CORPORATE REPORTING
PROFESSIONAL 1 EXAMINATION - AUGUST 2012
NOTES:
You are required to answer Questions 1, 2 and 3. You are also required to answer either Question 4 or 5.
(If you provide answers to both Questions 4 and 5, you must draw a clearly distinguishable line through the
answer not to be marked. Otherwise, only the first answer to hand for Questions 4 or 5 will be marked.)
PRO-FORMA STATEMENT OF COMPREHENSIVE INCOME BY NATURE,
STATEMENT OF COMPREHENSIVE INCOME BY FUNCTION
AND STATEMENT OF FINANCIAL POSITION ARE PROVIDED.
TIME ALLOWED:
3.5 hours, plus 10 minutes to read the paper.
INSTRUCTIONS:
During the reading time you may write notes on the examination paper but you may not commence
writing in your answer book. Please read each Question carefully.
Marks for each question are shown. The pass mark required is 50% in total over the whole paper.
Start your answer to each question on a new page.
You are reminded to pay particular attention to your communication skills and care must be taken
regarding the format and literacy of the solutions. The marking system will take into account the content
of your answers and the extent to which answers are supported with relevant legislation, case law or
examples where appropriate.
List on the cover of each answer booklet, in the space provided, the number of each question(s)
attempted.
The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.
CORPORATE REPORTING
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
PROFESSIONAL 1 EXAMINATION – AUGUST 2012
Time allowed 3.5 hours, plus 10 minutes to read the paper.
You are required to answer Questions 1, 2 and 3. You are also required to answer either Question 4 or 5.
(If you provide answers to both Questions 4 and 5, you must draw a clearly distinguishable line through the
answer not to be marked. Otherwise, only the first answer to hand for Questions 4 or 5 will be marked.)
You are required to answer Questions 1, 2 and 3.
1.
Inca plc (Inca) is a large public limited company based in Ireland. It has shareholdings in two other companies.
These are called Java plc (Java) and Lava plc (Lava). Statements of Financial Position are shown below for all
three companies as at 31 July 2012.
Statements of Financial Position as at 31 July 2012
Inca plc
Java plc
€ million
€ million
Non-current assets:
Property, plant & equipment
Investments
Current assets:
Inventories
Receivables
Cash & bank
Total assets
Equity:
Equity share capital of €1 each
Share premium
Retained earnings
Current liabilities:
Payables
Bank overdraft
Dividends proposed
Total equity & liabilities
Lava plc
€ million
180
83
263
43
27
70
37
46
32
8
86
23
14
2
39
16
12
28
349
109
65
100
75
132
307
50
20
16
86
25
8
12
45
29
18
13
7
13
42
5
23
20
349
109
65
37
The following additional information is to be taken into account insofar as it is relevant:
(i)
Inca bought 45m equity shares in Java on 1 August 2011. The consideration consisted of an immediate cash
payment of €58 million together with a deferred payment of €30 million due on 1 August 2013. The €58 million
has been accounted for in the accounts of Inca, but no record has been made of the deferred payment. Inca’s cost
of capital can be taken to be 10%.
(ii)
Inca also bought 10m equity shares in Lava on 1 November 2011, paying an amount of €25m cash for these
shares. This investment has been correctly recorded at cost.
(iii)
The equity share capital and share premium of Java and Lava have not changed since their respective dates of
acquisition. The retained earnings reserves were as follows on the respective acquisition dates: Java €10.6m,
Lava €9m.
Page 1
(iv)
Group accounting policy is to value non-controlling interests at fair value at the date of acquisition, and goodwill
should be calculated accordingly. On 1 August 2011, the fair value of the non-controlling interest in Java was €9.2
million. No impairment losses are considered necessary at 31 July 2012.
(v)
On the acquisition date, the fair values of the assets of Java were equivalent to their book values with two
exceptions. Certain plant was worth €4m in excess of its book value on the date Inca acquired its holding. Also,
Java’s investments, carried at €27 million, had a fair value of €28 million at the acquisition date. The plant was
estimated to have had a five-year useful life from the date of acquisition. The value of the investments has not
changed since the acquisition date.
(vi)
During the financial year ended 31 July 2012, Java had sold goods to Inca amounting to €6m. These goods were
sold inclusive of a mark-up of 50% on cost. 30% of these goods remained in the inventory of Inca at the reporting
date.
(vii)
Since acquiring its holding in Lava, Inca purchased €3 million of goods from Lava which had cost Lava €2 million.
All of these remained in inventory at the reporting date.
(viii)
There was an intra-group balance of €2.2m owed by Inca to Java at the reporting date. This amount was the same
in the books of both companies. An amount of €1.5 million was owed by Inca to Lava at the reporting date. Both
sets of books were again in agreement on the amount outstanding.
(ix)
Inca has not accounted for any dividend receivable from its group companies. Both Inca and Java have proposed
dividends as shown in current liabilities. Java’s proposed dividend relates to the post-acquisition period only.
(x)
Inca exercises significant influence over its investment in Lava.
(xi)
The present value interest factors for 10% may be taken as follows: Year 1 = 0.91, Year 2 = 0.83
REQUIREMENT:
(a)
Prepare the Consolidated Statement of Financial Position for the Inca group as at 31 July 2012 in accordance
with International Financial Reporting Standards.
(22 marks)
Format & Presentation (2 marks)
(b)
Write a short memorandum to a client explaining the two methods permitted by IFRS 3 Business Combinations
for calculating goodwill on the acquisition of a subsidiary.
(5 marks)
Format & Presentation (1 mark)
[Total: 30 MARKS]
Page 2
2.
Clawhammer plc is a public listed manufacturing company. Its summarised financial statements for the year ended
30 April 2012 (and 2011 comparatives) are as follows:
Statements of Comprehensive Income for the year ended 30 April:
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Investment income
Finance costs
Profit (loss) before taxation
Income tax (expense) relief
Profit (loss) for the year
Other comprehensive income (net of tax)
Revaluation losses
Total comprehensive income (loss) for the year
2012
€ million
310
(270)
40
(10)
(49)
(6)
(25)
4
(21)
2011
€ million
360
(260)
100
(8)
(39)
2
(5)
50
(15)
35
(45)
(66)
35
2012
€ million
2011
€ million
176
24
200
245
40
285
22
22
6
12
62
19
28
1
48
262
333
130
10
36
176
120
45
65
230
40
12
52
50
7
57
34
34
33
13
46
262
333
Statements of Financial Position as at 30 April:
Assets
Non-current assets:
Property, plant and equipment
Investments at fair value through profit or loss
Current assets:
Inventory and work-in-progress
Trade receivables
Tax refund due
Bank
Total assets
Equity and liabilities
Equity:
Equity shares of €1 each
Share premium
Revaluation reserve
Retained earnings
Non-current liabilities:
Bank loan
Long term provisions
Current liabilities
Trade payables
Current tax payable
Total equity and liabilities
Page 3
The following additional information is available:
(i)
Market conditions during the year ended 30 April 2012 proved very challenging due largely to difficulties in the
global economy as a result of a sharp recession. This has led to steep falls in share prices and property values.
Clawhammer plc’s properties have suffered revaluation losses of €60 million in the year. The excess of these
losses over previous surpluses has led to a charge to cost of sales of €15 million in addition to the normal
depreciation charge.
(ii)
The portfolio of investments at fair value through ‘profit and loss’ has been ‘marked to market’ (fair valued) resulting
in a loss of €16 million which is included in administrative expenses.
(iii)
There were no additions to, or disposals of, non-current assets during the year.
(iv)
In response to the downturn in the economy, the company has had to make a number of employees redundant
incurring severance costs of €3 million. These are included in cost of sales.
(v)
The difficulty in the credit markets has meant that the finance cost of the variable rate bank loan has increased
from 4.5% to 8% from 1 May 2011.
(vi)
In order to help cash flows, the company made a rights issue of shares during the year ending 30 April 2012, all
of which ranked for dividend. No shares were issued during the year ended 30 April 2011.
(vii)
The dividend per share has been reduced by 50% for year ended 30 April 2012.
REQUIREMENT:
(a)
Prepare a statement of changes in equity for years ended 30 April 2011 and 2012 insofar as the above information
permits.
(5 marks)
Format & Presentation (1 mark)
(b)
Analyse and discuss the financial performance and position of Clawhammer plc as portrayed in the financial
statements and in the additional information provided. Your analysis should be supported by ratios (8 marks are
available for calculation of suitable ratios, and 10 marks for analysis).
(18 marks)
(c)
Identify and explain briefly the factors limiting your analysis at (b) above.
(6 marks)
[Total: 30 MARKS]
Page 4
3.
The following multiple choice question contains eight sections, each of which is followed by a choice of
answers. Only one of each set of answers is strictly correct. Each question carries equal marks.
REQUIREMENT:
Record your answer to each section in the answer sheet provided.
1.
[Total: 20 MARKS]
Macroly plc prepared draft financial statements to year ended 31 December 2011 showing inventory at cost price
€760,000. Following investigations the auditors found this inventory included the following two items: (1) A batch
of electric guitars was carried at €60,000 but, due to obsolescence, these were expected to fetch only €36,000
on sale. Costs of selling and delivery are expected to be €1,500. (2) A batch of pianos was carried at €70,000,
but sold during January and February 2012 for a total of €17,500 net of all selling costs. The reason for the low
price was damage caused by a flood which took place in the warehouse in early January 2012.
What is the correct inventory figure for inclusion in Macroly’s 2011 year-end accounts in the light of the above
information?
(a)
€736,000
(b)
€734,500
(c)
€683,500
(d)
€682,000
2.
During the year ended 31 December 2011, Thornbird plc acquired 80% of the equity of another entity. The
consideration payable was €56 million comprising €12 million immediate cash, €30 million fair value of equity
issued as consideration, and €14 million fair value of contingent consideration (payable in 2014). The fair value
of the net assets of the entity acquired was €52 million, including cash of €15 million.
What figure should appear in Thornbird’s Consolidated Statement of Cash Flows under the heading “Cash Flows
from Investing Activities” in respect of the above acquisition?
(a)
€12 million outflow
(b)
€26 million outflow
(c)
€3 million inflow
(d)
€2.4 million inflow
3.
At the reporting date 31 December 2011, Jay plc carried a receivable from Kay Ltd, a major customer, at €10
million. The signing date of the financial statements was 16 February 2012. Kay Ltd declared bankruptcy on 14
February 2012.
What
(a)
(b)
(c)
(d)
4.
should Jay plc do in respect of its 2011 financial statements?
Disclose the fact that Kay Ltd has declared bankruptcy in the notes.
Make a provision for this event in its financial statements (as opposed to disclosure in footnotes).
Ignore the event and wait for the outcome of the bankruptcy because the event took place after the yearend.
Reverse the sale pertaining to this receivable in the comparatives for the prior period and treat this as an
“error” under IAS 8.
Lee plc is a construction contractor. At its reporting date of 31 March 2012 it had a contract in progress. The
contract price was €2.4 million, costs incurred were €0.5 million, and Lee plc’s engineers estimated the costs
remaining to complete the contract would be €1.6 million. The best estimate of stage of completion at the
reporting date was 22%. Lee plc’s accounting policy is to consider the outcome of construction contracts to be
reasonably foreseeable once they are 25% complete.
How much should be recognised as revenue, costs and profit in the Statement of Comprehensive Income of Lee
plc for year ended 31 March 2012?
(a)
(b)
(c)
(d)
Revenue
nil
€500,000
€528,000
€528,000
Costs
nil
€500,000
€500,000
€462,000
Page 5
Profit
nil
nil
€28,000
€66,000
5.
Ming plc has estimated its corporation tax liability for year ended 29 February 2012 at €79,000. The provision for
year ended 28 February 2011 was €91,000 of which only €87,000 was required to meet the actual tax liability for
that year. The journal entry required to incorporate the 2012 provision into the accounts is which of the following?
(a)
(b)
(c)
(d)
6.
loss
loss
loss
loss
(tax
(tax
(tax
(tax
expense)
expense)
expense)
expense)
Credit
Tax provision
Tax provision
Tax provision
Tax provision
€75,000
€79,000
€83,000
€79,000
€75,000
€79,000
€83,000
€4,000
Which of the following is not a condition that must be met in order to record revenue from the sale of goods under
IAS 18 Revenue?
(a)
(b)
(c)
(d)
7.
Debit
Profit or
Profit or
Profit or
Profit or
The amount of revenue can be measured reliably.
Stage of completion of the work can be measured reliably.
Costs incurred in respect of the transaction can be measured reliably.
The seller has transferred to the buyer effective control of the goods being supplied.
Smasher plc has an unfortunate history of causing serious environmental pollution. It addresses environmental
issues or pollution it has caused only when compelled to do so by law. At its reporting date 31 March 2012,
Smasher plc has caused environmental damage through its actions which would cost €2 million to rectify. €1.5
million of this is in Ireland, where strict anti-pollution laws require it to clean up. €0.5 million is in Hallyland, a
developing country which has no laws requiring the clean-up of pollution damage.
What provision should Smasher plc make in its accounts for year ended 31 March 2012 in order to comply with
IAS 37 Provisions, Contingent Liabilities and Contingent Assets?
(a)
(b)
(c)
(d)
8.
None, as no expenditure has yet been incurred.
None, but make disclosure of the expected cost as a result of damage caused.
€1.5 million, as this is the expected cost to Smasher plc of rectifying the damage caused by its actions to
date and it is probable that Smasher plc will have to pay this amount.
€2 million, as this is the amount of damage caused by Smasher plc to date.
Trent plc sometimes receives grants from the government in order to support certain investments. During financial
year ended 30 April 2012 it bought equipment for €100,000 and received a grant of €30,000 to assist with this
purchase. The following proposals are made to record this transaction:
(i)
Record the equipment at its gross cost of €100,000 and depreciate over its useful economic life whilst
simultaneously recording the grant as deferred income, releasing it to profit or loss over the life of the
equipment to which it relates.
(ii)
Record the equipment at its cost net of grant €70,000 and depreciate over its useful economic life.
How should Trent plc record this transaction under IAS 20 Accounting for Government Grants and Disclosure of
Government Assistance?
(a)
(i) only is correct.
(b)
(ii) only is correct.
(c)
The entity may choose either (i) or (ii).
(d)
Neither (i) nor (ii) is correct.
Page 6
Answer either Question 4 or Question 5
4.
The International Accounting Standards Board is currently in the process of updating its conceptual framework for
financial reporting. The updated project is being conducted in phases. To date, two chapters of the updated
framework have been issued: Chapter 1: The Objective of General Purpose Financial Reporting, and Chapter 3:
Qualitative Characteristics of Useful Financial Information. Chapter 4 of the conceptual framework contains the
remaining text of the approved 1989 conceptual framework. Within this chapter, it describes the elements of
financial statements and discusses definitions of each.
REQUIREMENT:
(a)
(i)
Explain the objective of “General Purpose Financial Reporting” as described in Chapter 1 of the revised
(5 Marks)
conceptual framework; and
(ii)
(b)
Discuss the usefulness of Chapter 1 in helping accountants determine appropriate accounting policies and
practices.
(5 marks)
Prepare a short memo for your Finance Director in which you briefly discuss the recognition and measurement of
one element of financial statements relating to financial performance and another element relating to financial
position.
(10 marks)
[Total: 20 MARKS]
OR
5.
Weathervane plc reported profits of €460,000 for year ended 31 March 2012. On 1 April 2011, its capital structure
consisted of 2.5 million equity shares of €1 each, and 600,000 8% preference shares of €1 each. The preference
dividend was paid during the year. An ordinary dividend of €60,000 was also paid during the year. Neither
dividend has been taken account of in the above profit figure. The reported basic earnings per share for year
ended 31 March 2011 was 8c.
During the year ended 31 March 2012, the following changes took place to the issued share capital of
Weathervane plc:
●
●
●
500,000 equity shares were issued in conjunction with the acquisition of another business. These were
issued at full market price at the date of issue, 1 July 2011.
To help fund expansion of the business, 1.8 million ordinary shares were issued for cash to existing
shareholders on 1 September 2011. The issue price was €1.40 per share, which represented a discount
of 64c on the traded price immediately before the issue, which was €2.04.
On 31 March 2012, a bonus issue was completed of one share for every two held at that date.
REQUIREMENT:
(a)
From the information above, calculate the basic Earnings Per Share (EPS) of Weathervane plc to be reported in
the financial statements for year ended 31 March 2012. Show also the recalculated comparative figure for the
preceding year.
(12 marks)
(b)
In another entity’s recent financial report you noticed that profit for the year increased from €300,000 to €500,000,
yet the basic EPS increased from 30c to just 36c. Identify and explain potential reasons for this.
(3 marks)
(c)
Briefly explain why EPS is considered an important measure of a company’s financial performance and briefly
explain some of the limitations of EPS.
(5 marks)
[Total: 20 MARKS]
END OF PAPER
Page 7
SUGGESTED SOLUTIONS
CORPORATE REPORTING
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
PROFESSIONAL 1 EXAMINATION – AUGUST 2012
SOLUTION 1
Marking scheme:
(a) Statement
Basic consolidation plan (100% I + 100% J + parent SC & SP)
FVA of PPE and investments (calculation and inclusion in SOFP)
Depreciation on FVA (calculation and inclusion in reserves)
Goodwill (calculation incl FVA)
Intra-group trading (elimination of URP)
Intra-group balances (elimination)
Trading with associate (elimination of URP)
Intragroup dividend (exclusion)
Calculation of NCI
Calculation of investment in associate
Calculation of group reserves
Presentation
Subtotal
(b)
4
1
1
3
1
1
1
1
2
2
5
2
24
Memorandum
Description of partial method in concept
Method of calculation
Description of full method in concept
Method of calculation
Presentation mark
Subtotal
1.5
1
1.5
1
1
6
Overall total
30
Page 8
(a)
Inca plc: Consolidated statement of financial position as at 31 July 2012
(100% Inca + 100% Java)
Non-current assets:
Property, plant & equipment (180 + 43 + 3.2(W6))
Investments
(83 + 27 – 58 – 25 +1(W6))
W5
Investment in associate
Goodwill
W2
286.5
Current assets:
Inventories
(46 + 23 – 0.6 (W7))
Receivables
(32 + 14 – 2.2 (W9))
Cash & bank
(8 + 2)
122.2
Total assets
Equity:
Equity capital
Share premium
Retained earnings
Non-controlling interest
Non-current liabilities:
Deferred consideration
Current liabilities:
Payables
Dividends proposed
€ million
226.2
28
25.8
6.5
68.4
43.8
10.0
408.7
100
75
138.4
W3
313.4
W4
323.0
9.6
(24.9(W2) + 2.5(W3))
27.4
(29 + 18 – 2.2 (W9)
(13 + 5 – 4.5 (W10)
58.3
44.8
13.5
Total equity & liabilities
408.7
W1 - Group structure:
Inca plc
–
Parent
Java plc
–
90% subsidiary at reporting date therefore include 100% of assets & liabilities.
Lava
–
40% associate, significant influence exerted, include under equity accounting method.
W2 – Goodwill
Cost of investment:
Immediate cash (note i)
Deferred cash (note i)(30 * 0.83)
€m
Value of non-controlling interest at acquisition (note iv)
Fair value of net assets at acquisition:
Equity share capital
Share premium
Retained earnings (note iii)
Fair value adjustments (W6)
Goodwill
Page 9
m
58
24.9
82.9
9.2
50
20
10.6
5
6.5
(85.6)
W3 – Group Retained earnings at 31 July 2012
Inca
€m
132
Balance per SOFP
Less: balance at acquisition
Interest on deferred consideration
Depreciation on fair value adjustment (W6)
URP Inventory (W7)
URP on trade with associate (W8)
Dividend receivable (W10)
Adjusted balances
Consolidate Java 4 * 90%
Consolidate Lava 3 * 40%
Total 138.4
Java
€m
16
(10.6)
Lava
€m
12
(9)
(2.5)
(0.8)
(0.6)
(0.4)
4.5
____
4
___
3
3.6
1.2
W4 – Non-controlling interest
Java
€m
9.2
0.4
9.6
Balance at acquisition
Add: share of post-acquisition results W3 (4* 10%)
W5 – Investment in associate
Lava
€m
25
(0.4)
1.2
25.8
Balance at acquisition
Less URP adjustment (W8)
Add: share of post-acquisition results W3 (3 * 40%)
W6 – Fair value adjustments
At acq
€m
4
1
5
Plant
Investments
Total
Movement
€m
(0.8)
(0.8)
At y/e
€m
3.2
1
4.2
W7 – Intra group trading (note (vi))
Unrealised profit is eliminated from inventory and reserves of selling company.
Amount: €6m *50/150 * 30% = €0.6m
W8 – Unrealised profit on trading with associate (note (vii)
Eliminate 40% of Lava’s gain on goods remaining in group inventory
Amount: €1m * 40% = €0.4m (reduce investment in associate and group reserves – would also accept reduction
to inventory instead of investment in associate)
W9 – intra-group balances at y/e (note viii)
Eliminate €2.2m from receivables and payables
W10 – intra-group dividend (note ix)
Dividend receivable by Inca from Java not recorded: €5m * 90% = €4.5m
Increase Inca’s reserves, reduce Java’s dividend payable.
Page 10
(b) – Memorandum:
To: Directors of Inca plc
From: Accountant
Re: Explanation of calculation of goodwill on acquisition of subsidiary
Date: 1st September 2012
Under IFRS 3 (revised) there are two permissible approaches to calculating goodwill. The only difference between
them is how the non-controlling interest (NCI) in the acquired entity is calculated at the date of acquisition.
The first, called the partial method, is based on the concept that goodwill is calculated only on the parent’s share of
the acquired entity. This is consistent with the logic that only purchased goodwill is recognised in the books. As only
the parent’s share is purchased, therefore that share is all we recognise. Following this approach, the NCI’s value
at the acquisition date consists only of its share of the identifiable net assets. It follows from this approach that any
revisions to the value of goodwill (arising due to impairment losses or exchange movements) are borne by the
parent only.
The second method, called the full method or fair value method, is based on the concept that goodwill is an asset
of the entire entity acquired. Therefore the NCI’s share of this needs to be calculated and recognised as an asset.
This is achieved by assigning to the NCI at acquisition date a fair value. This fair value is deemed to include not only
its share of identifiable net assets at the acquisition date, but also a portion of the entity’s goodwill. It follows that the
share of goodwill attributed to the NCI may not be proportional in value to the parent’s figure. If this method is
adopted, any subsequent changes to the value of goodwill are shares between the parent and the NCI. However
the ratio in which this is shared is their respective profit-sharing ratio, not proportional to their respective goodwill
values. This gives rise to inconsistencies at times.
The full method is widely adopted in the USA, and the IASB has adopted it as part of the convergence programme
with the US Financial Accounting Standards Board. It is likely that the partial method will be phased out eventually.
Page 11
SOLUTION 2
Marking scheme:
(a) Statement of changes in equity
Equity capital
Share premium
Revaluation reserve
Retained earnings
Presentation
Subtotal
(b)
(c)
1
1
1
2
1
6
Analysis
Ratio calculation (10 ratios for each company @ 1 mark each)
Analysis (up to)
Subtotal
8
10
18
Limitations
Any 6 relevant limitations X 1 mark each
6
Overall total
30
Note regarding the marking of analysis:
Analysis marks are awarded for quality and depth rather than simply number of points.
To get higher than 50%, the candidate needs to demonstrate understanding of the information given by a ratio, and
a capability to draw meaningful conclusions from it. In order to gain 70% plus, the candidate must show deep
understanding, and the ability to adjust ratios to allow for one-off items etc. The ability to make sensible
recommendations is especially welcomed.
SUGGESTED SOLUTION
(a)
Clawhammer plc: Statement of changes in equity for years ended 30 April 2011 and 2012
Balance 1 May 2010
Profit for year
Dividends paid (working)
Balance 30 Apr 2011
Profit for year
Revaluation loss
Share issue
Dividends paid (bal fig)
Balance 30 April 2012
Equity
capital
€ million
120
Share
premium
€ million
nil
Revaluation
Res
€ million
45
_____
120
_____
nil
_____
45
10
_____
130
10
_____
10
Retained
Earnings
€ million
44.8*
35
(14.8)
65
(21)
(45)
_____
nil
(8)
36
Total
€ million
209.8
35
(14.8)
230
(21)
(45)
20
(8)
176
Working:
€8 million was paid in dividends in y/e 30 April 2012 – calculated by balancing the retained earnings reserve.
This was 6.15c per share (130m shares in issue).
This was 50% less that previous year (per note (vii)).
Therefore dividend for year ended 30 April 2010 was12.31c per share.
As there were 120m shares in issue that year, the total dividend paid must have been €14.769m, or €14.8m.
Page 12
(b)
Analysis
Ratio calculation:
Gross margin
Net margin
ROCE
ROE PAT / Closing Equity
Current ratio
Acid test ratio
Interest cover
Gearing
Inventory days
Receivables days
Payables days
Gross profit / Revenue
PBIT / Revenue
PBIT / TALCL
-21/176 = -11.9%
CA / CL
(CA – stock) / CL
PBIT / Interest
Interest bearing debt / Equity
Closing inventory / COS * 365
Closing receivables / revenue * 365
Closing payables / COS * 365
30 Apr 2012
40/310 = 12.9%
-19/310 = -6%
-19/228 = -8.3%
35/230 = 15.2%
62/34 = 1.8:1
40/34 = 1.2:1
n/m
40/176 = 22.7%
22/270*365 = 30 days
22/310*365 = 26 days
34/270*365 = 46 days
Restate 2012 SOCI excluding one-off items:
Revenue
Cost of sales (270 – 15 – 3)
Gross profit
Distribution costs
Admin expenses (49 -16)
Finance costs
Profit before tax
30 Apr 2011
100/360 = 27.8%
55/360 = 15.3%
55/287 = 19.2%
48/46 = 1.04:1
29/46 = 0.63:1
55/5 = 11 tms
50/230=21.7%
19/260*365 = 27 days
28/360*365 = 28 days
33/260*365 = 46 days
€m
310
(252)
58
(10)
(33)
(6)
9
Revised 2012 ratios based on underlying performance:
Gross margin
58/310 = 18.7%
Net margin
15/310 = 4.8%
ROCE
15/228 = 6.6%
Interest cover
15/6 = 2.5 times
Inventory days
22/252*365 = 32 days
Payables days
34/252*365 = 49 days
Several of the following points should be made in a high quality answer. Many other points could also be made, and
would score equal marks.
Profitability
●
The performance of the entity has definitely deteriorated from 2010 to 2011. The gross margin, net margin and
both ROCE and ROE have declined markedly.
●
However, when the effect of the one-off items is excluded, the decline is a lot less severe than at first glance.
●
Examples of ratios should be given to illustrate this.
●
It is particularly concerning to see underlying gross margins dropping as well as sales volume. This trend has
the potential to destroy the business if not arrested immediately.
Liquidity
●
The business does not appear to have a serious liquidity issue. Although the liquidity ratios could be better,
they have improved over the course of the period reviewed.
●
The business was able to raise new equity even in tough times. This shows the business has shareholders
who believe in it and are willing to support it.
●
The interest cover has declined precipitously, though excluding the one-off items is still a reasonable 2.5
times. The low gearing gives some comfort as the business can survive tough times easier than if gearing were
higher.
●
The bank loan is a big uncertainty. The fact that none appears in current liabilities suggests that it is not due
immediately. However if this were repayable soon it could cause liquidity issues.
Operations
Inventory, receivables and payables days are well within normal ranges, although it is difficult to be definitive
on this without knowing industry averages.
●
One major concern is the rate of depreciation of property plant and equipment. If the revaluation loss of €60
million is excluded, the depreciation for year ended 30 April 2012 was only €9 million or 5%. It might be worth
checking if this is adequate, especially in the light of the downward trend in asset values.
●
Page 13
(c) Limitations of the above analysis
There are several limitations to ratio analysis in general, but some that are particularly relevant to this analysis are
as follows:
●
ROE was not calculated after excluding one-off items as it is not possible to measure the tax which would have
been charged had these items not been incurred.
●
Industry average figures would be very useful in order to evaluate performance better.
●
It would be useful to know the repayment schedule for the bank loan.
●
There is no indication as to what the long term provisions are for.
General points:
●
Figures are historic, therefore out of date. More up-to-date information should be sought to improve the quality
of analysis.
●
Many estimates go into preparing a set of accounts. These may or may not be reasonable.
●
The effect of inflation is ignored in IFRS financial statements.
Page 14
SOLUTION 3
Marking scheme: 2.5 marks per correct answer – Total 20 marks
Suggested solution (plus tutorial notes)
1.
Answer (b)
Batch (1) should be included at its net realisable value €34,500, for a reduction of €25,500
Batch (2) should be included at cost €70,000 as the event causing the damage had not existed at the reporting
date.
2.
Answer (c)
The cash paid out was €12 million. Cash received as part of the acquisition was €15 million. As the group
controls the subsidiary, 100% of its net assets are consolidated. Hence the effect of the group financial
statements of this transaction is a net increase in cash of €3 million.
3.
Answer (b)
IAS 10 specifically provides that the bankruptcy of a debtor in the period after the reporting date should be
treated as an adjusting event.
4.
Answer (b)
The contract is too early for the outcome to be reasonable foreseeable, hence no profit is recognised. Revenue
is recognised to the maximum extent of costs incurred provided they are expected to be recovered.
5.
Answer (a)
The over provision of €4,000 from the previous year means that the amount required to be provided for the
current year is lower by that amount.
6.
Answer (d)
This condition relates to the supply of goods, and is not relevant to the rendering of services.
7.
Answer (c)
IAS 37 requires that a provision be made (1) when an obligating event has occurred which causes a present
obligation, (2) it is probable that a cash outflow will be required to settle this obligation, and (3) a reliable
estimate can be made of the amount require to settle. This is the case in respect of the €1.5 million. However
in the case of the €0.5 million there is no probability that an outflow of economic benefits will be required to
settle. Hence no provision will be made for this.
8.
Answer (c)
IAS 20 allows a choice between the two treatments outlined.
Page 15
SOLUTION 4
MARKING SCHEME:
(a) Explanation:
Objective of general purpose financial reporting
How useful in helping accountants determine appropriate policies and procedures
Subtotal
(b)
5
5
10
Elements:
Definitions (2 X 2.5 marks)
Explanations (2 X 2.5 marks)
Subtotal
5
5
10
Total
20
SUGGESTED SOLUTION
(a)
(i)
The conceptual framework says that “The objective of general purpose financial reporting is to provide financial
information about the reporting entity that is useful to existing and potential investors, lenders and other
creditors in making decisions about providing resources to the entity. These decision involve buying, selling
or holding equity and debt instruments, and providing or settling loans and other forms of credit”.
As these individuals are taking risks with their capital, it is important that they have the best possible
information with which to inform their decisions. Absence of reliable information leads to sub-optimal decisions
being made. This means capital has been misallocated, and an opportunity to create wealth lost as a result.
The type of information financial statements are designed to provide includes information about:
Financial position of a reporting entity, including information about an entity’s resources and claims against
those resources;
The effects of transactions or other events that change an entity’s resources and claims.
Most market participants cannot access sufficient information from their own resources. Therefore to them the
company’s financial statements are the most important source of reliable information. Other users exist also,
but some have alternative sources of information available to them, and others have no entitlement to
information, so why should the reporting entity incur costs to meet their needs?
The IASB in considering who are the most important users, focused on the above because it believes that
information satisfying their needs is likely to also satisfy the needs of most other user groups.
(ii)
This chapter is hugely important as it provides a higher purpose to guide accountants when making decisions
about accounting for transactions and events. For example an accountant may be under pressure to make an
estimate in such a way as to increase reported profit, because management bonuses depend on a certain
target being hit. However, this chapter requires the accountant to think of the usefulness of the resulting
information to users in priority to other such concerns. It can provide moral support to the accountant trying
to do the right thing against an attitude like “Tell me where it says I can’t do that”.
Whilst IFRSs provide application guidance in several areas, it is common in practice to come across
transactions not covered by any IFRS, or one that can be interpreted in different ways. In situations like this,
considering the purpose of financial statements can guide us towards the best solution.
Page 16
(b)
In answering the question, the candidate will indicate which element selected for discussion relates to financial
performance and which elemnets relates to financial positions. There are five elements of financial statements
identified by the conceptual framework. These are as follows:
Asset: A resource controlled by the entity as a result of past events and from which future economic benefits
are expected to flow.
This definition has three main parts to it. First, the concept of control is key. The definition never mentions
ownership, because it is not necessary for an entity to own an asset in order to recognise it on the entity’s
books. It is however necessary that the entity control it, in order to generate future economic benefits. An
example of this in an asset leased under a finance lease. Legally it is not owned by the lessee, but IAS 17
requires that we record it as if it were. Second, the asset must result from a past event. It cannot be dependent
on a future event for its existence. Third, the asset must be expected to generate economic value. This can
be from use or sale.
Liability: A present obligation of the entity as a result of past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits.
Again, this definition has three main parts. First, there must be a present obligation, an obligation being an
unavoidable performance duty, usually to pay somebody money! Second, this obligation arises because
something happened in the past to cause it. Thirdly, it is expected that a transfer of economic benefit (again,
usually cash) will be required to settle it.
Equity: What is left when all liabilities are deducted from an entity’s assets. Also called owners’ interest.
[Any ONE of the above, plus any ONE of the following are sufficient for full marks]
Gain (Income): This is a transaction that results in an increase in an entity’s equity, but which does not result
from owners’ contributions. Sale of goods at a profit is an excellent example.
Loss (expense): This is the direct opposite – a transaction that results in a decrease in an entity’s equity, but
which is not the result of a distribution to owners.
The definitions of gains and losses are dependent on the definition of equity, which is itself dependent on the
definitions of assets and liabilities. Therefore it is clear that all elements of financial statements derive from
the definitions of assets and liabilities.
Page 17
SOLUTION 5
Marking scheme:
(a) Calculations
Calculate correct earnings - deduct pref divs, not equity divs
Treatment of issue at full market value
Treatment of rights issue – no. of shares added
Treatment of right issue – retrospective effect (incl TERP)
Treatment of bonus issue – retrospective effect
Recalculation of comparative
Subtotal
(b)
(c)
2
2
1
3
2
2
12
Explanation:
Recognition of differential in percentage increases in profit and EPS
Suggestion of 2 possible reasons
Subtotal
1
2
3
Importance and limitations of EPS:
Importance (up to 3 points at 1 mark each)
Limitations (up to 3 points at 1 mark each)
Maximum
3
3
5
Total
20
Suggested solution
(a) EPS consists of two figures, (1) Earnings relevant to equity shareholders, and (2) weighted average number
of equity shares in issue for the period.
Earnings for the year here are €460,000. We must subtract the preference dividend from this figure, as this
portion of profits must be paid to them, therefore it is not relevant to the equity holder. Equity dividends are
NOT subtracted as these form part of the equity shareholders’ return.
Hence the correct earnings figure for EPS purposes is €460,000 – (600,000 * 8%) = 412,000
The weighted average number of equity shares in issue must take into account the changes that happened
during the year. These were the issue at full market price, rights issue at a discount and bonus issue.
Every time there is a bonus issue (shares issued for free), the earning power of issued shares declines, as
more shares exist to share in the same resources of the business.
If shares are issued at a discount, this is equivalent to a partial bonus issue, as the average earning power
of each share declines here also, although not by the same degree.
Hence we must adjust for this effect in our calculations. As the effect of a bonus issue is permanent, in order
to have valid comparisons we must adjust comparative figures to the new reality. We use bonus fractions for
these adjustments. A bonus fraction quantifies the amount by which the value per share has been reduced
by increasing the number of shares to share in a given business.
For a pure bonus issue, the bonus fraction = (No. of shares after bonus issue / No. of shares before bonus
issue). Here, as the bonus issue is one new share for every two held, the bonus fraction is 3/2
For a rights issue, we must compute the bonus fraction based on relative valuations, before and after the
rights issue. The value before the issue will be a market fact. Here it is €2.04. The value after will be an
average of the existing price and the price of the new shares issued. Here, there were 3 million shares in
issue on the date of the rights issue. 1.8 million further shares were issued at the discounted price. Hence the
average value per share after the rights issue is (3 million * €2.04) + (1.8 million * 1.40) / 4.8 million (new total
no of shares). This is called the theoretical ex-rights price and works out at €1.80. Therefore the bonus fraction
is 2.04/1.80
The bonus fractions are applied to periods prior to the relevant share issue only.
Page 18
Date
Apr 1 – Jun 30
Jul 1 – Aug 31
Sep 1- Mar 31
Shares in existence
2,500,000
3,000,000
4,800,000
Bonus adjustors
2.04 / 1.80 * 3/2
2.04 / 1.80 * 3/2
3/2
Total weighted average
Weighting
3/12
3/12
6/12
No. of shares
1,062,500
1,275,000
3,600,000
5,937,500
EPS for year ended 31 March 2012 = €412,000 / 5,937,500
Restate comparative EPS: 8c * 1.8/2.04 * 2/3
6.9c
4.7c
(b)
This illustrates the power of EPS as an indicator of performance. Profit has gone up by 66.7% yet the EPS
went up by just 20%. This could only have happened due to an increase in the number of shares. This could
be due to either a bonus issue or an issue for cash. It could also arise due to the conversion of another
instrument into equity shares, or the exercise of share options.
(c)
Most stockmarket investors pay close attention to the EPS figure as it measures the earnings of the company
in terms of each unit of ownership. This is most relevant to an investor as it controls for issue or redemption
of shares by the entity. In addition, it is an intuitive measure, being easy to understand. It is widely quoted in
the press. It forms the denominator for the P/E ratio, an important measure of an entity’s value. Its calculation
is standardised by IAS 33, validating comparisons across different entities.
It does have several limitations. It includes one-off items such as exceptional write-offs etc. This can impair
its usefulness as a predictor of future results. Also it does not include other comprehensive income, for example
revaluation gains. OCI is arguably important as it adds value to an equity investment. However it is excluded
on the grounds that it is not yet realised. However even when it is realised (for example on subsequent disposal
of the asset) the gains do not find their way into the EPS figure. Many investors get round these limitations by
calculating their own version of EPS in addition to IAS 33 EPS. It is therefore important that financial reports
give users sufficient information to enable them do this if they wish.
Page 19