poor credit rating

supplier may stop further supplies

supplier may increase future selling prices

to compensate

could face legal action from the supplier

Bank overdrafts

Advantages

Flexibility as can use up to the overdraft

limit

Only pay for what is used, so cheaper

Disadvantages

Repayable on demand

May require security

Variable finance costs as they tend to alter

with the base cost

Loans

Advantages

Greater security as set for a period

Interest rates similar to overdrafts

Disadvantages

Less flexibility

May require security

Variable finance costs as they tend to alter

with the base cost

Topic 20: WCM – short-term finance and investments

| CIMA F1 187

Interest paid on the whole sum for the loan

duration

Factoring

The outsourcing of the credit control department to a third party.

The debts of the company are effectively sold to a factor. The factor takes on the responsibility to collect the debt for a fee. The factor offers three services:

1. Debt collection

2. Financing

3. Credit insurance.

The factor is often more successful at enforcing credit terms leading a lower level of debts outstanding. Factoring is therefore not only a source of short-term finance but also an external means of controlling or reducing the level of debtors.

Invoice discounting

A service also provided by a factoring company.

Selected invoices are used as security against which the company may borrow funds. This is a temporary source of finance repayable when the debt is cleared. The key advantage of invoice discounting is that it is a confidential service, the customer need not know about it.

Export finance

Selling goods overseas may involve offering longer credit periods than for similar domestic sales. The credit

customer may not be as well known as a domestic customer. There is potentially a greater risk of delay or non-

payment for goods. Entities may seek to raise finance in such circumstances to ease cash-flow problems.

Export factoring

Export factoring is essentially the same as for domestic factoring described above, with the factor providing a cash

advance, typically of about 80 per cent of invoice value. The credit insurance element of the factor’s service will

also protect against bad-debt risk.

Whereas factoring and the methods of finance mentioned above are relevant to an entity to finance domestic or

export sales, there are methods of finance that are specifically associated with financing export sales.

| CIMA F1 188

Bill of exchange

A bill of exchange is defined in CIMA’s Management Accounting: Official Terminology as follows:

A negotiable instrument, drawn by one party on another, for example, by a supplier of goods on a customer,

who by accepting (signing) the bill, acknowledges the debt, which may be payable immediately (a sight draft) or

at some future date (a time draft). The holder of the bill can thereafter use an accepted time draft to pay a debt

to a third party, or can discount it to raise cash.

The bill of exchange is essentially a written acknowledgement of a debt. They are more commonly used for export

transactions than for domestic transactions.

A bill of exchange is a device that may enable the supplier to receive the benefit of payment well before the

customer actually pays. The way it works is like this:

1. The supplier draws up a simple document (the bill of exchange) requiring the customer to pay the amount

due at some fixed future date. (The supplier is the drawer of the bill.)

2. The supplier signs the bill and sends it to the customer, who also signs it to signify that he/she agrees to

pay, and returns the bill to the supplier. (The customer is the acceptor of the bill.)

3. The supplier now has a piece of paper that is worth money, because it constitutes an agreement on the

customer’s part to pay the debt on the due date. The supplier can now do one of three things:

a. hold the bill until the due date and collect the money;

b. arrange to transfer the benefit of the bill to the bank in exchange for immediate cash. The bank will

make a charge for what is effectively a loan, so the amount received by the supplier will be less

than the face value of the bill. This is called discounting the bill of exchange with the bank;

c. transfer the bill to his/her own supplier in a settlement of the debt. That supplier may in turn pass

the bill to one of his/her own supplier, discount it or hold it to maturity.

4. When the due date of the bill arrives, the person holding it at that time presents it to the original acceptor

for payment. If the acceptor pays, that is the end of the matter. If the acceptor does not pay on the due

date, the bill is said to be dishonoured. Legal action by the parties concerned may then be initiated to

recover the money from the original acceptor. A bank bill is a bill of exchange drawn on a bank and is

typically used for arranging payment for imports.

Documentary credits

Documentary credits, or letters of credit as they are also called, provide an exporter with a secure method of

obtaining payment for overseas sales. Documentary credits also provide the exporter with a method of raising

short-term finance from a bank.

CIMA’s Management Accounting: Official Terminology defines a letter of credit as follows:

A document issued by a bank on behalf of a customer authorising a person to draw money to a specified amount

from its branches or correspondents, usually in another country, when the conditions set out in the document

have been met.

| CIMA F1 189

Forfaiting

Forfaiting is an arrangement whereby exporters, normally of capital goods or raw materials, can obtain medium-

term finance. The forfaiting bank buys at a discount to face value a series of promissory notes (or bills of exchange)

usually extending over a period of between 6 months and 5 years.

The promissory notes may be in any of the world’s major currencies. For promissory notes to be eligible for

forfaiting (and to provide the forfaiting bank’s security), the notes must be guaranteed or avalised by a highly rated

international bank (often in the importer’s country).

Forfaiting is non-recourse, with no claim on the exporter after the notes have been purchased by the bank; payment

of the notes is guaranteed by the avalising bank.

Short-term investments

Cash surpluses can be invested in a range of short-term interest-earning investments such as:

Interest-bearing bank accounts

Negotiable instruments

Short-dated government bonds

Other short-term investments

Investment criteria

When a business has surplus cash to invest temporarily, it has to decide which investments to select from the

different choices available. There are several criteria that should be considered when making these choices:

maturity

return

risk

liquidity

diversification

| CIMA F1 190

Calculating the MV of a bond

A bond’s market value is the PV of its interest inflows, plus the PV of its redemption amount, all discounted at the

yield to maturity.

| CIMA F1 191

Interest earned

Coupon rate

This is the rate of interest payable on the face value on a bond or loan. This is different to the redemption yield.


A $100 bond has a yield to maturity of 6% per annum and is due to mature in three years’ time. The next

interest payment is due in one year’s time. Today’s market value of the bond is $108.06.

Required:

Calculate the coupon rate on the bond.

Redemption yield

The yield on a bond investment is usually measured as a redemption yield. The redemption yield can be

calculated as the discounted annual rate of return (internal rate of return) at which the present value of the

future interest payments and the redemption value of the bond at maturity are equal to the current market value

of the bond.


A bond with a coupon rate of 7% is redeemable in eight years’ time for $100. Its current purchase price is $82

ex-interest. Calculate the percentage yield to maturity.


GF wants to sell an unquoted bond. The bond has a coupon rate of 5% and will repay its face value of $1,000 at

the end of four years.

GF estimates that the market requires a yield to maturity of 11% from this type of bond. GF has asked you to

recommend a selling price for the bond.

Calculate the selling price for the bond.

| CIMA F1 192

Learning outcome C2b – discuss approaches to the financing of working capital investment levels

Working capital is the level of investment in day-to-day operations of the business.

What is working capital?

Profitability V’s Liquidity

Working capital management

The management of all aspects of both current assets and liabilities, to minimise the risk of insolvency while

maximising the return on assets. If not managed appropriately:

The company may not be able to pay bills

Demands on cash during periods of growth being too great (Overtrading)

Overstocking

Topic 21: Working Capital Management (WCM)

| CIMA F1 193


Which of the following would NOT be associated with a company that is overtrading?

A. A dramatic reduction in sales revenue

B. A rapid increase in the outstanding overdraft amount

C. A rapid increase in the volume of inventory

D. A rapid increase in sales revenue

| CIMA F1 194

Learning outcome C2a – Analyse trade receivables, trade payables and inventory ratio’s

Working capital ratios

Current ratio

Measures how much of the total current assets are financed by current liabilities.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Quick (acid test) ratio

Measures how well current liabilities are covered by liquid current assets.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠−𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

| CIMA F1 195

The working capital cycle

The working capital cycle is the time span between production costs and receiving cash returns.

The faster the cycle the lower its investment in working capital will be.

Length of the cycle depends on:

liquidity versus profitability decisions

management efficiency

industry norms, e.g. retail versus construction.

| CIMA F1 196

Calculation of the working capital cycle

Raw materials holding period x

Less: payables’ payment period (x)

WIP holding period x

Finished goods holding period x

Receivables’ collection period x

–––

x

–––

The cycle may be measured in days, weeks or months and it is advisable, when answering an exam question, to

use the measure used in the question.


A company’s working capital cycle can be calculated as:

A. Inventory days plus accounts receivable days less accounts payable days

B. Accounts receivable days plus accounts payable days less inventory days

C. Inventory days plus accounts payable days less accounts receivable days

D. Accounts payable days plus accounts receivable days plus inventory days


A company’s trade payables days outstanding at 30 September 20X9 were 45 days. Purchases for the year to

30 September 20X9 were $324,444 occurring evenly throughout the year.

The company’s budgeted purchases for the year ending 30 September 20Y0 are $356,900 occurring evenly

throughout the year.

Calculate the budgeted trade payables days outstanding at 30 September 20Y0.

(Assume that the trade payables outstanding balance at 30 September 20Y0 will be the same amount as at 30

September 20X9.)

| CIMA F1 197


Calculate the following ratios, to the nearest 0.1 days, for PQ for 2011

(i) Receivables days

(ii) Payables days

(iii) Inventory days

Performance Operations 4 November 2012

1.5 JK has budgeted sales for next year of 24,000 units and inventory levels are expected

to remain constant throughout the year. Each unit produced will require 3 labour hours and the budgeted labour rate will be $15 per hour. It is estimated that 10% of units produced will be wasted.

It is expected that 15% of the total hours worked will be paid at overtime rates. 10% of the total hours will be paid at the basic rate plus an overtime premium of 50% of the basic rate. 5% of the total hours will be paid at the basic rate plus an overtime premium of 100% of the basic rate.

The labour cost budget for next year is:

A $ 1,350,000

B $ 1,306,800

C $ 1,188,000

D $ 1,320,000 (2 marks)

1.6 RS reviews the financial performance of potential customers before setting a credit

limit. The summarised financial statements for PQ, a potential major customer operating in the retail industry, are shown below.

Summary Statement of Financial Position for PQ at year end

2011 2010 $000 $000

Non-current assets 6,400 5,600 Inventories 1,200 1,120 Trade receivables 800 840 Cash 200 40 Trade payables (1,120) (1,160) Non-current liabilities (3,600) Net assets

(3,200) 3,880 3,240

Share capital 2,400 2,400 Retained earnings 1,480

840 3,880 3,240

Summary Income Statement for PQ for the years

2011 2010

$000 $000 Sales 12,000 10,000 Cost of sales 6,400 5,200 Operating profit 2,400 1,800

Required:

Calculate the following ratios, to the nearest 0.1 days, for PQ for 2011 (i) Receivables days (ii) Payables days (iii) Inventory days

(3 marks)

| CIMA F1 198


A company has annual sales revenues of $48 million. The company earns a constant gross margin of 40% on sales. All sales and purchases are on credit and are evenly distributed over the year.

The following are maintained at a constant level throughout the year:

Inventory $8 million

Trade receivables $10 million

Trade payables $5 million

The company’s cash operating cycle to the nearest day is:

A. 99 days

B. 114 days

C. 89 days

D. 73 days

| CIMA F1 199

Learning outcome - C2d discuss approaches to the financing of working capital investment levels

Working Capital Decisions

There are two decisions that a business must make with regards to its working capital:

The level of investment

The type of finance used

The Investment Decision

A HIGH level of working capital

Always able to respond to changes in requirements

BUT holding high levels of inventory/receivables/cash is expensive

A LOW level of working capital

Less expensive

BUT company may not be able to respond to a change in demand

The level of investment will also depend on the following factors:

1. The nature of the business,

2. Certainty in supplier deliveries,

3. The level of activity of the business,

4. The company’s credit policy.

Investment in working capital

| CIMA F1 200

The Financing Decision

Current assets can be classed as either permanent or fluctuating.

Permanent current assets – a level of current assets that is always present e.g. a buffer level of inventory, a

minimum level of cash kept in the bank

Fluctuating current assets – the element of current assets that always changes e.g. increases/decreases in

receivables/payables

Time

Assets

Fluctuating

current assets

Permanent

current assets

Non-current

assets

Short-term

funds

Short-term

funds or

Long-term

funds

Long-term

funds

| CIMA F1 201

Both types of current assets require funding. A number of different approaches can be adopted:

conservative

aggressive

moderate

Conservative

Mostly long term finance used.

All permanent and most fluctuating current assets are funded using long term finance.

Aggressive

Mostly short term finance used.

All fluctuating and part of the permanent current assets are funded using short term finance.

Moderate

Permanent current assets are funded using long term finance.

Fluctuating current assets are funded using short term finance.

| CIMA F1 202

Overtrading

Overtrading is the term applied to a company which rapidly increases its turnover without having sufficient capital backing, hence the alternative term “under-capitalisation”.

Output increase are often obtained by more intensive utilisation of existing fixed assets, and growth tends to be financed by more intensive use of working capital.

Overtrading companies are often unable or unwilling to raise long-term capital and thus tend to rely more heavily on short-term sources such as overdraft and trade creditors. Debtors usually increase sharply as the company follows a more generous trade credit policy in order to win sales, while stock tends to increase as the company attempts to produce at a faster rate ahead of increase demand.

Overtrading is thus characterised by rising borrowings and a declining liquidity position in terms of the quick ratio, if not always according to the current ratio.

Symptoms of overtrading

1. Rapid increase in turnover

2. Fall in liquidity ratio or current liabilities exceed current assets

3. Sharp increase in the sales-to-fixed assets ratio

4. Increase in the trade payables period

5. Increase in short term borrowing and a decline in cash balance

6. Fall in profit margins.

Overtrading is risky because short-term finance may be withdrawn relatively quickly if creditors lose confidence in the business, or if there is general tightening of credit in the economy resulting to liquidity problems and even bankruptcy, even though the firm is profitable.

The fundamental solution to overtrading is to replace short-term finance with long-term finance such as term loan or equity funds.

| CIMA F1 203

Learning outcome – c2b discuss policies for the management of the level of investment and working capital and

for the individual elements of working capital

Learning outcome – C2c evaluate working capital policies

Accounts receivables

Management of receivables has four key aspects:

Assessing creditworthiness

The creditworthiness of all new customers must be assessed before credit is offered, it is a privilege and not a

right. Existing customers must also be re-assessed on a regular basis. The following may be used to assess credit

status of a company

1. Bank references

2. Trade references

3. Published accounts

4. Credit rating agencies

5. Company’s own sales record.

Setting credit limits

Given that we are willing to offer credit to a company, we must now consider the limits to the agreement.

This may include:

1. Credit limit value

2. Number of days credit

3. Discount on early payment

4. Interest on overdue account.

Invoicing promptly and collecting overdue debts

Monitoring the credit system

The credit policy is dependent on the credit controllers implementing a set of simple but rigorous procedures.

Topic 22: Working Capital Management – accounts

receivable and payable

| CIMA F1 204

Time line Action

After 30 days Send statement of account

+7 days Reminder sent

+7 days 2nd reminder

+7 days Legal action threat

+7 days Take action to recover funds

Company credit terms will be influenced by:

demand for products

competitors' terms

risk of irrecoverable debts

financing costs

costs of credit control

| CIMA F1 205

The cost of financing receivables

Finance cost = receivables balance x Interest (overdraft) rate

Factoring Calculations


Paisley Co has sales of $20m for the previous year, receivables at the year-end were $4m, and the cost of

financing receivables is covered by an overdraft at the interest rate of 12%.

Calculate:

i) the receivable days

ii) the annual cost of financing receivables

• Factors will get payments in more quickly.

• This will reduce receivables turnover.Receivables turnover

• If receivables turnover (days) reduces, receivables are also reduced.Receivables = Sales x Days/365

• We assume receivables are funded using an overdraft.Overdraft interest

• A reduction in receivables means a reduction in overdraft interest.Interest saving

• The saving in interest is compared to the cost of the factoring service.Comparison

| CIMA F1 206

Early settlement discounts

Cash discounts are given to encourage early payment by customers. The cost of the discount is balanced against

the savings the company receives from a lower balance and a shorter average collecting period.

You may be asked to calculate:

The net benefit/cost of offering the early settlement discount

The effective annual interest rate of the early settlement discount


Paisley is now offering its customers a 3% discount for paying within 30 days. It is estimated that 50% of customers will accept the discount. Determine whether Paisley should offer the discount.


A supplier has offered CB an early settlement discount of 3% if payment is made within 20 days of the invoice date. CB currently takes 58 days to pay this supplier.

Required:

Calculate, to the nearest 0.1%, the effective annual interest rate to CB of the early settlement discount. You should assume a 365 day year and use a compound interest methodology.

| CIMA F1 207


GH is a manufacturer of leather goods. The company has recently won a contract to supply CD, a major

department store chain, with a range of products. The contract will require significant investment in non-

current assets and working capital. GH will raise a loan from its bank for the investment in non-current assets

but is considering alternative methods of reducing the required investment in working capital. These methods

include offering early settlement discounts and debt factoring.

CD’s normal credit term from its suppliers is 90 days. GH is considering offering an early settlement discount of

3% for payments received within ten days in order to reduce the working capital requirement.

Required:

(i) Calculate, to the nearest 0.1%, the effective annual interest rate to GH of the early settlement discount. You

should assume a 365-day year and use a compound interest methodology.

(ii) State TWO disadvantages to GH of using a bank loan to finance the additional working capital.

| CIMA F1 208

Factoring

Factoring is the 'sale of debts to a third party (the factor) at a discount in return for prompt cash'

The debts of the company are effectively sold to a factor (normally owned by a bank). The factor takes on the

responsibility of collecting the debt for a fee. The company can choose one or both of the following services

offered by the factor:

Debt collection and administration – The factor takes over the whole of the company’s sales ledger, issuing

invoices and collecting debts.

Non-recourse –protects the client against irrecoverable debts, the factor bears the loss

Recourse – client bears the cost of irrecoverable debts, so has to reimburse the factor any money received for

that debt.

Advantages Disadvantages

Saving in administration costs.

Reduction in the need for management control.

Particularly useful for small and fast growing

businesses where the credit control department

may not be able to keep pace with volume

growth.

Non-recourse is a convenient way of obtaining

insurance

Likely to be more costly than an efficiently run

internal credit control department.

Factoring has a bad reputation associated with

failing companies; using a factor may suggest your

company has money worries.

Customers may not wish to deal with a factor.

Once you start factoring it is difficult to revert

easily to an internal credit control system.

The company may give up the opportunity to

decide to whom credit may be given (non-

recourse factoring).

| CIMA F1 209


A company is considering factoring as a way of managing its trade receivables. It currently has a balance

outstanding on trade receivables of $250,000. It has annual sales revenue of $1,500,000 which occurs evenly

throughout the year. Trade receivables are expected to continue at the same level for the next year.

The factor will advance 80% of invoiced sales and will charge interest at a rate of 10% per annum.

The interest charge for next year payable to the factor will be:

A. $25,000

B. $150,000

C. $20,000

D. $120,000


a) A company manufactures office equipment in England but sells it in the UK and to overseas customers.

Current situation

UK customers (£2·1m annual revenue)

The company offers a cash discount of 3% for payment within 10 days to UK customers. Approximately 40% of

customers take advantage of the early payment discount whilst the remainder pay in 30 days.

Overseas customers (£0·9m annual revenue)

All sales are on credit but customers are required to pay a 20% deposit when they place their orders and the

balance in 60 days.

Debt factoring

The company is thinking about debt factoring. Investigations have revealed that a non- recourse factor will

accept 85% of the company’s UK customers. It is assumed that the remaining 15% will not take advantage of

the early settlement discount.

Required:

Calculate, based on a 365-day year, the total debtors’ days if

(i) the current situation continues

(ii) debt factoring is introduced

b) Discuss the non-financial factors that a company would need to consider before making a decision to

factor its debts.

| CIMA F1 210

Aged debt analysis


Performance Operations 6 November 2012

SECTION B – 30 MARKS

[You are advised to spend no longer than 9 minutes on each sub-question in this

section.]

ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.

Question Two

(a) FG is concerned that the payment record of one of its customers is extremely poor. An

extract from the trade receivable account for the customer, for the period 1 July to 31

October, is shown below: Date Narrative Debit Credit Balance $ $ $ 01/07/2011 Balance b/fwd 142 08/07/2011 Invoice No. 345 102 244 12/07/2011 Invoice No. 423 234 478 15/07/2011 Credit note No. C85 (Balance b/fwd) 78 400 23/07/2011 Receipt No. R69 (Balance b/fwd and Invoice No. 345) 166 234 04/08/2011 Invoice No. 460 156 390 11/08/2011 Invoice No. 489 87 477 14/08/2011 Invoice No. 558 34 511 05/09/2011 Receipt No. R92 (Invoice No. 558) 34 477 18/09/2011 Invoice No. 576 183 660 20/09/2011 Invoice No. 615 263 923 04/10/2011 Receipt No. R121 (Invoice No. 489) 87 836 16/10/2011 Invoice No. 678 128 964

Required:

(i) Prepare an aged debt analysis showing the outstanding debt of the customer at 31 October analysed by month.

(3 marks)

The credit control department has been chasing the outstanding invoices by telephone, email and post.

(ii) State TWO further actions that FG may take after reviewing the information

shown in the aged debt analysis prepared in part (i). (2 marks)

(Total for sub-question (a) = 5 marks)

| CIMA F1 211

Learning outcome – C2b discuss policies for the management of the total level of investment in working capital

and for the individual elements of working capital.

Objective: to reduce the levels of inventory held to the minimum required.

The lowest possible amount to minimise the level of capital employed to be funded, and ensure there is enough

inventory held, so there is no stock outs.

Costs of holding high inventory

The return the cash could get from else where

Holding costs

Storage

Store admin

Theft

Damage

Obsolescence

Cost of holding low inventory

Stock outs

Lost contribution

Production stoppages

Loss of goodwill from customers

Emergency orders

High re-order costs

Lost quantity discounts

Economic order quantity (EOQ)

The aim of the EOQ model is to minimise the total cost of holding and ordering inventory.

When the re-order quantity chosen minimises the total cost of holding and ordering, it is known as the EOQ.

Topic 23: Working Capital Management – inventory

control

| CIMA F1 212

Assumptions

The following assumptions are made:

demand and lead time are constant and known

purchase price is constant

no buffer inventory held as it is assumed that it is not needed since demand and lead times are known

with certainty.

Calculating EOQ

The EOQ can be more quickly found using a formula (given in the examination):

where:

CO = cost per order

D = annual demand

CH = cost of holding one unit for one year.

| CIMA F1 213

Dealing with quantity discounts

Discounts may be offered for ordering in large quantities. If the EOQ is different to the order

size needed for a discount, should the order size be changed?

Step 1: Calculate EOQ, ignoring discounts.

Step 2: If the EOQ is below the quantity qualifying for a discount, calculate the total annual inventory cost arising

from using the EOQ.

Step 3: Recalculate total annual inventory costs using the order size required to just obtain each discount.

Step 4: Compare the cost of Steps 2 and 3 with the saving from the discount, and select the minimum cost

alternative.

Step 5: Repeat for all discount levels.

| CIMA F1 214


FP is a retailer of office products. For one particular model of calculator there is an annual demand of 26,000 units. Demand is predictable and spread evenly throughout the year.

Supplies are received 2 weeks after placing the order and no buffer inventory is required.

The calculators cost $14 each. Ordering costs are $160 per order. The annual cost of holding one calculator in inventory is estimated to be 10% of the purchase cost.

The economic order quantity (EOQ) for this model of calculator will be:

A 2,438 units

B 771 units

C 67 units

D 2,060 units

Total annual cost

This is the total annual ordering cost plus the total annual holding cost.

𝐶𝑜𝐷

𝑄+

𝐶ℎ𝑄

2

FP has decided not to use the EOQ and has decided to order 2,600 calculators each time an order is placed. The total ordering and holding costs per annum will be:

A $5,240

B $19,800

C $208,014

D $3,420

| CIMA F1 215

Just in Time (JIT)

CIMA official definition

“A system whose objective is to produce or to procure products or components as they are required by a

customer for us, rather than for inventory. A just in time system is a ‘pull’ system which responds to demand,

rather than a ‘pull’ system in which inventory act as buffers between the different elements of the system, such

as purchasing, production and sales.”

In other words, little or no stock is held on site.

Characteristics

nil/negligible stock levels

nil/negligible stock costs

items only produced after an order has been placed

little room for error

higher quality

good supplier relations

frequent deliveries of small orders

| CIMA F1 216

Learning outcome – C3a discuss measures to manage short term cash position of an entity.

Why hold cash?

Transactions motive: To pay for every day expenditure

Precautionary motive: Anything goes wrong

Investment motive: To take advantage of opportunities

The objective is to have enough money to pay the bills, but not to hold too much that it becomes an idle asset.

Cash budgets and cash flow forecasts

Cash forecast: is an estimate of cash receipts and payments for a future period under existing conditions

Cash budget: is a commitment to a plan for cash receipts and payments for a future period after taking any action

necessary to bring the forecast in line with the overall business plan.

Topic 24: Working Capital Management – cash control

| CIMA F1 217

| CIMA F1 218


A company commenced business on 1 August. Total sales revenue in August was $200,000 and is expected to increase at a rate of 2% per month. Credit sales represent 60% of total sales revenue and the remaining 40% is cash sales. The credit period allowed is one month. Bad debts are expected to be 3% of credit sales but the remaining credit sales customers are expected to pay on time.

The estimated receipts in September from cash and credit sales are:

A $195,552

B $196,400

C $198,000

D $201,600

(2 marks)


The following details have been extracted from the accounts payable records of RS.

Invoices paid in the month of purchase 15% of total value

Invoices paid in the first month after purchase 65% of total value

Invoices paid in the second month after purchase 20% of total value

The pattern of payments is expected to continue in the future and has been used to produce RS’s cash budget for October to December.

Purchases for October to December are budgeted as follows:

October November December

$280,000 $250,000 $300,000

A settlement discount of 5% is taken on invoices paid in the month of purchase.

The amount budgeted to be paid to suppliers in December is:

A $264,500

B $261,250

C $250,325

D $263,500

| CIMA F1 219


JL is preparing its cash budget for the next three quarters. The following data have been extracted from the

operational budgets:

Sales revenue Quarter 1 $500,000

Quarter 2 $450,000

Quarter 3 $480,000

Direct material purchases Quarter 1 $138,000

Quarter 2 $151,200

Quarter 3 $115,600

Additional information is available as follows:

JL sells 20% of its goods for cash. Of the remaining sales value, 70% is received within the same quarter as sale

and 30% is received in the following quarter. It is estimated that trade receivables will be $125,000 at the

beginning of Quarter 1. No bad debts are anticipated.

50% of payments for direct material purchases are made in the quarter of purchase, with the remaining 50% in

the quarter following purchase. It is estimated that the amount owing for direct material purchases will be

$60,000 at the beginning of Quarter 1.

JL pays labour and overhead costs when they are incurred. It has been estimated that labour and overhead

costs in total will be $303,600 per quarter. This figure includes depreciation of $19,600.

JL expects to repay a loan of $100,000 in Quarter 3.

The cash balance at the beginning of Quarter 1 is estimated to be $49,400 positive.

Required: Prepare a cash budget for each of the THREE quarters.

| CIMA F1 220

Measures to improve a cash forecast situation

additional short-term borrowing

negotiating a higher overdraft limit with the bank

the sale of short-term investments, if the company has any

using different forms of financing to reduce cash flows in the short term, such as leasing instead of buying

outright

changing the amount of discretionary cash flows, deferring expenditures or bringing forward revenues.

(Dividends)

shortening the operating cycle by reducing the time taken to collect receivables, perhaps by offering a

discount or using a factor or invoice discounting

shortening the operating cycle by delaying payment to payables.

The Baumol model This is based on the EOQ formula from earlier

√2𝐶𝑜𝐷

𝐶ℎ

Where Co = the administration cost of selling or buying treasury bills D = annual demand for cash (cash consumed in a year) Ch = interest rate Baumol assumed that many companies would hold an inventory of marketable securities, which could be sold in order to replenish the cash balance The EOQ now gives the optimum amount of treasury bills to sell by value each time the cash balance needs replenishing


Troy has asked you to calculate the optimum amount of cash to be transferred each time using the Baumol

model, when:

A. Outgoings are $300,000 per annum

B. Money on deposit earns 10% per annum

C. Switching costs $20 per transaction

| CIMA F1 221

The Miller Orr Model

Miller and Orr did not assume that cash is consumed at a constant rate. Instead they assumed that cash flows

were entirely unpredictable.

They determined upper and lower cash limits of a company.

When the company hits the upper limit, they will buy up short term investments to reduce the cash in the bank.

When the company hits the lower limit, they will sell these investments to increase the cash in the bank

Whether buying or selling investments, the aim is to always bring the cash balance back to the same return point.

| CIMA F1 222

Formulae needed

Spread between upper and lower limit

3 𝑥 (

34

𝑥 𝑡𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡 𝑥 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 𝑜𝑓 𝑑𝑎𝑖𝑙𝑦 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤

𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒)

1/3

Lower limit will be given

Upper limit

𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑚𝑖𝑡 + 𝑆𝑝𝑟𝑒𝑎𝑑

Return point

𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑚𝑖𝑡 + 1/3(𝑆𝑝𝑟𝑒𝑎𝑑)


Ryan has asked you to investigate the Miller-Orr model when:

1 Lower limit is $1000

2 Interest rate is 0.025 per cent per day

3 The standard deviation of daily cash flows is $500, so the variance is $250,000 (the variance is the

standard deviation squared)

4 Switching costs $20 per transaction

Required:

Calculate the spread, the upper limit and the return point.

Documents

CIMA F1 - Ningapi.ning.com/.../CIMAF1StudentNotesfinalversion.pdf.ld.pdf · | CIMA F1 5 The Verb Hierarchy Learning Objective Verbs Used Definition 1 Knowledge What are you expected