MARKING SCHEME

FINANCIAL ACCOUNTING
MAN2907L
SUPPLEMENTARY PAPER AUGUST 2011

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FINANCIAL ACCOUNTING

MULTIPLE CHOICE QUESTION ANSWER SHEET

STUDENT REGISTRATION NO. .

PLEASE PLACE A CROSS AGAINST THE LETTER CORRESPONDING TO YOUR
ANSWER FOR EACH QUESTION ONE ANSWER ONLY FOR EACH QUESTION
THIS ANSWER SHEET MUST BE ATTACHED TO AND RETURNED WITH THE
QUESTION PAPER
EACH QUESTION CARRIES TWO MARKS: THERE IS NO NEGATIVE MARKING

Question

(A)

(B)

(C)

*
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5
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7
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8
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9
10

11

12
13

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(D)

*
*

14

15

Section B

ANSWER TO SEEN CASE QUESTION:

Christie & Chandler

1.

As can be seen from the amended company balance sheet, a cash investment of 5m does
not affect the net asset position of the company. However the strength of the balance sheet
has been reduced due to a reduction in liquidity and a net current liability position of 1.82m.
The directors should consider whether financing the acquisition by way of an overdraft is
appropriate, given the associated higher interest charges - and the long-term nature of the
investment.
A share issue causes the companys net asset position to increase by 5m. The
disadvantage of such a move, however, would be to dilute earnings per share - a result the
directors may wish to avoid. A preference share issue would avoid this problem.
As a 50% holding, it is likely that the joint venture would be accounted for as an associated
undertaking. However, further information - such as the composition of the board - would be
required to ascertain whether Christie had a dominant influence over the associate. If so,
under the Companies Act 1989, full consolidation as a subsidiary would be required. This
seems unlikely, perhaps, given the directors stated policy on this issue.
(10 marks)

2.

This option is more creative than the others! If Chandler issues 2.9m shares, then Christies
current holding of 2.7m shares would drop to 45.7% rather than the current 90%. Chandler
would thus become no longer a subsidiary undertaking and would only require to be dealt
with as an associated undertaking. The same question would arise as in 1.above as to any
dominant influence which Christie might exercise over Chandler. If no consolidation were
needed then the joint venture, although satisfying the requirements as an associated
undertaking of Chandler, would not need to be accounted for on an equity accounting basis,
since no group exists any longer.
In such a case, it may be that Christie would not have any influence over the policies of the
joint venture. This would be up to the directors of Chandler. The level of risk attaching to this
option by way of the reduced control/influence which could be exercised by Christie would
depend on the composition of the Chandler board and their relationship with Christie.
The effect of the share issue increases Chandlers net assets by 5m and has the same
benefits and drawbacks as for Christie in 1. above.
(5 marks)

3.

A cash payment by Chandler does not affect its net asset position. Depending on the degree
of control or influence, it is likely that the joint venture would be treated as an associated
undertaking. Without the share issue in 2. above, Chandler continues to be a subsidiary
undertaking of Christie.
However, this approach creates a substantial level of net current liability in Chandler,
adversely affecting the companys future borrowing capacity. Long-term loan finance might
offer a more attractive alternative to the overdraft route.
(15 marks)
(Total 40 marks)

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CHRISTIE AND CHANDLER

Computations

Company balance sheet as at December 31, 20X2

Share
In cash

issue

,000

,000

Non-current assets
Property, plant and equipment

7,000

7,000

Investment in Chandler

6,000

6,000

Investment in joint venture

5,000

5,000

18,000

18,000

Dividends receivable

180

180

Inter-company balance - Chandler

140

140

3,000

3,000

Current assets

Other
Cash

Total assets

860
3,320

4,180

21,320

22,180

12,000

15,500

Equity
Share capital
Share premium

1,500

Capital reserves

2,000

2,000

Retained earnings

2,180

2,180

16,180

21,180

Total equity
Current liabilities
Overdraft

4,140

Other

1,000

1,000

5,140

1,000

21,320

22,180

Total equity and liabilities

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Christie Group plc balance sheet at December 31, 20X2

Share
In cash

issue

,000

,000

Non-current assets
Property, plant and equipment

13,500

13,500

1,950

1,950

5,000

5,000

20,450

20,450

Other

4,000

4,000

Cash

500

1,360

4,500

5,360

24,950

25,810

12,000

15,500

Goodwill

Note 1

Investment in joint venture

Current assets

Total assets
Equity
Share capital
Share premium

1,500

Capital reserves
Retained earnings
Shareholders' funds
Minority interests
Total equity

Note 2

2,000

2,000

2,450

2,450

16,450

21,450

480

480

16,930

21,930

20

20

Current liabilities
Dividend payable
Overdraft

4,140

Other

3,860

3,860

8,020

3,880

24,950

25,810

Total equity and liabilities

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Chandler company balance sheet after issue of 2.9m shares

Chandler Limited balance sheet at December 31, 20X2
,000
Non-current assets
Property, plant and equipment

6,500

Investment in joint venture

5,000
11,500

Current assets
Total assets

1,500
13,000

Equity
Share capital

5,900

Share premium

2,100

Retained earnings

1,800

Shareholders' funds

9,800

Current liabilities

3,200

Total equity and liabilities

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13,000

Chandler

Christie

,000

,000

Non-current assets
Property, plant and equipment

6,500

Goodwill
Investment in joint venture

13,500
1,950

5,000

5,000

11,500

20,450

1,000

4,000

Current assets
Other
Cash
Total assets

860
1,000

4,860

12,500

25,310

3,000

12,000

Equity
Share capital
Capital reserves

2,000

Retained earnings

1,800

2,450

Shareholders' funds

4,800

16,450

Minority interests
Total equity

480
4,800

16,930

Dividend payable

200

20

Inter-company balance

140

Current liabilities

Overdraft

4,500

4,500

Other

2,860

3,860

7,700

8,380

12,500

25,310

Total equity and liabilities

Note 1 - Goodwill on acquisition of Chandler

,000
Consideration

6,000

Share capital

3,000

Reserves at December 31, 20X1

1,000

Apportioned profits to July 1, 20X2

,000

500

- (800 ret'd+200 divi)/2

Pre-acquisition reserves

1,500

Net assets at acquisition

4,500

90% acquired
Goodwill - balance sheet
Note 2 - Consolidated retained earnings at December 31, 20X2
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4,050
1,950

,000
Christie's reserves

2,180

Share of Chandlers post-acquisition reserves

90% of half year profits - 300k - (500 apportioned-200 dividend)

270
2,450

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Section C
Question 1
(a) IAS 10 requires that financial statements should be prepared on the basis of conditions existing
at the reporting date, and therefore lays down the following treatment for events after the
reporting date.
A material event after the reporting date requires changes in the amounts to be included in the
financial statements where
- It is an adjusting event (i.e. an event which provides additional evidence of conditions
existing at the reporting date); or
(1 mark)
- It indicates that application of the going concern concept to the whole or a material part of
the company is not appropriate.
(2 mark)
A material event after the reporting date should be disclosed where
It is a non-adjusting event
-

an event which concerns conditions which did not exist at reporting date
(2 mark)
of such materiality that its non- disclosure would affect the ability of the users of financial
statements to reach a proper understanding of the financial positions
(2 mark)

or
It is the reversal or maturity after the year end
-

of a transaction entered into before the yearend

(1 mark)
the substance of which was primary to alter the appearance of the companys statement of
financial position.
(2 mark)
(subtotal 10 marks)

(b) 12 marks (marks each for underlined + 1 mark for overall style)
(i)

The closure of the company's factory is a discontinuance of a business segment, as it was

clearly a material and separately identifiable component of the companys business
operations. Under IFRS 5, disclose under discontinued heading.
(4 marks)

(ii)

This is an unusual item, because it is material ($300,000) and requires separate disclosure
for users to properly understand the accounts. It should be charged in arriving at the profit
for the year, and should be disclosed separately.
(4 marks)

(iii)

The rights issue relates entirely to the period after the year end, therefore it is a nonadjusting event under IAS 10. It should be disclosed by way of notes.
(4 marks)
(subtotal 12 marks)

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(c)
(i)
IAS 24 para. 9 state that a related party is a party that can exercise significant influence over
another party.
Significant influence would normally be assumed if a party owns at least 20% of voting rights.
Alan is therefore presumed to be a related party
However, Alan would not appear to be able to influence the financial and operating policies
because of the disagreement.
Further, enquiry would be required to establish that this has actually been the effect of the
disagreement.
(6 marks: 1 mark for each point +1)
(ii)
Key management is defined as a person in a senior position having authority or responsibility
for directing or controlling the major activities and resources of the reporting entity.
Barbara appears to fall within the definition of key management personnel.
Barbara is therefore presumed to be a related party.
Barbaras abilities to take 35% of the turnover with her would be prima facie evidence of such
authority.
(2 marks)
(6 marks: 1 mark for each point, 2 marks for last point +1)
(iii)
Both would be presumed to be related parties to Alpha Limited
Connie is an employee and there would be no requirement to disclose emoluments.
Christopher is not an employee and amounts paid to Christopher by Alpha Limited would be
disclosed.
The disclosure required by para. 17 of IAS 24 includes:
- Description of relationship
- Description of the transaction
- The amounts involved
- Any additional information required to understand the transaction
- Amounts due at statement of financial position date.
(2 marks)
(6 marks: 1 mark for each point, 2 marks for last point +1)

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Question 2
(a) EPS
(i)
Bravo earnings =
Profit less preference dividends = 280,000 90,000 = 190,000
(1 mark)
No of share = (1,000,000 / 0.50) = 2,000,000 shares
(0.5 mark)
Bravo EPS = 190,000 / 2,000,000 = 9.5p
(0.5 mark)
(ii)

Charlie earnings = 240,000

(0.5 mark)

No of share (weighted average) = (1,000,000+500,000/2) / 0.50) = 2,500,000

(2 mark)
Charlie EPS = 240,000 / 2,500,000 = 9.6p
(0.5 mark)
(subtotal 5 marks)
(b) PE ratio
Bravo

= 475 / 9.5

= 50 times

= 480 / 9.6

= 50 times

(1.5 marks)
Charlie

(1.5 marks)
(subtotal 3 marks)
(c)
-

PE ratio of Bravo & Charlie are the same although once the additional shares in Charlie
have been held for a full year this may mean Charlies P/E will decrease. At present the
market is not really distinguishing between the two in its expectations for the future and
there is equal demand for shares in both companies. Charlie has a higher EPS than Bravo
and if there is expectation that this differential will be maintained or even increased then the
P/E for Charlie may outstrip Bravo despite the higher number of shares. The share price in
Charlie would have been expected to reduce on issuing the bonus shares if no other
circumstances changed. So based on P/E and EPS Charlie possibly has a slight edge over
Bravo
- (4 marks)

Any three of the following reasons that the market will be taking on board in assessing its
expectations for the future
(i)
Type of industry
(ii)
Growth potential
(iii)
Track record of past performance
(iv)
Diversity of its products
(v)
Quality of management
(vi)
Customer attachment and so on
(6 marks : 2 marks each)

(d) Other matters Steven should take account of before he makes his choice
(i)

What Charlie Limiteds EPS would have been if there had been no bonus issue
= 240,000/ 2,000,000 = 12.0p
Charlie Limited appears better than Bravo Limited
(1 mark)

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(ii)

Return on capital employed (ROCE) = (PBIT/ capital employed) x 100%

Bravo Limited = (588,000/ 2,710,000) x 100% = 21.7%
(1.5 marks)
Charlie Limited = (445,000/2,450,000) x 100% = 18.2%
(1.5 marks)

(iii)

Return on equity capital (ROEC)

= (PBT less Preference dividend/ equity capital + reserves) x 100%
Bravo Limited = (354,000/ 1,310,000) x 100% = 27%
(2 marks)
Charlie Limited= (385,000/1,950,000) x 100% = 19.7%
(2 marks)

(iv)

Bravo Limited provides a better return on equity

Bravo Limiteds EPS is not quite so favourable
Bravo Limited is more geared
Bravo Limited had borrowed at a significantly higher cost than Charlie Limited
(4 marks: 1 mark for each factor)
(subtotal 12 marks)

(e) Advantage and disadvantage of gearing

Advantage
- Equity shareholders benefit if the return on investment exceeds the costs of borrowing
- There is no dilution of the existing shareholders interest if funds are raised by borrowing
rather than by an issue to new shareholders.
- Loan interest is allowable for tax relief.
- Lenders normally obtain some form of security in the form of either a charge on assets or
prior rights on liquidation. This means that their risk is lower and therefore, their required
rate of interest is lower.
(5 marks: 2 marks for each factor + 1 mark for style)
Disadvantage
- Impact on the companys funding if loan covenants are breached, e.g. may be required to
renegotiate the loan at a higher rate of interest or even by issuing additional ordinary
shares to the lenders in recognition of their increased risk.
- Impact on companys funding if equity shareholders perceived that there is a greater risk to
equity funds if there is high gearing and as a result require a higher return on their
investment.
- Adverse impact on amount available for distribution to shareholders if profits fall.
(5 marks: 2 marks for each factor + 1 mark for style)
(subtotal 10 marks)
(Total 40 marks)
Question 3
(a)

Statement of cash flows for the year ended 31 March 20X2

000
Operating Activities
Profit before tax
Depreciation
Loss on disposal

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545
113
21

000
2 marks
1 mark
2 marks

679
(4)
(4)
6
677
(217)

Inventories increase
Receivables increase
Payables increase
Cash generated from operations
Taxation paid (927 + 343 1,053)
Net cash from operating activities

2 marks
2 marks
2 marks
3 marks
460

Investing Activities
Purchase of non-current assets
Proceeds on disposal (800 - 350 - 21)
Net cash used in investing activities
Financing Activities
Equity dividends paid (110 + 200 - 140)
Net cash used in financing activities
Increase in cash and cash equivalents in the year
Cash and cash equivalents B/F
Cash and cash equivalents C/F

(700)
429

1 mark
3 marks
(271)

(170)

3 marks
(170)
19 1 mark
53 1 mark
72
1 mark

Note: IAS 7 allows interest paid and dividend paid to be an operating cash flow or a
financing cash flow. Interest received can be an operating cash flow or an investing cash
flow. Either of these options from students is acceptable.
(subtotal 24 marks)
(b)

Ways in which a company could manipulate the year-end cash position (elaboration is
needed for good marks)
Offering short term incentives to customers to increase sales
Reducing the selling price to increase sales
Cutting expenses
Disposing of assets
Delaying payments to creditors
Encouraging debtors to pay early by offering discounts
Resourcing effective debt collection procedures
(3 marks each point + 1 for overall style max 16)
(Total 40 marks)

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