Paper 3.

6(GBR)
Advanced Corporate
Reporting
(UK Stream)

PART 3

TUESDAY 12 DECEMBER 2006

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A This ONE question is compulsory and MUST be

answered

Section B THREE questions ONLY to be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination

hall

The Association of Chartered Certified Accountants

Section A – This ONE question is compulsory and MUST be attempted

1 The following group draft financial statements relate to Andash, a public limited company:
Draft Group Balance Sheets at 31 October
2006 2005
£m £m
Fixed assets
Plant and machinery 5,170 4,110
Goodwill 111 130
Investment in associate 60 –
–––––– ––––––
5,341 4,240
–––––– ––––––
Current assets
Stocks 2,650 2,300
Debtors 2,400 1,500
Cash at bank and in hand 140 300
–––––– ––––––
5,190 4,100
Creditors: Amounts falling due within one year:
Creditors (4,700) (2,800)
Interest payable (70) (40)
Current tax payable (300) (770)
–––––– ––––––
(5,070) (3,610)
–––––– ––––––
Net current assets 120 490
–––––– ––––––
Total assets less current liabilities 5,461 4,730
–––––– ––––––
Creditors: Amounts falling due after more than one year:
Long term borrowings (3,100) (2,700)
Deferred tax (400) (300)
–––––– ––––––
(3,500) (3,000)
–––––– ––––––
Net assets 1,961 1,730
–––––– ––––––
Capital and reserves:
Share capital – ordinary shares 400 370
Other reserves 120 80
Profit and loss account 1,241 1,100
–––––– ––––––
1,761 1,550
Minority interest 200 180
–––––– ––––––
Capital employed 1,961 1,730
–––––– ––––––

2
 Draft Consolidated
Profit and Loss Account for the
year ended 31 October 2006
£m
Turnover 17,500
Cost of sales (14,600)
–––––––
Gross Profit 2,900
Distribution costs (1,870)
Administrative expenses (499)
Finance costs – interest payable (148)
Gain on disposal of subsidiary 8
–––––––
Profit on ordinary activities before tax 391
Tax on profit on ordinary activities (160)
–––––––
Profit on ordinary activities after taxation 231
Equity minority interests (40)
–––––––
Profit for financial year 191
–––––––
Reconciliation of movements in group shareholders’ funds for the year ended 31 October 2006
Share capital Other reserves Profit and loss Total
account
£m £m £m £m
Shareholders’ funds
at 31 October 2005 370 80 1,100 1,550
Profit for period 191 191
Dividends (50) (50)
Issue of share capital 30 30 60
Share options issued 10 10
–––––– –––––– –––––– ––––––
Shareholders’ funds at
31 October 2006 400 120 1,241 1,761
–––––– –––––– –––––– ––––––
The following information relates to the draft group financial statements of Andash:
(i) There had been no disposal of plant and machinery during the year. The depreciation for the period included in
cost of sales was £260 million. Andash had issued share options on 31 October 2006 as consideration for the
purchase of plant. The value of the plant purchased was £9 million at 31 October 2006 and the share options
issued had a market value of £10 million. The market value had been used to account for the plant and share
options.
(ii) Andash had acquired 25 per cent of Joma on 1 November 2005. The purchase consideration was 25 million
ordinary shares of Andash valued at £50 million and cash of £10 million. Andash has significant influence over
Joma. The investment is stated at cost in the draft group balance sheet. The reserves of Joma at the date of
acquisition were £20 million and at 31 October 2006 were £32 million. Joma had sold stock in the period to
Andash at a selling price of £16 million. The cost of the stock was £8 million and the stock was still held by
Andash at 31 October 2006. There was no goodwill arising on the acquisition of Joma.
(iii) Andash purchased 100 per cent of a subsidiary Broiler, a public limited company on 1 November 2004. The
goodwill arising on acquisition was £90 million. The carrying value of Broiler’s identifiable net assets (excluding
goodwill arising on acquisition) in the group consolidated financial statements is £266 million at 31 October
2006. The recoverable amount of Broiler is expected to be £260 million and no impairment loss has been
recorded at 31 October 2005. Goodwill is amortised over ten years using the straight line method.

3 [P.T.O.
(iv) On 30 April 2006 a wholly owned subsidiary, Chang, had been disposed of. Chang prepared interim financial
statements on that date which are as follows:
£m
Plant and machinery 10
Stock 8
Debtors 4
Cash at bank and in hand 5
Creditors (6)
Current tax payable (7)
–––
14
–––
Share capital 10
Profit and loss account 4
–––
14
–––
The consolidated carrying values of the assets and liabilities at that date were the same as above. The group
received cash proceeds of £32 million and the carrying amount of goodwill was £10 million.
(Ignore any taxation effects of the above adjustments required to the group financial statements and round all
calculations to the nearest £million)

Required:
Prepare a group cash flow statement using the indirect method for the Andash Group for the year ended
31 October 2006 in accordance with FRS1 ‘Cash Flow Statements’ after making any necessary adjustments
required to the draft group financial statements of Andash as a result of the information above.
(Candidates are not required to produce the adjusted group financial statements of Andash)

(25 marks)

4
Section B – THREE questions ONLY to be attempted

2 Misson, a public limited company, has carried out transactions denominated in foreign currency during the financial
year ended 31 October 2006 and has conducted foreign operations through a foreign entity. Its functional and
presentation currency is the pound sterling. A summary of the foreign currency activities is set out below:
(a) Misson has a 100% owned foreign subsidiary, Chong, which was formed on 1 November 2004 with a share
capital of $100 million which has been taken as the cost of the investment. The total shareholders’ funds of the
subsidiary as at 31 October 2005 and 31 October 2006 were $140 million and $160 million respectively.
Chong has not paid any dividends to Misson and has no other reserve than profit and loss reserve in its financial
statements. The subsidiary was sold on 31 October 2006 for $195 million.
Misson would like to know how to treat the sale of the subsidiary in the parent and group accounts for the year
ended 31 October 2006. (8 marks)
(b) Misson has purchased goods from a foreign supplier for $8 million on 31 July 2006. At 31 October 2006, the
creditor was still outstanding and the goods were still held by Misson. Similarly Misson has sold goods to a foreign
customer for $4 million on 31 July 2006 and it received payment for the goods in dollars on 31 October 2006.
Additionally Misson had purchased an investment property on 1 November 2005 for $28 million. At 31 October
2006, the investment property had a fair value of $24 million.
Misson would like advice on how to treat these transactions in the financial statements for the year ended 31
October 2006. (7 marks)
(c) Misson has further entered into a contract to purchase plant and machinery from a foreign supplier on 30 June
2007. The purchase price is $4 million. A non-refundable deposit of $1 million was paid on signing the contract
on 31 July 2006 with the balance of $3 million payable on 30 June 2007. Misson was uncertain as to whether
to purchase a $3 million bond on 31 July 2006 which will not mature until 30 June 2010, or to enter into a
forward contract on the same date to purchase $3 million for a fixed price of £2 million on 30 June 2007 and
to designate the forward contract as a cash flow hedge of the purchase commitment. The bond carries interest
at 4% per annum payable on 30 June 2007. Current market rates are 4% per annum. The company chose to
purchase the bond with a view to selling it on 30 June 2007 in order to purchase the plant and machinery. The
bond is not to be classified as a cash flow hedge but at fair value through profit or loss.
Misson would like advice as to whether it made the correct decision and as to the accounting treatment of the
items in (c) above for the current and subsequent year. (10 marks)

Dollar:£ Average
rate ($:£)
Exchange Rates for year to
1 November 2004 1·1
31 October 2005 1·4 1·2
1 November 2005 1·4
31 July 2006 1·6
31 October 2006 1·3 1·5

Required:
Discuss the accounting treatment of the above transactions in accordance with the advice required by the
directors.
(Candidates should show detailed workings as well as a discussion of the accounting treatment used.)

(25 marks)

5 [P.T.O.
3 Seejoy is a famous football club but has significant cash flow problems. The directors and shareholders wish to take
steps to improve the club’s financial position. The following proposals had been drafted in an attempt to improve the
cash flow of the club. However, the directors need advice upon their implications.
(a) Sale and leaseback of football stadium (excluding the land element)
The football stadium is currently accounted for using historical cost. The carrying value of the stadium will be
£12 million at 31 December 2006. The stadium will have a remaining life of 20 years at 31 December 2006,
and the club uses straight line depreciation. It is proposed to sell the stadium to a third party institution on 1
January 2007 and lease it back under a 20 year finance lease. The sale price and fair value are £15 million
which is the present value of the minimum lease payments. The agreement transfers the title of the stadium back
to the football club at the end of the lease at nil cost. The rental is £1·2 million per annum (in advance)
commencing on 1 January 2007. The directors do not wish to treat this transaction as the raising of a secured
loan.
The implicit interest rate on the finance in the lease is 5·6% (9 marks)

(b) Player registrations

The club capitalises the unconditional amounts (transfer fees) paid to acquire players.
The club proposes to amortise the cost of the transfer fees over ten years instead of the current practice which is
to amortise the cost over the duration of the player’s contract. The club has sold most of its valuable players
during the current financial year but still has two valuable players under contract.
Transfer fee Amortisation to Contract Contract
Player capitalised 31 December 2006 commenced Expires
£m £m
A. Steel 20 4 1 January 2006 31 December 2010
R. Aldo 15 10 1 January 2005 31 December 2007
If Seejoy win the national football league, then a further £5 million will be payable to the two players’ former
clubs. Seejoy are currently performing very poorly in the league. (5 marks)

(c) Issue of bond

The club proposes to issue a 7% bond with a face value of £50 million on 1 January 2007 at a discount of
5% that will be secured on income from future ticket sales and corporate hospitality receipts, which are
approximately £20 million per annum. Under the agreement the club cannot use the first £6 million received
from corporate hospitality sales and reserved tickets (season tickets) as this will be used to repay the bond. The
money from the bond will be used to pay for ground improvements and to pay the wages of players.
The bond will be repayable, both capital and interest, over 15 years with the first payment of £6 million due on
31 December 2007. It will have an effective interest rate of 7·7%. There will be no active market for the bond
and the company does not wish to use valuation models to value the bond. (6 marks)

(d) Player trading

Another proposal is for the club to sell its two valuable players, Aldo and Steel. It is thought that it will receive a
total of £16 million for both players. The players are to be offered for sale at the end of the current football season
on 1 May 2007. (5 marks)

Required:
Discuss how the above proposals would be dealt with in the financial statements of Seejoy for the year ending
31 December 2007, setting out their accounting treatment and appropriateness in helping the football club’s
cash flow problems.
(Candidates do not need knowledge of the football finance sector to answer this question)

(25 marks)

6
4 The Gow Group, a public limited company, and Glass, a public limited company, have agreed to create a new entity,
York, a limited liability company on 31 October 2006. The companies’ line of business is the generation, distribution,
and supply of energy. Gow supplies electricity and Glass supplies gas to customers. Each company has agreed to
subscribe net assets for a 50% share in the equity capital of York. York is to issue 30 million ordinary shares of £1.
There was no written agreement signed by Gow and Glass but the minutes of the meeting where the creation of the
new company was discussed have been approved formally by both companies. Each company provides equal
numbers of directors to the Board of Directors. The net assets of York were initially shown at amounts agreed between
Gow and Glass, but their values are to be adjusted so that the carrying amounts at 31 October 2006 are based on
UK accounting standards.
Gow had contributed the following assets to the new company in exchange for its share of the equity:
£m
Cash 1
Debtors – Race 7
Intangible assets – contract with Race 3
Land and buildings 6
Plant and machinery 3
–––
20
–––
The above assets form an income generating unit (an electricity power station) in its own right. The unit provided
power to a single customer, Race. On 31 October 2006 Race went into receivership and the contract to provide power
to Race was cancelled. On 1 December 2006, the receivers of the customer provisionally agreed to pay a final
settlement figure of £5 million on 31 October 2007, including any compensation for the loss of the contract. Gow
expects York will receive 80% of the provisional amount. On hearing of the cancelled contract, an offer was received
for the power station of £16 million. York would be required to pay the disposal costs estimated at £1 million.
The power station has an estimated remaining useful life of four years at 31 October 2006. It has been agreed with
the government that it will be dismantled on 31 October 2010. The cost at 31 October 2010 of dismantling the power
station is estimated at £5 million.
The directors of Gow and York are currently in the final stages of negotiating a contract to supply electricity to another
customer. As a result the future net cash inflows (undiscounted) expected to arise from the income generating unit
(power station) are as follows:
£m
31 October 2007 6
31 October 2008 7
31 October 2009 8
31 October 2010 8
–––
29
–––
The dismantling cost has not been provided for, and future cash flows are discounted at 6% by the companies.
Glass had agreed to contribute the following net assets to the new company in exchange for its share of the equity:
£m
Cash 10
Intangible asset 2
Stock at cost 6
Buildings – carrying value 4
Lease receivable 1
Lease payable (3)
–––
20
–––

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

Required:
(a) Discuss the nature and accounting treatment of the relationship between Gow, Glass and York. (5 marks)

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

(25 marks)

8
5 Jones and Cousin, a public quoted company, operate in twenty-seven different countries and earn revenue and incur
costs in several currencies. The group develops, manufactures and markets products in the medical sector. The growth
of the group has been achieved by investment and acquisition. It is organised into three global business units which
manage their sales in international markets, and take full responsibility for strategy and business performance. Only
five per cent of the business is in the country of incorporation (UK). Competition in the sector is quite fierce.
The group competes across a wide range of geographic and product markets and encourages its subsidiaries to
enhance local communities by reinvestment of profits in local educational projects. The group’s share of revenue in a
market sector is often determined by government policy. The markets contain a number of different competitors
including specialised and large international corporations. At present the group is awaiting regulatory approval for a
range of new products to grow its market share. The group lodges its patents for products and enters into legal
proceedings where necessary to protect patents. The products are sourced from a wide range of suppliers, who, once
approved both from a qualitative and ethical perspective, are generally given a long term contract for the supply of
goods. Obsolete products are disposed of with concern for the environment and the health of its customers, with
reusable materials normally being used. The industry is highly regulated in terms of medical and environmental laws
and regulations. The products normally carry a low health risk.
The Group has developed a set of corporate and social responsibility principles during the period which is the
responsibility of the Board of Directors. The Managing Director manages the risks arising from corporate and social
responsibility issues. The group wishes to retain and attract employees and follows policies which ensure equal
opportunity for all the employees. Employees are informed of management policies, and regularly receive in-house
training.
The Group enters into contracts for fixed rate currency swaps and uses floating to fixed rate interest rate swaps. The
cash flow effects of these swaps match the cash flows on the underlying financial instruments. All financial
instruments are accounted for as cash flow hedges. A significant amount of trading activity is denominated in the
Dinar and the Euro. The pound sterling is its functional currency.

Required:
(a) Describe the principles behind the Operating and Financial Review discussing whether the review should be
mandatory or whether directors should be free to use their judgement as to what should be included in such
a statement. (13 marks)

(b) Draft a report suitable for inclusion in an Operating and Financial Review for Jones and Cousin which deals
with:
(i) the principal risks and relationships of the business (9 marks)
(ii) the position of the business regarding its treasury policies. (3 marks)
(Marks will be awarded in part (b) for the identification and discussion of relevant points and for the style of the
report.)
(25 marks)

End of Question Paper