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Professional Examination – Paper 2.5(INT)


Financial Reporting (International) Answers

1 (a) Hanford Consolidated Balance Sheet at 30 September 2001


Non-current assets: $000 $000
Goodwill (6,250 – 625 (w (ii))) 5,625
Property, plant and equipment (w (i)) 108,360
113,985
Current Assets
Inventory (7,450 + 4,310) 11,760
Accounts receivable (12,960 + 4,330 – 820 (w (vi))) 16,470
Insurance claim (w (ii)) 600
Bank 520 29,350
Total assets 143,335
Equity and Liabilities
Capital and reserves:
Ordinary shares of $1 each (20,000 + 10,000 (w (v))) 30,000
Reserves:
Share premium (10,000 + 10,000 (w (v))) 20,000
Accumulated profits (w (iii)) 65,575 85,575
115,575

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Minority interests 5,950


Non-current liabilities
8% Loan notes 2004 6,000
Current liabilities
Trade accounts payable (5,920 + 4,160 – 620 (w (vi))) 9,460
Bank overdraft 1,700
Other accounts payable – dividend payable to minority 200
Provision for taxation (1,870 + 1,380) 3,250
Proposed final dividend 1,200 15,810
Total equity and liabilities 143,335

Workings: (all figures in $000)


(i) Property, plant and equipment:
Amount from question – Hanford 78,540
– Stopple 27,180
Fair value adjustment (group share only) $4,000 x 75% 3,000
Unrealised profit in transfer of plant (w (iii)) (360)
108,360

(ii) Cost of control


Investments at cost 25,000 Ordinary shares (8,000 x 75%) 6,000
Pre-acquisition dividend (w (iii)) (150) Share premium (2,000 x 75%) 1,500
Adjusted cost of investment 24,850 Pre acq profit 7,500
Fair value adjustments (see below) 3,600
Goodwill 6,250
24,850 24,850

Fair value adjustments


The benchmark treatment requires that only Hanford’s share of the excess value of the land has to be recognised as a fair
value adjustment (i.e. $4 million x 75% = $3 million). Although the insurance claim is a contingent asset and cannot be
recognised by Stopple, IAS 22 requires Hanford to make an assessment of all assets and liabilities of Stopple at the date
of acquisition. The best estimate of the claim would be full settlement of $800,000, however the benchmark treatment
requires that only Hanford’s share of this would be recognised in the consolidated financial statements i.e. $600,000.
Total fair value adjustments are therefore $3·6 million.
Goodwill depreciation will be $6·25 million/5 years x 6/12 = $625,000

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(iii) Consolidated reserves


Hanford Stopple Hanford Stopple
Unrealised profit in plant sold 360 B/f 63,260 14,000
Central admin costs 200 Post acq profit 2,850
Minority interest ((14,000 – 200) x 25%) 3,450 Post acq dividend
Pre acq profit ((6,000 + (8,000 x 6/12)) x 75%) 7,500 from Stopple 450
Post acq profit ((4,000 – 200) x 75%)) 2,850
Goodwill amortisation 625
Balance c/f 65,575
66,560 14,000 66,560 14,000

Notes: the unrealised profit on the sale of the plant was initially $400,000, of this 10% i.e. $40,000 has been realised via
Stopple’s depreciation charge, giving a net adjustment of $360,000 to both Hanford’s profits and the carrying value of the
plant.
Stopple’s dividends for the year are $1,200,000 ($400,000 interim plus $800,000 final). The post acquisition amount
of these attributable to Hanford is $450,000 (1,200,000 x 75% x 6/12); therefore of the $600,000 ($800,000 x 75%)
of Stopple’s proposed dividend that Hanford will receive, $150,000 should be treated as pre-acquisition.
(iv) Minority interest
Balance c/f 5,950 Ordinary shares (8,000 x 25%) 2,000
Share premium (2,000 x 25%) 500
Accumulated profits (w (iii)) 3,450

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5,950 5,950

(v) Share exchange:


Hanford acquired six million shares in Stopple. On the basis of an exchange of five for three, Hanford would issue
10 million new shares. The total value of the consideration is $25 million of which $5 million was for cash, therefore the
value of the 10 million shares would be $20 million, or $2 each i.e. they were issued at a premium of $1 each.
(vi) Elimination of current accounts:
The difference on the current accounts is due to the invoice for central administration of $200,000. A summary of the
intra-group adjustment/cancellation is:
Dr Cr
Hanford’s overdraft 200
Accounts payable 620
Accounts receivable 820
820 820

(b) The reasons why a parent company may not wish to consolidate a subsidiary can be broken down into two broad groups: (i) to
improve the reported position of the group financial statements; and (ii) for the reasons, and in compliance with, IAS 27
‘Consolidated Financial Statements and Accounting for Investments in Subsidiaries’.
Improvement of the financial position:
The financial statements of a subsidiary could show any of the following:
– substantial operating losses;
– a poor liquidity position; or
– high levels of borrowing (high gearing).
If a parent were to consolidate such a subsidiary, it would proportionately worsen the group position in the above areas. Thus a
parent may prefer not to consolidate poorly performing subsidiaries.
IAS 27’s requirements:
Subsidiaries should be excluded from a parent’s consolidated financial statements for the following reasons:
– the subsidiary operates under severe long-term restrictions. In effect the parent does not have full control (particularly over
the ability to transfer funds to the parent) over the subsidiary.
– control is intended to be temporary because the investment is held exclusively with a view to its subsequent resale.
Exclusion on these grounds is only permitted where a subsidiary has never been consolidated in the past.
It is apparent that the first group of reasons for non-consolidation is not permitted by International Accounting Standards,
whereas the latter group is.
IAS 27 also makes reference to subsidiaries sometimes being excluded on the basis of differing activities. Companies that have
adopted this approach argue that to add together the assets and liabilities of companies whose activities differ greatly could lead
to consolidated financial statements that give a misleading impression (or not show a true and fair view). IAS 27 does not permit
exclusion on these grounds because it feels that ‘differing activity’ problems are overcome by the provision of segmental
information.

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2 (a) (i) Telenorth Income Statement – Year to 30 September 2001


$000 $000
Sales revenue 283,460
Cost of sales (w (i)) (155,170)
Gross profit 128,290
Distribution expenses (22,300)
Administration expenses (42,200) (64,500)
Operating profit 63,790
Profit from operations
Financing cost (96 + 600 (w (iii))) (696)
Investment income 1,500 804
Profit before tax 64,594
Income tax (23,400 + 1,200) (24,600)
Net profit for the period 39,994

(ii) Telenorth – Balance Sheet as at 30 September 2001


Assets
Tangible Non-current assets $000 $000
Property, plant and equipment 83,440
Investments 34,500

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117,940
Current Assets
Inventory (w (iv))) 16,680
Trade accounts receivable (35,700 + 12,000) (w (iii)) 47,700 64,380
182,320
Equity and Liabilities
Capital and Reserves:
Ordinary shares of $1 each (20,000 + 4,000 + 6,000) (w (vi)) 30,000
8% Preference shares 12,000
42,000
Reserves:
Revaluation (3,400 – 1,000 deferred tax) 2,400
Share premium (4,000 + 12,000) (w (vi)) 16,000
Accumulated profits (w (vi)) 46,694 65,094
107,094
Current liabilities
Trade and other payables (w (v)) 18,070
Loan from Kwikfinance ((9,600 + 96) w (iii)) 9,696
Provision for income tax 23,400
Proposed dividends (w (v)) 4,980
Overdraft 1,680 57,826
Non-current liabilities
6% Loan note 10,000
Deferred tax (5,200 + 1,200 + 1,000) 7,400 17,400
Total equity and liabilities 182,320
Workings (all figures in $000)
(i) Cost of sales:
Opening inventory 12,400
Purchases 147,200
Depreciation (w (ii)) 12,250
171,850
Closing inventory (w (iv)) (16,680)
155,170
Administration:
Per question 34,440
Incorrect factoring charge (w (iii)) (2,400)
Depreciation of computer system (w (ii)) 10,160
42,200

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(ii) Property, plant and equipment: cost depreciation carrying value


Leasehold 56,250 20,250 (18,000 + 2,250) 36,000
Plant and equipment 55,000 22,800 (12,800 + 10,000) 32,200
Computer system 35,000 19,760 (9,600 + 10,160) 15,240
83,440

Depreciation for year:


Leasehold (56,250/25 years) 2,250
Plant (55,000 – 5,000)/ 5 year life) 10,000
Charged to cost of sales 12,250
Computer system charged to administration ((35,000 – 9,600) x 40%) 10,160

(iii) Accounts receivable/factoring:


As Telenorth still bears the risk of slow payment and bad debts, the substance of the factoring is that of a loan on
which finance charges will be made. The amount receivable from the customer should not have been derecognised
(removed from the balance sheet) nor should all of the difference between the amount due from the customer and the
amount received from the factor have been treated as an administration cost. The required adjustments can be
summarised as follows:
Dr Cr
Accounts receivable 12,000
Loan from factor 9,600

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Administration (12,000 – 9,600) 2,400


Finance costs: accrued interest ($9·6 million x 1·0%) 96
Accruals 96
12,096 12,096

There would also be loan note interest of $600,000 charged for the year ($300,000 paid + $300,000 accrued).
(iv) Closing inventory:
As this was not counted at the year-end, the actual count needs to be adjusted for movements in the period between
the year-end and the date of the count;
Balance on 4 October 2001 16,000
Add goods sold at cost: normal sales (1,400/140 x 100) 1,000
sale or return (650/130 X 100) 500
Less goods received at cost (820)
Adjusted value 16,680

(v) Current liabilities


Trade and other payables:
Accounts payable from question 17,770
Accrued loan note interest (w (iii)) 300
18,070
Proposed dividends (480 preference + 4,500 ordinary (at 15 cents on 30 million shares)) 4,980

(vi) Share capital/accumulated profits/suspense account:


The elimination of the suspense account is as follows: Dr Cr
Suspense account (per trial balance) 26,000
Director’s options: share capital (4 million at $1) 4,000
share premium (4 million at $1) 4,000
Rights issue: share capital ((20 million + 4 million)/4) 6,000
share premium (6 million at $2) 12,000
26,000 26,000
Accumulated profit:
Balance 1 October 2000 14,160
Net profit for the period 39,994
Dividends – Preferences (8% x 12,000) 960
– Ordinary (2,000 + 4,500 interim + final) 6,500 (7,460)
Balance 30 September 2001 46,694

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(b) Telenorth – Earnings per Share (EPS) for the year to 30 September 2001 000’s
Number of shares at 1 October b/f 20,000
Exercise of options on this date 4,000
24,000
Rights issue of 1 for 4 on 1 July 2001(24,000/4) 6,000
Number in issue at year end 30,000

Theoretical ex-rights price:


Holding $ $
4 shares worth 4·00 each 16
1 new share 3·00 each 3
5 shares 3·80 each (balance) 19
Therefore $3·80 would be the theoretical ex-rights price
Weighted average number of shares in issue: 000’s
24,000 x 9/12 x 4·00/3·80 = 18,947
30,000 x 3/12 = 7,500
26,447

$000
Profit for the period 39,994

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Deduct preference dividends (960)


Earnings attributable to ordinary shares 39,034

Therefore EPS is 39,034/26,447 x 100c 148c

3 (a) (i) Although the broad principles of accounting for non-current assets are well understood by the accounting profession,
applying these principles to practical situations has resulted in complications and inconsistency. For the most part, IAS 16
codifies existing good practice, but it does include specific rules which are intended to achieve improved consistency and
more transparency.
Cost
The cost of an item of property, plant and equipment comprises its purchase price and any other costs directly attributable
to bringing the asset into a working condition for its intended use. This is expanded upon as follows:
– purchase price is after the deduction of any trade discounts or rebates (but not early settlement discounts), but it does
include any transport and handling costs (delivery, packing and insurance), non-refundable taxes (e.g. sale taxes
such as VAT/GST, stamp duty, import duty). If the payment is deferred beyond normal credit terms this should be
taken into account either by the use of discounting or substituting a cash equivalent price;
– directly attributable costs are the incremental costs that would have been avoided had the assets not been acquired.
For self constructed assets this includes labour costs of own employees. Abnormal costs such as wastage and errors
are excluded;
– installation costs and site preparation costs; and
– professional fees (e.g. legal fees, architects fees)
In addition to the ‘traditional’ costs above two further groups of cost may be capitalised:
– IAS 23 ‘Borrowing Costs’ allows (under the allowed alternative method), directly attributable borrowing costs to be
capitalised. Directly attributable borrowing costs are those that would have been avoided had there been no
expenditure on the asset.
– IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ says that if the estimated costs of removing and
dismantling an asset and restoring its site qualify as a liability, they should be provided for and added to the cost of the
relevant asset.
Finally the carrying amount of an asset may be reduced by any applicable government grants under IAS 20 ‘Accounting for
Government Grants and Disclosure of Government Assistance’.

(ii) Subsequent expenditure:


Traditionally the appropriate accounting treatment of subsequent expenditure on non-current assets revolved around
whether it represented a revenue expense, in effect maintenance or a repair, or whether it represented an improvement that
should be capitalised. IAS 16 bases the question of capitalisation of subsequent expenditure on whether it results in a
probable future economic benefit in excess of the amount originally assessed for the asset. All other subsequent
expenditure should be recognised in the income statement as it is incurred. Examples of circumstances where subsequent
expenditure should be capitalised are where it:

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– represents a modification that enhances the economic benefits of an asset (in excess of its previously assessed
standard of performance). This could be an increase in its life or production capacity;
– upgrades an asset with the effect of improving the quality of output; or
– is on a new production process that reduces operating costs.
In addition to the above the Standard says it is important to take into account the circumstances of the expenditure. For
example normal servicing and overhaul of plant is a revenue cost, but if the expenditure represents a major overhaul of an
asset that restores its previous life, and the consumption of the previous economic benefits has been reflected by past
depreciation charges, then the expenditure should be capitalised (subject to not exceeding its recoverable amount). A
further example of where subsequent expenditure should be capitalised is where a major component of an asset that has
been treated separately (for depreciation purposes) is replaced or restored (e.g. new engines for an aircraft).

(b) Revaluation (particularly of properties) has been an area of great flexibility and inconsistency, often leading to misleading
financial statements and accusations of ‘creative accounting’. Under IAS 16 revaluations are permitted under its allowed
alternative treatment rules for the measurement of assets subsequent to their initial recognition. The Standard attempts to bring
some order and consistency to the practice of revaluations.
Where an entity chooses to revalue a tangible non-current asset, it must also revalue the entire class of assets to which it
belongs. Further, sufficiently regular revaluations should be made such that the carrying amounts of revalued assets should not
differ materially to their fair values at the balance sheet date. The Standard stops short of requiring annual valuations, but it does
contain detailed rules on the basis and frequency of valuation. It should be noted that where an asset has been written down to
its recoverable amount due to impairment, this is not classed as being a policy of revaluation. The effect of the above is that it
prevents selective or favourable valuations being reported whilst ignoring adverse movements, and where a company has
chosen to revalue its assets (or class thereof), the values must be kept up-to-date.

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Surpluses and deficits:


These are measured as the difference between the revalued amounts and the book (carrying) values at the date of the valuation.
Increases (gains) are taken to equity under the heading of revaluation surplus (this may be via a Statement of Total Recognised
Gains and Losses (STRGL)), unless, and to the extent that, they reverse a previous loss (on the same asset) that has been
charged to the income statement. In which case they should be recognised as income.
Decreases in valuations (revaluation losses) should normally be charged to the income statement. However, where they relate
to an asset that has previously been revalued upwards, then to the extent that the losses do not exceed the amount standing to
the credit of the asset in the revaluation reserve, they should be charged directly to that reserve (again this may pass through a
STRGL).
Any impairment loss on revalued property, plant and equipment, recognisable under IAS 36 ‘Impairment of Assets’, is treated as
a revaluation loss under IAS 16.
Gains and losses on disposal:
The gain or loss on disposal is measured as the difference between the net sale proceeds and the carrying value of the asset at
the date of sale. In the past some companies reverted to historic cost values to calculate a gain on disposal thus inflating the gain
(assuming assets had increased in value). All gains and losses should be recognised in the income statement in the period of the
disposal. Any revaluation surplus standing to the credit of a disposed asset should be transferred to accumulated realised profits
(as a movement on reserves).

(c) (i) The initial measurement of the cost at which the plant would be capitalised is calculated as follows:
$ $
basic list price of plant 240,000
less trade discount of 12·5% on list price (30,000)
210,000
shipping handling and installation costs 2,750
estimated pre-production testing 12,500
site preparation costs
electrical cable installation (14,000 – 6,000) 8,000
concrete reinforcement 4,500
own labour costs 7,500 20,000
dismantling and restoration costs (15,000 + 3,000) 18,000
Initial cost of plant 263,250

Note: the early settlement discount is a revenue item (probably deducted from administration costs). The maintenance
cost is also a revenue item, although a proportion of it would be a prepayment at the end of the year of acquisition (the
amount would be dependent on the date on acquisition). The cost of the specification error must be charged to the income
statement.

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(ii) Broadoak 30 September 2000 30 September 2001


Income statement extract $ $
Amortisation (20,000) (21,000)
Revaluation loss (25,000)
Balance sheet
Leasehold 231,000 175,000
Revaluation reserve
Balance 1 October 1999 50,000
Revaluation gain (see below) 11,000
Balance 30 September 2000 61,000
Transfer to accumulated profits (11,000 x 1/11) (1,000)
Proportion of revaluation loss (see below) (10,000)
Balance 30 September 2001 50,000

Workings:
Cost 1 October 1999 240,000
Amortisation to 30 September 2000 (240,000/12 years) (20,000)
220,000
Revaluation gain 11,000
Carrying value 30 September 2000 231,000
Amortisation to 30 September 2001 (231,000/11 years) (21,000)

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210,000
Revaluation loss directly to revaluation reserve (10,000)
Remaining loss to income statement (25,000)
Carrying value 30 September 2001 175,000

4 Charmer Cash Flow Statement for the year to 30 September 2001:


Reconciliation of operating profit to net cash inflow from operating activities
Note: figures in brackets are in $000 $000 $000
Net profit before interest and tax (3,198 – 1,479) 1,719
Adjustments for:
depreciation – buildings (w (i)) 80
– plant (w (i)) 276
loss on disposal of plant (w (i)) 86 442
amortisation of government grants (w (ii)) (125)
negligence claim previously provided (120)
Operating profit before working capital changes 1,916
increase in inventories (1,046 – 785) (261)
increase in accounts receivable (935 – 824) (111)
decrease in accounts payable (760 – 644) (116)
Cash generated from operations 1,428
interest paid (260 + 25 – 40) (245)
income tax paid (w (iv)) (368)
dividends paid (30 + 150 interim) (180)
Net cash inflow from operating activities 635
Cash flows from investing activities
Purchase of land and buildings (w (i)) (50)
Purchase of plant (w (i)) (848)
Purchase of non-current investments (690)
Purchase of treasury bills (120 – 50) (70)
Proceeds of sale of plant (w (i)) 170
Receipt of government grant (w (ii)) 175
Investment income 120
(1,193)
Cash flows from financing activities
Issue of ordinary shares (w (iii)) 300
Net decrease in cash and cash equivalents (258)
Cash and cash equivalents b/f 122
Cash and cash equivalents at the end of the period (136)

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Workings $000
(i) Non-current assets:
Land and buildings – cost/valuation
Balance b/f 1,800
Revaluation surplus 150
Balance c/f (2,000)
Difference cash purchase (50)
Plant – cost
Balance b/f 1,220
Disposal (500)
Balance c/f (1,568)
Difference cash purchase (848)

Depreciation of non-current assets:


Building (760 – 680) 80
Plant (464 – (432 – 244)) 276
The plant had a carrying value of $256,000 at the date of its disposal (500 cost – 244 depreciation). As there was a loss on
sale of $86,000 (given in question), the sale proceeds must have been $170,000 (i.e. 256 – 86).
(ii) Government grant:
Balances b/f – current (125)

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– non-current (200)
Amortisation credited to cost of sales 125
Balances c/f – current 100
– non-current 275
Difference cash receipt 175

(iii) Share capital and convertible loan stock:


A reconciliation of share capital, share premium and the revaluation reserve shows the shares issued for cash:
share capital share premium revaluation reserve
$000 $000 $000
opening balance (1,000) (60) (40)
revaluation of land (150)
bonus issue 1 for 10 (100) 100
conversion of loan stock (see below) (100) (300)
closing balance 1,400 460 90
difference issued for cash 200 100 nil

The 10% convertible loan stock had a carrying value of $400,000 at the date of conversion to equity shares. This would be
taken as the consideration for the shares issued which would be 100,000 $1 shares (i.e. 400,000/100 x 25). This would
increase issued share capital by $100,000 and share premium by $300,000.
(iv) Income tax: $000
Tax provision b/f (367)
Deferred tax b/f (400)
Income statement tax charge (520)
Tax provision c/f 480
Deferred tax c/f 439
Difference cash paid (368)

5 (a) (i) The fundamental accounting concept of consistency dictates that similar items should be treated in a consistent manner in
each accounting period and over time. Where a company changes its accounting policy it impairs the consistency and
comparability of financial statements. Therefore a change should only occur if a new policy is preferable to the old policy
in that it gives a more appropriate presentation of events or transactions. This normally occurs where there is a change in
an accounting statute or an accounting standard. It sometimes occurs on the acquisition of a subsidiary, where the
subsidiary’s policy differs to that of the group. The adoption of an accounting policy for the first time, or when a company
applies a policy to transactions that differ substantially from any of its previous transactions, does not constitute a change
of accounting policy.

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(ii) Income statement year to: 30 September 2001 30 September 2000


(restated)
$000 $000
Amortisation (1,060 x 25%) 265 ((1,060 – 400) x 25%) 165
Balance sheet
Intangible non-current assets
Development expenditure – cost 1,230 (1,230 – 560) 670
– amortisation (see below) (505) (240)
– net book value 725 430

Accumulated profit 1 October 2000 1,000


Prior period adjustment (see below) 345
Accumulated profit at 1 October 2000 as restated 1,345

Workings: $000
Amortisation as at 30 September 2000 – eligible re 1999 300 x 25% x 2 years 150
– eligible re 2000 360 x 25% x 1 year 90
240

Amortisation as at 30 September 2001 – eligible re 1999 300 x 25% x 3 years 225


– eligible re 2000 360 x 25% x 2 years 180

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– eligible re 2001 400 x 25% x 1 year 100


505

Prior period adjustment


The amount of the prior period adjustment would be the net book value of the development expenditure of $345,000
(420,000 – 75,000) that would have been included in the balance sheet at 30 September 1999. The $420,000 is the
recognised amount of development costs, and the $75,000 is one year’s amortisation of the qualifying amount i.e.
$300,000 x 25%.

(b) (i) It is argued that the principal reasons for holding investment properties are that the owner expects to receive rental income
from them and benefit from capital appreciation. They are not held for ‘consumption’ in the normal course of business i.e.
they are not used as part of a company’s operations in the production or supply of goods and services or administrative
purposes. As they are held as an investment for (eventual) disposal, it is often considered that it is the current values of the
investments and the changes in them that are more important than their original costs. IAS 40 ‘Investment Properties’
takes this into account by permitting a choice of either a ‘cost’ model or a ‘fair value’ model on which the accounting
treatment of investment properties must be based.
Cost method
This is the benchmark treatment in IAS 16 ‘Property, Plant and Equipment’ which requires investment properties to be
measured at depreciated historic cost (less any impairments). In effect this treats investment properties in a similar manner
to owner-occupied properties. Where the cost model is adopted, the fair values of investment properties must be disclosed.
Fair value model
This requires investment properties to be measured at their fair values on the balance sheet with changes in fair values
being recognised in income. This differs from a revaluation model that requires (with certain exceptions) revaluation
surpluses to be recognised as changes in equity (reserve movements), not as income. In the introduction to the Standard
the IASC makes it clear that they consider the fair value model to be desirable, although they point out that it is an
evolutionary step forward and therefore stop short, at this stage, of making it a requirement.
(ii) Consolidated balance sheet extracts as at 30 September 2001
Non-current Assets cost/valuation accumulated depreciation carrying value
$000 $000 $000
Property, plant and equipment – A 150 6 (2 years) 144
Investment properties –B 145 nil 145
–C 150 nil 150
Consolidated income statement extracts year to 30 September 2001:
Depreciation:
Property A 3 (150/50 years)
Deficit in fair value of investment property B (180 – 145) (35)
Surplus in fair value of investment property C (140 – 150) 10
Note: property A is let to a subsidiary of Myriad, therefore in Myriad’s consolidated financial statements it would be treated
as an owner-occupied property (benchmark treatment in IAS 16). By contrast, when preparing the entity financial
statements of Myriad, it would be treated as an investment property. The fair value of property A of $200,000 would be
disclosed in the financial statements.

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(c) This is a complex situation. The selling prices of some items of inventory after the balance sheet date appear to be below their
cost and this indicates that part of the closing inventory (at 30 September 2001) may require writing down to net realisable
value with the resultant loss recognised in the current year. This is an adjusting post balance sheet event if the losses are due to
circumstances that occurred before the year-end. However, if the losses are due to circumstances that developed in the post
balance sheet period, they should be included in the following year’s financial statements (to 30 September 2002). If these
losses (in 2002) are material they should be brought to the attention of shareholders in the notes to the financial statements for
the year to 30 September 2001 as a non-adjusting event. Applying the above to the circumstances of the question would give
the following analysis:
$
Cost 48
Net realisable value (NRV) 41
Apparent loss 7 per pack

The NRV of $41 is the reduced selling price for A4 paper of $45 less the cost of getting the goods into a saleable condition of
$4.
From the question it would appear that this loss is partly attributable to the remedial cost of the water leak. This is an adjusting
event requiring a write down of $2 per pack of the relevant items. The net realisable value at the year-end would have been $46
(original selling price of $50 less $4 remedial costs), which is $2 below the cost of $48. The remainder of the loss, $5 ($50 –
$45), is caused by the price reduction in response to competitive pressure in the post balance period. This is a non-adjusting
event requiring appropriate disclosure if material.
The above ignores the effect of the information concerning the sale to Securiprint. If the ‘marks’ are due to the water leak or other

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flaw in manufacture, Myriad will probably be liable to pay compensation to Securiprint. This would be an actual liability
requiring a provision to be made in the current year unless the amount cannot be determined reliably (the IASC says this should
be rare). The provision would be for a refund of the cost of the goods sold and compensation for consequential losses caused by
the faulty goods. If the marks were not due to the actions of Myriad then there would be no liability. It may be that at this early
stage there is insufficient information to come to a conclusion as to who is at fault, but this represents at least a contingent
liability on the part of Myriad and should be disclosed appropriately in the notes to the financial statements. The information
may also indicate that other customers could have similar claims against Myriad.
A final point to consider is that if the above fault is not due to Securiprint, it may mean that all of the inventory affected by the
water leak is still damaged (despite the remedial work). If so, this would be evidence that the value of the inventory is impaired
and a further provision would be required to write down the inventory (probably to nil) in the current year. Clearly no more of this
inventory should be sold until the problem is resolved.

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Professional Examination – Paper 2.5(INT)


Financial Reporting (International) Marking Scheme

This marking scheme is given as a guide in the context of the suggested answers. Scope is given to markers to award marks for alternative
approaches to a question, including relevant comment, and where well-reasoned conclusions are provided. This is particularly the case for
written answers where there may be more than one definitive solution.

1 (a) Balance sheet: Marks


goodwill – calculation 3
– depreciation 1
property, plant and equipment 4
inventory 1
accounts receivable 2
insurance claim 1
bank/overdraft 1
accounts payable 2
dividend to minority 1
tax and dividend 1
minority interest 2
8% loan note 1
share capital 1
share premium 1
Consolidated reserves – treatment of admin charge 1

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– post acq profit 1


– post acq dividend 1
available 25
maximum 20

(b) For reasons of – poor profitability 1


– poor liquidity/gearing 1
– long-term restrictions 1
– subsequent resale 1
– differing activities 1
First two prohibited, last three permitted 1
available 6
maximum 5
Maximum for question 25

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Marks
2 (a) (i) Income statement
cost of sales 3
sales revenue and distribution 1
administration 2
finance costs 2
investment income 1
taxation 2
available 11
maximum 8
(ii) Balance sheet
non-current assets 3
inventory 1
accounts receivable/payable from question 1
treatment of factored accounts receivable 2
tax provision 1
loan note 1
deferred tax 1
proposed dividends 1
ordinary shares 1
revaluation reserve 1
share premium 1

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accumulated profits 1
dividends 1
available 16
maximum 12
(b) earnings attributable to ordinary shares 1
calculation of theoretical ex-rights price 1
weighting exercise 2
calculation of earnings per share (in cents) 1
maximum 5
Maximum for question 25

3 (a) (i) cost – purchase price net of trade discount 1


– incidentals, transport etc 1
– installation 1
– borrowing costs 1
– site restoration etc 1
available 5
maximum 4
(ii) subsequent expenditure – 1 mark per circumstance maximum 3
(b) must revalue whole class of assets 1
must keep values up-to-date 1
treatment of revaluation – surpluses 2
– deficits 2
impairment loss treated as a revaluation loss 1
gain/loss on disposal – basis of calculation 1
– treatment of previous surplus 1
available 9
maximum 8
(c) (i) deduction of trade discount 1
inclusion of – shipping and preparation costs 1
– testing and installation 2
– dismantling etc 1
exclusion of error, maintenance and early settlement discount 1
available 6
maximum 5
(ii) amortisation charges 2
revaluation loss to income statement 1
movements on revaluation reserve 2
carrying value of leasehold at year ends 2
available 7
maximum 5
Maximum for question 25

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Marks
4 net profit before interest and tax 1
depreciation adjustments 2
loss on sale of plant 1
amortisation of government grants 1
negligence adjustment 1
working capital 1 per item 3
interest paid 2
tax 2
dividends 2
purchase of – land and buildings 2
– plant 2
– investments 1
– treasury bills 1
sale of plant 1
receipt of government grant 1
investment income 1
share issue 3
movement in cash and cash equivalents 1
available 28
Maximum for question 25

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5 (a) (i) principle of consistency/comparability 1


to give a fairer presentation or more useful information 1
usually because of new standard or statute 1
initial implementation for new circumstances not a change 1
maximum 4
(ii) Income statement: depreciation 2
Balance Sheet: Development expenditure – cost 2
– amortisation 2
Prior period adjustment 1
available 7
maximum 6

(b) (i) reasons for different accounting treatment 2


measurement models 2
maximum 4
(ii) non-current asset figure – 1 mark for each property 3
income statement items 3
disclosure of fair value 1
available 7
maximum 5

(c) total loss per pack is $7 1


$2 is an adjusting event 1
$5 is non-adjusting, perhaps requiring disclosure 1
if ‘marks’ due to water damage, provision required 1
if not enough information, treat as a contingency 1
possibility of similar claims from other customers 1
may be that remaining inventory should be written down 1
available 7
maximum 6
Maximum for question 25

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