Advanced Corporate Reporting

(International Stream)
PART 3 TUESDAY 12 DECEMBER 2006

QUESTION PAPER Time allowed 3 hours This paper is divided into two sections Section A This ONE question is compulsory and MUST be answered THREE questions ONLY to be answered

Section B

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

The Association of Chartered Certified Accountants

Paper 3.6(INT)

Section A This ONE question is compulsory and MUST be attempted 1 The following draft group financial statements relate to Andash, a public limited company: Draft Group Balance Sheets at 31 October Assets Non-current assets Property, plant and equipment Goodwill Investment in associate 2006 $m 5,170 120 60 5,350 2,650 2,400 140 5,190 10,540 2005 $m 4,110 130 4,240 2,300 1,500 300 4,100 8,340

Current assets Inventories Trade receivables Cash and cash equivalents

Total assets Equity and Liabilities Equity attributable to equity holders of parent Share capital Other reserves Retained earnings Minority interest Total equity Non-current liabilities Long term borrowings Deferred tax Total non-current liabilities Current liabilities Trade payables Interest payable Current tax payable Total current liabilities Total liabilities Total equity and liabilities

400 120 1,250 1,770 200 1,970 3,100 400 3,500 4,700 70 300 5,070 8,570 10,540

370 80 1,100 1,550 180 1,730 2,700 300 3,000 2,800 40 770 3,610 6,610 8,340

Draft Group Income Statement for the year ended 31 October 2006 Revenue Cost of sales Gross profit Distribution costs Administrative expenses Finance costs interest payable Gain on disposal of subsidiary Profit before tax Income tax expense Profit after tax Attributable to equity holders of parent Attributable to minority interest $m 17,500 (14,600) 2,900 (1,870) (490) (148) 8 400 (160) 240 200 40 240

Draft Statement of changes in equity of the parent for the year ended 31 October 2006. Share capital $m 370 Other reserves $m 80 Retained earnings $m 1,100 200 (50) Total $m 1,550 200 (50) 60 10 1,770

Balance at 31 October 2005 Profit for period Dividends Issue of share capital Share options issued Balance at 31 October 2006

30 400

30 10 120

1,250

The following information relates to the draft group financial statements of Andash: (i) There had been no disposal of property, plant and equipment during the year. The depreciation for the period included in cost of sales was $260 million. Andash had issued share options on 31 October 2006 as consideration for the purchase of plant. The value of the plant purchased was $9 million at 31 October 2006 and the share options issued had a market value of $10 million. The market value had been used to account for the plant and share options.

(ii) Andash had acquired 25 per cent of Joma on 1 November 2005. The purchase consideration was 25 million ordinary shares of Andash valued at $50 million and cash of $10 million. Andash has significant influence over Joma. The investment is stated at cost in the draft group balance sheet. The reserves of Joma at the date of acquisition were $20 million and at 31 October 2006 were $32 million. Joma had sold inventory in the period to Andash at a selling price of $16 million. The cost of the inventory was $8 million and the inventory was still held by Andash at 31 October 2006. There was no goodwill arising on the acquisition of Joma. (iii) Andash owns 60% of a subsidiary Broiler, a public limited company. The goodwill arising on acquisition was $90 million. The carrying value of Broilers identifiable net assets (excluding goodwill arising on acquisition) in the group consolidated financial statements is $240 million at 31 October 2006. The recoverable amount of Broiler is expected to be $260 million and no impairment loss has been recorded up to 31 October 2005.

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(iv) On 30 April 2006 a wholly owned subsidiary, Chang, was disposed of. Chang prepared interim financial statements on that date which are as follows: Property, plant and equipment Inventory Trade receivables Cash and cash equivalents $m 10 8 4 5 27 10 4 6 7 27

Share capital Retained earnings Trade payables Current tax payable

The consolidated carrying values of the assets and liabilities at that date were the same as above. The group received cash proceeds of $32 million and the carrying amount of goodwill was $10 million. (Ignore the taxation effects of any adjustments required to the group financial statements and round all calculations to the nearest $million) Required: Prepare a group cash flow statement using the indirect method for the Andash Group for the year ended 31 October 2006 in accordance with IAS7 Cash Flow Statements after making any necessary adjustments required to the draft group financial statements of Andash as a result of the information above. (Candidates are not required to produce the adjusted group financial statements of Andash) (25 marks)

Section B THREE questions ONLY to be attempted 2 Misson, a public limited company, has carried out transactions denominated in foreign currency during the financial year ended 31 October 2006 and has conducted foreign operations through a foreign entity. Its functional and presentation currency is the dollar. A summary of the foreign currency activities is set out below: (a) Misson has a 100% owned foreign subsidiary, Chong, which was formed on 1 November 2004 with a share capital of 100 million euros which has been taken as the cost of the investment. The total shareholders equity of the subsidiary as at 31 October 2005 and 31 October 2006 was 140 million euros and 160 million euros respectively. Chong has not paid any dividends to Misson and has no other reserves than retained earnings in its financial statements. The subsidiary was sold on 31 October 2006 for 195 million euros. Misson would like to know how to treat the sale of the subsidiary in the parent and group accounts for the year ended 31 October 2006. (8 marks) (b) Misson has purchased goods from a foreign supplier for 8 million euros on 31 July 2006. At 31 October 2006, the trade payable was still outstanding and the goods were still held by Misson. Similarly Misson has sold goods to a foreign customer for 4 million euros on 31 July 2006 and it received payment for the goods in euros on 31 October 2006. Additionally Misson had purchased an investment property on 1 November 2005 for 28 million euros. At 31 October 2006, the investment property had a fair value of 24 million euros. The company uses the fair value model in accounting for investment properties. Misson would like advice on how to treat these transactions in the financial statements for the year ended 31 October 2006. (7 marks) (c) Misson has further entered into a contract to purchase plant and equipment from a foreign supplier on 30 June 2007. The purchase price is 4 million euros. A non-refundable deposit of 1 million euros was paid on signing the contract on 31 July 2006 with the balance of 3 million euros payable on 30 June 2007. Misson was uncertain as to whether to purchase a 3 million euro bond on 31 July 2006 which will not mature until 30 June 2010, or to enter into a forward contract on the same date to purchase 3 million euros for a fixed price of $2 million on 30 June 2007 and to designate the forward contract as a cash flow hedge of the purchase commitment. The bond carries interest at 4% per annum payable on 30 June 2007. Current market rates are 4% per annum. The company chose to purchase the bond with a view to selling it on 30 June 2007 in order to purchase the plant and equipment. The bond is not to be classified as a cash flow hedge but at fair value through profit or loss. Misson would like advice as to whether it made the correct decision and as to the accounting treatment of the items in (c) above for the current and subsequent year. (10 marks) Exchange rates 1 November 2004 31 October 2005 1 November 2005 31 July 2006 31 October 2006 Required: Discuss the accounting treatment of the above transactions in accordance with the advice required by the directors. (Candidates should show detailed workings as well as a discussion of the accounting treatment used.) (25 marks) Euro:$ 11 14 14 16 13 Average rate (Euro:$) for year to 12

15

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Seejoy is a famous football club but has significant cash flow problems. The directors and shareholders wish to take steps to improve the clubs financial position. The following proposals had been drafted in an attempt to improve the cash flow of the club. However, the directors need advice upon their implications. (a) Sale and leaseback of football stadium (excluding the land element) The football stadium is currently accounted for using the cost model in IAS16, Property, Plant, and Equipment. The carrying value of the stadium will be $12 million at 31 December 2006. The stadium will have a remaining life of 20 years at 31 December 2006, and the club uses straight line depreciation. It is proposed to sell the stadium to a third party institution on 1 January 2007 and lease it back under a 20 year finance lease. The sale price and fair value are $15 million which is the present value of the minimum lease payments. The agreement transfers the title of the stadium back to the football club at the end of the lease at nil cost. The rental is $12 million per annum in advance commencing on 1 January 2007. The directors do not wish to treat this transaction as the raising of a secured loan. The implicit interest rate on the finance in the lease is 56%. (9 marks) (b) Player registrations The club capitalises the unconditional amounts (transfer fees) paid to acquire players. The club proposes to amortise the cost of the transfer fees over ten years instead of the current practice which is to amortise the cost over the duration of the players contract. The club has sold most of its valuable players during the current financial year but still has two valuable players under contract. Player A. Steel R. Aldo Transfer fee capitalised $m 20 15 Amortisation to 31 December 2006 $m 4 10 Contract commenced 1 January 2006 1 January 2005 Contract expires 31 December 2010 31 December 2007

If Seejoy win the national football league, then a further $5 million will be payable to the two players former clubs. Seejoy are currently performing very poorly in the league. (5 marks) (c) Issue of bond The club proposes to issue a 7% bond with a face value of $50 million on 1 January 2007 at a discount of 5% that will be secured on income from future ticket sales and corporate hospitality receipts, which are approximately $20 million per annum. Under the agreement the club cannot use the first $6 million received from corporate hospitality sales and reserved tickets (season tickets) as this will be used to repay the bond. The money from the bond will be used to pay for ground improvements and to pay the wages of players. The bond will be repayable, both capital and interest, over 15 years with the first payment of $6 million due on 31 December 2007. It has an effective interest rate of 77%. There will be no active market for the bond and the company does not wish to use valuation models to value the bond. (6 marks) (d) Player trading Another proposal is for the club to sell its two valuable players, Aldo and Steel. It is thought that it will receive a total of $16 million for both players. The players are to be offered for sale at the end of the current football season on 1 May 2007. (5 marks) Required: Discuss how the above proposals would be dealt with in the financial statements of Seejoy for the year ending 31 December 2007, setting out their accounting treatment and appropriateness in helping the football clubs cash flow problems. (Candidates do not need knowledge of the football finance sector to answer this question.) (25 marks)

The Gow Group, a public limited company, and Glass, a public limited company, have agreed to create a new entity, York, a limited liability company on 31 October 2006. The companies line of business is the generation, distribution, and supply of energy. Gow supplies electricity and Glass supplies gas to customers. Each company has agreed to subscribe net assets for a 50% share in the equity capital of York. York is to issue 30 million ordinary shares of $1. There was no written agreement signed by Gow and Glass but the minutes of the meeting where the creation of the new company was discussed have been approved formally by both companies. Each company provides equal numbers of directors to the Board of Directors. The net assets of York were initially shown at amounts agreed between Gow and Glass, but their values are to be adjusted so that the carrying amounts at 31 October 2006 are based on International Financial Reporting Standards. Gow had contributed the following assets to the new company in exchange for its share of the equity: Cash Trade receivables Race Intangible assets contract with Race Property, plant and equipment $m 1 7 3 9 20

The above assets form a cash generating unit (an electricity power station) in its own right. The unit provided power to a single customer, Race. On 31 October 2006 Race went into administration and the contract to provide power to Race was cancelled. On 1 December 2006, the administrators of the customer provisionally agreed to pay a final settlement figure of $5 million on 31 October 2007, including any compensation for the loss of the contract. Gow expects York will receive 80% of the provisional amount. On hearing of the cancelled contract, an offer was received for the power station of $16 million. York would be required to pay the disposal costs estimated at $1 million. The power station has an estimated remaining useful life of four years at 31 October 2006. It has been agreed with the government that it will be dismantled on 31 October 2010. The cost at 31 October 2010 of dismantling the power station is estimated to be $5 million. The directors of Gow and York are currently in the final stages of negotiating a contract to supply electricity to another customer. As a result the future net cash inflows (undiscounted) expected to arise from the cash generating unit (power station) are as follows: 31 31 31 31 October October October October 2007 2008 2009 2010 $m 6 7 8 8 29

The dismantling cost has not been provided for, and future cash flows are discounted at 6 per cent by the companies. Glass had agreed to contribute the following net assets to the new company in exchange for its share of the equity: Cash Intangible asset Inventory at cost Property-carrying value Lease receivable Lease payable $m 10 2 6 4 1 (3) 20

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The property contributed by Glass is held on a 10 year finance lease which was entered into on 31 October 2000. The property is being depreciated over the life of the lease on the straight line basis. As from 31 October 2006, the terms of the lease have been changed and the lease will be terminated early on 31 October 2008 in exchange for a payment of $1 million on 31 October 2006 and a further two annual payments of $600,000. The first annual payment under the revised terms will be on 31 October 2007. York will vacate the property on 31 October 2008 and the revised lease qualifies as a finance lease. The cash paid on 31 October 2006 is shown as a lease receivable and the change in the lease terms is not reflected in the values placed on the net assets above. The effective interest rate of the lease is 7%. Glass had entered into a contract with an agency whereby for every new domestic customer that the agency gained, the agency received a fixed fee. On the formation of York, the contract was terminated and the agency received $500,000 as compensation for the termination of the contract. This cost is shown as an intangible asset above as the directors feel that it represents the economic benefits related to the future reduced cost of gaining retail customers. Additionally, on 31 October 2006, a contract was signed whereby York was to supply gas at fair value to a major retailer situated overseas over a four year period. On signing the contract, the retailer paid a non refundable cash deposit of $15 million which is included in the cash contributed by Glass. The retailer is under no obligation to buy gas from York but York cannot supply gas to any other company in that country. The directors intend to show this deposit in profit or loss when the first financial statements of York are produced. At present, the deposit is shown as a deduction from intangible assets in the above statement of net assets contributed by Glass. (All calculations should be made to one decimal place and assume the cash flows relating to the cash generating unit (electricity power station) arise at the year end.) Required: (a) Discuss the nature and accounting treatment of the relationship between Gow, Glass and York. (5 marks)

(b) Prepare the balance sheet of York at 31 October 2006, using International Financial Reporting Standards, discussing the nature of the accounting treatments selected, the adjustments made and the values placed on the items in the balance sheet. (20 marks) (25 marks)

Jones and Cousin, a public quoted company, operate in twenty seven different countries and earn revenue and incur costs in several currencies. The group develops, manufactures and markets products in the medical sector. The growth of the group has been achieved by investment and acquisition. It is organised into three global business units which manage their sales in international markets, and take full responsibility for strategy and business performance. Only five per cent of the business is in the country of incorporation. Competition in the sector is quite fierce. The group competes across a wide range of geographic and product markets and encourages its subsidiaries to enhance local communities by reinvestment of profits in local educational projects. The groups share of revenue in a market sector is often determined by government policy. The markets contain a number of different competitors including specialised and large international corporations. At present the group is awaiting regulatory approval for a range of new products to grow its market share. The group lodges its patents for products and enters into legal proceedings where necessary to protect patents. The products are sourced from a wide range of suppliers, who, once approved both from a qualitative and ethical perspective, are generally given a long term contract for the supply of goods. Obsolete products are disposed of with concern for the environment and the health of its customers, with reusable materials normally being used. The industry is highly regulated in terms of medical and environmental laws and regulations. The products normally carry a low health risk. The Group has developed a set of corporate and social responsibility principles during the period which is the responsibility of the Board of Directors. The Managing Director manages the risks arising from corporate and social responsibility issues. The group wishes to retain and attract employees and follows policies which ensure equal opportunity for all the employees. Employees are informed of management policies, and regularly receive in-house training. The Group enters into contracts for fixed rate currency swaps and uses floating to fixed rate interest rate swaps. The cash flow effects of these swaps match the cash flows on the underlying financial instruments. All financial instruments are accounted for as cash flow hedges. A significant amount of trading activity is denominated in the Dinar and the Euro. The dollar is its functional currency. Required: (a) Describe the principles behind the Management Commentary discussing whether the commentary should be mandatory or whether directors should be free to use their judgement as to what should be included in such a commentary. (13 marks) (b) Draft a report suitable for inclusion in a Management Commentary for Jones and Cousin which deals with: (i) the key risks and relationships of the business (9 marks) (3 marks)

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

(Marks will be awarded in part (b) for the identification and discussion of relevant points and for the style of the report.) (25 marks)

End of Question Paper