MARKING SCHEME

FINANCIAL ACCOUNTING
MAN2907L
SUPPLEMENTARY PAPER AUGUST 2010

DO NOT INCLUDE IN ANY EXAMINATION SCRIPT

***
Section A
Question

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

B
X
X

X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X

Section B
Question One
(a)

Investment income of Celsius

From Hitemp

000

000

60%

240

144

20%

60

12
156

From Lotemp

30%

740

222
378
(10% of marks)

(b)

Consolidated Income statement for the Celsius Group for the year ended 31
December
2009
000
Sales (13,500+3,300-750)
Cost of sales (6,960+1,860-750+75)
Gross profit
Expenses (4,200+660)
Operating profit
Share of profit to associate (W1)
Profit before tax
Income tax (600+240)
Share of tax of associate (30% X 440)
Total comprehensive income for the year
Attributable to:
Owners of the parent
Minority interest (W2)

16,050
(8,145)
7905
(4,860)
3,045
475
3,520
(840)
(132)
2,548
2,308
240
2,548

Workings
W1
Share of profit of associate
Profit before tax 30% x 1,720
Less: URP stock (4,050/9000) x 300 = 135 x 0.3
W2

Minority interest
000
540 Profit after tax Hitemp
60 Preference dividend
480 For ordinary shareholders

000
516
(41)
475
000

x 0.8 =
x 0.4 =

48
192
240

(40% marks)
(c)

Celsius Group Retained Profit

000
Retained profit c/f: Celsius

2,568

Hitemp

990

Lotemp (30% x 2,250)

675
4,233

Hitemp pre-acquistion profit

(144)

Minority interest

(396)

Lotemp b/f (30% x 1,710)

(513)

URP Stock:

Hitemp

(75)

Lotemp

135

Balance c/f

3,064
(20% marks)

(d) Any two of the following:

i)

As part of a business combination it is necessary to determine the goodwill as the

residual amount in the process of allocating the consideration paid to the identifiable
assets, liabilities and contingent liabilities acquired. IFRS 3 Business combination
requires the allocation process to be completed within a period of 12 months from the
date of acquisition.
Within this allowed period it is likely that the parent company will have to produce annual
financial statements. Thus it may be necessary to determine (some) fair values on a provisional
basis. The consequences are that in the following accounting period the provisional values may
need to be restated. IFRS 3 requires the conformed values to be recognized as from the date of
acquisition. This would mean restating the goodwill and any asset or liability whose provisional
estimate has been revised in the corresponding amounts of the financial statements following
the year of acquisition.
This would mean that the corresponding figures presented would not agree with the original
presentation of those financial statements. Depreciation charges (and possible impairment of
goodwill) may also need revision. It is important to note that any adjustment to provisional
values must reflect conditions that existed at the date of acquisition. Fair value changes as a
result of subsequent events are not part of this process.
ii) Another situation where corresponding amounts are stated is for the correction of errors
(discovered subsequent to publication of the financial statements). The error may be one of
recognition, measuremet or presentation. Such errors must be either material or immaterial
and deliberate (i.e. done internationally to improve the appearance of the financial
statements). The revision of an Accounting Estimates and Errors requires prior period errors
to be accounted for retrospectively. This is achieved by restating any affected comparative

amounts for the prior periods presented or by restating opening balance of assets, liabilities
and equity if the error occurred before the earliest prior period presented.
iii) comparability is an important characterstic of financial statement. If a companychanges an
accounting policy this is likely to impair comparibilty because the current year;s financial
statements (applying a new accountin policy) will have been prepared on a different basis to
the corresponding amounts (using the previous policy to be applied retrospectively. This
means that the financial statements presented (including corresponding amounts) should be
presented if the new accounting policy had always been in place. This will mean that the
corresponding financial statements will be different to when they were originally published.
(30% of marks)
(Total 100% marks)

Question Two
(a)

Dividend per share

Dividend for the year/ Number of shares in issue
10,000/50,000 = 20 pence per share
Dividend cover
Profit after tax for ordinary shareholders/Dividend
11.150/10,000 = 1.1 times
Earning per share
Net profit after tax/No. of ordinary shares
11,150/50,000 = 22 pence per share
Price earning ratio
Price per share/Earning per share
150/22.3= 6.7
Debt/equity ratio
1,000/32,520 = 3%
Interest cover
Profit before interest and taxation/Interest
12,715/50 = 254 times
(40% marks)

(b)

Comment on Perths ratios

Dividend per share

The level of dividend per share available to Perths shareholder is double that available to
Inverness. This may suggest a generous level of dividend which will please shareholders in the
short term.
Dividend cover
The level of dividend does not appear to be justified by the available profit. It also
suggests that this level of dividend may not be sustainable in the future.
Earning per share
The EPS for Perth is similar to Invernesss EPS. However, Inverness has retained half
its earning for future investment. This is not the case for Perth and would suggest profit
level may stagnate.
Price earning ratio
A comparison of the PE ratio suggests that investors are keener to invest in Inverness
than Perth. This may be because of concerns regarding the future profitability to Perth.
Debt/equity ratio
The gearing ratio for Perth seems low in comparison with Inverness. It may be that Perth
is not borrowing sufficiently to invest in the future of the company. Alternatively Inverness
may have high borrowings.
Interest cover
Perth can comfortably afford to meet its interest charges, so can Inverness. This suggest
that perth could afford to increase its borrowing to invest.
(20% marks)
(c)

Dividend

Preference shares

Ordinary shares

Specified by terms on

Dividend is payable at the

which the share were issued.

discretion of the directors.

Usually, though not always

Variable.

at a fixed rate.
Often guaranteed by terms.

Dependent on cash
Flow/future plans.

Return of

Preferential right to return of

Capital

capital on liquidation.

No guarantee of return of
Capital on liquidation.

Voting rights

No right to vote at meetings.

Risk

Lower risk of loss of capital.

Debt or equity? Regarded as Debt.

Current ratio

Carries voting rights.

Risk bearing capital.
Regarded as equity.

Defined as: current assets/current liabilities.

In the short term, this is likely to improve as the issue of shares will
improve the companys
cash position, thereby increasing current assets, and consequently the current ratio.
In the longer term, however this is likely to be a lesser a improvement in the current ratio. If the
expansion for which the funds are to be used is successful, there is likely to be an increase I
non-current assets and stock levels as well as the amounts due from customers and payable to
suppliers.
Overall the increase in current assets (stocks and debtors) is likely to be greater than the
increase in creditors, leading to an improvement (probably minor) in the current ratio.
Gearing ratio

Defined as: debt as a % of equity (ordinary shares + reserves)

The effect on the gearing ratio will depend on the type of shares which

are issued.

As noted above, preference shares will be regarded as debt. This will have the effect of
increasing the gearing ratio.
If ordinary shares are issued, the gearing ratio will reduce.

(25% marks)

(d) Preference shares will lead to an increase in the gearing ratio, which means that further
pressure will be brought to bear on that measure.

A further point to bear in mind is the effect of the dividend. As it is likely that a guaranteed
dividend will have to be one of the terms under which the preference shares are issued,
there will be an ongoing requirement to pay a dividend. If ordinary shares were issued, this
would not be the case.
(15% of marks)
(Total 100% marks)

Question Three
(a)

i) Nature of depreciation and impairment

Depreciation is an expense which is charged to reflect the value of economic benefits which
have been consumed due to the use of a fixed asset during the reporting period. This is an
application of the accruals principle, under which profit is calculated by charging expenses
against profit as they are incurred. The annual charge is normally calculated on the basis of a
predetermined policy. When accounts are prepared, the total depreciation to date is deducted
from the cost to arrive at the net book value. It is this value that is reported on the statement of
financial position.
Impairment is the term used when the value (effectively the market value) of a fixed asset falls
below the net book value. Impairment arises for a reason other than the consumption of
economic benefits, for instance damage to an asset, or a change in market conditions.
ii) A fall in the value of non-current assets
If an asset falls in value, it is necessary to consider whether the carrying value continues to be
fairly stated. The carrying value must not be more than the recoverable amount. This is defined
as the higher of the amount which could be realized from disposal less any costs of disposal
(net realizable value); and the present value of cash flows resulting from the continued use of
the sheet.
iii) A revaluation of non-current assets.
Initially non-current assets are reported as cost less accumulated depreciation. If certain assets
are appreciating in value it is open to the directors to choose to revalue such assets.
Revaluation is not obligatory, but if it is chosen the following principles must be followed:
-

All assets in the same class must be revalued;

Revaluations must be kept up to date;

Depreciation is charged on the revalued amount;

The increase(s) I value are not included in the calculation of profit, but are credited to a
revaluation reserve;

The balance on the revaluation reserve is not available for distribution, as it has not been
realized.

iv) Internally generated tangible assets such as goodwill

Internally generated assets may only be recognized if there is a readily ascertainable market
value for the asset. This means that there must be an active market for the asset. From this it
follows that such assets can not be unique. There can be no clearer example of a unique asset
than a companys goodwill. While goodwill will benefit the company in the future, it cannot be
traded on the open market. Therfor, it is not recognized in the financial statements.
(40% marks)

(b)

Nature of depreciation and impairment

The directors are required to choose the method which is used to charge depreciation. In doing
so, they should seek to reflect the consumption of economic benefits which occurs. Once
chosen, a method of depreciation should be consistently applied to all assets in a class. From
the above it follows that the value of economic benefits consumed by using assets should be
charged as an expense to the profit and loss account.
It is accepted that freehold land is not consumed by the activities of business (unless the land is
physically damaged, as would be the case in a mining company) and therefor need not be
depreciated. On the assumption that the normal activities of Trenchard do not damage the land,
the policy of not depreciating would appear to be appropriate.
It is often the case that companies depreciate machinery on a straight line basis and vehicles on
a reducing balance basis. The straight line basis means that the depreciation charge is the
same from year to year, while the reducing balance basis leads to reducing charges in each
successive year. As vehicles tend to require increasing maintenance expenditure as they
become older, the companys policies for these classes of assets would seem to be appropriate.
(10% marks)
(c)

Depreciation:

Buildings
Cost 1,800,000, depreciation straight line over 30 years
Thus depreciation charge is 60,000 per annum, and the net book value at 31 March 2010 is:
Cost

1,800,000

Less depreciation to date

720,000 (660,000+60,000)

Net book value

1,080,000

However, the value of the buildings is 1,000,000. As this is less than the net book value, and
assuming the conditions giving rise to the new valuation are continue in the long term, there has
been impairment, and the value must be reduced to 1,000,000.
Plant ad Machinery
Depreciation charge is

2,480,000 x 15% = 372,000

Vehicles
Depreciation charge is

1,600,000

Less

980,000

NBV

620,000

x 20%

124,000

Revaluation of land
The directors are not required to reflect the increase in value of the land in the financial
statements, but may choose to do so. However, as the land has not been sold, the increase is
not a realized gain. As such it is only allowed to reported in the other comprehensive income
and then taken to a revaluation reserve.
Increase in value of land 4,800,000 - 4,500,000 = 300,000

(20% marks)
(d)

Trenchard Revised Draft Statement of Financial Position

000
Non-current assets (W1)

16,364

Current assets

3,470

Creditors: amounts falling due within one year

(2,640)
17,194

Creditors: amounts falling due in more one year

Total net assets

(1,500)
15,694

Capital and reserves:

Share capital

3,000

Retained profit (W2)

12,394

Revaluation reserve

300
15,694

W1

000

Non-current asset value as given

16,700

Add: Revaluation

300

Less: Depreciation/Impairment

(636) (140+372+124)
16,364

W2
Retained profit as given
Less: Depreciation/impairment

13,030
(636)
12,394
(30% marks)
(Total 100% marks)

Question Four
(a)

There are many users of financial statements, including lenders, customers, suppliers,
employees (The question only required two users to be identified)

The IACBs position is that while some users can obtain specialized information (for example,
managers have access to detailed management information, which is tailored to their specific
needs) the needs of a wide range of users will best be met by general purpose financial
statements. Such reports are designed primarily to meet the needs of the investors (both
present and future) in the company.
The respective needs of the users noted above may be summarised as follows:
Lenders will be primarily concerned with the ability of the company to meet the payments
required by the loan agreement. In particular they will wish to ensure that interest will be paid on
due date and capital repayments will be paid when they fall due.
Customers wish to have a reasonable certainty that they can join community of supply and will
therefore wish to assess the financial stability of the company. The interest in community will be
increased if the customer has been provided with nay form of warranty.
The prime concern of suppliers will be the ability of the company to pay for goods acquired on
credit. To some extent suppliers will also wish to ensure that if the company is a major customer,
there is a reasonable prospect of the company continuing to trade for the foreseeable future.
The stability of companys financial position and ots ability to offer reasonable rates of pay (and
in current economic climate, to meet pension obligations) will be the most pressing issue for
employees.
These needs contrast with the needs of shareholders, which are essentially about ensuring that
the directors have discharged their responsibility of stewardship, by achieving a return
commensurate with the level of risk involved in the business.
Shareholders will therefore be concerned to assess the returns generated by the company in
light of the overall investment.
While the company may be producing returs which, for example, will satisfy lenders that the
payments due under the loan agreement will continue to be made, shareholders will assess the
returns generated by the company after payment of costs such as loan interest. Equally, while
suppliers may be concerned with short term liquidity, shareholders will be more concerned with
long term growth.
(20% marks)
(b)

Relevance refers to the ability of information to influence the decisions of the user. This
means that the user should be able to use the information to predict what may happen in
the future, and also to confirm any judgments which were made in the past. The
relevance of information can be enhanced (or reduced) by the way it is presented. The
requirement to report continuing and discounted activities separately in the profit and

loss account is an example of this. This form of presentation allows users to assess the
underlying and continuing profitability of the company.
For example, employees will wish to assess the likelihood of continued employment by
reference to the profit generated by continuing activities.
Reliability means that the user can have reasonable confidence that the information can be
relied on. This is generally taken to mean that information is neutral, materially correct, complete
and prudent.

The neutrality of financial information is enhanced by requirement to meet the needs of a wide
range of users, which means that it is not presented in a manner which seeks to influence the
user in a particular way. Rather the user is left to apply his or her own judgment.
The notion of materiality is central to financial reporting. While one cannot expect
financial to be absolutely correct, it is reasonable to expect that they are free from
material error or omission. An item is considered material if its omission or misstatement
could be reasonably expected to influence the decision of users. It almost goes without
saying that if financial information is incomplete, it is less than useful. However it must
be remembered that completeness must be judged in the context of materiality.
Prudence is often referred to as taking a pessimistic view. While few users would wish
financial statements to include unjustifiably optimistic assumptions, prudence should
only be exercised if there is an element of uncertainty with regard to a particular item.
Reliability is an important issue for all users, but specific reference might be made to the
needs of lenders, who will be concerned to ensure that the financial statements provide
reliable information about companys liabilities, in order to allow an assessment of the
companys ability to service existing and proposed debt.
It is important that users are able to make comparisons of financial performance over
time. As this will allow users to assess trends, it is relevant in all cases. Comparability is
most often achieved by applying accounting policies consistently from one period to
next, and ensuring that any changes in accounting policies are disclosed, together with
an evaluation of the effect of change. This is of importance to lenders, particularly those
who have providing long term funds to the company.
For information to be understandable, users must appreciate its significance. The extent
to which information can be understood is affected by the manner in which it is
presented. It is a basic tenet of financial reporting that users are assumed to have
reasonable knowledge, and that they will take reasonable care in reviewing information.
This is of significance to, for example, potential lenders who will be expected to carry out
a reasonably through review of the companys position before committing any funds to
the company.
(55% marks)
(c)
The arguments for having accounting standards:
Accounting standards restrict the number of choices in the methods used to prepare financial
statements and therefore reduce the risk of creative accounting. This would help the users of
accounts to compare the financial performance of different organizations.

Companies are obliged to disclose the accounting policies they have used in the preparation of
accounts. This should help the users of accounts better understand the information presented.
Accounting standards should increase the credibility of accounts by increasing uniformity of
accounting treatment between companies.
Accounting standards require companies to disclose information which might not want to
disclose if the standards did not exist.
Accounting standards provide a focal point for discussion about accounting practice.
The arguments against having accounting standards:
Sometimes the accounting method advocated may not be appropriate in some particular
circumstances or for certain types of organization.
Accounting standards may be overly prescriptive, reducing flexibility and the opportunity for
accountants to use their professional judgment.
Standards may be too general, resulting in a lack of clear guidance in some situations.

If standards contain too many detailed rules, there is a danger that preparers will develop
creative accounting techniques that technically adhere to the rules but conflict with the overall
aims and principles behind financial statements.

Accounting standards may have been drafted as a consequence of a particular pressure group.

Some accounting standards can be expensive to comply with.

(25% marks)
(Total 100% marks)

Question Five
(a)

Statement of cash flows for the year ended 31 March 2010

000

000

Operating activities
Profit before tax

545

Depreciation

113

Loss on disposal

21
679

Inventories increase

(4)

Receivables increase

(4)

Payable increase

Cash generated from operations

677

Taxation paid (927 + 343 1,053)

(217)

Net cash from operating activities

460

Investing activities
Purchase of non-current assets

(700)

Proceeds on disposal (800 -350 -21)

429

Net cash used in investing activities

(271)

Financing activities
Equity dividends paid (110 + 200 140)

(170)

Net cash used in financing activities

(170)

Increase in cash and cash equivalents in the year

19

Cash and cash equivalents B/F

53

Cash and cash equivalents B/F

72

Note: IAS 7 allows interest paid and dividend paid to be an operating cash flow or a financing
cash flow. Interest received can be an operating cash flow or an investing cash flow. Either of
these options from student is acceptable.
(60% marks)
(b)

Ways in which a company could manipulate the year-end cash position (elaboration
is needed for good marks):
-

Offering short term incentives to customers to increase sales

Reducing the selling price to increase sales

Cutting expenses

Disposing of assets

Delaying payments to creditors

Encouraging debtors to pay early by offering discounts

Resourcing effective debt collection procedures

(40% marks)
(Total 100% marks)