FIN OPERATIONS CIMA

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Financial Operations 1 September 2012

The Examiner's Answers

F1 - Financial Operations

September 2012

Some of the answers that follow are fuller and more comprehensive than would be expected from a well- prepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike.

SECTION A

Answers to Question One

Rationale

Question One consists of 10 objective test sub-questions. These are drawn from all sections ofthe syllabus. They are designed to examine breadth across the syllabus and thus cover many

learning outcomes.

1.1 C

1.2 A

1.3 A

1.4 A scheduler system of taxation is a system that has a number of schedules that sets out how the differenttypes of income should be treated for tax purposes.

1.5 C

1.6 B

1.7 To review new financial reporting issues, not specifically addressed in IFRSs.To clarify issues where unsatisfactory or conflicting interpretations have developed, with a view to reachinga consensus on the most appropriate treatment.



September 2012 2 Financial Operations

1.8$

Cost 420,000Duties

450,00030,000

Indexation (40%)630,000180,000

Selling price (700,000)Selling cost 10,000

GainTax at 25% 15,000

60,000

1.9 B

1.10 C



F1 September 2012 ANSWERS


SECTION B

Answers to Question Two

(a)

(i) PY Statement of comprehensive income for the year to 31 March 2012 – Taxation workings$000

Balance over-provided year to 31 March 2011 (1820 – 1795) (25)Charge for the year 1,980

Increase in deferred tax (560 – 540) 201,975

PY will charge $1,975,000 to its Statement of comprehensive income for taxation.

(ii)

The deferred tax provision is calculated using the latest estimate of future tax rates, the current rate usually beingthe best estimate of future rates. If a new rate is known to be likely to be introduced the new rate should be used.

If the rate of income tax were to be increased to 30% PY’s deferred tax provision would need to be increased to:

560/0.25x0.3 = 672

An increase of $112,000 in the year ended 31 March 2012.

Rationale

To test candidates’ understanding of the requirements of IAS 12 relating to treatment oftax in the financial statements and the calculation of deferred tax.

Tests learning outcome A4a.

Suggested Approach

Calculate PY’s tax charge for the year to 31 March 2012.Explain the effect the tax increase would have on deferred tax and calculate the amountof increase.




(b)

Rationale

To test candidates’ understanding of the treatment of overseas earnings and double taxrelief.


Suggested Approach

Explain the three main methods of giving double taxation relief to entities with overseasearnings

The three main methods of giving double taxation relief are:

1. Exemption – the countries involved agree the types of income that will be exempt in one country or theother.

2. Deduction – the foreign tax is deducted from the foreign income and the net amount is taxable in thecountry of residence.

3. Tax credit – the tax paid in one country is allowed as a tax credit, at the lower tax rate (lower of the foreigntax rate and country of residence tax rate) in another country.

(c)

Rationale

To test candidates’ understanding of income tax calculations.


Suggested Approach

Calculate the tax effect of disposal of old vehicle.Calculate the depreciation and tax allowance due on the new vehicle.Calculate SM’s taxable profit

Calculate tax due

$Profit before tax 43,000Entertaining 6,300Loss on disposal 1,000Depreciation 16,500New vehicle depreciation 4,000Tax depreciation (19,300)New vehicle tax depreciation (50%) (16,000) Tax at 25%

35,5008,875

SM is due to pay $8,875 tax for the year ended 31 March 2012





(d)

Rationale

To test candidates’ understanding of the treatment of construction contracts, IAS 11, infinancial statements.

Tests learning outcome C2a.

Suggested Approach

Calculate overall profitability of contract.Calculate revenue and cost of sales for the year.Calculate amount due to client

Overall profitability:$000

Revenue 9,000 Total costPredicted loss

10,000(1,000)

Year to 31 March 2012:Revenue (9000 x 35%) 3,150Cost of sales in year (10000 x 35%) 3,500Loss in year (350)Additional expected loss (650)

(1,000)

Amount due to client:Cost to date (WIP) 4,000Total loss (1,000)Less cash receivedDue to client

(3,250)(250)

TY should include the following in its statement of comprehensive income for the year to 31 March 2012:

Revenue (9000 x 35%) 3,150

Cost of salesCost to date (10000 x 35%) 3,500Additional expected loss

4,150650

TY should include the following in its statement of financial position as at 31 March 2012:Under current liabilities:Amount due to client (250)




(e)

Rationale

To test candidates’ understanding of the development of an IFRS.

Tests learning outcome B1e.

Suggested Approach

Explain each of the five possible steps that an IFRS may go through duringdevelopment.

The IASB standard setting process can involve the following steps:• The IASB establishes an advisory committee to advise on the issues arising from the project. The IASB

consults with this committee and the IFRS advisory council throughout the development process.• IASB develops and publishes a Discussion Paper for public comment.• The IASB reviews the comments on the Discussion Paper and prepares and publishes an Exposure Draft

for public comment.• The comments on the Exposure Draft are reviewed by the IASB and if necessary the Exposure Draft is

amended before being issued as a final standard.• On occasion where there are significant changes to the exposure draft it may be reissued for further public

comment before being issued as a final standard.





(f)

Rationale

To test candidates’ understanding of the treatment of situations by the audit report.

Tests learning outcome B1g.

Suggested Approach

Explain how each of the two situations would be treated by an auditor in the auditreport.

(i) Impact on the audit report

The inventory value is material, 30% of profit and 4.5% of revenue and there is a lack of evidence to support theinventory valuation it will impact on the audit report opinion.As the auditors have agreed with VB’s directors on the treatment of the court case it will not affect the audit reportopinion.

(ii) Modification of audit report

The auditors will have to issue a modified report for the inventory valuation as it is due to a material misstatementcaused by insufficient appropriate evidence. The modification required is a qualified opinion expressed as showinga true and fair view ‘except for’ the inventory valuation.

The auditors can issue an unqualified opinion for the court case. However there is material inherent uncertainty

over the outcome of the court case so the unqualified report would have to include a “fundamental uncertainty”emphasis of matter.




SECTION C

Question Three

Rationale

To test candidates’ ability to clear a suspense account.To test candidates’ ability to prepare a set of financial statements for a single entity,including the application of a number of IFRS/IAS.

Tests learning outcome C 2a and C1a.

Suggested Approach

Prepare journal entries to clear QWE’s suspense accountPrepare the non-current asset depreciation and development amortisation calculationsPrepare workings for cost of sales, administration and distribution costsPrepare all other required workingsPrepare the statement of comprehensive incomePrepare the statement of financial positionPrepare the statement of changes in equity

(a)QWEJournal entries to clear suspense:

Debit Credit$000 $000

Suspense account 15Plant and equipment disposal account 15Cash received on disposal of some plant and equipment

Research expense account 20Suspense account 20Research cost to be treated as an expense

(b)

QWE - Statement of comprehensive income for the year ended 31 March 2012$000 $000Revenue 2,220Cost of sales W3 (1,675)Gross Profit 545Administrative expenses W3 (295)Distribution costs W3 (72 (367)Profit from operations 178Finance cost W4 (20)Profit before tax 158Income tax expense W5 (116)Profit for the period 42

Statement of changes in equity for the year ended 31 March 2012





QWE - Statement of Financial Position at 31 March 2012 $000 $000

Non-current assetsProperty, plant and equipment W1 2,301Deferred development expenditure W2 105

Current assetsInventory 214Trade receivables 98Cash and cash equivalents 42

Total assets

354

2,760

Equity and liabilitiesEquity

Share capital 930Share premium 310Retained earnings 601

Total equity 1,841

Non-current liabilitiesLong term borrowings 500Deferred tax 111

Total non-current liabilities 611

Current liabilitiesTrade payables 190Tax payable 83Provision legal claim 25Interest payable 10

Total current liabilitiesTotal equity and liabilities

3082,760

Workings (All figures in $000)

(W1) Non-current assets

Cost Land Buildings Plant and equipmentBalance b/fwd 800 1,610 560Disposal (W6) . . (82)Balance c/fwd 800 1,610 478

DepreciationBalance b/fwd 0 386 185Disposal (W6) . . (79)

0 386 106Year (1610x3%) 48Year [(478-106)x12.5%)] . . 47Balance c/f 0 434 153

Carrying Value 800 1,176 325Total P, P&E c/f 2,301

Equity shares

Share Premium

Retained Earnings

Total

$000 $000 $000 $000 Balance at 1 April 2011 930 310 621 1,861Statement of comprehensive income for year 42 42Dividend paid (62) (62)Balance at 31 March 2012 930 310 601 1,841




(W2) Deferred Development Expenditure

Balance b/f 150Years amortisation – 10% (15)Amortisation b/f (30)Balance c/f 105

(W3)Cost of sales Administration Distribution

Trial balance 1,605 190 72Amortisation development expenditure W2 15Research (from part (a) 20Depreciation – buildings W1 48Depreciation – plant and equipment W1 47Gain on disposal PPE W6 (12)Bad debt 32Legal claim . 25 .Totals 1,675 295 72

(W4) InterestYears loan interest (500x4%) 20Paid 10Accrued 10

(W5) Tax Last Year b/f 8Current year 83

91Increase in deferred tax 25

116

(W6) Disposal of plant and equipment

Cost 82Less depreciationCarrying value 3

(79)

ProceedsGain on disposal

(15) (12)





Question Four

Rationale

To test candidates’ understanding of intra-group sales of non-current assets.

To test candidates’ ability to prepare a set of financial statements for a group of entities.

Tests learning outcomes C2b and C1b, c and d.

Suggested Approach

Explain the treatment of assets sold within a group.Calculate goodwill arising on acquisition of Plank.Calculate investment in associated entity Bush.Prepare workings for intra-group activities.Calculate consolidated retained earnings.

Prepare the consolidated statement of comprehensive incomePrepare consolidated statement of financial position.

(a)The sale to Plank must be recognised in the group consolidated accounts at carrying value, with no profitor loss recognised. Therefore the following adjustments need to be made:

• Cancel the profit on the sale - reduce consolidated profit for the year/consolidated retainedearnings by $20,000.

• Cancel the increase in depreciation [($95,000-$75,000)/10], $2,000 - increase consolidated profitfor the year/consolidated retained earnings by $2,000.

•

Reduce consolidated non-current assets – property, plant and equipment in the statement offinancial position by $20,000-$2,000 = $18,000.

(b)

Wood purchased all 6,000,000 shares in Plank on 1 April 2011.Investment of Wood in Plank

100% shares purchased therefore treat Plank as wholly owned subsidiary of Wood from 1 April 2011.

Wood purchased 1,540,000 of Bush’s 5,500,000 shares on 1 April 2011.Investment of Wood in Bush

This gave Wood 28% of Bush’s equity.As Wood has in excess of 20% of Bush’s equity and can exercise significant influence over all aspects ofBush’s strategic and operational decisions Wood will treat Bush as an associated entity from 1 April2011.

Workings (All workings in $000)

Equity Shares 6,000(i) Fair value of net assets of Plank at acquisition

Retained earnings 1,280Fair value adjustment 1,350

8,630




Cost 9,200(ii) Goodwill - Plank

Fair value of net assets acquired:Goodwill 570

8,630

ImpairmentBalance at 31 March 2012

(80)490

Cost 2,420(iii) Investment in associate - Bush

Add group share of post acquisition profits(1,240 - 410) = 830 x 28% = 232Investment at 31 March 2012 2,652

Mark up on cost 100% = 100/200 or 50% margin on selling price.(iv) Intra-group trading

Selling price 520; unrealised profit = 520 x 50% = 260All goods remain in inventory - 260

Dr. Cr.Consolidated cost of sales 260Consolidated current assets - inventory 260Consolidated revenue 520Consolidated cost of sales 520

Loan interestDr Cr

Accrue interest receivable by Wood:Receivables - interest 155Interest receivable - SoCI 155Receivables - interest 155Loan interest payable 155

Interest payable – SoCI 155Interest receivable -SoCI 155

Consolidated interest payable = (810+440-155) = 1,095Consolidated Receivables - interest (155 - 155) = 0

Consolidated Trade ReceivablesWood 13,400Plank 5,710Less intra-group sales (520)Less cheque in transit (210)

18,380

Consolidated Trade PayablesWood 3,910Plank 3,740Less intra-group sales (520)

(v) Excess depreciation

7,130

Fair value adjustment – 1,350Economic life 15 years, straight line basisExcess depreciation = 1,350/15 = 90





Balance – Wood at 1 April 2011 (5,400-3,490) 1,910(vi) Consolidated Retained Earnings

Add consolidated profit for yearBalance 31 Jan 2012

5,8297,739

Wood 11,820(vii) Consolidated Property, plant and equipment

Plank 7,240Adjustment for sale of asset, net (see (a)) (18)Fair value adjustment 1,350Excess depreciation (90)

20,302

Wood Group – Consolidated Statement of Comprehensive Income for year ended 31 March 2012$000

Revenue(15,500+6,900-520) 21,880Cost of sales (8,700+3,080-520+260+90+20-2)

Gross profit 10,252

(11,628)

Expenses (1,250+750+80)Profit from operations 8,172

(2,080)

Share of profit of associated entity 232Finance costProfit before tax 7,309

(1,095)

Tax (1,250+230)Profit for the year

(1,480)5,829

Wood Group - Consolidated Statement of Financial Position as at 31 March 2012$000 $000

Non-Current Assets

Property, plant and equipment (vii) 20,302Goodwill (ii) 490Investment in associate (iii) 2,652

23,444Current AssetsInventory (12,060+3,215-260) 15,015Trade receivables (iv) 18,380Cash and cash equivalents (1,730+510+210) 2,450 Total assets

35,84559,289

Equity and Liabilities

Equity Shares 38,900Share premium 5,520Retained Earnings (vi) 7,739

52,159Current LiabilitiesTrade payables (iv) 7,130

59,289

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