ACCA

Fundamentals

Paper F7

Financial Reporting

(International)

Course Examination 1

Question Paper

Time allowed

Reading and Planning Writing

7½ minutes 1½ hours

ALL THREE questions are compulsory and MUST be attempted (in your real exam you will have 5 compulsory questions to complete in 3 hours)

Instructions: Please attempt this exam under test conditions and attach the frontsheet complete with your name and address to your script. The completed package should be sent to BPP Professional Education.

Take a few moments to review the notes on the inside of this page titled, ‘Get into good exam habits now!’ before attempting this exam.

DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER EXAMINATION CONDITIONS

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Get into good exam habits now! Take a moment to focus on the right approach for this exam.

Effective time management • Watch the clock, allocate 1.8 minutes to each mark and move on if you get behind.

• Take a few moments to think what the requirements are asking for and how you are going to answer them.

• Remember one mark is usually allocated for each valid point you give in a discursive question.

Effective planning • This paper is in exactly the same format as the real exam. You should read through the paper

and plan the order in which you will tackle the questions. Always start with the one you feel most confident about.

• Read the requirements carefully: focus on mark allocation, question words (see below) and potential overlap between requirements.

• Identify and make sure you pick up the easy marks available in each question.

Effective layout • Present your numerical solutions using the standard layouts you have seen. Show and

reference your workings clearly.

• With written elements try and make a number of distinct points using headings and short paragraphs. You should aim to make a separate point for each mark.

• Ensure that you explain the points you are making ie why is the point a strength, criticism or opportunity?

• Give yourself plenty of space to add extra lines as necessary, it will also make it easier for the examiner to mark.

Common terminology Advise To counsel, inform or notify Analyse Examine in detail the structure of Calculate/compute To ascertain or reckon mathematically Compare and contrast Show the similarities and/or differences Define Give the exact meaning of Describe Communicate the key features of Discuss To examine in detail by argument Distinguish Highlight the differences between Evaluate To appraise or assess the value of Explain Make clear or intelligible/state the meaning of Identify Recognise, establish or select after consideration Interpret Process information to explain its meaning Justify To produce reasons in support of List State short pieces of information on separate lines Prepare To make or get ready for use Recommend To advise on a course of action Summarise To express the most important facts of

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1 Passive Passive acquired 800,000 of Soft's $1 ordinary shares on 1 October 20X4 for $2.5 million. One year later, on 1 October 20X5, Passive acquired 200,000 $1 ordinary shares in Active for $800,000. The statements of financial position of the three companies at 30 September 20X6 are shown below:

Passive Soft Active $'000 $'000 $'000 $'000 Non-current assets Freehold property 2,560 1,400 800 Plant 1,420 900 540 Patents 250 420 – Investments – in Soft 2,500 – in Active 800 – others 150 200 60

3,450 7,680 2,920 1,400 Current assets Inventories 570 400 300 Trade receivables 420 380 400 Cash and cash equivalents – 150 120 990 930 820 8,670 3,850 2,220 Equity Share capital - $1 shares 2,000 1,000 500 Share premium 1,000 500 100 Retained earnings 4,500 1,900 1,200 7,500 3,400 1,800 Non-current liabilities Deferred tax liability 200 – 80 Current liabilities Overdraft 80 – – Trade payables 750 450 280 Current tax 140 60 970 450 340 8,670 3,850 2,220

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The following information is relevant:

(i) The balance of the retained earnings of the three companies were:

Passive Soft Active $000 $000 $000 at 1 October 20X4 2,000 1,200 500 at 1 October 20X5 3,000 1,500 800

(ii) At the date of its acquisition the fair values of Soft's net assets were equal to their book values with the exception of a plot of land that had a fair value of $200,000 in excess of its book value.

(iii) On 26 September 20X6 Passive processed an invoice for $50,000 in respect of an agreed allocation of central overhead expenses to Soft. At 30 September 20X6 Soft had not accounted for this transaction. Prior to this the current accounts between the two companies had been agreed at Soft owing $70,000 to Passive (included in trade receivables and trade payables respectively).

(iv) During the year Passive sold goods to Active at a selling price of $140,000 which gave Passive a profit of 40% on cost. Active had half of these goods in inventories at 30 September 20X6.

(v) It is the policy of Passive to value non-controlling interests at fair value at the date of acquisition. The market price of Soft’s shares at the date of acquisition by Passive was $3.

(vi) An impairment review conducted at the year end revealed cumulative impairment losses of $90,000 relating to the recognised goodwill of Soft. No impairment loss adjustments are necessary relating to the investment in Active.

Required

(a) Prepare the consolidated statement of financial position of Passive as at 30 September 20X6. (20 marks)

(b) Explain why IFRS 3 Business Combinations considers it important to consolidate the fair values of assets and liabilities of an acquired subsidiary at the date of acquisition. (5 marks)

(Total = 25 marks)

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2 Construct Construct, undertakes construction projects of various types. At the year end 31 March 20X8, one construction contract, to build a shopping complex, was in process. The contract is worth $95m in total invoiced at various points in the contract.

The following data has been extracted from the accounting records at 31 March 20X8:

Work in progress (costs incurred to date) $34m Invoices issued $52m Amounts received from the customer $26m

In addition to the costs above, a further $3m was incurred in the current period due to the need to rebuild part of a wing of the shopping centre where incorrect materials had been used.

The remaining costs to complete the project were estimated at $16m at 31 March 20X8.

In the previous accounting period, $21m of revenue had been recognised and $11m of costs.

Construct measures the proportion of completion of its contracts by comparing the proportion of sales revenue earned compared to total contract price. A professionally qualified surveyor estimated the sales value of work completed by 31 March 20X8 at $59m.

Required

(a) Critically appraise the treatment of profit attribution in IAS 11 Construction Contracts in the context of the Framework for the Preparation and Presentation of Financial Statements. (7 marks)

(b) Prepare extracts from Construct's financial statements for the above contract for the year ended 31 March 20X8.

Work to the nearest $1m (8 marks)

(Total = 15 marks)

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3 Dawes The following problems and issues have arisen during the preparation of the draft financial statements of Dawes, a public listed company, for the year to 30 September 20X7:

The following schedule of the movement of plant has been drafted:

Cost Depreciation $m $m Balance at 1 October 20X6 81.20 32.50 Additions at cost 23.00 – Depreciation charge for year – 19.84 Disposal (see (ii) below) (5.00) – Balance 30 September 20X7 99.20 52.34

(i) The addition of plant is made up of: $m Basic cost from supplier 20.00 Recoverable sales tax (see (iii) below) 3.50 Installation costs 1.00 Pre-production testing 0.50 Annual insurance and maintenance contract 1.00 Less government grant (see (iv) below) (3.00) 23.00

(ii) The disposal figure of $5 million is the proceeds from the sale of an item of plant during the year which had cost $15 million on 1 October 20X3 and had been correctly depreciated prior to disposal. Dawes charges depreciation of 20% per annum on the cost of plant held at the year end.

(iii) The recoverable sales tax paid on acquisition of assets is recoverable from the taxing authorities.

(iv) The company policy for government grants is to treat them as deferred income in the statement of financial position.

Required

Prepare the disclosure note of movements in net book value of plant and equipment as required by IAS 16 Property, Plant and Equipment. Explain your treatment of items (ii) to (iv) above (10 marks)

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Student self-assessment Having completed this paper take a few minutes to consider what you did well and what you found difficult. Use this as a basis to focus your future study on effectively improving your performance.

Common problems Future emphasis if you answer Yes

Timing and planning

Did you finish too early? Y/N Focus your planning time on generating more ideas. Use models to help develop breadth to your thinking.

Did you overrun? Y/N Focus on allocating your time better. Practise questions under strict timed conditions. If you get behind leave space and move on.

Did you waffle? Y/N Focus your planning time on developing a logical structure to your answer.

Layout

Was your answer difficult to follow? Y/N Use headings and subheadings. Use numbering sequences when identifying points. Leave space between each point.

Did you fail to explain each point clearly? Y/N Show why the point identified answers the question set.

Did you fail to show any workings or were your workings unclear? Y/N Give yourself time and space to make the marker's job easy.

Content

Did you struggle with:

Interpreting the questions? Y/N Learn the meaning of common terminology (inside front cover). Learn subject jargon (key terms in study text). Read questions carefully noting all the parts. Practise as many questions as possible.

Understanding the subject? Y/N Review your notes/text. Work through easier examples first. Classroom students please contact your tutor for further help. Home Study students please contact ACCA queries for further help (accaqueries@bpp.com).

Remembering the notes/text? Y/N Quiz yourself constantly as you study. You need to develop your memory as well as your understanding of a subject.

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ACF7CE10(J) INT

AC110 – F7 INT (1)

ACCA

Fundamentals

Paper F7

Financial Reporting

(International)

Course Examination 1

Commentary, Marking scheme and Suggested solutions

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Commentary Tutor guidance on improving performance on the exam paper. This exam included questions of a style and standard that you would expect to see on a real examination paper, although your exam will have 5 questions to complete in 3 hours.

Overall this was a fair paper covering important topics from the first part of the syllabus.

Q1 Passive This question is an example of the revised IFRS 3 approach calculating non-controlling interests at fair value. There were some 'easy marks' to be had if you read the question carefully and adopted a logical approach. This question also incorporated the usual adjustments including fair value adjustments, intra group transactions and dividends. Note that the impairment loss is allocated to the non-controlling interests according to its % shareholding.

Q2 Construct This required candidates to comment on the treatment of construction contracts from a conceptual point of view, followed up with some illustrative financial statement extracts in part (b) of the question.

This is typical of question 4, which combines an accounting area, in this case construction contracts with the conceptual framework, so make sure you are up-to-speed on your conceptual framework principles and know how to evaluate accounting standards in the context of those principles.

Q3 Dawes This question tested your knowledge of issues relating to non-current assets. It was not difficult but you should set your answer out clearly so that the marker can understand it. It is important to explain your reasoning.

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1 Passive

Top tips. This is a consolidated statement of financial position with an associate and with the non-controlling interests at fair value. Remember to add the NCI goodwill onto the year end balance. The unrealised profit is in the parent, so that is straightforward. Note that the current account balances do not include the overhead charge.

Easy marks. If you dealt correctly with the goodwill, the non-controlling interests and the fair value adjustment you could have scored high marks. There were a number of marks per items which only needed adding up.

Marking scheme Marks (a) Freehold property 2 Plant 1 Calculation of goodwill 3 Patents 1 Investment in associate 2 Other financial assets 1 Inventories ½ Trade receivables ½ Cash and overdraft (shown separate) 1 Share capital and share premium 1 Retained earnings 2 Deferred tax 1 Non-controlling interests 2 Trade payables 1 Income tax 1

Maximum 20

(b) Correctly value the sub at acquisition 1 Consistent with concept of H.C when acquired 1 Book values lead to out of date values 1 Wrong goodwill figure 1 Wrong value of other assets 1 Total 5 25

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Suggested solution (a) Consolidated statement of financial position of Passive as at 30 September 20X6

$000Non-current assets Freehold property (2,560 + 1,400 + (W6) 200) 4,160Plant (1,420 + 900) 2,320Goodwill (W2) 110Patents (250 + 420) 670Investment in associate (W3) 952Other financial assets (150 + 200) 350 8,562 Current assets Inventories (570 + 400) 970Trade receivables (420 + 380 – 70 – (W8) 50) 680

Cash and cash equivalents 150 1,800

10,362

Equity attributable to owners of the parent Share capital - $1 shares 2,000Share premium 1,000Retained earnings (W4) 5,100

8,100Non-controlling interests (W5) 712

8,812

Non-current liabilities Deferred tax 200 Current liabilities Overdraft 80Trade payables (750 + 450 – (W8) 70) 1,130Current tax 140 1,350

10,362

Workings

1 Group structure

Passive

80% 40%

Soft Active

Pre acquisition ret’d earnings $1,200,000 $800,000

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2 Goodwill – Soft

$'000 $'000 Consideration transferred 2,500

Non-controlling interests (at 'full' FV (200,000 × $3)) 600 Fair value of identifiable net assets at acq'n: Share capital 1,000 Share premium 500 Retained earnings 1,200 FV adjustment 200 (2,900) Goodwill at acquisition 200 Impairment losses to date (90) Goodwill at year end 110

3 Investment in associate $'000 Cost of associate 800 Share of post-acq'n ret'd earnings (W4) 160 Unrealised profit (W7) (8) 952

4 Retained earnings Passive Soft Active $'000 $'000 $'000 Per question 4,500 1,900 1,200 Unrealised profit on inventories (W7) (8) Central overhead recharge (W8) (50) Pre-acquisition (1,200) (800) 650 400 Group share of post acquisition ret'd earnings:

Soft (650 × 80%) 520 Active (400 × 40%) 160

Group share of impairment losses to date (90 × 80%) (72) 5,100

5 Non-controlling interests $'000 NCI at acquisition (W2) 600 NCI share of post acquisition ret'd earnings (650 × 20%) 130 NCI share of impairment losses to date (90 × 20%) (18) 712

6 Fair value adjustment

At acquisition Movement At year end $'000 $'000 $'000 Freehold land 200 – 200 200 – 200

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7 Unrealised profit on inventories

$'000 Unrealised profit (140 × 40/140 × ½) 20 Group share 40% 8

Transaction with associate: therefore multiplied by investor's share (40%).

8 Elimination of current accounts

The current accounts of Passive and Soft, were agreed at $70,000 before the charge for the allocation of central overheads. When Passive processed this transaction it would have debited Soft's current account to give a balance of $120,000 which must be eliminated. The corresponding adjustments are to eliminate $70,000 from Soft's payables and debit $50,000 to the retained earnings of Soft. In summary:

Dr Cr Trade payables (elimination of intragroup payable) 70 Retained earnings of Soft reflecting the charge 50 Trade receivables (elimination of intragroup receivable)

120

120 120

(b) Importance of fair values upon consolidation

IFRS 3 considers it important to consolidate the net fair values of the identifiable assets and liabilities of an acquired subsidiary upon consolidation as this treatment best reflects the correct value of the subsidiary at the time of its acquisition. This is also consistent with the concept of historical cost as items are shown at their value when acquired.

The alternative would be to consolidate the book values of the assets and liabilities. This treatment would lead to out of date values being used for some of the items in the statement of financial position and therefore a different goodwill figure would arise which would in effect incorporate any fair value adjustments. Put simply this would lead to a misallocation of fair value adjustments to the goodwill caption.

Fair values allow the users of the accounts to see the value of the items acquired and the resulting goodwill figure.

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2 Construct

Top tips. In part (a) think about the different construction contract scenarios, state them and then compare this with relevant concepts you can think of from the Framework. You can learn the financial statement extracts as proformas for part (b).

Easy marks. Stating relevant accounting treatments in part (a). Proformas to fill out in part (b).

Marking scheme Marks (a) Outcome can be measured reliably – explanation & evaluation 2 Expected losses – explanation & evaluation 2 Outcome cannot be estimated reliably – explanation & evaluation 1 Consistency with Framework asset-driven approach 2

7 (b) Revenue 1 Cost of sales 3 Contract costs incurred 1 Recognised profit 1 Progress billings 1 Trade receivables 1 8 Maximum for the question 15

Suggested solution (a) Where a contract is in progress, but not completed at the year end, providing the outcome can be

reliably measured IAS 11 requires revenue, cost and profit to be measured on an accruals basis, consistent with the Framework underlying assumption. This can be measured in 3 ways: physical proportion completed, proportion of costs versus expected total costs or proportion of revenue certified as earned versus total revenue.

There are those that argue that three methods of profit recognition allow a company too much flexibility in manipulation of profits, while others view it as necessary due to different industry practices and the difficulty of measuring figures such as work certified reliably in some industries.

Where a contract is loss making, IAS 11 requires the whole loss to be recognised immediately. This no longer applies the accruals concept, but is a prudent approach and is consistent with the treatment of onerous contracts under IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Where the outcome of a contract cannot be reliably measured at the year end, e.g. because it has only recently begun or costs and revenues may fluctuate substantially. IAS 11 allows revenue to be recognised only to the extent of costs incurred expected to be recovered, i.e. zero profit until the outcome can be estimated reliably. This combines an accruals approach of recognising costs and revenue as the contract progresses with a prudent approach of not recognising profit until the outcome can be measured reliably.

One final and important point to note is that IAS 11 is a profit and loss driven standard. The revenue, cost and profit figures are calculated and the amounts shown in the statement of financial position depend on these figures. This is inconsistent with the Framework definitions of income and expenses, which are defined as changed in assets and liabilities and is therefore an area the IASB will need to

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look to resolve in the future, not just for this standard, but also for other elements of revenue recognition under IAS 18 Revenue.

(b) Profit or loss $'m Revenue (59 – 21) 38 Cost of sales ((59/95 x (W1) 50) + (W2) 3 – 11) (23) Gross profit 15

Statement of financial position

Gross amounts due from customers: $'m Contract costs incurred (34 + 3) 37 Recognised profit (21 – 11 + 15) 25 62 Less: progress billings (52) 10 Trade receivables: $m Progress billings 52 Cash received (26) 26

Workings

1 Overall profit on contract

$'m $'m Revenue 95 Costs to date (34) Expected future costs (16) (50) Rectification costs (3) 42

The contract is profitable and so profits are accrued using the work certified approach in the question.

2 Rectification costs

The rectification costs of $3m are charged to profit or loss in the period incurred, rather than spread over the remaining life of the contract.

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3 Dawes

Top tips. This question requires good knowledge of non-current assets. These will always appear somewhere on the paper. Set your schedule out neatly so that you don’t forget anything. Note the treatment of the government grant.

Easy marks. There were 3 marks here just for correctly calculating additions and 2 easy marks for explaining the sales tax and insurance, so half marks were available before dealing with the disposal or depreciation.

Marking scheme Addition 3 Depreciation 2 Disposal 2 Government grants 1 Sales tax 1 Insurance and maintenance 1 10

Suggested solution DAWES NOTES TO THE FINANCIAL STATEMENTS

Movement in plant and equipment

$'m Net book value at 1 October 20X6 (81.20 – 32.50) 48.70 Additions (W1) 21.50 Disposals (W2) (6.00) Depreciation charge for the year (17.54) Net book value at 30 September 20X7 46.66

At 30 September 20X7 $'m Cost or valuation (81.20 + 21.50 – 15.00) 87.70 Accumulated depreciation (32.5 – 9.0 + 17.54) (41.04) Net book value 46.66 At 30 September 20X6 Cost or valuation 81.20 Accumulated depreciation (32.50) Net book value 48.70

Workings

1 Additions to plant

$'m Basic cost 20.00 Installation 1.00 Testing 0.50 21.50

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Notes:

The sales tax on the plant can be reclaimed by Dawes and therefore does not form part of its cost. The company policy for government grants does not allow them to be offset against the cost of the asset.

Insurance and maintenance are revenue expense items chargeable to the profit or loss.

2 Disposal of equipment

The accumulated depreciation on the equipment disposed of would be 20% of $15m for three years = $9m.

Net book value at disposal is therefore $15m - $9m = $6m.

The depreciation charge for the year is 20% of the corrected cost of the plant at the year end, i.e. 20% × $87.7m = $17.54m.

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