Q1 Consolidated Accounts

Statement of Financial Position as at Persimon Sherburn Axon

31 December 2018 Ltd Ltd Ltd
£ £ £
Non current asset (land) 860,000 260,000 300,000
Goodwill
Investment in Associate
Investment 380,000
Inventories 140,000 40,000 50,000
Trade receivables 8,000 30,000 60,000
Dividend receivable from group companies 12,000
Inter-company loans receivable from Sherburn Ltd 90,000
Inter-company loans receivable from Axon Ltd 30,000
Cash at bank 130,000 60,000 30,000
1,650,000 390,000 440,000

Share capital (£1 nominal value) 600,000 100,000 200,000

Retained profits 260,000 210,000 160,000
Revaluation reserve 30,000
Trade payables 730,000 30,000 10,000
Inter-company loans payable to Persimon Ltd 40,000 20,000
Dividend payable 60,000 10,000 20,000
Non controlling interest
1,650,000 390,000 440,000

Additional Information
P acquired S on 1/1/14 for £ 290,000 70%
S share capital and reserves on 1/1/14 was £ 190,000
Fair value of S non current assets on 1/1/14 was £ 280,000
Recorded value of S non current assets on 1/1/14 was £ 260,000

P acquired A on 1/1/15 for £ 70,000 25%

A share capital and reserves on 1/1/15 was £ 250,000
Fair value of A non current assets on 1/1/15 was £ 300,000

Dividends declared £ per share 0.10

P sold to S inventory worth £ 10,000 S acq for £ 2,000

P sold to A inventory worth £ 15,000 A acq for £ 5,000

Goodwill to be capitalised. Impairment of S goodwill 50,000

Workings:
Calculate goodwill of S on date of acquisition
Goodwill = consideration less FV net assets of S

Consideration 290,000
Less:
Share capital and reserves of S 190,000
Adjustment for fair value of non current assets 20,000
 210,000
P share of S (147,000) 70%
Goodwill of S before impairment 143,000
Impairment charge (50,000)
Goodwill of S after impairment 93,000

Investment in A
Initial cost of holding 70,000
Share of post-acquisition reserves of A
Capital and reserves 31/12/18 390,000 At 31/12/18 share cap 200k
Capital and reserves 1/1/15 250,000
Difference (post-acquisition reserves of A) 140,000
Provision for unrealised profit of A (10,000)
130,000
P Share of post-acquisition reserves of A 32,500 25%
102,500

Inter-entity elimination of unsold goods

Unrealised profits (Subsidiary) 8,000
Unrealised profits (Associate) 10,000
Total unrealised profits 18,000

Cash in Transit
S to P 50,000
A to P 10,000

Group Retained Profits

P only 260,000
S post-acquisition profits 120,000
Provision for unrealised profit of S (8,000)
112,000
P share of S post-acquisition profits 78,400 70%
A post-acquisition profits 110,000
Provision for unrealised profit of A (10,000)
100,000
P share of A post-acquisition profits 25,000 25%
P share of A revaluation reserve 7,500
Goodwill impairment (S) (50,000)
320,900

Dividend payable
P 60,000
S dividends payable outside of group 3,000
Group dividend payable 63,000

Non controlling interest

S share capital 100,000
S retained profits 210,000
Provision for unrealised profit (8,000)
S FV non current assets 20,000
322,000
Non controlling interest as at 31/12/18 96,600
Consolidated
Group
£
1,140,000
93,000
102,500
20,000
172,000
38,000
5,000
-
30,000
240,000
1,840,500

600,000
320,900
-
760,000
-
63,000
96,600
1,840,500
-
31/12/18 share cap 200k + retained profits 160k + reval reserve 30k
Q2 Deferred Tax

Machine purchased during year 1=£ 50,000 UEL (years)

Residual value end of life 5,000
Capital allowances: see below Tax rate
Estimated profit per year £: 42,000

Year 2019 2020 2021

Capital allowance (given) 19,500 13,500 12,000

Depreciation 15,000 15,000 15,000

Capital allowance 19,500 13,500 12,000
Temporary differences 4,500 (1,500) (3,000)
Deferred tax charge 900 (300) (600)

Statement of Financial Position

Year 2019 2020 2021
Provision for DT liability 900 600 0
(changes in DT charge)

Comprehensive income statement: P&L

This is what the income statement looks like without deferred tax
Year 1 2 3
Profit before depreciation 57,000 57,000 57,000
Capital allowance 19,500 13,500 12,000
Taxable profits 37,500 43,500 45,000
Current tax 7,500 8,700 9,000
Profit after current tax 30,000 34,800 36,000

How deferred tax leads to income smoothing

Year 1 2 3
Profit before tax 42,000 42,000 42,000
Current tax 7,500 8,700 9,000
Deferred tax charge 900 (300) (600)
Profit after tax 33,600 33,600 33,600

Effect of deferred tax is that it allows income smoothing (profit after current tax fluctuates more)

Critique
1. Deferred tax not liability until it accrues
2. Financial statements should
show tax expense for year = income taxes levied (i.e., tax returns)
any income tax refunds show as receivables or unpaid as payables
disclose in notes to statements
3. What DID happen (i.e., agreed tax to be paid) v what DID NOT happen (tax payable
due to timing differences had not occurred)

In favour
1. Upholds the accrual accounting assumption (Matching / going concern)
Helps to predict future cash flows of the business
2. Substance over form
Legal argument - deferred tax not legal liability until it accrues contradicts substance
over form - demonstrate economic reality (e.g., fair values)
 3

20%

i.e., tax returns)

paid as payables
Q3 Leases

Part A
What are Define finance lease
Define operating lease
IAS17 Define substance over form (use economic principles to classify transactions rather than legal ti
Outlining key arguments for classifying lease using substance over form
Lease as two transactions, loan finance and asset purchase
Percentage of asset value covered by sum of lease payments discounted to pres
Interpret Which transaction more favourable on the balance sheet? Discussion of ratio analysis & industr
Empirical examples of how companies restructure transactions to fit definition
IFRS16 IFRS16 proposals (valid 1/1/19) amended IAS17 to further restrict the ability to use operating l

Part B
Asset A
Total amount 319,770
Annual payments 60,000
Number of payments 6
Payment in advance 1
Adjusted payments 5

Calculate rate implied in lease 319,770 = 60,000

Annuity 5|i = 259,770
From tables, the half yearly interest rate is approx. = 5%

Date Rental Finance Reduction Balance of obligation

in obligation under finance lease
1/1/2018 319,770
1/1/2018 60,000 - 60,000 259,770
7/1/2018 60,000 12,989 47,012 212,759
1/1/2019 60,000 10,638 49,362 163,396
7/1/2019 60,000 8,170 51,830 111,566
1/1/2020 60,000 5,578 54,422 57,145
7/1/2020 60,000 2,857 57,143 2

Income Statement
2018 Finance charge current period Jan-Jun 12,989
accrual Jul-Dec 10,638
23,626

Depreciation expense 106,590

2019 Finance charge current period Jan-Jun 8,170

accrual Jul-Dec 5,578
13,748

Depreciation expense 106,590

 Statement of financial position
2018 Non-current asset 319,770
Accumulated depreciation 106,590
Net book value 213,180

2019 Non-current asset 319,770

Accumulated depreciation 213,180
Net book value 106,590

2018 Current liability - repayment outstanding 101,192

Current liability - interest accured 10,638
Non-current liability 111,566

2019 Current liability - repayment outstanding 111,564

Current liability - interest accured 5,578
Non-current liability 2
ansactions rather than legal title)

payments discounted to present value

on of ratio analysis & industry pressures
transactions to fit definition
the ability to use operating leases

+ 60,000 Annuity 5|i

/ 60,000 = 4.3295

rounding
rounding

rounding

rounding
Q4 Financial instruments

IAS 32: Definition

A financial instrument is any contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another entity

IAS 32: Financial asset is any asset that is:

Cash
An equity instrument of another entity
A contractual right:
- to receive cash or another financial asset from another entity, or
- to exchange financial assets or financial liabilities with another entity under conditions
that are potentially favourable to the entity or
A contract that will or may be settled in the entity's own equity statements

IAS 39: Financial assets:

1 Financial assets at fair value through profit or loss:
include held for trading assets and assets designated in this category upon initial recognition;
the option of evaluating financial asset performance on a fair value basis is open for any financial asset.
2 Held-to-maturity investments: fixed or determinable payments and fixed maturity.
3 Loans and receivables.
4 Available for sale financial assets: that is, all other financial assets.

IAS 32: Financial liability is any liability that is:

A contractual obligation:
- to deliver cash or another financial asset to another entity or
- to exchange financial assets or financial liabilities with another entity under conditions
that are potentially unfavourable to the entity or
A contract that will or may be settled in the entity's own equity instruments

IAS 39: Financial liabilities:

1 Financial liabilities at fair value through profit or loss
(the equivalent of the first of the above financial asset types).
2 Other.

Recognition of financial instruments

IAS39 IFRS 9 and IAS39 has the same recognition criteria
An entity shall recognise a financial asset or a financial liability in its statement of financial position
when, and only when, the entity becomes party to the contractual provisions of the instrument.

This is different from the recognition criteria in the conceptual framework of assets / liabilities

CF There's a probable inflow or outflow of resources

The asset or liability has a cost or value that can be measured reliably

Equity instruments held for trading are classified as measured at fair value through P&L.
Transaction costs on financial instruments so classified are expensed through P&L.
Statement of profit or loss
Invesment income (change in fair value 50,000 x (4.20 - 3.50) )
Invesment income (dividend received of 50,000 x 0.06)
Transaction costs

Statement of financial position

Investments in equity instruments (50,000 x 4.20)

Given that the company has made an election to recognise the equity instrument at fair value
through other comprehensive income, the transaction costs are included in the initial
measurement of the asset.

Statement of profit or loss

Invesment income (dividend received of 50,000 x 0.06)

Statement of other comprehensive income

Gain on investment in equity instruments
(Change in fair value) (50,000 x 4.20 - ((50,000 x 3.50) + 2500))

Statement of financial position

Investments in equity instruments (50,000 x 4.20)
 recognition;
n for any financial asset.

of financial position
he instrument.

sets / liabilities
 £
35,000
3,000
(2,500)

210,000

at fair value

3,000

32,500

210,000
Q5 Employment benefits

Part A IAS 19 definitions:

Defined contribution
Pension scheme where contribution from both employees and
employers are fixed (normally at % employees' salaries)
Employees bear the risks of uncertain investment returns (normally
from the stock market)

Defined benefit
All other pension schemes other than defined contribution schemes
Amount paid to employees is guaranteed and determined by length
of service and salary levels
Contribution into the scheme is variable, but as employees typically
pay a fixed contribution, the risk of insufficient funds is borne by
the employer (but employer also gains if the scheme is in surplus)
Two types of schemes (funded and unfunded)

Valuation of DB pensions is by actuarial methods due to uncertainty of payments to meet the benefits payable.
Depend on assumptions such as employee turnover, future salary, life expectancy
and the value of assets in the scheme

IAS19 Accounting for retirement benefit plans

Financial statements of a company with a retirement benefit plan should reflect at fair value the assets and
liabilities arising from its retirement benefit obligations and any related funding.

The operating costs of providing retirement benefits to employees should be recognised in the accounting
period(s) in which the benefits are earned by the employees.

Related finance costs and any other charges in value of the assets and liabilities should be recognised in the
accounting periods in which they arise.

The financial statements should contain adequate disclosure of the cost of providing retirement benefits and
the related gains, losses, assets and liabilities.

Defined contributions
Employer's contribution is accounted for as a remuneration expense in the period for which the services are
provided by the employee on an accruals basis. Any unpaid at the end of the period are a liability, but
overpayments are accounted as a prepayment (but only to the extent that there will be a reduction of future
contribution or a refund).

Defined benefits
As the valuation of the benefits and contributions depend on actuarial valuations, accounting is more complex.
Consider what the obligations are to provide agreed benefits to current and former employees, and whether the
pension plan's assets are sufficient to meet these.

PV defined benefit obligation at reporting date X

FV plan assets at reporting date Y
Plan deficit / (surplus) Z Deficit
Surplus

If the plan is in surplus, recognise the asset as the lower of:

i) surplus
 ii) asset ceiling (PV economic benefits in the form of refunds from the plan or reductions in future
contributions to the plan).

Part B 2018 2019

£'000 £'000
Rate on high quality corporate bonds at the start of year 10% 9%
Current service cost 160 140
Benefits paid 150 180
Contributions paid 90 100
Prevent value of obligations at 31 December 1,100 1,380
Market value of plan assets at 31 December 1,190 1,372

In 2019 the plan was amended to provide additional benefits with effect from 1 January 2019.
The present value as at 1 January 2019 of additional benefits for employee service before
1 January 2019 was: £ '000 50

Step 1 Change in the net pension obligation

2018 2019
£'000 £'000
Present value of asset (obligation), 1 January - 90.0
Net interest gain (cost) (at 10%, 9% & 8% respectively) - 8.1
Current service cost (160.0) (140.0)
Past service cost - (50.0)
Contributions paid 90.0 100.0
Actuarial gain (loss) on obligation [balancing figure]* 160.0 (16.1)
Present value of asset (obligation), 31 December 90.0 (8.0)
* Here, we do not distinguish between actuarial gains and losses and differences in the
actual and expected return on plan assets.

Step 2 Calculate the impact on the statement of comprehensive income

2018 2019
£'000 £'000
Operating costs:
Current service cost (160.0) (140.0)
Past service cost - (50.0)
Net interest benefit (cost) - 8.1
Profit and loss charge (160.0) (181.9)
Other comprehensive income:
Actuarial gains (losses) 160.0 (16.1)

Step 3 Calculate the statement of financial position

2018 2019
£'000 £'000
Present value of pension obligation, 31 December 1,100 1,380
Fair value of plan assets, 31 December 1,190 1,372
Asset (liability) recognised 90 (8)
to meet the benefits payable.

fair value the assets and

gnised in the accounting

ould be recognised in the

ng retirement benefits and

for which the services are

d are a liability, but
l be a reduction of future

accounting is more complex.

employees, and whether the

non current liability

non current asset
uctions in future

2020
£'000
8%
150
190
110
1,455
1,188

nuary 2019.

2020
£'000
(8.0)
(0.6)
(150.0)
-
110.0
(218.4)
(267.0)

2020
£'000

(150.0)
-
(0.6)
(150.6)

(218.4)

2020
£'000
1,455
1,188
(267)
Q6 Mix questions

A Issue of shares 1,000,000

Nominal value £ / share 0.50
Issue price £ / share 12.50
Cost of share issue 1% of total raised Total raised 12,500,000
Bonus share for each share 0.2

£ Additional shares After new issue Cost

Ordinary share capital 1,250,000 500,000 1,750,000
Ordinary share premium 3,750,000 12,000,000 15,750,000 (125,000)
Preference share capital 1,000,000
Profit and loss account reserve 40,000,000
46,000,000 12,500,000 17,500,000 (125,000)

B Define
Earnings per share earnings or profit / weighted number of ordinary shares
Gearing ratio long term debt / (long term debt + equity) or long term debt / equity
Return on equity Profit (for shareholders) / Equity

Increase in long term debt Increase gearing ratio but no direct effect on EPS or return on equity; but see below for c
Profits may rise from the increase in (debt financed) non-current and current assets gener
so indirectly EPS and RoE can also rise as a result
Alternatively you could argue that profits may fall because of the increase in interest cost

C Events after the reporting period (IAS 10)

Adjusting events Accounting treatment
Events that provided evidence of conditions Adjust the financial statements to
that existed at the end of the reporting period reflect the adjusting event

Non-adjusting events
Events that are indicative of conditions that Do not adjust the financial statements,
arose after the reporting period but provide details of the event in a note

If financial statements are to provide relevant information to the users then information about
significant or material events which could affect their decisions, even those that occur after the
end of the financial year, should be incorporated into the financial statements.

D On 1 June 2018 SFP Rate Reds £

Dr Non-current asset (machine) 10 100,000 10,000
Cr Payables 10,000

On 31 December 2018 SFP

Machine (b/f from 1/6/18) 10,000
Payables 12 100,000 8,333
Cr Profit and loss (gain) 1,667
 Cost = (125,000)

Net Adjustment After bonus issue

1,750,000 350,000 2,100,000
15,625,000 (350,000) 15,275,000
1,000,000 1,000,000
40,000,000 40,000,000
58,375,000 - 58,375,000

equity; but see below for context

nt and current assets generating additional revenues,

he increase in interest costs from additional loans

Part B: Essay questions

Q7 Regulation
Regulation is needed to make up for externalities caused by asymmetric information.
For example, the Principal-Agent framework that underpin financial reporting in the UK is too difficult and costly to monitor
especially if there are multiple contracts between parties. Therefore, regulation provides society and users with information nee
that may not otherwise be made publicly available. Answers should explain in greater detail what the Principal-Agent framewo
Main beneficiaries are the society at large, the public (but free riding can be a problem), and other users of the accounts who m
have sufficient ability to procure information from self-interested managers. Costs is that regulation is a form of tax that punish
for the failures of a small group of people (i.e. the market for lemons argument, costs of signalling etc.).

Q8
Define non current tangible assets
Define investment properties
Definition: IAS40 on Investment property - property held (by the owner or by the lessee under a finance
lease) to earn rentals or for capital appreciation or both, rather than for:
a) use in the production or supply of goods or services or for admin purposes, or
b) sale in the ordinary course of business
Current standards use two different approaches - cost valuation and fair values
Difference is about the way in which property is used. Under tangible assets, property is used as part of a range of assets to gen
Under investment property, the asset is treated more like a form of inventory, for shorter term use and immediately profitable

QUALITATIVE CHARACTERISTICS OF A CF
Relevance; Reliability; Comparability etc.

Relevance – for example, even in HCA, modifications are made to reflect current values for selective adjustments

Reliability – prudence / conservatism (do not recognise estimated future income streams until realised)

The trade off is thus between relevance versus reliability (examples)

IAS40 Investment Property
difficult and costly to monitor
and users with information needs
at the Principal-Agent framework is in an accounting context.
er users of the accounts who may not otherwise
tion is a form of tax that punishes everybody

part of a range of assets to generate revenue.

e and immediately profitable

ctive adjustments