Exam Derivatives

8/10/2019 Exam Derivatives

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LANCASTER UNIVERSITY

JANUARY 2014 EXAMINATIONS

EXAMINATIONS FOR THE DIPLOMA, MASTER OF RESEARCH AND MASTER OFSCIENCE IN ACCOUNTING AND FINANCIAL MANAGEMENT AND DIPLOMA,MASTER OF RESEARCH AND MASTER OF SCIENCE IN FINANCE, AND MASTEROF SCIENCE IN FINANCIAL ANALYSIS

AcF 503 PRINCIPLES OF FINANCIAL REPORTINGTime: 2 hours

(+ 15 minutes reading time)

Section A

No choice. Answer all parts of all five questions (Total marks 40)

1. a) Ball, Robin & Wu (2003, J. Accounting & Economics, Vol. 36, 235-270) examine the properties ofearnings numbers produced by firms in Hong Kong, Malaysia, Singapore, and Thailand in whichGenerally Accepted Accounting Principles (GAAP) is heavily influenced by common-lawpractices and International Accounting Standards (IAS). They find that earnings in thesecountries do not attain common-law levels of transparency, despite the influence of common-lawstandards in the region. Discuss underlying reasons for their finding and its implications withrespect to IFRS adoption.

(5 marks)

b) Provide one example that shows that International Accounting Standard Boards (IASB) is issuingstandards that contravene its own Conceptual Framework.

(2 marks)

(TOTAL 7 MARKS)

2. a) Opponents of fair value accounting believe that fair value accounting focuses too much onproviding useful information to predict future cash flows but does not fulfill a variety of other roles

of financial statements. Discuss two potential roles of financial statements for which fair valueaccounting is less useful.

(4 marks)

b) Explain the valuation hierarchy described in IFRS 13 Fair Value Measurement and provide anexample for each level.

(6 marks)

(TOTAL 10 MARKS)


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3. a) Explain two reasons why International Financial Reporting Standards (IFRS) adoption mayreduce accounting quality.

(4 marks)

b) Company Alice purchased a building at 1 million in 1970 and still records the building at 1million on its balance sheet. Using this case, analyse a trade-off between two appropriatequalitative characteristics in IASBs Conceptual Framework (2010).

(4 marks)

(TOTAL 8 MARKS)

4. a) Discuss the role of disclosure in facilitating the detection of earnings management.(4 marks)

b) Discuss managers possible earnings management incentives regarding the following statement.In July Apples share price fell sharply after the companys quarterly earnings disappointedinvestors, even though its net profit rose by 21%, to 8.8 billion.

(2 marks)

(TOTAL 6 MARKS)

5. a) Managers often argue that reporting non-GAAP measures help them to convey relevant

information about performance. However, some critics claim that non-GAAP earnings representsmanagements attempt to present a more favourable impression of performance. Provide threereasons to support this claim of critics.

(6 marks)

b) What are the two alternative classification bases for the disclosure of expenses in a statement ofcomprehensive income and what factors should be take into account when selecting betweenthese two alternative presentation formats?

(3 marks)

(TOTAL 9 MARKS)


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Section B

Answer three questions only (Total marks 60)

6. a) Hillier Construction plc commenced the construction of a building on 1 July 2013. It has a fixed-price contract for total revenues of 45 million. The expected completion date is 30 June 2016.

The expected total cost to Hillier Construction at the beginning of the project is 35 million. Thefollowing information relates only to the construction of this building:

For the year ending 30 June 2014 (000) 2015 (000) 2016 (000)

Costs for the year 12,500 15,000 10,000

Costs incurred to date 12,500 27,500 37,500

Estimated costs to complete 23,000 8,500 -

Progress billings during the year 10,000 12,000 23,000

Cash collected during the year 10,000 11,000 24,000

Hillier Construction uses the percentage-of-completion method based on cost to account for itsconstruction contracts. What is the gross profit to be recognised for the year ending 30 June2014, 2015, and 2016, respectively (rounded to the nearest 000)?

(8 marks)

b) An entity sells 3500 products for 55 each. Sales are made for cash, rather than on credit terms.The entitys customary business practice is to allow a customer to return any unused productwithin 30 days and receive a full refund. The cost of each product is 10. To determine thetransaction price, the entity decides that the approach that is most predictive of the amount ofconsideration to which the entity will be entitled is the most likely amount. Using the most likelyamount, the entity estimates that 55 products will be returned. The entitys experience ispredictive of the amount of consideration to which the entity will be entitled. The entity estimatesthat the costs of recovering the products will be immaterial and expects that the returnedproducts can be resold at a profit.

Provide the accounting entries to record the sale (and cost of goods sold), and the subsequent

return of the assets, assuming that the returns occur in accordance with expectations.(8 marks)

c) Werribee Direct plc is a mail order company that allows its customers to order online and returnthe goods without obligations during specified period. Werribee Direct plc had started thisbusiness recently and experienced a high ratio of returned merchandise from online sales. Whatis the appropriate accounting treatment for this sale that is in accordance with IASB (2011)Revenue?

(2 marks)

d) Company Zumba delivers goods to Customer Yuppie on 1 January 2011. The agreementbetween the two parties states that Customer Yuppie pays for the goods in two instalments, thefirst (10,000) being paid on delivery and the second (5,000) being paid one year from the

delivery date. The goods are transferred to the control of Customer Yuppie at the date ofdelivery. (Assume that Company Zumba determines that the discount rate for imputing interest tothe transaction is 10%.) What is the amount of revenue that Company Zumba recognises for theyear to 31 March 2011?

(2 marks)

(TOTAL 20 MARKS)


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7. a) Analyse managements incentives to revalue (or not to revalue) depreciable assets wheremanagement's bonuses are tied to profit (i.e. net income)-based performance measures. Providethe reasons for the incentives. Assume that fair value of the asset is higher than its cost.

(5 marks)

b) Seagull Marinas plc owns land that was purchased for 300,000 to be used as the future site of a

boat shed. Due to the development of a resort in the vicinity, the land's fair market value hadrisen to 480,000 and was revalued on 30 June 2009 accordingly. On 30 June 2012, the landwas revalued to 150,000.

What are the journal entries required to record the revaluations on 30 June 2009 and 30 June2012? What is the impact of the journal entries on net income and total comprehensive incomefor the year ending 30 June 2012?

(5 marks)

c) Kensington plc, an Irish Company, is an importer and retailer of Danish made glass crystals. Forthe year ended 30 June 2012, Kensington plc holds 30 units of an item originally purchased for10,000 each and having at that date a net realisable value of 8,000 each. On 1 June 2013 theTV show Home Improvement featured a similar item prompting an increase in demand for this

glass crystal. Management believes that the net realisable value of this item is 15,000 each on30 June 2013. All 30 items remain unsold on 30 June 2013.

What is the impact on profit of holding this inventory for the years ended 30 June 2012 and2013?

(4 marks)

d) Lancaster Company sells pumps for commercial use. The inventory data are shown below.

Assuming Lancaster uses a periodic inventory system, determine (1) the cost of inventory onhand at 31 March (2) the cost of goods sold for March and (3) gross profit, under FIFO.

(6 marks)

(TOTAL 20 MARKS)

units Price per unit () Total ()

Commercial pumps

Inventory at 28 Feb 600 800 480,000

Purchases:3 March 600 900 540,000

12 March 300 950 285,000

21 March 500 1000 500,000

Sales:

18 March 900 1080 972,000

29 March 600 1140 684,000

Inventory at 31 March 500


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8. a) Weil (2004) argues that operating leases often plump up earnings through, among other things,lower depreciation expenses (p. 2). Comment on this statement in relation with Figure 2 ofImhoff et al. (1991), which is reproduced below.

.(6 marks)

b) Discuss the impact of lease capitalisation of operating leases on current return on assets (ROA)and debt-to-equity ratios and its implications for managers incentives in choosing betweenoperating and finance leases.

(5 marks)

c) Deliveries plc leased a truck from a truck dealer, City Vans plc. City Vans plc acquired the truckat a cost of 180,000. Deliveries plc plans to keep the truck after the lease but has not made anycommitment to the lessor to purchase it. The terms of the lease are as follows:

Date of entering lease: 1 July 2015

Duration of lease: 4 years

Life of leased asset: five years, after which it will have no residual value.

Lease payment: 100,000 at the end of each year (e.g. 30 June 2016, 2017).

Interest rate implicit in the lease: 10 percent

Unguaranteed residual value: 50,000 Fair value of truck at inception of the lease 351,140

(i) Prepare the journal entries to account for the lease transaction in the books of the lessor,City Vans plc, at 1 July 2015 and 30 June 2016.

(5 marks)

(ii) Prepare the journal entries to account for the lease transaction in the books of the lessee,

Deliveries plc, at 30 June 2016.

(4 marks)

(TOTAL 20 MARKS)


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9. a) Banshee plc issues 12 million (par value) in 8-year, 8%, semi-annual coupon debentures. Therate of return required by the market is 12%. What is the journal entry to record the first paymentof interest assuming that Banshee uses the effective-interest method to amortise any discount orpremium (round to the nearest pound)?

(5 marks)

b) In accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, differentiate

provisions from accruals and provide one example for each type of liability. (5 marks)

c) A whisky blending company, Wright whisky, has several years worth of maturing whisky instock. It contracts to sell a certain quantity of the whisky to a bank for 5 million, and agrees tobuy it back one year later for 5.5 million. The whisky remains on Wright whiskys premises.

Analyse the possible accounting treatments. State which is the most appropriate treatment andexplain why this is so.

(4 marks)

d) The following diagram illustrates how to distinguish between provisions and contingent liabilities.What are the appropriate actions for (A), (B), and (C) in the following diagram? Also provide oneexample for each action.

(6 marks)

(TOTAL 20 MARKS)

END OF EXAM

(A) (B) (C)

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