SD 2024 FR

This scenario relates to three requirements.

The directors of Clocking Co purchased 80% of the 100 million ordinary (equity) $1 shares in
Stopping Co on 1 April 20X8. The consideration comprised of a one-for-four share exchange.
There was also an immediate cash payment of $2.80 per share and a further $2.70 per share is
payable on 1 April 20X9. On 1 April 20X8, the market value of each equity share in Clocking Co
and Stopping Co was $12.50 and $8.00 respectively.
The retained earnings of Stopping Co at 1 October 20X7 were $610m and the company
reported a profit for the year ended 30 September 20X8 of $88m. The group has a policy of
valuing non-controlling interests at acquisition at fair value and has a cost of capital of 8%.
The directors of Clocking Co have accounted for the acquisition of Stopping Co correctly and
have prepared the following:
Clocking Group
Consolidated statement of profit or loss (extracts) for the year ended 30 September

20X8 20X7
$'000 $'000

Revenue 418,000 340,400

Cost of sales (260,750) (181,880)

Gross profit 157,250 158,520

Operating expenses (60,473) (57,038)

Operating profit 96,777 101,482

Finance costs (10,067) (3,187)

Profit before tax 86,710 98,295

Clocking Group
Consolidated statement of financial position (extracts) as at 30 September

20X8 20X7
$'000 $'000

EQUITY AND LIABILITIES

Equity attributable to the parent

Ordinary (equity) shares 220,000 200,000

Share premium 230,000 –

Retained earnings 718,287 652,305

1,168,287 852,305

Total non-current liabilities 387,000 104,000

All profits accrued evenly throughout each year.

Clocking Co has suffered from decreased revenue in recent years, which directors believe is
mainly due to a general economic downturn. The falling sales were the main reason for the
investment in Stopping Co, so that Clocking Co could have more control over its competitors.
To encourage customers to continue purchasing from Clocking Co throughout the economic
downturn, many products are now being sold at significantly discounted prices.
To assist in generating future revenue, Clocking Co raised additional finance in September 20X8
by issuing $25m of loan notes.
(a) Calculate the goodwill on the acquisition of Stopping Co.
(5 marks)
(b) Using the Clocking Group’s consolidated financial statements and the pre-formatted table
provided, calculate the following ratios for the years ended 30 September 20X8 and 20X7:

– Gross profit margin

– Operating profit margin
– Return on capital employed
– Net asset turnover
– Gearing (debt ÷ equity)
– Interest cover
(5 marks)

(c) Analyse the comparative performance and gearing of Clocking Co for the years ended 30
September 20X8 and 20X7 and comment on the limitations of the ratios based on the
consolidated financial statements.

Note: A maximum of 2 marks may be awarded for comments on the limitations of the ratio
analysis in part (c).
(10 marks)

(20 marks)
Solution:
(c)
Profitability
The gross and operating profit percentages across the two years have fallen which seems
reasonable given the view of management that the economic downturn has led to significant
discounts to maintain volume.
There has been an increase in sales, despite the economic downturn, showing that the
discounting strategy is working and that the extra financing raised through the loan notes is
being put to good use.
Operating profit margin has not fallen as much as gross profit margin, suggesting that the
companies have controlled operating expenses well; this is surprising as the group is likely to
have incurred fees because of the purchase of Stopping Co.
There are two key issues affecting the return on capital employed – the fall in the operating
margin and the reduction in net asset turnover across the two years. The group has suffered a
fall in operating profits and an issue of share capital (consideration) alongside the consolidation
of Stopping Co’s retained earnings.
Gearing
Non-current liabilities have increased by $283m ($387m – $104m), $25m of which relates to
the new loan notes issued to finance future operations. This means that there must be other
borrowing which Clocking Co has taken out and we are not aware of (perhaps in anticipation of
meeting the deferred consideration) on 1 April 20X9.
Some existing borrowing and associated finance costs could have been included in the accounts
of Stopping Co and is now being consolidated into Clocking Co’s consolidated financial
statements. Consequently, the gearing ratio has increased significantly from 12·2% to 33·1%.
There has also been an increase in the issued share capital, due to the share for share exchange
part funding the purchase of Stopping Co but the issue of shares is a small part of the total
consideration.
Clocking Co may have been better to have negotiated for more of the consideration to be in
the form of a share exchange as it now has a liability to fund a deferred payment on 1 April
20X9.

Limitations
The consolidated financial statements for the year ended 30 September 20X8 only include
Stopping Co from 1 April 20X8 and so results are not wholly comparable.
We do not have any information about company operations and, if the companies each sell
different products in different markets, an analysis of each company rather than the whole
group would be more appropriate.
Conclusion
If Stopping Co was acquired with the objective of having a bigger share of the market and
improving profitability, it has not yet achieved its objective. However, without reviewing the
individual financial statements of Stopping Co, it is not possible to explain why this might be the
case. The acquisition has increased the debt and gearing of the group with the inclusion of the
deferred consideration as a liability. A further analysis of the cash position of Clocking Co is
required to ensure that there is sufficient cash available to settle this debt when it falls due.
This scenario relates to two requirements.

Newcraighall Co
Trial balance (draft) as at 31 December 20X1
Dr Cr
$'000 $'000
Property – cost 32,500
Property – accumulated depreciation as at 1 January 20X1 9,200
Equipment – cost 16,200
Equipment – accumulated depreciation as at 1 January 20X1 8,420
Financial assets 3,500
Inventories 4,640
Trade receivables 2,810
Cash and cash equivalents 210
Retained earnings as at 1 January 20X1 12,620
Share capital 14,000
Loan payable 5,000
Trade and other payables 5,780
Draft profit before tax for the year ended 31 December 20X1 4,420
59,650 59,650

The following information is relevant:

On 1 July 20X1, Newcraighall Co received a $5m 8% loan which was accounted for
correctly at that date. It is due for repayment on 31 December 20X6. The interest is
payable annually in arrears.

The $5m was used to fully fund the construction of a new building. The construction
(1)
cost has been correctly capitalized but no other accounting entries in respect of the
property or loan have been made since that date.

The construction is due to be completed by 31 January 20X2.

On 1 December 20X1, Newcraighall Co placed an order for equipment at a cost of

(2) $3m. This cost was included within equipment and trade payables. The equipment was
received and paid for on 6 January 20X2.
 Property includes land at a cost of $12m. Newcraighall Co’s depreciation policy is:

Property – straight line over 20 years

(3)
Equipment – diminishing balance at 25%
Right-of-use assets – straight line and in accordance with IFRS® 16 Leases

The financial assets are 3% bonds that were acquired for $3.5m on 1 January 20X1
and which Newcraighall Co intends to keep until maturity. Transaction costs of $0.5m
were incurred. The bonds were capitalized at $3.5m and transaction costs were
expensed.
(4)
The bonds have an effective interest rate of 7%. Newcraighall Co received the annual
receipt of $105,000 on 31 December 20X1 and recognized this as income.

On 1 January 20X1, Newcraighall Co entered a five-year lease for equipment. The

equipment had a useful life of five years.

Newcraighall Co will make five payments of $2.4m on 1 January each year, including
on the commencement date.
(5)
Using the implicit interest rate of 13%, present value of future lease payments after the
first payment was made was $7.139m.

The $2.4m paid on 1 January 20X1 was expensed and no other accounting was
performed.

The current tax payable at 31 December 20X1 was $680,000.

(6)

In the financial statements for the year ended 31 December 20X1, Newcraighall Co
planned to disclose a contingent asset of $1.2m relating to a court case. On 30
(7)
December 20X1, a court ruled that Newcraighall Co would receive only $1m. No
accounting adjustments have been made in respect of this.

(a) Calculate, using the pre-formatted table provided, Newcraighall Co’s adjusted profit for
the year ended 31 December 20X1.
(7 marks)

(b) Prepare Newcraighall Co’s statement of financial position as at 31 December 20X1.

(13 marks)
(20 marks)