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F1
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Contents
A. REGULATORY ENVIRONMENT AND CORPORATE GOVERNANCE 3
1. Regulatory environment 3
2. External audit and the audit report 9
3. Corporate Governance 13
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C. ACCOUNTING STANDARDS 19
5. IAS 1 Presentation of Financial Reporting 19
6. IAS 7 Statement of Cash Flows 23
7. IAS 16 Property, Plant and Equipment 31
8. IAS 23 Borrowing costs 37
9. IAS 20 Government Grants 39
10. IAS 40 Investment Properties 41
11. IAS 38 Intangible Assets 43
12. IAS 36 Impairment of Assets 45
13. IFRS 5 Non-current assets held for sale and discontinued operations 49
14. IAS 19 Employee Benefits 53
15. IAS 21 Foreign Currency Transactions 57
16. IAS 10 Events after the reporting period 59
17. IAS 2 Inventories 61
18. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors 63
19. IAS 12 Income Taxes 65
20. IFRS 8 Operating Segments 67
21. IAS 34 Interim financial Reporting 69
22. IFRS 13 Fair value Measurement 71
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Chapter 1
REGULATORY ENVIRONMENT
2. Regulatory environment
The key elements of the regulatory environment are
๏ Local corporate law – Accounting regulations must follow the legal requirement of the
country where it is registered
๏ Local and international conceptual frameworks – Accounting standards are driven by
conceptual frameworks, the fundamental principles/ideas that must be followed in
developing accounting standards.
๏ Local and international financial reporting standards – Accounting standards are
developed both locally and internationally. Companies will follow either local rules or
international rules depending on the local corporate laws.
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๏ Law
๏ Religion
๏ Social attitudes
๏ Professional bodies
๏ Businesses
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Relationships that bias or unduly influence the professional judgment of the professional
accountant should be avoided.
4.3. Professional Competence and Due Care
A professional accountant has a continuing duty to maintain professional knowledge and skill
at the level required to ensure that a client or employer receives competent professional
service based on current developments in practice, legislation and techniques. A professional
accountant should act diligently and in accordance with applicable technical and professional
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Example 1 – Ethics
Which ONE of the following is NOT a fundamental principle identified in CIMA’s code of
ethics?
A Professional competence
B Professional behaviour
C Integrity
D Independence
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๏ Advocacy threat – Arising if promoting a position or opinion to the point that your
subsequent objectivity is compromised.
๏ Familiarity – When you become so sympathetic to the interests of others as a
result of a close relationship that your professional judgement
becomes compromised.
๏ Intimidation – When you are deterred from acting objectively by actual or
perceived pressure or influence
6. Regulatory bodies
The regulatory bodies ensure that both local and international frameworks and standards are
upheld to take account of the ever changing nature of corporate business.
6.1. Financial reporting standards
๏ International Financial Reporting Standards (IFRSs) – A global set of accounting
standards that are prepared on international conceptual frameworks
๏ Local Generally Accepted Accounting Principles (Local GAAP) – Accounting
standards that are prepared following local conceptual frameworks.
6.2. Principles of financial reporting standards
๏ Principles based – the preparation of the accounting standards follows the principles/
idea laid out in the conceptual framework, which results in more judgement in the
preparation of the financial statements
๏ Rules based – the preparation of the accounting standards follows rules, as there are
no fundamental principles to follow.
6.3. Role and structure of regulatory bodies
IFRSs are developed and published by the International Accounting Standards Board (IASB).
The IASB has 14 members, 12 of whom are full-time employees. Appointment of members is
primarily based on their having sufficient technical expertise to ensure the IASB has the
experience to tackle the relevant business and economic issues.
Seven of the full-time members of staff are responsible for liaising with national standard-
setters in order to promote the convergence of accounting standards.
The IASB has complete responsibility for all technical matters, including the preparation and
publication of international financial reporting standards (IFRS) and exposure drafts;
withdrawal of IFRSs and final approval of interpretations.
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IFRS Foundation oversees the processes of the IASB. Its objectives are:
๏ Develop a set of high, quality, understandable, enforceable and globally accepted
international accounting standards.
๏ Promote the use and application of those standards
๏ Take account of the financial reporting needs of emerging economies and small and
medium-sized entities
๏ Bring about convergence on national accounting standards and IFRSs
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IFRS Advisory Council will consult with local standard setters, academics and other interested
parties to determine their views on a range of issues.
IFRS Interpretations Committee is responsible for reviewing new financial reporting issues
and issuing guidance on the application of IFRSs.
As well as the IASB and its associated bodies, other bodies can also influence the setting of
IFRSs.
International Organisation of Securities Commissions (IOSCO) – represent the worlds’
securities markets regulators
Financial Accounting Standards Board (FASB) – US accounting standards setting body
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Chapter 2
EXTERNAL AUDIT AND THE AUDIT
REPORT
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In preparing their report the auditors are required to consider the following:
๏ Compliance with legislation
๏ Truth and fairness of accounts
๏ Adequate records and returns
๏ Agreement of accounts to records
๏ Consistency of other information
In order to carry out the duties, the auditors have the following rights:
๏ Access to records
๏ Information and explanation
๏ Attendance at general meetings
๏ Right to speak at general meetings
๏ Rights in relation to written resolutions
๏ Right to require laying of accounts
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opinions on them
4. Basis of Opinion – explaining how the audit work was done and the opinions reached
5. Opinion – whether the Accounts are true and fair, and whether they have been
properly prepared
6. Date and Signature
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A An unmodified opinion
B An adverse opinion
C An emphasis of matter
D A qualified opinion
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Chapter 3
CORPORATE GOVERNANCE
Directors are acting as agents of the entity as they run the business on behalf of the
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shareholders.
Shareholders need to ensure that the systems and processes that are in place to control the
running of the entity are regularly monitored and controlled.
Corporate governance is the process that ensures the systems and processes are monitored
and controlled.
Corporate Governance has come to the attention of many over recent years following major
corporate scandals.
๏ Enron
๏ WorldCom
๏ Co-Operative Group
๏ Volkswagen Group
All of the above corporate scandals came about due to inappropriate corporate governance
in place.
Rules based
๏ Emphasises measurable achievements by companies
๏ Can easily be applied in jurisdictions where the letter of the law is stressed.
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Chapter 4
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3. Underlying assumption
Going concern – the financial statements are prepared on the basis that an entity will
continue in operation for the foreseeable future.
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reality.
‣ Neutral – free from bias
‣ Complete – includes all necessary information, descriptions and explanations.
‣ Free from error – in the descriptions and processes the financial information is
produced
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C. ACCOUNTING STANDARDS
Chapter 5
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X
Current assets
Inventories X
Trade and other receivables X
Cash and cash equivalents X
X
Total assets X
Non-current liabilities
Redeemable preference share capital X
Borrowings X
X
Current liabilities
Trade and other payables X
Dividends payable X
Overdraft X
Tax payable X
X
Total equity and liabilities X
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Statement of profit and loss and other comprehensive income for the year ended
[date]
$’000s
Revenue X
Cost of sales (X)
Gross profit X
Distribution expenses (X)
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Chapter 6
IAS 7 STATEMENT OF CASH FLOWS
Statement of cash flows for the year ended [date]
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$m $m
Operating Activities
Profit before tax X
Depreciation X
Impairment X
Gain/loss on disposal of PPE (X)/X
Finance cost X
Inventory (X)/X
Receivables (X)/X
Payables X/(X)
Cash generated from operations X
Interest paid (X)
Tax paid (X)
Cash generated from operating activities X
Investing Activities
Proceeds from sale of PPE X
Purchase of PPE (X)
Dividends received X
Cash generated from investing activities X
Financing Activities
Proceeds from issue of shares X
Loan issue/repayment X/(X)
Dividend paid (X)
Cash generated from financing activities X
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Current liabilities
Overdraft - 150
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2. Operating activities
The principal revenue producing activities of the entity and other activities that are not
investing or financing activities.
IAS 7 allows two methods to calculate the cash generated from operations.
๏ Direct method – using nominal ledger T-accounts
๏ Indirect method – using the financial statements
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$000
Cash received from customers X
Cash payments to suppliers and employees X
Calculate the cash from operating activities to appear in the company’s statement of cash
flows.
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$000
Profit before taxation X
Depreciation X
Investment income (X)
Finance cost X
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$’000
Profit before interest and tax 3,200
Finance cost (500)
Investment income 150
Profit before tax 2,850
Income tax (350)
Profit for the year 2,500
Statement of financial position (extract) as at 31 December 20X5
20X5 20X4
$’000 $’000
Current assets
Inventory 6,500 7,200
Receivables 4,300 3,900
Cash 250 500
Current liabilities
Trade payables 5,200 6,500
Depreciation for the year was $850,000.
Calculate the cash from operating activities to appear in the company’s statement of cash
flows.
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Interest payable
B/f X
C/f X
X X
Tax payable
B/f – current tax X
X X
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3. Investing activities
The acquisition and disposal of non-current assets (PPE, intangibles and investments)
3.1. Disposal of PPE
Profit/loss on disposal = Proceeds − Carrying value
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PPE (CV)
B/f X
Depreciation X
Revaluation X
Disposal X
Cash - additions (β)
C/f X
X X
Equity
Revaluation surplus 500 150
Additional information:
1. Depreciation of $850,000 has been charged in the year
2. An item of machinery was disposed of for $120,000 with a carrying value of $100,000
Calculate the cash outflow for the purchase of property, plant and equipment to appear in
the statement of cash flows.
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Interest receivable
B/f X
C/f X C/f X
X X
4. Financing activities
Activities that result in changes in the size and composition of the contributed equity and
borrowings of the entity
Debt
Issue of debt = increase in borrowings
Repayment of debt = decrease in borrowings
Equity
Issue of shares = movement in share capital and share premium
Dividend paid
Retained earnings
B/f X
C/f X
X X
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$000
Revenue 360
Cost of sales and other expenses 150
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Current liabilities
Trade payables 21 15
Income tax 47 68 40 55
709 732
Additional information:
1. During the year, the company paid a dividend of $36,000
2. Included within expenses are a loss on disposal of $9,000 and depreciation of $59,000
3. Property, plant and equipment includes $45,000 for the purchase of a new piece of
machinery
Prepare a statement of cash flow for the year ended 31 December 20X5 in accordance with
the requirements of IAS 7.
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Chapter 7
IAS 16 PROPERTY, PLANT AND
EQUIPMENT
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1. Initial Recognition
The cost of an item of property, plant and equipment is made up of:
๏ Purchase price, including irrecoverable taxes and after deducting trade discounts (not
cash/settlements discounts)
๏ Costs directly attributable to bringing the asset to the location and condition necessary
for it to be capable of operating in the manner intended by management (e.g. site
preparation, delivery and handling costs, installation and assembly, testing, professional
fees)
Note: Initial estimate of the costs of dismantling and removing the item and restoring
the site on which it is located where a present obligation exists are included in the
cost of the asset at present value.
The following costs are not included in the cost of an item of property, plant and
equipment:
๏ Costs that are incidental to the construction (e.g. errors)
๏ Start-up costs
๏ General overhead costs
๏ Initial losses before the asset reaches its intended use
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$
Shipping & handling charges 3,500
Pre-production testing 12,000
Site preparation costs 17,000
General overheads 4,500
Included in the site preparation costs is $3,000 which is as a result of Jones providing incorrect
requirements for the asset.
Calculate the initial cost of the machine to be recorded in accordance with IAS 16 Property,
plant and equipment.
2. Subsequent Expenditure
Subsequent expenditure on property, plant and equipment should only be capitalised if it
improves the asset beyond its originally assessed standard of performance e.g. faster
production or higher quality output. All other subsequent expenditure should be written off.
Separate components, inspection and overhaul costs
If items of property, plant and equipment comprise separate components with different
useful lives the separate components should be capitalised as separate assets and each
depreciated over their useful lives.
Normally all inspection and overhaul costs are expensed as they are incurred. However, to the
extent that they satisfy the IAS 16 rules for separate components, such costs should be
capitalised separately as a non-current asset and depreciated over their useful lives.
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3. Depreciation
๏ Straight line
๏ Reducing balance
Depreciation starts when the asset is ready for its intended use and not from when it starts to
be used.
Any change in estimate is applied prospectively by applying the new estimates to the
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4. Subsequent measurement
Revaluations
Example 4 - Revaluation
Charlie bought a building on 1 January 20X5 for $500,000 with an estimated useful economic life of
twenty five years and no residual value. A straight line method of depreciation was adopted.
On 1 January 20X7 Charlie decided to revalue all non- current assets in line with IAS 16. The
building was revalued at $600,000. The useful economic life is unchanged.
Show how the revaluation would be accounted for in the financial statements for the year
ended 31 December 20X7.
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Chapter 8
IAS 23 BORROWING COSTS
Borrowing costs, net of income received from the investment of the money borrowed, on a
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Capitalisation must stop when the asset is ready for its use (whether or not it is being used) or
when there is no active construction.
Capitalisation for specific borrowings is capitalised using the effective rate of interest.
Venezuela commenced the construction of an item of property, plant and equipment on 1 January
2015 for which it used its existing borrowings. $10 million of expenditure was used on 1 January
and $15 million was used on 1 July.
Calculate the amount of interest to be capitalised as part of the non-current assets.
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Chapter 9
IAS 20 GOVERNMENT GRANTS
Recognise the grant when the:
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Chapter 10
IAS 40 INVESTMENT PROPERTIES
Investment property is property (land or a building – or part of a building – or both) held) to
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Initial measurement
Investment properties should initially be measured at cost plus directly attributable costs.
Subsequent measurement
Fair value model Cost model
๏ The investment properties are revalued ๏ The investment properties are held
to fair value at each reporting date using the benchmark method in IAS 16
๏ (cost)
Gains or losses on revaluation are
recognised directly through profit or ๏ The properties are depreciated like any
loss other asset
๏ The properties are not depreciated
Transfers into and out of investment property should only be made when supported by a
change of use of the property.
๏ IP to owner occupied (IAS 16) – Fair value at date of change
๏ IP to inventory (IAS 2) – Fair value at date of transfer
๏ Owner occupied (IAS 16) to IP – Revalue under IAS 16 and then treat as IP
๏ Inventory (IAS 2) to IP – Fair value on change and gain/loss to profit or loss
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Chapter 11
IAS 38 INTANGIBLE ASSETS
An identifiable, non-monetary asset with no physical substance but has value to the business.
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๏ patents
๏ brand names
๏ licences
3 factors to consider
Separate acquisition
Capitalise at cost (purchase price, import duties and non-refundable purchase taxes less any
trade discounts) plus any directly attributable costs (e.g. legal fees, testing costs).
Amortisation is charged over the useful life of the asset, starting when it is available for use.
Research
Research expenditure is charged immediately to profit or loss in the year in which it is
incurred.
Development
Development expenditure must be capitalised when it meets all the criteria.
๏ Sell/use
๏ Commercially viable
๏ Technically feasible
๏ Resources to complete
๏ Measure cost reliably (expense)
๏ Probable future economic benefits (overall)
Internally generated
Internally generate brands, mastheads cannot be capitalised as their cost cannot be
separated from the overall cost of developing the business.
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Revaluations
An intangible asset can only be revalued if there exists an active market.
An active market is one where the following conditions are all met:
๏ The items traded are homogenous
๏ Willing buyers and sellers can normally be found at any time
๏ Prices are available to the public
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Amortisation
If an intangible has a finite life then it should be amortised over its useful economic life.
Residual value is normally assumed to be zero unless there is a commitment from a buyer or
an active market exists.
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.
It will therefore be subject to annual impairment reviews.
Example 1 – Intangibles
GKS is a large pharmaceutical business involved in the research and development of viable new
drugs. It commenced initial investigation into the viability of a new drug on 1 February 20X5 at a
cost of $40,000 per month. On 1 August 20X5 GSK were able to demonstrate the commercial
viability of the new drug and intend to sell it on the open market once fully complete.
Costs subsequent to 1 August 20X5 remained at $40,000 per month. At 31 December 20X5, GSK’s
reporting date, the drug was not yet complete but it is believed that by mid-20X6 the drug will be
available for sale.
The finance director is confident of the success of the drug’s sales that he wishes to revalue the
intangible at the reporting date, using a discounted future cash flow model to establish the fair
value.
Explain the treatment of the above costs in GSK’s financial statements for the year-ended 31
December 20X5.
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Chapter 12
IAS 36 IMPAIRMENT OF ASSETS
1. Identify possible impairments (external vs. internal)
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1. Indicators of Impairment
External sources
๏ A significant decline in the asset’s market value more than expected by normal use or
passage of time
๏ A significant adverse change in the technological, economic or legal environment
Internal sources
๏ Obsolescence or physical damage
๏ Significant changes, in the period or expected, in the way the asset is being used e.g.
asset becoming idle, plans for early disposal or discontinuing/ restructuring the
operation where the asset is used
๏ Evidence that asset’s economic performance will be worse than expected
๏ Operating losses or net cash outflows for the asset
๏ Loss of key employee
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2. Impairment review
If the carrying value of the asset is greater than its recoverable amount, it is impaired and
should be written down to its recoverable amount.
Recoverable amount - the greater of fair value less cost to sell and value in use.
Fair value less costs to sell - the amount receivable from the sale of the asset less the costs
of disposal.
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Value in use - the present value of the future cash flows from the asset.
Example 1 - Impairment
A machine was acquired on 1 January 20X5 at a cost of $50,000 and has a useful economic life of
ten years.
At 31 December 20X9 an impairment review was performed. The fair value of the machine is
$26,000 and the selling costs are $2,000.
The expected future cash flows are $5,000 per annum for the next five years. The current cost of
capital is 10%. An annuity factor for this rate over this period is 3.791
Prepare extract from the financial statement for the year-ended 31 December 20X9.
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$000
Goodwill 90,000
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Chapter 13
IFRS 5 NON-CURRENT ASSETS HELD
FOR SALE AND DISCONTINUED
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OPERATIONS
Example 1 – NCA-HFS
At 1 January 2014, Namibia carried a property in its statement of financial position at its revalued
amount of $14 million in accordance with IAS 16 Property, Plant and Equipment. Depreciation is
charged at $300,000 per year on the straight line basis.
In April 2014, the management decided to sell the property and it was advertised for sale. By 31
April 2014, the sale was considered to be highly probable and the criteria for IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations were met at this date. At that date, the asset’s fair
value was $15·4 million. Costs to sell the asset were estimated at $300,000.
On 31 January 2015, the property was sold for $15·6 million.
Explain how the above transaction should be dealt with in the financial statements of
Namibia for the year-ended 31 December 2014 and 31 December 2015.
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2. Discontinued operations
IFRS 5
Discontinued Operations
Definition
๏ Disposed of, or
๏ Held for sale, and:
Discontinued
Disposed of in the
Held for sale
year
Disclosure
P or L SCF SFP
PFY → face Net cash flows → face or notes Fully disposed of → none
Revenue, expenses, pre-tax Not fully disposed of → ‘assets
profit, tax expense → face held for sale’
or notes
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Continuing operations
Revenue X
Cost of sales (X)
Gross profit X
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Discontinued operations
Profit for the period from discontinued operations* X
Total profit for the period X
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Chapter 14
IAS 19 EMPLOYEE BENEFITS
๏ Short-term benefits
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๏ Long-term benefits
๏ Post-employment benefits
1. Pensions
๏ Defined Contribution Scheme (money purchase)
This does not present any accounting problems as the income statement charge will
equal the contributions payable into the scheme.
Contributions are accrued in the financial statements with an expense recognised in
profit or loss.
๏ Defined Benefit Scheme (final salary)
At any point in time (usually each year) we need to know the value of the scheme so
that we can decide whether or not it is worth enough (i.e. the assets will be enough to
cover the liabilities.)
Statement of financial position (extract)
$m
Fair value of scheme assets X
Fair value of scheme liabilities (X)
Net pension asset/(liability) X/(X)
The valuation of a defined benefit scheme will be carried out by an actuary who will decide if
the scheme is in surplus (net pension asset) or deficit (net pension liability)
This is done by making a number of assumptions:
๏ Level of investment return
๏ Number of leavers
๏ Number of new members
๏ Number of people who die
As time goes by the actual outcome will not be the same as the assumed outcome.
The differences are known as actuarial differences (remeasurement component).
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Financing costs
Interest expense (X)
Return on investment X
๏ Current service cost – increase in the value of the scheme liabilities as a result of
employee service during the period.
๏ Past service cost – increase in the value of the scheme liabilities as a result of employee
service in previous periods.
๏ Interest cost – represents the unwinding of the discount factor- the nearer you get to
paying off a liability the bigger it gets.
๏ Return on investment – this is the interest or dividends receivable on the pension fund
assets.
Note: Actuarial differences are recognised in other comprehensive income, hence no impact
on profit or loss.
Workings
Assets $m Liabilities $m
Opening X Opening X
Return on investment X Interest X
Contributions paid in X Service costs X
Benefits paid out (X) Benefits paid out (X)
Expected X Expected X
Re-measurement component (β) X/(X) Re-measurement component (β) X/(X)
Closing (per actuary) X Closing (per actuary) X
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$m
Current service cost 9
Past service cost 8
Contributions paid in 5
Benefits paid out 6
Calculate the amounts that will appear in the financial statements of Finland for the year-
ended 31 December 2015.
2. Curtailment
A curtailment occurs when there are a significant number of employees who leave the
scheme, commonly seen if there is a re-organisation of the business or change in scheme
from defined benefit to defined contribution.
The asset and liability are re-measured to fair value and any change is taken to profit or loss.
Example 2 – Curtailment
Flannagan announces the re-organisation of its business, resulting in the loss of jobs within the
business.
The fair value of the plan assets and liabilities, immediately before the re-organisation, were $48
million and $60 million respectively.
The plan assets do not change following the curtailment but the pension liabilities are measured at
$55 million.
Explain the accounting treatment of the curtailment in the financial statements.
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3. Asset ceiling
If a company has an overall pension asset on its statement of financial position then the asset
can only be recognised up to the level of the asset ceiling. The asset ceiling is the present
value of any future cash savings of not having to contribute to the scheme as it is in surplus. If
the asset needs to be reduced to the asset ceiling limit then the reduction in the asset is
shown as an expense in profit or loss.
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Chapter 15
IAS 21 FOREIGN CURRENCY
TRANSACTIONS
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If an entity has foreign currency transactions then the amount will need to be translated into
the functional currency before it is recorded within the general ledger.
The functional currency is the currency of the primary economic environment in which the
entity operates. This is deemed to be where the entity generates and expends cash.
Management should consider the following factors in determining the functional
currency:
๏ The currency that dominates the determination of the sales prices
๏ The currency that most influences operating costs
๏ The currency in which an entity’s finances are denominated is also considered.
Note: No specific guidance is given as to where any exchange differences are recorded within
profit or loss. The general accepted practice is:
๏ Trading transaction – operating costs
๏ Financing transaction – financing costs
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Chapter 16
IAS 10 EVENTS AFTER THE REPORTING
PERIOD
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IAS 10
Adjusting Non-adjusting
Information relating to a condition that existed Doesn’t reflect conditions that existed at the
at the reporting date reporting date
๏ Fall in value of investments
๏ Settlement of outstanding court case
๏ Major purchase of assets
๏ Bankruptcy of a customer
๏ Announcing a discontinued operation
๏ Sale of inventory at below cost
๏ Announcing a restructuring
๏ Determination of purchase/sale price of
PPE
Disclose nature and financial effect if MATERIAL
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Chapter 17
IAS 2 INVENTORIES
Measure @ lower of
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Cost NRV
Costs incurred in bringing inventory
to its present condition and location Selling price X
Less:
๏ Materials
Costs to complete (X)
๏ Labour
Costs of selling (X)
๏ Manufacturing overheads (based
NRV X
on normal output)
๏ Transport costs
๏ Irrecoverable taxes
Line-by-line basis
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Chapter 18
IAS 8 ACCOUNTING POLICIES, CHANGES
IN ACCOUNTING ESTIMATES AND
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ERRORS
IAS 8
1. Accounting policies
The specific principles, bases, conventions, rules and practices applied by an entity in
preparing and presenting the financial statements.
Selection
Retrospective application
๏ Adjust b/f figures
๏ Restate comparatives
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2. Accounting estimates
Changes in accounting estimate are recognised prospectively:
๏ Period of change
๏ Period of change and future periods
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Chapter 19
IAS 12 INCOME TAXES
1. Current tax
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Current tax is the amount of income taxes payable (recoverable) in respect of the taxable
profit (tax loss) for a period.
2. Recognition
Current tax should be recognised based on the year-end estimate of the tax payable.
The income tax expense though profit or loss is adjusted for any under/over provision from
the prior year.
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Chapter 20
IFRS 8 OPERATING SEGMENTS
IFRS 8 Operating segments aims to assist users to:
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1. Disclosure
An operating segments results must be disclosed if:
๏ Segment revenue is greater than 10% of the total revenue (internal and external)
๏ Segment profits are greater than 10% of the total profits (excluding losses)
๏ Segment assets are greater than 10% of total assets
If the total reportable segment revenue does not make up at least 75% of external revenue
then additional segment will need to be disclosed.
Two or more operating segments may be combined if they have similar economic
characteristics with regards to the following:
๏ The nature of the products or services
๏ The nature of the production process
๏ The type or class of customer
๏ The methods used to distribute the products/services
๏ The nature of the regulatory environment
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๏ Depreciation/amortisation
๏ Other non-cash expenses
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Chapter 21
IAS 34 INTERIM FINANCIAL REPORTING
IAS 34 requires only condensed financial statements (headings and sub-totals) and selected
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explanatory note disclosures, with particular focus on new events, activities and
circumstances. The minimum content specified is as follows:
๏ Statement of financial position at interim date and previous reporting date.
๏ Statement of profit or loss and other comprehensive income for both interim/
cumulatively to date for the year and previous interim/cumulatively to date for previous
year (incl. EPS and diluted EPS)
๏ Statement of changes in equity cumulatively to interim date and direct comparative
๏ Statement of cash flows cumulatively to date and comparable period.
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Chapter 22
IFRS 13 FAIR VALUE MEASUREMENT
Definition
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The price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
The IFRS says that you should always use market value wherever possible and gives more
detailed guidance on measurement of items that do not have a readily available market price.
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Chapter 23
CONSOLIDATED STATEMENT OF
FINANCIAL POSITION
100%
Basic principles
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Control is the power to govern the financial and operating policies of an entity so as to
obtain benefit from its activities.
Control is usually achieved by the purchase of more than 50% of a company’s equity share
capital.
2. Basic consolidation
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2.3. Goodwill
On acquisition of a subsidiary, the parent will usually pay more for the subsidiary than the
value of the net assets (assets less liabilities). Why?
๏ Customer loyalty
๏ Good reputation
The difference between what the parent pays and what the net assets are truly worth is
referred to as goodwill.
Example 4 - Goodwill
A parent company buys 75% of the equity shares in a subsidiary company for $156,000.
The remaining shares were valued at $56,000 and the net assets at acquisition were $170,000.
Calculate the goodwill arising on acquisition assuming that:
1. Non-controlling interest is measured using the proportionate share of net assets method
2. Non-controlling interest is measured using the fair value method.
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Workings
W1) Group Structure
20-50%
>50%
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Example 5 - Workings
Matthews purchased 80% of Jones for $600,000 two years ago when Jones’s retained earnings
showed a balance of $100,000.
Matthews Jones
$000 $000
Non-current assets 1,000 500
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Additional information:
Matthews measures the non-controlling interest using the fair value method.
The fair value of Jones’s equity shares was $200,000 at acquisition
Prepare the consolidated statement of financial position for the Matthews group for the
year-ended 31 December 20X5.
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3. Adjustments – Group
3.1. Intra-company balances
The intragroup receivable balance and intragroup payable balance should not be shown in
the consolidated accounts as we treat the group as a single entity.
๏ Remove the payable
๏
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2,400 1,100
Additional information:
1. James bought 80% of the equity shares in Molly for $800,000 when the retained earnings
were $150,000.
2. Non-controlling interest is measured using the fair value method.
3. During the year Molly sold goods to James at $120,000 based on a mark-up of 20%. Half of
the goods remain in inventory at the year-end.
Prepare the James Group consolidated statement of financial position as at 31 December
20X5.
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3.4. Consideration
A parent may acquire a controlling interest in a subsidiary in other fashions as opposed to just
a cash payment.
Other considerations are as follows:
๏ Share for share exchange
๏ Deferred cash consideration
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๏ Contingent consideration
Share for share exchange
1. Calculate the number of subsidiary shares acquired
2. Calculate the number of P shares issued
3. Value the P shares issued
4. Record the journal entry
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was through the offer of a share exchange of two shares issued for every three shares acquired and
a cash payment of $1 per share payable on 31 December 20X5. The fair value of the Pany’s equity
shares was $2 at 1 January 20X5.
The present value of $1 received in one year’s time is $0.91 at a rate of 10%.
Calculate the cost of the investment in Star at 1 January 20X5
The deferred consideration needs to be unwound to its final value and is done so using the
interest rate originally applied to discount back the original entry and is recorded as follows:
Dr Finance cost
Cr Deferred consideration liability
NOTE: The adjustment does not impact the fair value of consideration.
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Chapter 24
CONSOLIDATED STATEMENT OF
PROFIT OR LOSS
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X/12
P S Adj. Group
Revenue X X (X) X
COS (X) (X) X
-PUP (Inventory ) (X) (X) (X)
Gross profit X
Dist costs (X) (X) (X)
Admin exp. (X) (X) (X)
Finance cost (X) (X) X (X)
Investment income X X (X) X
-Dividend from S (X)
Profit before tax X
Taxation (X) (X) (X)
PFY X X
Parent (β) X
NCI = NCI% x S’s PFY X
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Additional information:
1. On 1 July 20X5, Vader acquired 80% of the equity shares of Maul. It is the group policy to
measure the non-controlling interest at acquisition at fair value.
2. Maul declared a dividend during the year of $10,000.
3. Assume that profits accrue evenly during the year.
Prepare a consolidated statement of profit or loss for the Vader group for the year-ended 31
December 20X5
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1. Adjustments
1.1. Intra-group trading transactions
E.g. sales, loans/debenture interest and management charges
Additional information
1. Gary acquired 80% of Nick on 1 January 20X5. Goodwill on acquisition has been impaired by
$1m during the year and should be charged to operating expenses.
2. During the year Nick sold $10m goods to Gary at a mark-up of 25% on cost. One quarter of
those goods are in inventory at the year end.
Prepare the Gary Group consolidated statement of profit or loss for the year to 31 December
20X5.
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IFRS 10 Consolidated Financial Statements defines control and tells us how to consolidate.
A parent/subsidiary relationship can exist even where the parent owns less than 50% of the
voting power of the subsidiary since the key to the relationship is control and the power to
direct the activities.
The following instances are where control is exerted:
๏ power over more than half of the voting rights by virtue of an agreement with other
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investors;
๏ power to govern the financial and operating policies of the entity under a statute or
agreement;
๏ power to appoint or remove the majority of the members of the board of directors or
equivalent governing body and control of the entity is by that board or body; or
๏ power to cast the majority of votes at meetings of the board of directors or equivalent
governing body and control of the entity is by that board or body.
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Chapter 25
ASSOCIATES
A shareholding of between 20% and 50% is assumed to give the investing company
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Chapter 26
CASH MANAGEMENT
A business can be profitable whilst at the same time be losing cash. It is vitally important for a
business therefore to ensure that it does not just focus on profitability but also manage its
cash position.
To ensure that the business can determine if it is generating or spending cash overall it will
need to prepare cash flow forecasts.
A cash flow forecast will identify exactly when the cash inflows and outflows will arise which
can then help identify when the business will have either cash surpluses or cash deficits.
1 2 3
Inflows
Cash sales X X X
Cash from credit customers X X X
Outflows
Cash purchases (X) (X) (X)
Cash payments to credit suppliers (X) (X) (X)
Cash expenses (X) (X) (X)
Capital expenditure (X) - -
Interest (X) (X) (X)
Taxation (X) (X) (X)
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the year
90% of the sales are made on credit terms, the remainder for cash, and credit customers settle the
balance as follows:
1. 60% in the month of sale
2. 40% in the month following sale
Calculate the cash inflows for January and February.
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Sales in January and February 20X5 are forecast to be 10,000 units in each month. As a direct result
of marketing expenditure of $95,000 in March 20X4, sales are expected to be 11,000 units in March
and to increase by 1,000 units in each subsequent month.
30% of sales are paid for when they occur and 70% of sales are paid for in the month following sale.
Stocks of finished goods at the end of each month are required to be 20% of the expected sales for
the following month. Stocks of materials at the end of each month are required to be 50% of the
materials required for the following month’s production.
Materials are paid for in the month following purchase.
Labour and direct expenses are paid for in the month in which they occur. Overheads for
production, administration and distribution will be $32,000 per month, including depreciation of
$10,000 per month. These overheads are payable in the month in which they occur.
CF has a $500,000 bank loan at 5% per annum on which it pays interest twice per year, in March
and September.
Prepare the cash flow forecast for CF for the three months of 20X5.
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Chapter 27
SHORT-TERM FINANCE AND CASH
INVESTMENT
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On preparation of the cash flow forecast the businesses can then identify whether it needs to
raise short-term finance is there is a cash deficit or alternatively deposit cash if it has a surplus
cash balance.
1. Short-term finance
1.1. Trade payables
A company can delay the payment due to suppliers, which effectively acts as a source of
finance. It is therefore using the credit terms on offer by its supplier.
This is a risky strategy as if cash flow difficulties occur then the supplier may no longer supply
the company.
1.2. Overdrafts
An overdraft is a facility provided to the company by a bank whereby the company can
borrow up to a predetermined limit on its bank account.
Interest is paid on any amounts of cash lent by the bank and the bank has the right to recall
the overdraft facility on demand.
1.3. Short-term loans
A short-term loan is an agreement between the company and the bank to borrow a set
amount of cash that is then repayable over a fixed period.
1.4. Debt factoring
Debt factoring is where a company’s receivables are sold to a third party (a debt factoring
company) for cash. The debt factoring company then collects the cash on behalf of the
company for an agreed fee.
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.
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Chapter 28
WORKING CAPITAL
1. Definition
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Working capital is the amount of current assets (inventory, receivables and payables) that a
business needs to maintain in order to fund its debts as they fall due.
The ability of a company to pay its obligations as and when they fall due (its liquidity) is a
major concern of any credit analysis.
Short term liquidity can be assessed by comparing current assets with current liabilities in a
variety of forms:
Working Capital = Current Assets - Current Liabilities.
A working capital surplus represents a cushion of protection for current creditors; it indicates
the amount by which the value of current assets could decrease still leaving enough to repay
current liabilities from the sale of current assets.
The optimum amount of working capital varies considerably from company to company and
from industry to industry, thus the nature of the company's business and the quality of its
assets must be considered.
Companies functioning within industry sectors with short production/sales cycles (e.g.
supermarkets) can generally function satisfactorily with a much smaller amount of working
capital than those with a long production cycle (e.g. heavy engineering).
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A company’s policy on working capital will be influenced by the risk relating to working
capital and will lead to one of the following approaches:
๏ Conservative – Attempts to reduce the risk by holding high levels of working capital.
‣ High levels of finished goods
‣ Generous customer payment terms
‣ Prompt payment to suppliers
Unproductive assets, increased finance cost and cash flow issues
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Short-term
funds
Short-term
Permanent current assets funds or long-
term funds?
Time
๏ Conservative - Mostly long term finance used. All permanent and most fluctuating
current assets are funded using long term finance.
‣ Short-term finance when current assets increase
‣ Cash surplus if current assets are low
๏ Aggressive - Mostly short term finance used. All fluctuating and part of the permanent
current assets are funded using short term finance.
‣ Increased risk of liquidity problems
‣ Cheaper and flexible
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๏ Moderate - Permanent current assets are funded using long term finance.
Fluctuating current assets are funded using short term finance.
Current assets
Current ratio =
Current liabilities
A current ratio of over one indicates that a company has a higher level of current assets than
current liabilities and should, therefore, be in a position to meet its short term obligations as
and when they fall due. However, some companies function adequately on current ratios of
less than one whilst others need a much higher ratio. Generally the more liquid the current
assets are the higher this ratio will be.
Trends are difficult to analyse but generally higher ratios indicate greater liquidity. However,
an increase may reflect a high level of unsaleable stock or overdue receivables whereas a
decrease may result from greater efficiency.
Some factors to consider:
๏ Asset quality
๏ Seasonality
4.2. Quick ratio (acid test)
Inventory
Inventory days = x 365
Cost of sales
Shows how long a business is holding its inventory. A higher number of days inventory might
indicate holdings of obsolete or unsaleable inventory, but it might also signify a purchase of
raw materials now in anticipation of an increase in price later.
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Trade receivables
Trade receivables collection period = x 365
Revenue
Providing revenue is evenly spread throughout the year the ratio will indicate how effectively
debts are being collected.
An increase in the ratio of receivables to revenue could, providing the proportion of cash
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Trade payables
Trade payables payment period = x 365
Cost of sales
If purchases are spread evenly throughout the year, this ratio will show the length of credit
the company is taking. An increase in the ratio may indicate that more reliance is being
placed upon the payables to finance the business. A drop in days may indicate that a
company is taking cash discounts or may indicate suppliers are cutting credit terms because
of the company's decreased creditworthiness.
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Cash payment
Payable days
Operating cycle
An increase in the operating cycle shows that cash is not being recovered as quickly from
business activities, which can cause cash flow problems.
A business will try to reduce the length of the cash operating cycle through careful
management of inventory, receivables and payables.
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Chapter 29
WORKING CAPITAL MANAGEMENT
1. Inventory management
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Many companies, particularly those involved in manufacturing, will hold levels of stock to
meet expected customer demand. It is an important consideration as holding stock incurs
costs but in order to reduce level of inventory and the associated cost the risk of stock out
arises.
The costs of inventory management that will need to be controlled are as follows:
๏ Ordering costs (independent of order size)
‣ Administrative
‣ Delivery
๏ Holding costs
‣ cost of the investment in stock
‣ Storage
‣ Insurance
‣ Deterioration
‣ Obsolescence
‣ Theft
๏ Stock shortage costs
‣ Lost sales/contribution
‣ Loss of customers
‣ Purchase costs of new supply
‣ Production stoppages
๏ Purchase cost
‣ Bulk discounts
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TAC
holding cost
ordering cost
Order size
2C o D
Q=
Ch
Example 1 - EOQ
The annual demand for an item of inventory is 32,000 units. The item costs $40 per unit to
purchase with order costs of $15 per order. The annual inventory holding costs are $1.20 per unit.
Calculate the economic order quantity for this item and the total annual cost of inventory.
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3. Bulk discounts
If a quantity discount is offered by a supplier, we can evaluate the discount simply by
comparing the total annual cost that would arise if the discount were accepted, against the
corresponding total annual cost at the EOQ.
Annual demand is 120,000 units. Ordering costs are $30 per order and holding costs are $20/unit/
annum. The material can normally be purchased for $10/unit, but if 1,000 units are bought at one
time they can be bought for $9,800. If 5,000 units are bought at one time, they can be bought for
$47,500.
What reorder quantity would minimize the total cost?
4. Trade receivables
A company will offer credit to its customers to increase the level of sales but this then
introduces an increased level of risk as the customer may default on payment.
To ensure that the business grants the correct amount of credit it should:
๏ Assessing the credit status of its customer
๏ Consider the specific terms it offers its customers
๏ Plan on how it will management the collection of cash on a day to day basis.
4.1. Assessing credit status
The creditworthiness of all new customers must be assessed before credit is offered.
Existing customers must also be re-assessed on a regular basis.
The following may be used to assess credit status of a company:
๏ Bank references
๏ Trade references
๏ Published accounts
๏ Credit rating agencies
๏ Company’s own sales record.
4.2. Offering credit terms
Upon deciding to grant a customer credit status a business must then determine the specific
credit terms to be offered, which may include:
๏ Credit limit value
๏ Number of days credit
๏ Discount on early payment
๏ Interest on overdue account.
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Reminder letter
๏ Send a second reminder letter
๏ Threaten legal action
๏ Take action to recover funds
Control of trade receivable information
Trade receivables are usually analysed by the age of the debt to monitor the specific level and
amount of outstanding debt and aid collection.
This is simply a list of the customers who currently owe money, showing the total amount
owed, and the period of time for which money has been owed.
There is no set proforma for an age analysis of trade receivables, but a typical exam question
is shown below.
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The receivables balance needs to be financed, usually via short-term finance. Any change to
the receivables balance will lead to a change in the financing cost of the business.
Interest cost = Receivables balance × Interest rate
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6. Factoring
6.1. CIMA Official Definition
The sale of debts to a third party (the factor) at a discount, in return for prompt cash. A
factoring service may be with recourse, in which case the supplier takes the risk of the debt
not being paid, or without recourse, when the factor takes the risk.
Advantages
๏ Saving in internal administration costs.
๏ Reduction in the need for day to day 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.
Disadvantages
๏ Should 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.
๏ The company may give up the opportunity to decide to whom credit may be given.
6.2. Invoice discounting
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.
The service is also provided by a factoring company.
Example 6 - Factoring
Coral limited currently has turnover of $25m. Receivables turnover is currently 40 days. Interest is
charged on the overdraft at 12%.
A factoring company has offered its services for an annual fee of 1% of turnover. The factoring
company can reduce receivables turnover to 15 days.
The factor will also generate an admin saving for the company of $15,000.
Should Coral limited accept the factors offer?
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7. Payables
Payables may be used as a source of short-term finance. If a company delays payment by a
further month then they now have a further months use of the cash.
However, delaying payment may lose the company it’s credit status with the supplier and
could result in supplies being stopped.
Additionally, the company could lose the benefit of any settlement discount offered by the
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Example 4
A supplier offers a 2% discount if invoices are paid within 10 days of receipt. Currently we take 30
days to pay invoices and therefore do not receive the discount.
Calculate the annual % effective cost of refusing the discount.
Example 5
A company currently takes 40 days credit from suppliers on the basis that this is ‘free’ finance.
Annual purchases are $100,000 and the company pays overdraft interest of 13%.
Payment within 15 days would attract a 1.5% quick settlement discount.
Should the company pay sooner in order to take advantage of the discount?
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8. 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
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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
๏ Rapid increase in turnover
๏ Fall in liquidity ratio or current liabilities exceed current assets
๏ Sharp increase in the sales-to-fixed assets ratio
๏ Increase in the trade payables period
๏ Increase in short term borrowing and a decline in cash balance
๏ 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.
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Chapter 30
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TAXATION
1. What is Taxation?
Taxation is a contribution by individuals, property or businesses to state revenue. It can be
collected by the state/government either directly or indirectly and is the main way in which it
raises money to fund its expenditure.
Taxation can also be used as a means of influencing economic decision making or promoting
social values and priorities in a country. Hence, no two countries tax systems will be identical.
Note: Specific tax rules in different countries are not required in F1. Exam questions are
focused on fictitious countries and so it is only important to understand the general principles
of how taxation works.
Principles of taxation
The general principles of good taxation (Adam Smith) are that it should show:
๏ Equity – Fair to different individuals, reflecting their ability to pay
๏ Efficient – Cheap and easy to administer with regards collection and
timing
๏ Economic effects – Consideration to different business sectors should be
considered in tax policies
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๏ Formal incidence – the person or business having direct contact with the tax
authorities.
๏ Effective (or actual) incidence – the person or business which actually ends up
bearing the cost of the tax.
Competent Jurisdiction
An authority whose tax laws apply to an individual or a company is referred to as a competent
jurisdiction.
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3. Types of taxation
๏ Progressive taxes – these take an increasing proportion of income as income
rises.
๏ Proportional taxes – these take the same proportion of income as income rises.
๏ Regressive taxes – these take a decreasing proportion of income as income
rises.
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4. Indirect taxation
๏ Unit taxes – based on either a number or weight of items, e.g. import/
excise duties
๏ Ad valorem taxes – based on the value of the items, e.g. sales tax
๏ Excise duties – a tax charged on the amount of commodity (alcohol,
tobacco, oil products and motor vehicles)
๏ Property taxes – a tax charged on the value of an individual’s or company’s
property (land and buildings)
๏ Wealth taxes – a tax charged on the value of an individual’s or company’s
wealth (asset value)
๏ Consumption taxes – a tax charged on the purchase of goods or services by
either an individual or a company.
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Each supply of goods or services in the course of business falls into one of the following types
of supply:
๏ Standard rated – taxed at the standard rate
๏ Higher rated – taxed at the appropriate higher rate
๏ Zero rated – taxed at the zero rate
๏ Exempt – not taxed
Although it may not be obvious there is a difference between zero rated and exempt
supplies. If an entity makes zero rated supplies it can register for VAT and therefore reclaim
input VAT incurred relating to those supplies.
If an entity makes wholly exempt supplies it cannot register for VAT and therefore cannot
reclaim input VAT incurred relating to the exempt supplies.
5.2. Partially Exempt Trades
If an entity conducts several activities some being standard rated, some zero rated and some
exempt, it can register for VAT but its right to offset input tax is restricted.
It can reclaim input tax relating to all standard rated and zero rated supplies. It cannot
reclaim input tax relating to exempt supplies.
Other input tax incurred in the production of all supplies e.g. heat/light expenses, is reclaimed
on a pro-rata basis.
Example 4 – VAT
AB is resident in County X, where monthly VAT returns are required. At the end of each month, AB
pays the net VAT due to the local tax authorities.
In the last month, AB purchase raw material costing $120,000, excluding VAT which is chargeable at
the standard rate of 15%.
The raw materials were converted into two products X and T. Produt X is zero rated and product t
is standard rated for VAT purposes.
Product X was sold for $90,000 and product T for $130,000, both excluding VAT.
Calculate the amount of VAT that AB should pay, assuming there to be no other VAT-related
transactions.
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6. Direct taxation
6.1. Corporate income tax and capital tax computations
Companies pay corporate tax on the following:
๏ Profits from trade and other activities
๏ Gains on the sale of investments and assets
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SunJones qualifies for accelerated tax depreciation in the first-year on the plant at the rate of 50%.
The second and subsequent years will be at 25% on the reducing balance method.
The industrial building qualifies for an annual tax depreciation allowance of 5% on the straight line
basis.
Calculate SunJones’s tax depreciation for the three years ended 31 December 20X7, 20X8
and 20X9.
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Rollover relief
Countries may allow for capital gains to be deferred where a business asset has been sold and
subsequently replaced.
Deferral is allowed as businesses often use the cash from the sale of the asset to buy the
replacement one thus leaving no cash available to pay any tax liability.
The company is allowed to roll the gain arising on the sale against the base cost of the
replacement asset.
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The effect is that when the replacement asset is sold in the future, a larger gain will arise at
that time, resulting in more tax payable in the future, effectively deferring the tax due on the
original gain.
Capital Losses
Capital losses are calculated in the same way as capital gains. In most countries capital losses
are only ever offset against capital gains arising in the same accounting period or are carried
forward and offset against capital gains arising in future accounting period(s). Capital losses
are never carried back or offset against other income.
Calculate JKL’s corporate income tax due for each of the years ended 31 December 20X7 to
20X9.
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Chapter 31
REGULATORY ENVIRONMENT AND
INTERNATIONAL TAXATION ISSUES
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2. Administration of Taxation
2.1. Principles of record keeping
Tax legislation usually required businesses to retain records. Records will usually be kept for:
๏ Corporate tax
๏ VAT or sales tax
๏ Excise duties
๏ Employee taxes
Corporate Income Tax
A business must keep all records required to support its financial statements and all records
to support adjustments made to the financial statements for tax purpose.
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Sales Tax
In many countries adequate records must be kept including business documentation such as:
๏ Orders and delivery notes
๏ Purchases and sales books
๏ Cash books and other account books
๏ Invoices
๏
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Bank statements
Excise duties
If a business has an overseas subsidiary, it will also need to retain records relating to transfer
pricing policy between the two entities.
Employee Taxes and Social Security
Employers keep detailed records of employees pay and amounts of tax and social security
deductions.
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Tax avoidance is tax planning to minimise the tax liability. It is strictly legal but usually
exploits loopholes in legislation.
4.3. Anti-Avoidance Provisions
As well as legislating, tax authorities use other administration methods to minimise evasion
and avoidance.
๏ Reducing the opportunity by deducting tax at source and simplifying the tax structure.
๏ Increasing the perceived risk by auditing tax returns and payments.
๏ Reducing the overall gain by regularly reviewing the penalty structure.
๏ Changing social attitudes towards evasion and avoidance by developing an honest,
equitable and customer friendly tax administration.
4.4. Ethical considerations
Ethical considerations can arise when businesses try to reduce their tax liability through use
of tax legislation.
It is felt that businesses may pursue an aggressive form of tax avoidance to try and reduce
their tax liability to amounts that public opinion may consider to be unfair.
Recent examples can be looked at with regards Google, Facebook and Starbucks in the UK.
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Place of incorporation – if a country uses this as a basis any entity registered in that country
will be deemed to be resident for tax purposes.
Place of permanent establishment (trade carried out or decisions made) – if a business wholly
or partly conducts business through a fixed place of business
Permanent establishment includes:
๏ A place of management
๏ A branch
๏ An office
๏ A factory
๏ A workshop
๏ A mine, oil or gas well
๏ A building or construction site
It is therefore possible for an entity to be resident for tax purposes in more than one country
which will lead to the problem of double taxation. It is possible that an entity has income
taxed in the country it was earned and also in a different company where the company is
resident.
5.2. Double Taxation
Double taxation relief exists to reduce the incidence of tax being paid twice. Often the
taxpayer is allowed to deduct form its total tax liability, an amount equal to the tax already
paid overseas, thus eliminating tax being paid twice.
The OECD has suggested a model tax convention which states can adopt in their dealings
with each other for tax purposes.
The OECD model suggests that business profits of an enterprise can only be taxed in a
country where permanent establishment is apparent.
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Dividends are paid out of post-tax profits. If a company in Country A receives a dividend from
a company in Country B, the dividend would have been taxed in Country B before receipts.
The foreign tax paid in relation to this dividend receipt is called underlying tax.
The overseas dividend would be included as income for corporate tax purposes in the
receiving company’s tax computation and would therefore be taxed again. This leads to
double taxation.
Branch Subsidiary
๏ Same legal entity ๏ Separate legal entity
๏ Branch profits liable in main entity’s tax ๏ Parent liable to tax on foreign dividends
computation received
๏ Branch taxable gains liable in main ๏ Parent not subject to capital gains made
entity’s tax computation by subsidiary
๏ Losses can be set off in main entity’s tax ๏ Losses cannot usually be set off against
return the parent’s profits
๏ Transfer of assets is not usually subject to ๏ Transfer of assets may become subject to
tax on capital gains tax on capital gains
๏ Transfer pricing issues may arise
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ANSWERS TO EXAMPLES
Chapter 1
Regulatory environment
Answer 1 – Ethics
D Independence is not one of the fundamental principles in CIMA’s code of ethics.
Chapter 2
External audit and the audit report
If an external auditor does not agree with the directors’ accounting treatment of a mterial item in
the accounts, the first action they should take is to FORCE/PERSUADE the directors to change the
accounting treatment of the item in the accounts.
Chapter 3
Corporate Governance
No examples
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Chapter 4
Conceptual Framework for Financial Reporting
Chapter 5
IAS 1 Presentation of Financial Reporting
No examples
Chapter 6
IAS 7 Statement of Cash Flows
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Receivables↑ (400)
Payables (1,300)
Cash generated from operations 3,200
Interest paid (500)
Tax paid (350)
Cash generated from operating activities 2,350
Interest payable
B/f 90
C/f 120
590 590
Tax payable
B/f – current tax 210
560 560
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C/f 13,200
14,150 14,150
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Finance cost 14
Inventory ↑ (2)
Receivables ↑ (8)
Payables ↑ 6
Cash generated from operations 274
Interest paid (14)
Tax paid (= 40 + 62 – 47) (55)
Cash generated from operating activities 205
Investing Activities
Proceeds from sale of PPE (W) 6
Purchase of PPE (45)
Cash generated from investing activities (39)
Financing Activities
Proceeds from issue of shares
16
= (180 + 18) – (170 + 12)
Loan issue/repayment (150)
Dividend paid (36)
Cash generated from financing activities (170)
Workings
Profit/loss on disposal = Proceeds − Carrying value
(9,000) = Proceeds − (27,000 – 12,000)
Proceeds = 15,000 − 9,000
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PPE (Cost)
B/f 780
Disposal (β) 27
Cash - additions (β) 45
C/f 798
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825 825
Depreciation 59
Disposal (β) 12
C/f 159
171 171
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Chapter 7
IAS 16 Property, plant and equipment
$17,500,000
Annual depreciation (new) = = $3,500,000 per annum
5 years
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$26,214
Annual depreciation (new) = = $5,243
5 years
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Answer 4 – Revaluation
SFP (extract) SPLOCI(extract)
$ $
Non-current assets
PPE (W) 573,913 Depreciation (PL) (26,087)
SOCE (extract)
Retained Revaluation
earnings surplus
$ $
B/F X -
Revaluation in the year - 140,000
Reserve transfer 6,087 (6,087)
C/F X 133,913
Workings
$ $ $
Cost (1.1.X5) 500,000
Accumulated depreciation
(40,000)
(=500,000/25 x 2 years)
Carrying value (31.12.X6) 460,000 600,000 140,000
Dereciation
(20,000) (26,087) (6,087)
(=600,000/23)
Carrying value (31.12.X7) 573,913 133,913
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Profit on disposal
93,478
(=550,000 – 456,522 (W))
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SOCE (extract)
Retained Revaluation
earnings surplus
$ $
B/F X 120,522
C/F X -
Workings
$ $ $
Cost (1.1.X5) 400,000
Accumulated depreciation
(32,000)
(=400,000/25 x 2 years)
Carrying value (31.12.X6) 368,000 500,000 132,000
Dereciation
(32,000) (43,478) (11,478)
(=500,000/23 x 2 years)
Carrying value (31.12.X8) 456,522 120,522
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Chapter 8
IAS 23 Borrowing costs
2.2
Weighted average = x 100%
65
= 3.38%
Chapter 9
IAS 20 Government grants
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Chapter 10
IAS 40 Investment Properties
expense through profit or loss of $0.5 million ($20 million/20 years x 6/12), thus reducing the
carrying value to $19.5 million ($20 million - $0.5 million).
The property is revalued to its fair value of $21 million on 1 July 2015 under IAS 16, giving a gain
through other comprehensive income of $1.5 million ($21 million - $19.5 million).
The property is now classified as investment property and no longer depreciated.
It is revalued to a fair value of $21.6 million at the reporting date with the gain of $0.6 million going
through profit or loss.
Chapter 11
IAS 38 Intangible Assets
Answer 1 – Intangibles
The purchase of the patent should be capitalised at $15 million and amortised over its useful life.
The $6 million spent on the investigative phase is essentially research and should be expensed
through profit or loss as incurred.
The $8 million subsequently spent after completion of the research phase is development
expenditure and is capitalised as an intangible non-current asset on the statement of financial
position.
It is not yet amortised as the project is not yet complete but an impairment review should be
carried out to see if the asset has lost value.
The $1.5 million spent on marketing and training should both be expensed through profit or loss
immediately.
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Chapter 12
IAS 36 Impairment of Assets
Answer 1 – Impairment
SFP (extract) SPLOCI(extract)
$ $
Non-current assets
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Workings
$50,000
Annual depreciation = = $5,000 per annum
10 years
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Chapter 13
IFRS 5 Non-current assets held for sale and discontinued operations
Answer 1 – NCA-HFS
SFP SPLOCI
$’000 $’000
Current assets Depreciation 100
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NCA-HFS 15,100
OCI
Workings
Historic cost Revaluation Revaluation
$000s model reserve
$000s
Revalued amount 14,000
Depreciation 300 x 4/12 (100)
15,100
13,900 1,400
(=15,400 – 300)
31 December 2016
The operation is now classified as a discontinued operation as it has now ceased operating.
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Chapter 14
IAS 19 Employee benefits
Financing costs
Interest expense (3,200)
Return on investment 3,000
Workings
Assets $’000 Liabilities $’000
Opening 60,000 Opening 64,000
Return on investment Interest
3,000 3,200
(5% x 60,000) (5% x 64,000)
Service costs
Contributions paid in 5,000 17,000
(9,000 + 8,000)
Benefits paid out (6,000) Benefits paid out (6,000)
Expected 62,000 Expected 78,200
Re-measurement gain (β) Re-measurement gain (β)
4,000 (3,200)
(↑ asset) (↓ liability)
Closing (per actuary) 66,000 Closing (per actuary) 75,000
Answer 2 – Curtailment
The re-organistion has led to redundancies and therefore a significant number of employees will
have left the scheme as they are no longer entitled to earn nay future pension benefits.
The net liability on the statement of financial position will be $7 million ($48 million - $55 million)
and a gain will be shown through profit or loss of $5 million, being the reduction in the liability ($60
million - $55 million).
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Chapter 15
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400,000 Dinar
= = $97,561
4.1
31 December 2015
Retranslate the monetary balance (payable) at the closing rate (4.3 Dinar:$1)
400,000 Dinar
= = $93,023
4.3
Do not retranslate the non-monetary balance (inventory), and leave it at $97,561 at the reporting
date.
10 January 2016
Translate the payment at the exchange rate on the day of the transaction
400,000 Dinar
= = $90,909
4.4
DR Payables $93,023
CR Bank $90,909
CR Profit or loss $2,114
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Chapter 16
IAS 10 Events after the reporting period
(i) Non-adjusting events as the issue of shares does not give evidence of a condition that existed
at the year-end. The company would use the issue of shares in its calculation of basic EPS.
(ii) An adjusting event as the legal action and its outcome give evidence of a condition the
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(iii) An adjusting event that reduces the value of year-end inventory by $10,000 as it gives
evidence of the fall in value of the inventory held at the reporting date. Inventory included in
the accounts at the year-end would now be included at $15,000.
(iv) A non-adjusting event as the condition did not exist at the reporting date. As the item is
material a disclosure of its nature and financial impact would be made in the notes.
Chapter 17
IAS 2 Inventories
Total inventory valuation = (800 undamaged units x $11) + (200 damaged units x $10) = $10,800
Chapter 18
IAS 8 Accounting policies, changes in accounting estimates and errors
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Chapter 19
IAS 12 Income taxes
Workings
Tax payable
B/f 500
C/f 4,200
4,200 4,200
Chapter 20
IFRS 8 Operating Segments
Chapter 21
IAS 34 Interim financial Reporting
No examples
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Chapter 22
IFRS 13 Fair value Measurement
No examples
Chapter 23
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Answer 4 – Goodwill
(i) Proportionate share of net assets method
$
FV of consideration 156,000
NCI at acquisition
42,500
(25% x 170,000)
FV of net assets at acquisition (170,000)
Goodwill at acquisition 28,500
$
FV of consideration 156,000
NCI at acquisition 36,000
FV of net assets at acquisition (W2) (170,000)
Goodwill at acquisition 22,000
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Answer 5 – Workings
Matthews
Group
$000
Non-current assets
1,500
(1,000 + 500)
Goodwill (W3) 500
Current assets
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1,400
(800 + 600)
Total assets 3,400
Workings
W1) Group Structure
Matthews
80%
Jones
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Current Assets
1,290
(700 + 600 – 10 (PUP))
3,340
Current liabilities
1,600
(1,100 + 500)
3,340
Workings
W1) Group Structure
James
80%
Molly
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4. Journal entry
Dr Investment $6,000,000
Cr Share capital $2,000,000
Cr Share premium (β) $4,000,000
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Deferred consideration
PV of consideration = 24,000,000 x $1 x 0.91 = 21,840,000
Total consideration
= 32,000,000 + 21,840,000 = $53,840,000
Chapter 24
Consolidated Statement of Pro t or Loss
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(25/125 x 10,000 x ¼)
Gross profit 99,500
Op exp. (20,000) (35,000)
(56,000)
-Impairment (1,000)
Finance cost (2,000) (500) (2,500)
Profit before tax 41,000
Taxation (6,000) (3,000) (9,000)
PFY 10,000 32,000
Parent (β) 30,000
NCI = 20% x 10,000 2,000
Chapter 25
Associates
Answer 1 – Associate
$
Cost of investment in A 250,000
Add: 30% x 170,000 51,000
Less: impairment of goodwill (20,000)
281,000
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Chapter 26
Cash Management
January February
Inflows
Cash sales 1,100 1,210
Cash from credit customers 9,540 10,494
10,640 11,704
Workings
December January February
11,000 12,100
Sales 10,000
(10,000 x 1.1) (11,000 x 1.1)
1,000 1,100 1,210
Cash sales
(10% x 10,000) (10% x 11,000) (10% x 12,100)
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Outflows
Material 48,960 48,960 53,760
Labour 16,320 17,920 19,520
Direct expenses 14,280 15,680 17,080
Fixed overheads 22,000 22,000 22,000
Advertising - 95,000 -
Interest - - 12,500
Total payments 101,560 199,560 124,860
Workings
December January February March
Sales (units) 10,000 10,000 11,000 12,000
Sales ($) 150,000 150,000 165,000 180,000
45,000 45,000 49,500 54,000
Cash sales
(30% x 150,000) (30% x 150,000) (30% x 165,000) (30% x 180,000)
Direct expenses
14,280 14,280 15,680 17,080
( x $1.40/unit)
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Chapter 27
Short-term nance and cash investment
Return – clearly, the company will wish to maximize return. However, high returns can usually only
be achieved with high risk. As noted above, it is therefore likely that only relatively low returns will
be possible.
Liquidity – the company needs to consider how easily the funds can be withdrawn. This will
depend on: the terms of the investments (ie how long are the funds tied up for?), what penalties
are there for early withdrawal and can the investment be sold on before maturity date?
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Chapter 28
Working Capital
350
Receivable days = x 365 = 57.8 days
0.85 x 2,600
260
Payable days = x 365 = 63.9 days
0.90 x 1,650
114 days
Payables = x 110,000 = $64,356
365 days
88 days
Receivables = x 250,000 = $60,274
365 days
68 days
Inventory = x 110,000 = $20,493
365 days
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Chapter 29
Working Capital Management
Answer 1 – EOQ
Q = 2 x $15 x 32,000
$1.20
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Q = 894 units
Therefore the company should choose a reorder quantity of 1,000 as this minimizes the total cost.
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Answer 6 – Factoring
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Reduction in Receivables
$
Reduction in overdraft interest 205,479
$1,712,329 x 12%
Admin Saving 15,000
Fee (250,000)
(26,521)
Therefore Coral Limited should not accept the factors offer.
1.2
IRR = 0.07 + x (0.08 – 0.07) = 7.4%
(1.2 + 1.9)
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Chapter 30
Taxation
Answer 4 – VAT
Input VAT = 15% x $120,000 = $18,000
Output VAT = 15% x $130,000 = $19,500
VAT payable = $1,500
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Chapter 31
Regulatory Environment and International Taxation Issues
Withholding tax
5,000
(45,000/90 x 10)
50,000
50,000
Underlying tax = x 100,000 = 12,500
(500,000 – 100,000)
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