1.

TANGIBLE NCA & INTANGIBLE NCA

ENCA - JUNE 2014 (Q4) – TANGIBLE CURRENT ASSETS
(a) A director of Enca, a public listed company, has expressed concerns about the accounting
treatment of some of the company’s items of property, plant and equipment which have increased
in value. His main concern is that the statement of financial position does not show the true value
of assets which have increased in value and that this ‘undervaluation’ is compounded by having
to charge depreciation on these assets, which also reduces reported profit. He argues that this does
not make economic sense.
Required: Respond to the director’s concerns by summarising the principal requirements
of IAS 16 Property, Plant and Equipment in relation to the revaluation of property, plant
and equipment, including its subsequent treatment. (5 marks)
Answer:
The requirements of IAS 16 Property, Plant and Equipment may, in part, offer a solution to the
director’s concerns. IAS 16 allows (but does not require) entities to revalue their property, plant
and equipment to fair value; however, it imposes conditions where an entity chooses to do this.
First, where an item of property, plant and equipment is revalued under the revaluation model of
IAS 16, the whole class of assets to which it belongs must also be revalued. This is to prevent
what is known as ‘cherry picking’ where an entity might only wish to revalue items which have
increased in value and leave other items at their (depreciated) cost.
Second, where an item of property, plant and equipment has been revalued, its valuation (fair
value) must be kept up-to-date. In practice, this means that, where the carrying amount of the
asset differs significantly from its fair value, a (new) revaluation should be carried out. Even if
there are no significant changes, assets should still be subject to a revaluation every three to five
years.
A revaluation surplus (gain) should be credited to a revaluation surplus (reserve), via other
comprehensive income, whereas a revaluation deficit (loss) should be expensed immediately
(assuming, in both cases, no previous revaluation of the asset has taken place). A surplus on one
asset cannot be used to offset a deficit on a different asset (even in the same class of asset).
Subsequent to a revaluation, the asset should be depreciated based on its revalued amount (less
any estimated residual value) over its estimated remaining useful life, which should be reviewed
annually irrespective of whether it has been revalued.
An entity may choose to transfer annually an amount of the revaluation surplus relating to a
revalued asset to retained
earnings corresponding to the ‘excess’ depreciation caused by an upwards revaluation.
Alternatively, it may transfer all of the relevant surplus at the time of the asset’s disposal.
The effect of this, on Enca’s financial statements, is that its statement of financial position will be
strengthened by reflecting the fair value of its property, plant and equipment. However, the
downside (from the director’s perspective) is that the depreciation charge will actually increase
(as it will be based on the higher fair value) and profits will be lower than using the cost model.
Although the director may not be happy with the higher depreciation, it is conceptually correct.
The director has misunderstood the purpose of depreciation; it is not meant to reflect the change
(increase in this case) in the value of an asset, but rather the cost of using up part of the asset’s
remaining life.
 (b) The following details relate to two items of property, plant and equipment (A and B) owned by
Delta which are depreciated on a straight-line basis with no estimated residual value:

At 31 March 2014 item A was still in use, but item B was sold (on that date) for $70 million.
Note: Delta makes an annual transfer from its revaluation surplus to retained earnings in respect
of excess depreciation.

Required: Prepare extracts from:

(i) Delta’s statements of profit or loss for the years ended 31 March 2013 and 2014 in
respect of charges (expenses) related to property, plant and equipment;

(ii) Delta’s statements of financial position as at 31 March 2013 and 2014 for the
carrying amount of property, plant and equipment and the revaluation surplus.

Answer:

(i) Delta – Extracts from statement of profit or loss (see workings):

Year ended 31 March 2013

Plant impairment loss 20,000

Plant depreciation (32,000 + 22,400) 54,400

Year ended 31 March 2014

Loss on sale 8,000

Plant depreciation (32,000 + 26,000) 58,000

DEARING (12/08 AMENDED) TANGIBLE NCA & BORROWING COST

(b) Dearing is building a new warehouse. The directors are aware that in accordance with IAS 23
Borrowing costs certain borrowing costs have to be capitalised.

Required

Explain the circumstances when, and the amount at which, borrowing costs should be capitalised in
accordance with IAS 23. (5 marks)

Answer:
DETERXITY (6/ 04 AMENDED) – INTANGIBLE ASSET
(a) During the last decade it has not been unusual for the premium paid to acquire control of a business to
be greater than the fair value of its tangible net assets. This increase in the relative proportions of
intangible assets has made the accounting practices for them all the more important. During the same
period many companies have spent a great deal of money internally developing new intangible assets
such as software and brands. IAS 38 'Intangible assets' was issued in September 1998 and prescribes the
accounting treatment for intangible assets.

Required

In accordance with IAS 38, discuss whether intangible assets should be recognised, and if so how they
should be initially recorded and subsequently amortised in the following circumstances:

(i) When they are purchased separately from other assets

(ii) When they are obtained as part of acquiring the whole of a business

(iii) When they are developed internally. (10 marks)

Note: Your answer should consider goodwill separately from other intangibles

Answer:

Goodwill

Only goodwill arising from a business combination is recognised. Under IFRS 3 goodwill is the excess of
the cost of a business combination over the acquirer's interest in the net fair value of the assets, liabilities
and contingent liabilities of the business acquired. Once recognised goodwill is held indefinitely, without
amortisation but subject to impairment reviews.

One of the key aspects of goodwill is that it cannot be separated from the business that it belongs to.
Therefore goodwill cannot be purchased separately from other assets. In addition, IAS 38 states that
internally generated goodwill must not be capitalised.
Other intangible assets

Other intangibles can be recognised if they can be distinguished from goodwill; typically this means that
they can be separated from the rest of the business, or that they arise from a legal or contractual right.

Intangibles acquired as part of a business combination are recognised at fair value provided that they can
be valued separately from goodwill. The acquirer will recognise an intangible even if the asset had not
been recognised previously. If an intangible cannot be valued, then it will be subsumed into goodwill.

Internally generated intangibles can be recognised if they are acquired as part of a business combination.
For example, a brand name acquired in a business combination is capitalised whereas an internally
generated brand isn't. Expenditure on research can not be capitalised. Development expenditure is
capitalised if it meets the IAS 38 criteria. It is then amortised over the life-cycle of the product. Goodwill
and intangibles with an indefinite useful life are not amortised but tested annually for impairment

b. Dexterity is a public listed company. It has been considering the accounting treatment of its intangible
assets and has asked for your opinion on how the matters below should be treated in its financial
statements for the year to 31March 20X4.

(i) On 1 October 20X3 Dexterity acquired Temerity, a small company that specialises in pharmaceutical
drug research and development. The purchase consideration was by way of a share exchange and valued
at $35million. The fair value of Temerity's net assets was $15 million (excluding any items referred to
below). Temerity owns a patent for an established successful drug that has a remaining life of eight years.
A firm of specialist advisors, Leadbrand, has estimated the current value of this patent to be $10 million,
however the company is awaiting the outcome of clinical trials where the drug has been tested to treat a
different illness. If the trials are successful, the value of the drug is then estimated to be $15 million. Also
included in the company's statement of financial position is $2 million for medical research that has been
conducted on behalf of a client. (4 marks)

(ii) Dexterity has developed and patented a new drug which has been approved for clinical use. The costs
of developing the drug were $12 million. Based on early assessments of its sales success, Leadbrand have
estimated its market value at $20 million. (3 marks)

(iii) Dexterity's manufacturing facilities have recently received a favourable inspection by government
medical scientists. As a result of this the company has been granted an exclusive five-year licence to
manufacture and distribute a new vaccine. Although the licence had no direct cost to Dexterity, its
directors feel its granting is a reflection of the company's standing and have asked Leadbrand to value the
licence. Accordingly they have placed a value of $10 million on it. (3 marks)

(iv) In the current accounting period, Dexterity has spent $3 million sending its staff on specialist training
courses. Whilst these courses have been expensive, they have led to a marked improvement in production
quality and staff now need less supervision. This in turn has led to an increase in revenue and cost
reductions. The directors of Dexterity believe these benefits will continue for at least three years and wish
to treat the training costs as an asset. (2 marks)
(v) In December 20X3, Dexterity paid $5 million for a television advertising campaign for its products
that will run for 6 months from 1 January 20X4 to 30 June 20X4. The directors believe that increased
sales as a result of the publicity will continue for two years from the start of the advertisements.

Required

Explain how the directors of Dexterity should treat the above items in the financial statements for
the year to 31 March 20X4. (3 marks)

Answer:

(i) Temerity The following assets will be recognised on acquisition:

The patent is recognised at its fair value at the date of acquisition, even if it hadn't previously been
recognised by Temerity. It will be amortised over the remaining eight years of its useful life with an
assumed nil residual value.

The higher value of $15m can't be used because it depends on the successful outcome of the clinical trials.
The extra $5m is a contingent asset, and contingent assets are not recognised in a business combination.
(Only assets, liabilities and contingent liabilities are recognised.)

Although research is not capitalised, this research has been carried out for a customer and should be
recognised as work-in-progress in current assets. It will be valued at the lower of cost and net realizable
value unless it meets the definition of a construction contract.

The goodwill is capitalised at cost. It is not amortised but it will be tested for impairment annually.

(ii) New drug

Under IAS 38 the $12m costs of developing this new drug are capitalised and then amortised over its
commercial life. (The costs of researching a new drug are never capitalised.)

Although IAS 38 permits some intangibles to be held at valuation it specifically forbids revaluing patents,
therefore the $20m valuation is irrelevant.

(iii) Government licence

IAS 38 states that assets acquired as a result of a government grant may be capitalised at fair value, along
with a corresponding credit for the value of the grant. Therefore Dexterity may recognise an asset and
grant of $10m which are then amortised/released over the five year life of the license. The net effect on
profits and on shareholders funds will be nil.

(iv) Training costs

Although well trained staff adds value to a business IAS 38 prohibits the capitalisation of training costs.
This is because an entity has 'insufficient control over the expected future economic benefits' arising from
staff training; in other words trained staff are free to leave and work for someone else. Training is part of
the general cost of developing a business as a whole.

(v) Advertising costs

IAS 38 Para 69 states that advertising and promotional costs should be recognised as an expense when
incurred. This is because the expected future economic benefits are uncertain and they are beyond the
control of the entity.

However, because the year end is half way through the campaign there is a $2.5m prepayment to be
recognised as a current asset.

LAIDLAW - DECEMBER 2013 (Q4) – CONCEPTUAL FRAMEWORK

(a) The Conceptual Framework for Financial Reporting identifies faithful representation as a fundamental
qualitative characteristic of useful financial information.

Required: Distinguish between fundamental and enhancing qualitative characteristics and explain
why faithful representation is important. (5 marks)

(a) The Conceptual Framework for Financial Reporting implies that the two fundamental qualitative
characteristics (relevance and faithful representation) are vital as, without them, financial statements
would not be useful, in fact they may be misleading. As the name suggests, the four enhancing qualitative
characteristics (comparability, verifiability, timeliness and understandability) improve the usefulness of
the financial information. Thus financial information which is not relevant or does not give a faithful
representation is not useful (and worse, it may possibly be misleading); however, financial information
which does not possess the enhancing characteristics can still be useful, but not as useful as if it did
possess them. In order for financial statements to be useful to users (such as investors or loan providers),
they must present financial information faithfully, i.e. financial information must faithfully represent the
economic phenomena which it purports to represent (e.g. in some cases it may be necessary to treat a sale
and repurchase agreement as an in-substance (secured) loan rather than as a sale and subsequent
repurchase). Faithfully represented information should be complete, neutral and free from error.
Substance is not identified as a separate characteristic because the IASB says it is implied in faithful
representation such that faithful representation is only possible if transactions and economic phenomena
are accounted for according to their substance and economic reality.

(b) Laidlaw has produced its draft financial statements for the year ended 30 September 2013 and two
issues have arisen:

(i) On 1 September 2013, Laidlaw factored (sold) $2 million of trade receivables to Finease. Laidlaw
received an immediate payment of $1·8 million and credited this amount to receivables and charged
$200,000 to administrative expenses. Laidlaw will receive further amounts from Finease depending on
how quickly Finease collects the receivables. Finease will charge a monthly administration fee of $10,000
and 2% per month on its outstanding balance with Laidlaw. Any receivables not collected after four
months would be sold back to Laidlaw; however, Laidlaw expects all customers to settle in full within
this period. None of the receivables were due or had been collected by 30 September 2013. (5 marks)
(ii) On 1 October 2012, Laidlaw sold a property which had a carrying amount of $3·5 million to a
property company for $5 million and recorded a profit of $1·5 million on the disposal. Part of the terms of
the sale are that Laidlaw will rent the property for a period of five years at an annual rental of $400,000.
At the end of this period, the property company will sell the property through a real estate
company/property agent at its fair value which is expected to be approximately $6·5 million. Laidlaw will
be given the opportunity to repurchase the property (at its fair value) before it is put on the open market.

All of the above amounts are deemed to be at commercial values. (5 marks)

Required: Explain, and quantify where appropriate, how Laidlaw should account for the above two
issues in its financial statements for the year ended 30 September 2013.

(b) (i) When dealing with the factoring of receivables, probably the most important aspect of the
transaction is which party bears the risk of any non-payment by the customer (irrecoverable receivables).
In this case, that party is Laidlaw as it will have to ‘buy back’ any receivables not settled within four
months of their ‘sale’. Thus Finease is acting as an administrator (for a fee of $10,000 per month) and as a
provider of finance (charging 2% interest per month). Laidlaw should not ‘derecognise’ the receivables as
suggested in the question, but instead treat the $1·8 million cash received from Finease as a current
liability (a loan or financing arrangement secured on the receivables). Laidlaw should charge $10,000 as
an administration fee and $36,000 ($1·8 million x 2%) as interest (for the month of September 2013), to
profit or loss as administrative expenses and finance costs respectively. Both these amounts should also
be added to the current liability (the amount owed to Finease) which at 30 September 2013 would amount
to $1,846,000.

(ii) The critical aspect of these transactions (the sale, the rental and the potential repurchase) is that they
are (or will be) all carried out at commercial values. Thus Laidlaw has adopted the correct treatment by
recording the disposal of the property as a ‘true’ sale and, presumably, charged $400,000 to profit or loss
under operating lease arrangements for the rental of the property for the year ended 30 September 2013.
The fact that Laidlaw will be given the opportunity to repurchase the property in five years’ time before it
is put on the open market is not an asset and should not be recognised as such, nor does it affect the
substance of the sale. This is because the price of the potential repurchase is at what is expected to be its
fair value and is therefore not favourable to Laidlaw.

APEX 6/10 BORROWING COST

a. Apex is a publicly listed supermarket chain. During the current year it started the building of a
new store. The directors are aware that in accordance with IAS 23 Borrowing costs certain
borrowing costs have to be capitalised.

Required

Explain the circumstances when, and the amount at which, borrowing costs should be capitalised in
accordance with IAS 23. (5 marks)

Answer:
‘Qualifying’ borrowing costs are borrowing costs incurred in the construction of qualifying assets. These
are assets that necessarily take a substantial period of time to get ready for intended use or sale. Since the
revision of IAS 23, qualifying borrowing costs now must be capitalised.

Where funds are borrowed specifically to finance the construction of a qualifying asset, the amount
eligible for capitalisation will be the borrowing costs incurred at the effective rate of interest, less any
investment income earned on the temporary investment of those borrowings.

Where funds are borrowed generally and the borrowings attributable to a particular asset cannot be
readily identified, the amount eligible for capitalisation will have to be estimated by applying a weighted
capitalisation rate to the funds used in constructing the asset.

Capitalisation commences when expenditure and necessary activities begin on the asset and borrowing
costs are incurred. Capitalisation is suspended during any period in which activities on the asset are
suspended and it ceases when substantially all activities necessary to prepare the asset for its intended use
or sale are complete.

b. Details relating to construction of Apex’s new store:

Apex issued a $10 million unsecured loan with a coupon (nominal) interest rate of 6% on 1 April 20X8.
The loan is redeemable at a premium which means the loan has an effective finance cost of 7·5% per
annum. The loan was specifically issued to finance the building of the new store which meets the
definition of a qualifying asset in IAS 23. Construction of the store commenced on 1 May 20X8 and it
was completed and ready for use on 28 February 20X9, but did not open for trading until 1 April 20X9.
During the year trading at Apex’s other stores was below expectations so Apex suspended the
construction of the new store for a twomonth period during July and August 20X8. The proceeds of the
loan were temporarily invested for the month of April 20X8 and earned interest of $40,000.

Required

Calculate the net borrowing cost that should be capitalised as part of the cost of the new store and the
finance cost that should be reported in profit or loss for the year ended 31 March 20X9.

Answer
The total finance costs for the year are $750,000 ($10m x 7.5%)

However, the finance costs can only be capitalised for those periods during which the activity was taking
place, not before the development begins, while it is suspended or after it has ceased.

Finance costs to be capitalised are therefore $’000

May/June 20X8 ($10m x 7.5% x 2/12) 125

Sept X8 – Feb X9 ($10m x 7.5% x 6/12) 375

500

$500,000 will be debited to PPE as part of the cost of the new store.
 $’000

Finance costs to be expensed (750 – 500) 250

These will be debited to profit or loss.

The period during which the funds were invested was before the development activity began, so during a
period in which finance costs were not being capitalised. Therefore the interest received of $40,000 is not
deducted from the capitalised finance costs, but is credited to profit or loss as investment income.

EMERALD 12/07 – INTANGIBLE ASSETS (DEVELOPMENT EXPENDITURE)

Product development costs are a material cost for many companies. They are either written off as an
expense or capitalised as an asset.

Required

(a) Discuss the conceptual issues involved and the definition of an asset that may be applied in
determining whether development expenditure should be treated as an expense or an asset. (4 marks)

Answer:

The IASB Conceptual Framework defines an asset as a resource controlled by the entity as a result of past
events and from which future economic benefits are expected to flow to the entity. The recognition
criteria also require that the asset has a cost or value that can be measured reliably.

In the case of development expenditure it is not always possible to determine whether or not economic
benefits will result. IAS 38 deals with this issue by laying down the criteria for recognition of an
intangible asset arising from development expenditure. An entity must be able to demonstrate that it is
able to complete and use or sell the asset and has the intention to do so, that the asset will generate
probable future economic benefits and that the expenditure attributable to the asset can be reliably
measured. If these criteria are met, the asset is recognised and will be amortised from the date when it is
available for use

(b) Emerald has had a policy of writing off development expenditure to profit or loss as it was
incurred. In preparing its financial statements for the year ended 30 September 20X7 it has become
aware that, under IFRS rules, qualifying development expenditure should be treated as an intangible
asset. Below is the qualifying development expenditure for Emerald:

All capitalised development expenditure is deemed to have a four year life. Assume amortisation
commences at the beginning of the accounting period following capitalisation. Emerald had no
development expenditure before that for the year ended 30 September 20X4.

Required
Treating the above as the correction of an error in applying an accounting policy, calculate the
amounts which should appear in the statement of profit or loss and statement of financial position
(including comparative figures), and statement of changes in equity of Emerald in respect of the
development expenditure for the year ended 30 September 20X7.

Answer

FLIGHTLINE 6/09 – COMPLEX NCA

(a) Explain what is meant by a 'complex' non-current asset and explain briefly how IAS 16 requires
expenditure on complex non-current assets to be accounted for. (5 marks)
(b) Flightline is an airline which treats its aircraft as complex non-current assets. The cost and other
details of one of its aircraft are:

No residual values are attributed to any of the component parts.

At 1 April 20X8 the aircraft log showed it had flown 10,800 hours since 1 April 20X5. In the year
ended 31 March 20X9, the aircraft flew for 1,200 hours for the six months to 30 September 20X8
and a further 1,000 hours in the six months to 31 March 20X9.
On 1 October 20X8 the aircraft suffered a 'bird strike' accident which damaged one of the engines
beyond repair. This was replaced by a new engine with a life of 36,000 hours at cost of $10.8
million. The other engine was also damaged, but was repaired at a cost of $3 million; however, its
remaining estimated life was shortened to 15,000 hours. The accident also caused cosmetic
damage to the exterior of the aircraft which required repainting at a cost of $2 million. As the
aircraft was out of service for some weeks due to the accident, Flightline took the opportunity to
upgrade its cabin facilities at a cost of $4.5 million. This did not increase the estimated remaining
 life of the cabin fittings, but the improved facilities enabled Flightline to substantially increase the
air fares on this aircraft

Required
Calculate the charges to profit or loss in respect of the aircraft for the year ended 31 March
20X9 and its
carrying amount in the statement of financial position as at that date.
Note. The post accident changes are deemed effective from 1 October 20X8.

Answer
DARBY 12/09 – NCA
The same assistant has encountered the following matters during the preparation of the draft financial
statements of Darby for the year ending 30 September 20X9. He has given an explanation of his treatment
of them:

(i) Darby spent $200,000 sending its staff on training courses during the year. This has already
led to an improvement in the company's efficiency and resulted in cost savings. The organiser
of the course has stated that the benefits from the training should last for a minimum of four
years. The assistant has therefore treated the cost of the training as an intangible asset and
charged six months' amortisation based on the average date during the year on which the
training courses were completed.
Answer
IAS 38 makes the point that ‘an entity usually has insufficient control over the expected
future economic benefits arising from a team of skilled staff..’ This is the case in this
situation. Darby’s trained staff may stay with the company for the next four years or they
may decide to leave and take their skills with them. Darby has no control over that. For this
reason, the expenditure on training can not be treated as an asset and must be charged to
profit or loss.

(ii) During the year the company started research work with a view to the eventual development
of a new processor chip. By 30 September 20X9 it had spent $1.6 million on this project.
Darby has a past history of being particularly successful in bringing similar projects to a
profitable conclusion. As a consequence the assistant has treated the expenditure to date on
this project as an asset in the statement of financial position.

Darby was also commissioned by a customer to research and, if feasible, produce a computer
system to install in motor vehicles that can automatically stop the vehicle if it is about to be
involved in a collision. At 30 September 20X9, Darby had spent $2.4 million on this project,
but at this date it was uncertain as to whether the project would be successful. As a
consequence the assistant has treated the $2.4 million as an expense in the statement of profit
or loss.
Answer:
The work on the new processor chip is research with the aim of eventually moving into
development work. IAS 38 requires all research expenditure to be expensed as incurred. Even
at the development stage, it will not be possible to capitalise the development costs unless
they satisfy the IAS 38 criteria. When the criteria are satisfied and development costs can be
capitalised, it will still not be possible to go back and capitalise the research costs. The
company’s past successful history makes no difference to this.
The research work on the braking system is a different case, because here the work has been
commissioned by a customer and the customer will be paying, regardless of the outcome of
the research. In this situation, as long as Darby has no reason to believe that the customer will
not meet the costs in full, the costs should be treated as work in progress, rather than being
charged to profit or loss.
 (iii) Darby signed a contract (for an initial three years) in August 20X9 with a company called
Media Today to install a satellite dish and cabling system to a newly built group of residential
apartments. Media Today will provide telephone and television services to the residents of
the apartments via the satellite system and pay Darby $50,000 per annum commencing in
December 20X9. Work on the installation commenced on 1 September 20X9 and the
expenditure to 30 September 20X9 was $58,000. The installation is expected to be completed
by 31 October 20X9. Previous experience with similar contracts indicates that Darby will
make a total profit of $40,000 over the three years on this initial contract. The assistant
correctly recorded the costs to 30 September 20X9 of $58,000 as a non-current asset, but then
wrote this amount down to $40,000 (the expected total profit) because he believed the asset to
be impaired
The contract is not a finance lease. Ignore discounting.
Answer:
If we agree that the assistant was correct to record $58,000 as a non-current asset, the only
question is whether it should be regarded as impaired.
An impairment has occurred when the recoverable amount of an asset falls below its carrying
amount.
The projected results for this contract are:
$
Revenue (50,000 × 3) 150,000
Costs (bal) (110,000)
Profit 40,000
If we ignore discounting, the future cash flows are $150,000, less remaining costs of $52,000
($110,000 - $58,000), which amounts to $98,000. This is well in excess of the $58,000
carrying amount, so no impairment has taken place and the non-current asset should remain at
$58,000.
Required
For each of the above items (i) to (iii) comment on the assistant's treatment of them in the
financial
statements for the year ended 30 September 20X9 and advise him how they should be
treated under
International Financial Reporting Standards.

SPECULATE Q5 06/13 – IP
(a) The accounting treatment of investment properties is prescribed by IAS 40 Investment Property.

Required:

(i) Define investment property under IAS 40 and explain why its accounting treatment is different
from that of owner-occupied property;

Answer:

An investment property is land or buildings (or a part thereof) held by the owner to generate rental
income or for capital appreciation (or both) rather than for production or administrative use. It would also
include property held under a finance lease and may include property under an operating lease, if used for
the same purpose as other investment properties. Generally, non-investment properties generate cash
flows in combination with other assets, whereas a property that meets the definition of an investment
property means that it will generate cash flows that are largely independent of the other assets held by an
entity and, in that sense, such properties do not form part of the entity’s normal operations.

(ii) Explain how the treatment of an investment property carried under the fair value model differs
from an owner-occupied property carried under the revaluation model.

Answer:

Superficially, the revaluation model and fair value sound very similar; both require properties to be
valued at their fair value which is usually a market-based assessment (often by an independent valuer).
However, any gain (or loss) over a previous valuation is taken to profit or loss if it relates to an
investment property, whereas for an owner-occupied property, any gain is taken to a revaluation reserve
(via other comprehensive income and the statement of changes in equity). A loss on the revaluation of an
owner-occupied property is charged to profit or loss unless it has a previous surplus in the revaluation
reserve which can be used to offset the loss until it is exhausted. A further difference is that owner-
occupied property continues to be depreciated after revaluation, whereas investment properties are not
depreciated.

(b) Speculate owns the following properties at 1 April 2012:

Property A: An office building used by Speculate for administrative purposes with a depreciated
historical cost of $2 million. At 1 April 2012 it had a remaining life of 20 years. After a reorganisation on
1 October 2012, the property was let to a third party and reclassified as an investment property applying
Speculate’s policy of the fair value model. An independent valuer assessed the property to have a fair
value of $2·3 million at 1 October 2012, which had risen to $2·34 million at 31 March 2013.

Property B: Another office building sub-let to a subsidiary of Speculate. At 1 April 2012, it had a fair
value of $1·5 million which had risen to $1·65 million at 31 March 2013.

Required:

Prepare extracts from Speculate’s entity statement of profit or loss and other comprehensive
income and statement of financial position for the year ended 31 March 2013 in respect of the above
properties. In the case of property B only, state how it would be classified in Speculate’s
consolidated statement of financial position.

Answer:
In Speculate’s consolidated financial statements property B would be accounted for under IAS 16
Property, Plant and Equipment and be classified as owner-occupied. Further information is required to
determine the depreciation charge.

2. IAS 36 IMPAIRMENT OF ASSET

TELEPATH 6/12
(a) The objective of IAS 36 Impairment of assets is to prescribe the procedures that an entity applies to
ensure that its assets are not impaired.

Required

Explain what is meant by an impairment review. Your answer should include reference to assets
that may form a cash generating unit.

Note. You are not required to describe the indicators of an impairment or how impairment losses are
allocated against assets. (4 marks)

Answer:

(a) An impairment review as laid out in IAS 36 Impairment of Assets is carried out to determine whether
the value of an asset may have fallen below its carrying amount in the statement of financial position. It is
a requirement for goodwill carried in the statement of financial position that it should be tested annually
for impairment.

An asset is considered to be impaired if its carrying amount exceeds its recoverable amount, defined as
the higher of fair value less costs to sell and value in use. Value in use is the present value of the future
cash flows which will be generated by the asset. It is often not possible to attribute cash flows to an
individual asset, so in this case the impairment review is carried out at the level of the cash generating
unit to which the asset belongs. A cash generating unit is a group of assets which together generate cash
flows. For instance, a production unit in a factory could be treated as a cash generating unit and any
impairment identified will be apportioned between the assets of the CGU.

(b) (i) Telepath acquired an item of plant at a cost of $800,000 on 1 April 20X0 that is used to produce
and package pharmaceutical pills. The plant had an estimated residual value of $50,000 and an estimated
life of five years, neither of which has changed. Telepath uses straight-line depreciation. On 31 March
20X2, Telepath was informed by a major customer (who buys products produced by the plant) that it
would no longer be placing orders with Telepath. Even before this information was known, Telepath had
been having difficulty finding work for this plant. It now estimates that net cash inflows earned from the
plant for the next three years will be:

On 31 March 20X5, the plant is still expected to be sold for its estimated realisable value. Telepath has
confirmed that there is no market in which to sell the plant at 31 March 20X2.

Telepath's cost of capital is 10% and the following values should be used:

(ii) Telepath owned a 100% subsidiary, Tilda, that is treated as a cash generating unit. On 31 March
20X2, there was an industrial accident (a gas explosion) that caused damage to some of Tilda's plant. The
assets of Tilda immediately before the accident were:

As a result of the accident, the recoverable amount of Tilda is $6.7 million.

The explosion destroyed (to the point of no further use) an item of plant that had a carrying amount of
$500,000.

Tilda has an open offer from a competitor of $1 million for its patent. The receivables and cash are
already stated at their fair values less costs to sell (net realisable values).

Required

Calculate the carrying amounts of the assets in (i) and (ii) above at 31 March 20X2 after applying
any impairment losses.

Answer:
ADVENT (12/04)
Advent is a publicly listed company.

Details of Advent's non-current assets at 1 October 20X8 were:

The following information is relevant:

(i) The land and building were revalued on 1 October 20X3 with $80 million attributable to the land and
$200 million to the building. At that date the estimated remaining life of the building was 25 years. A
further revaluation was not needed until 1 October 20X8 when the land and building were valued at $85
million and $180 million respectively. The remaining estimated life of the building at this date was 20
years.

(ii) Plant is depreciated at 20% per annum on cost with time apportionment where appropriate. On 1 April
20X9 new plant costing $45 million was acquired. In addition, this plant cost $5 million to install and
commission. No plant is more than four years old.

(iii) The telecommunications licence was bought from the government on 1 October 20X7 and has a 10
year life. It is amortised on a straight line basis. In September 20X9, a review of the sales of the products
related to the licence showed them to be very disappointing. As a result of this review the estimated
recoverable amount of the licence at 30 September 20X9 was estimated at only $100 million. There were
no disposals of non-current assets during the year to 30 September 20X9.

Required

(a) Prepare extracts from the statement of financial position relating to Advent's non-current assets as
at 30 September 20X9 (including comparative figures), together with any disclosures (other than those
of the accounting policies) under current International Financial Reporting Standards. (9 marks)

Answer:
Buildings are depreciated over 25 years and plant over 5 years.

On 1st October 20X8 the land and buildings were valued by XYZ, Chartered Surveyors, on an open
market xisting use basis

(b) Explain the usefulness of the above disclosures to the users of the financial statements. (4 marks)

Answer:

The disclosures give the reader more information about the nature and value of the non-current assets.
Firstly, there is the split between tangible assets (property, plant and equipment) and intangible assets.

Lenders are less willing to use intangibles as security for loans than tangibles, and in the event of a
winding up intangibles are often worthless without the business to support them.

Within property, plant and equipment there is the split between land and buildings and the rest. Land and
buildings are often seen as the best source of security by lenders.

Land and buildings can go up in value as well as down, and so the note indicates the effect of revaluations
during the year. The revaluation reserve note elsewhere in the financial statements will show the total
revaluation compared with original cost. Because valuations are subjective the identity and qualifications
of the valuer are disclosed.

The rates of depreciation indicate how prudent (or otherwise) the depreciation policies are, and whether
the reported profits are fairly stated. The ratio between carrying value and cost gives a rough idea of the
age of the assets, and of how soon they will need replacing.

The disclosure of the impairment loss flags a bad investment; the shareholders will want more
information about this at their annual general meeting.
WILDERNESS (12/05)
(a) IAS 36 Impairment of assets was issued in June 1998 and subsequently amended in March 2004. Its
main objective is to prescribe the procedures that should ensure that an entity's assets are included in its
statement of financial position at no more than their recoverable amounts. Where an asset is carried at an
amount in excess of its recoverable amount, it is said to be impaired and IAS 36 requires an impairment
loss to be recognised.

Required

(i) Define an impairment loss explaining the relevance of fair value less costs to sell and value in use;
and state how frequently assets should be tested for impairment; (6 marks)

Note: your answer should NOT describe the possible indicators of an impairment.

Answer:

An impairment occurs when the carrying value of an asset exceeds its recoverable amount. Recoverable
amount represents the amount of cash that an asset will generate either through use (value in use) or
through disposal (fair value less costs to sell).

The value in use is the present value of all future cash flows derived from an asset, including any disposal
proceeds at the end of the asset's life. The present value of future cash flows will be affected by the
timing, volatility and uncertainty of the cash flows. This can be reflected in the forecasted cash flows or
the discount rate used.

Very few business assets generate their own cash flows, and so assets are often grouped together into cash
generating units for impairment purposes. A cash generating is the smallest group of assets generating
independent cash flows

Fair value less costs to sell is the amount obtainable for an asset in an arm's length transaction between
knowledgeable, willing parties, less the cost of disposal. The fair value of used assets with no active
market will have to be estimated. Valuations are based on willing parties, and so a 'forced sale' value
would not normally be used.

Impairment reviews

 At each reporting date an entity shall assess whether there are any indications that an impairment
has occurred; if there are such indications then the recoverable amount of the asset must be
estimated.
 Intangible assets with indefinite lives (and those not ready for use) should be reviewed for
impairment annually. The review should take place at the same time each year.
 Cash generating units that include goodwill should be reviewed for impairment annually.

(ii) Explain how an impairment loss is accounted for after it has been calculated. (5 marks)

Impairment losses should be recognised immediately. They will normally be charged to profit or loss
alongside depreciation, but the impairment of a revalued asset should be taken directly to the revaluation
surplus (until the balance on the revaluation surplus is reduced to zero). In the statement of financial
position the impairment will normally be included within accumulated depreciation, although it could be
disclosed separately if material. Future depreciation charges will be based on the impaired value and the
remaining useful life at the date of the impairment.

Impairments of cash generating units must be apportioned to the individual assets within that unit. The
impairment is firstly allocated to goodwill, and then it is apportioned to all other assets (both tangible and
intangible) on a pro rata basis. However, individual assets are not impaired below their own realisable
value; any unused impairment being re-apportioned to the other assets.

3. IFRS 15 REVENUE CONTRACT

DERRINGDO MCQ
Derringdo is a broadband provider which receives government assistance to provide broadband to remote
areas. Derringdo invested in a new server at a gross cost of $800,000 on 1 October 20X2. The server has
an estimated life of ten years with a residual value equal to 15% of its gross cost. Derringdo uses straight-
line depreciation on a time apportioned basis.

The company received a government grant of 30% of its cost price of the server at the time of purchase.
The terms of the grant are that if the company retains the asset for four years or more, then no repayment
liability will be incurred. Derringdo has no intention of disposing of the server within the first four years.
Derringdo's accounting policy for capital-based government grants is to treat them as deferred credits and
release them to income over the life of the asset to which they relate.

1. What is the net amount that will be charged to operating expenses in respect of the server for
the year ended
31 March 20X3?
A $10,000
B $28,000
C $22,000
D $34.000

Operating expenses

Depreciation charge (800,000 × 85% × 10% × 6/12)) 34,000

Release of grant (240,000 × 10% × 6/12) (12,000)

22,000

2. What amount will be presented under non-current liabilities at 31 March 20X3 in respect of
the grant?
A $228,000
B $216,000
C $240,000
D $204,000
 3. Derringdo also sells a package which gives customers a free laptop when they sign a two-year
contract for provision of broadband services. The laptop has a stand-alone price of $200 and
the broadband contract is for $30 per month.
In accordance with IFRS 15 Revenue from contracts with customers, what amount will be
recognised as revenue on each package in the first year?
A $439
B $281
C $461
D $158

4. Determining the amount to be recognised in the first year is an example of which step in the
IFRS 15 5-step model?
A Determining the transaction price
B Recognising revenue when a performance obligation is satisfied
C Identifying the separate performance obligations
D Allocating the transaction price to the performance obligations

5. Derringdo is carrying out a transaction on behalf of another entity and the finance director is
unsure whether Derringdo should be regarded as an agent or a principal in respect of this
transaction.
Which one of the following would indicate that Derringdo is acting as an agent?
A Derringdo is primarily responsible for fulfilling the contract.
B Derringdo is not exposed to credit risk for the amount due from the customer.
C Derringdo is responsible for negotiating the price for the contract.
D Derringdo will not be paid in the form of commission

BRIDGENORTH
Bridgenorth has undertaken a $5 million contract to repair a railway tunnel. The contract was signed on 1
April 20X8 and the work is expected to take two years. This is a contract where performance obligations
are satisfied over time and progress in satisfying performance obligations is to be measured according to
% of work completed as certified by a surveyor. Bridgenorth has an enforceable right to payment for
performance completed to date.

At 31 December 20X9 the details of the contract were as follows:

1. What is the profit recognised for the year ended 31 December 20X8? $240,000

2. What amount would have been included in trade receivables at 31 December 20X8? $500,000
Work invoiced less cash received
3. What is the contract asset to be recognised at 31 December 20X9?

4. Bridgenorth measures performance obligations completed by reference to percentage of

completion. Which one of these would also be an acceptable method of measuring the
performance obligations completed?

The correct answer is: Costs incurred as a % of total expected costs. This is a valid measure
of the inputs expended to satisfy the performance obligation

5. If at 31 December 20X8 Bridgenorth had completed only 10% of the contract for costs of
$400,000 and felt that it was too early to predict whether or not the contract would be profitable,
what amount, if any, could Bridgenorth have recognised as revenue? $400,000 Bridgenorth can
recognise revenue to the extent of costs incurred to date

ILLUSTRATIVE EXAMPLE
1. 5-step revenue recognition model
Customer enters into a 12 month contract with a mobile phone provider, offering a new handset and a sim
for £65 per month. The provider sells the same mobile phone model for £600 outright.

Answer:

2. Contract modification

During the year ended 31/12/2018 coffee machine manufacturer receives an order for 300 coffee
machines from a retailer, at £500 per coffee machine (total order value £150k), in 3 delivery batches.

01/08/2018 the first 100 coffee machines are delivered

01/09/2018 the retailer amends the original order by ordering additional 200 units.

The manufacturer agrees a 30% discount for the additional units (£350 per unit), hoping to encourage
further orders and a long-term business relationship with the retailer.

By 31/12/2018 the manufacturer delivers 400 coffee machines (300 of the original order, and another 100
towards the additional order).

New contract will arise if the modification relates to distinct goods and if the price at which the goods are
sold amounts to a stand-alone price at which the goods are normally sold on the market.

Does contract modification result in new distinct goods or services supplied?

Answer:

Yes (2 conditions are met)

 Additional units will deliver economic benefits the recipient (in their own right or together with other
goods)

 Promise of goods is separate from the other goods – the new order was placed separately and
subsequently to the original order and the new units ordered can be distinguished from those in the
original contract; the additional units are not dependent or interrelated with other goods in the contract, or
integrated with an associated service.

Are the goods sold at a standalone selling price?

No. The consideration agreed for the additional units does not reflect the normal stand-alone selling price,
due to the significant discount offered exclusively to this customer.

Is there a new contract?

The additional units on their own do not create a new contract limited to those units. The additional order
needs to be bundled with any unfulfilled part of the original contract. Modification causes the original
order for 300 units to be extinguished at the quantities fulfilled prior to modification event (after the
delivery of the first 100 units on 01/08/2018). A new contract is created at the point of modification, for
all units to be delivered after the modification date, reflecting new price per unit, as follows:

New price per unit: £170,000 / 400 units = £425 per unit

As at 31/12/2018 the manufacturer recognises revenue as follows:

If the price offered was a standalone price, for example £490 per unit (which is different from the original
price of £500 but may simply reflect demand for the product at the time when the additional order was
placed), the modification would have resulted in a new contract from the point of modification at £490
per unit . The original contract would have continued unchanged, recognising all units still to be delivered
at the original price of £500.

If the modification did not create a separate promise, the old contract would have continued and no new
contract would be created. For example, if no additional units were ordered, but instead the retailer
negotiated a discount on the original price applying to units already delivered, due to unsatisfactory
quality, an adjustment to revenue already recognised would modify the old contract retrospectively.

3. Revenue recognition ‘at a point of time’ vs. ‘over time’

A property developer constructs 50 identical residential units and enters into sales contracts as follows:

 10% Deposit payable at the date of signing

 50% payment 1 year from signing date
 40% payment on completion

1) Contract A to sell unit 1 at £200k, with no other specific terms

2) Contract B to sell unit 2 at £200k with the following terms:

a) Buyer has an exclusive right to purchase unit 2 which cannot be transferred to any other party unless
the buyer defaults

b) Buyer is legally required to exchange and complete

c) Property developer is entitled to full consideration, even if the buyer defaults

d) Buyer has requested custom-made higher spec fit-out rather than standard

Answer:

Contract A – revenue recognised at a point in time

 Vendor has no enforceable right to be paid before the payment is actually received - If the buyer
withdraws from the contract after paying the deposit, the developer is entitled to the deposit funds only
but no additional consideration in proportion to the works completed to date
 Asset may have an alternative use to the vendor – there is no contractual provision prohibiting the
vendor from selling the unit to a different buyer, the unit is not uniquely made to the buyer’s specification

 As a result, revenue is recognised at the point cash payments received

Contract B – revenue recognised over time

 Vendor does not have an alternative use of the asset – unit cannot be transferred to another buyer

 Vendor has an enforceable right to be paid - Buyer has to complete and cannot withdraw from contract

 Revenue is recognised over time using input or output methods

 Recognition pattern and timing does not correspond to cash received as in contract A

SANROLINA - CONTRACT PROFITS

The main business of Santolina Co is building work. At the end of September 20X3 there is an
uncompleted contract on the books, details of which are as follows.

Date commenced 1.4.X1 Expected completion date 23.12.X3

Total contract revenue 290,000

Costs to 30.9.X3 210,450

Value of performance obligations satisfied to 30.9.X3 230,000

Amounts invoiced for work certified to 30.9.X3 210,000

Cash received to 30.9.X3 194,000

Estimated costs to completion at 30.9.X3 20,600

Santolina calculates satisfaction of performance obligations based on work certified as a percentage of

contract price.

Required

Prepare calculations showing the amount to be included in the statement of profit or loss and
statement of financial position at 30 September 20X3 in respect of the above contract

Answer:

This is a contract where performance obligations are recognised over time. It will be included in the
statement of financial position at cost plus recognised profit less amounts invoice
HAGGRUN - CONTRACT PROFITS
Haggrun Co has two contracts in progress, the details of which are as follows

Haggrun measures satisfaction of performance obligations based on percentage of work certified as

complete.

Required

Show extracts from the statement of profit or loss and other comprehensive income and the statement
of financial position for each contract, assuming they are both certified as:

(a) 40% complete; and

(b) 36% complete

Answer:
 4. IAS 20 GOVERNMENT GRANTS
EXAMPLE
A company receives a 20% grant towards the cost of a new item of machinery, which cost $100,000. The
machinery has an expected life of four years and a nil residual value. The expected profits of the
company, before accounting for depreciation on the new machine or the grant, amount to $50,000 per
annum in each year of the machinery's life.

Answer:
ERRSEA – GG & PPE
The following is an extract of Errsea’s balances of property, plant and equipment and related government
grants at 1 April 20X6.

Details including purchases and disposals of plant and related government grants during the year are:

(i) Included in the above figures is an item of plant that was disposed of on 1 April 20X6 for $12,000
which had cost $90,000 on 1 April 20X3. The plant was being depreciated on a straight-line basis over
four years assuming a residual value of $10,000. A government grant was received on its purchase and
was being recognised in profit or loss in equal amounts over four years. In accordance with the terms of
the grant, Errsea repaid $3,000 of the grant on the disposal of the related plant.

(ii) An item of plant was acquired on 1 July 20X6 with the following costs:

Base cost 192,000

Modifications specified by Errsea 12,000

Transport and installation 6,000

The plant qualified for a government grant of 25% of the base cost of the plant, but it had not been
received by 31 March 20X7. The plant is to be depreciated on a straight-line basis over three years with a
nil estimated residual value.

(iii) All other plant is depreciated by 15% per annum on cost

(iv) $11,000 of the $30,000 non-current liability for government grants at 1 April 20X6 should be
reclassified as a current liability as at 31 March 20X7.

(v) Depreciation is calculated on a time apportioned basis.

Required

Prepare extracts of Errsea’s statement of profit or loss and statement of financial position in respect of
the property, plant and equipment and government grants for the year ended 31 March 20X7.

Answer:
MCQ
1. Which of the following are acceptable methods of accounting for a government grant relating to an
asset in accordance with IAS 20 Accounting for Government Grants and Disclosure of Government
Assistance?

(i) Set up the grant as deferred income

(ii) Credit the amount received to profit or loss

(iii) Deduct the grant from the carrying amount of the asset

(iv) Add the grant to the carrying amount of the asset

A (i) and (ii)

B (ii) and (iv)

C (i) and (iii) : The grant can be treated as deferred income or deducted from the carrying amount
of the asset. It
cannot be credited directly to profit or loss

D (iii) and (iv)

2. A company receives a government grant of $400,000 on 1 April 20X6 to facilitate purchase on the
same day of an asset which costs $600,000. The asset has a five-year useful life and is depreciated on a
25% reducing balance basis. Company policy is to account for all grants received as deferred income.
What amount of income will be recognised in respect of the grant in the year to 31 March 20X8?
$75,000

5. CONSOLIDATED SOFP
ZANDA MAR-JUN 2016
On 1 October 2015, Zanda Co acquired 60% of Medda Co’s equity shares by means of a share
exchange of one new share in Zanda Co for every two acquired shares in Medda Co. In addition,
Zanda Co will pay a further $0·54 per acquired share on 30 September 2016.

Zanda Co has not recorded any of the purchase consideration and its cost of capital is 8% per annum.
The market value of Zanda Co’s shares at 1 October 2015 was $3·00 each. The summarised
statements of financial position of the two companies as at 31 March 2016 are:
The following information is relevant:

(i) At the date of acquisition, Zanda Co conducted a fair value exercise on Medda Co’s net assets
which were equal to their carrying amounts (including Medda Co’s financial asset equity
investments) with the exception of an item of plant which had a fair value of $2·5 million
below its carrying amount. The plant had a remaining useful life of 30 months at 1 October
2015. The directors of Zanda Co are of the opinion that an unrecorded deferred tax asset of
$1·2 million at 1 October 2015, relating to Medda Co’s losses, can be relieved in the near
future as a result of the acquisition. At 31 March 2016, the directors’ opinion has not
changed, nor has the value of the deferred tax asset.
(ii) Zanda Co’s policy is to value the non-controlling interest at fair value at the date of
acquisition. For this purpose, a share price for Medda Co of $1·50 each is representative of
the fair value of the shares held by the noncontrolling interest.
(iii) At 31 March 2016, Medda Co held goods in inventory which had been supplied by Zanda Co
at a mark-up on cost of 35%. These goods had cost Medda Co $2·43 million.
(iv) The financial asset equity investments of Zanda Co and Medda Co are carried at their fair
values at 1 April 2015. At 31 March 2016, these had fair values of $6·1 million and $1·8
million respectively, with the change in Medda Co’s investments all occurring since the
acquisition on 1 October 2015.
(v) There is no impairment to goodwill at 31 March 2016.
 Required: Prepare the following extracts from the consolidated statement of financial position of
Zanda Co as at 31 March 2016: (i) Goodwill; (ii) Retained earnings; (iii) Non-controlling interest.

The following mark allocation is provided as guidance for this question: (i) 6 marks (ii) 7 marks (iii)
2 marks

Answer:

PARADIGM Q1 JUNE 2013

(a) On 1 October 2012, Paradigm acquired 75% of Strata’s equity shares by means of a share
exchange of two new shares in Paradigm for every five acquired shares in Strata. In addition,
Paradigm issued to the shareholders of
Strata a $100 10% loan note for every 1,000 shares it acquired in Strata. Paradigm has not
recorded any of the purchase consideration, although it does have other 10% loan notes already in
issue. The market value of Paradigm’s shares at 1 October 2012 was $2 each. The summarised
statements of financial position of the two companies as at 31 March 2013 are:
The following information is relevant:

(i) At the date of acquisition, Strata produced a draft statement of profit or loss which showed it had
made a
net loss after tax of $2 million at that date. Paradigm accepted this figure as the basis for calculating
the
pre- and post-acquisition split of Strata’s profit for the year ended 31 March 2013.
Also at the date of acquisition, Paradigm conducted a fair value exercise on Strata’s net assets which
were
equal to their carrying amounts (including Strata’s financial asset equity investments) with the
exception of
an item of plant which had a fair value of $3 million below its carrying amount. The plant had a
remaining
economic life of three years at 1 October 2012.

Paradigm’s policy is to value the non-controlling interest at fair value at the date of acquisition. For
this
purpose, a share price for Strata of $1·20 each is representative of the fair value of the shares held by
the
non-controlling interest.

(ii) Each month since acquisition, Paradigm’s sales to Strata were consistently $4·6 million. Paradigm
had
marked these up by 15% on cost. Strata had one month’s supply ($4·6 million) of these goods in
 inventory
at 31 March 2013. Paradigm’s normal mark-up (to third party customers) is 40%.

(iii) Strata’s current account balance with Paradigm at 31 March 2013 was $2·8 million, which did
not agree
with Paradigm’s equivalent receivable due to a payment of $900,000 made by Strata on 28 March
2013,
which was not received by Paradigm until 3 April 2013.

(iv) The financial asset equity investments of Paradigm and Strata are carried at their fair values as at
1 April
2012. As at 31 March 2013, these had fair values of $7·1 million and $3·9 million respectively.

(vi) There were no impairment losses within the group during the year ended 31 March 2013.
Required:
Prepare the consolidated statement of financial position for Paradigm as at 31 March
2013.

Answer:
PARTY – SEPDEC 2017
The following are the draft statements of financial position of Party Co and Streamer Co as at 30
September 20X5:
The following information is relevant:

(i) On 1 October 20X4, Party Co acquired 80% of the share capital of Streamer Co. At this date the
retained earnings of Streamer Co were $34m and the revaluation surplus stood at $4m. Party Co paid an
initial cash amount of $92m and agreed to pay the owners of Streamer Co a further $28m on 1 October
20X6. The accountant has recorded the full amounts of both elements of the consideration in investments.
Party Co has a cost of capital of 8%. The appropriate discount rate is 0·857.

(ii) On 1 October 20X4, the fair values of Streamer Co’s net assets were equal to their carrying amounts
with the exception of some inventory which had cost $3m but had a fair value of $3·6m. On 30
September 20X5, 10% of these goods remained in the inventories of Streamer Co.

(iii) During the year, Party Co sold goods totalling $8m to Streamer Co at a gross profit margin of 25%.
At 30 September 20X5, Streamer Co still held $1m of these goods in inventory. Party Co’s normal
margin (to third party customers) is 45%.

(iv) The Party group uses the fair value method to value the non-controlling interest. At acquisition the
non-controlling interest was valued at $15m.

Required:

(a) Prepare the consolidated statement of financial position of the Party group as at 30 September
20X5.

(b) Party Co has a strategy of buying struggling businesses, reversing their decline and then selling
them on at a profit within a short period of time. Party Co is hoping to do this with Streamer Co.

As an adviser to a prospective purchaser of Streamer Co, explain any concerns you would raise
about making an investment decision based on the information available in the Party Group’s
consolidated financial statements in comparison to that available in the individual financial
statements of Streamer Co.

Answer:
b. The consolidated financial statements of the Party Group are of little value when trying to assess the
performance and financial position of its subsidiary, Streamer Co. Therefore the main source of
information on which to base any investment decision would be Streamer Co’s individual financial
statements. However, where a company is part of a group, there is the potential for the financial
statements (of a subsidiary) to have been subject to the influence of related party transactions. In the case
f Streamer Co, there has been a considerable amount of post-acquisition trading with Party Co and,
because of the related party relationship, there is the possibility that this trading is not at arm’s length (i.e.
not at commercial rates). Indeed from the information in the question, Party Co sells goods to Streamer
Co at a much lower margin than it does to other third parties.

This gives Streamer Co a benefit which is likely to lead to higher profits (compared to what they would
have been if it had paid the market value for the goods purchased from Party Co). Had the sales of $8m
been priced at Party Co’s normal prices, they would have been sold to Streamer Co for $10·9 million (at a
margin of 25% these goods cost $6m; if sold at a normal margin of 45% they would have been sold at
$6m/55% x 100). This gives Streamer Co a trading ‘advantage’ of $4·9 million ($10·9 million – $6
million).There may also be other aspects of the relationship where Party Co gives Streamer Co a benefit
which may not have happened had Streamer Co not been part of the group, e.g. access to
technology/research, cheap finance, etc.

The main concern is that any information about the ‘benefits’ Party Co may have passed on to Streamer
Co through related party transactions is difficult to obtain from published sources. It may be that Party Co
has deliberately ‘flattered’ Streamer Co’s financial statements specifically in order to obtain a high sale
price and a prospective purchaser would not necessarily be able to determine that this had happened from
either the consolidated or entity financial statements.

PYRAMID (6/12)
On 1 April 20X1, Pyramid acquired 80% of Square’s equity shares by means of an immediate share
exchange and a cash payment of 88 cents per acquired share, deferred until 1 April 20X2. Pyramid has
recorded the share exchange, but not the cash consideration. Pyramid’s cost of capital is 10% per annum.

The summarised statements of financial position of the two companies as at 31 March 20X2 are:
The following information is relevant:

(i) At the date of acquisition, Pyramid conducted a fair value exercise on Square’s net assets which were
equal to their carrying amounts with the following exceptions:

– An item of plant had a fair value of $3 million above its carrying amount. At the date of acquisition it
had a remaining life of five years. Ignore deferred tax relating to this fair value.

– Square had an unrecorded deferred tax liability of $1 million, which was unchanged as at 31 March
20X2.

Pyramid’s policy is to value the non-controlling interest at fair value at the date of acquisition. For this
purpose a share price for Square of $3·50 each is representative of the fair value of the shares held by the
non-controlling interest.

(ii) Immediately after the acquisition, Square issued $4 million of 11% loan notes, $2·5 million of which
were bought by Pyramid. All interest due on the loan notes as at 31 March 20X2 has been paid and
received.

(iii) Pyramid sells goods to Square at cost plus 50%. Below is a summary of the recorded activities for the
year ended 31 March 20X2 and balances as at 31 March 20X2:
On 26 March 20X2, Pyramid sold and despatched goods to Square, which Square did not record until
they were received on 2 April 20X2. Square’s inventory was counted on 31 March 20X2 and does not
include any goods purchased from Pyramid.

On 27 March 20X2, Square remitted to Pyramid a cash payment which was not received by Pyramid until
4 April 20X2. This payment accounted for the remaining difference on the current accounts.

(iv) Pyramid bought 1·5 million shares in Cube on 1 October 20X1; this represents a holding of 30% of
Cube’s equity. At 31 March 20X2, Cube’s retained profits had increased by $2 million over their value at
1 October 20X1. Pyramid uses equity accounting in its consolidated financial statements for its
investment in Cube.

(v) The other equity investments of Pyramid are carried at their fair values on 1 April 20X1. At 31 March
20X2, these had increased to $2·8 million.

(vi) There were no impairment losses within the group during the year ended 31 March 20X2.

Required : Prepare the consolidated statement of financial position for Pyramid as at 31 March 20X2.

Answer:
JOGGER Co (CBE Sep/Dec 19) – Consolidated BS
On 1 April 20X4, Runner Co acquired 80% of Jogger Co's equity shares when the retained earnings of
Jogger Co were $19.5m. The consideration consisted of cash of $42.5m paid on 1 April 20X4 and a
further cash payment of $21m, deferred until 1 April 20X5. No accounting entries have been made in
respect of the deferred cash payment. Runner Co has a cost of capital of 8%. The appropriate discount
rate is 0.926.

The draft, summarised statements of financial position of the two companies at 31 March 20X5 are shown
below:

Runner Co Jogger Co
$'000 $'000
 
ASSETS
Non-current assets
Property plant and equipment 455,800 44,700
Investments 55,000 –
510,800 44,700
Current assets
Inventory 22,000 16,000
Trade receivables 35,300 9,000
Bank 2,800 1,500
60,100 26,500
Total assets 570,900 71,200
 
Equity and liabilities
Equity
Equity shares of $1 each 202,500 25,000
Retained earnings 286,600 28,600
489,100 53,600
Current liabilities
Trade Payables 81,800 17,600
Total equity and liabilities 570,900 71,200

i. Runner Co’s policy is to value the non-controlling interest at fair value at the date of
acquisition. The fair value of the non-controlling interest in Jogger Co on 1 April 20X4 was
estimated at $13m.
The fair values of Jogger Co's other assets, liabilities and contingent liabilities at 1 April
20X4 were equal to their carrying amounts with the exception of a specialised piece of plant
which had a fair value of $10m in excess of its carrying amount. This plant had a ten year
remaining useful life on 1 April 20X4.

ii. In December 20X4 Jogger Co sold goods to Runner Co for $6.4m, earning a gross margin of
15% on the sale. Runner Co still held $4.8m of these goods in its inventories at 31 March
20X5.
Jogger Co still had the full invoice value of $6.4m in its trade receivables at 31 March 20X5,
however, Runner Co’s payables only showed $3.4m as it made a payment of $3m on 31
March 20X5.

(a) Prepare the consolidated statement of financial position for Runner Co as at 31 March 20X5.
(16 marks)
 
(b) Runner Co acquired 30% of Walker Co's equity shares on 1 April 20X5 for $13m, Walker Co had
been performing poorly over the last few years and Runner Co hoped its influence over Walker Co would
help to turn the company around. In the year ended 31 March 20X6 Walker Co made a loss of $30m.
Runner Co has no contractual obligation to make good the losses relating to Walker Co.
 
Explain how Walker Co should be accounted for in the consolidated Statement of financial position
of Runner Co for the year ended 31 March 20X6. Your answer should also include a calculation of
the carrying amount of the investment in the associate at that date. 

Answer:
(b) Runner Co has significant influence over Walker Co, therefore Walker Co should be treated as an
associate in the consolidated financial statements, using the equity method.

In the consolidated statement of financial position, the interest in the associate should be presented as
‘investment in associate’ as a single line under non-current assets. The associate should initially be
recognised at cost and subsequently adjusted each period for the parent’s share of the post-acquisition
change in net assets (retained earnings). This figure should be reviewed for impairment at each year end
which given the fall in value of the investment due to the loss would be most likely.

Calculation:

Cost of investment 13,000

Share of post-acquisition change in net assets ((30,000 x 30%) = 9,000) (9,000)

4,000