The Examiners Answers F1 Financial Operations

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
1.1 D

1.2

1.3

1.4

Tax evasion is the illegal manipulation of the tax system to avoid paying tax.

1.5

1.6

1.7

2,400,000 / 6 = 400,000 new shares 400,000 x $1 = $400,000 Less issue costs $45,000 Total share premium = $355,000

1.8

Fair value adjustment = 350 -325 = 25 Cost Value Acquired: Equity shares Share premium Retained earnings Fair value adjustment Goodwill $000 342 200 40 62 25 327 15

Financial Operations

September 2011

1.9 Original investment Share of profit for year Less share of dividend paid Value of investment in SX $000 70 45.5 (28) 87.5

1.10

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SECTION B

Answers to Question Two Answer to (a)

(i) Single stage sales tax is payable on sales at a specific part of the trade cycle, e.g. retail sales. There is no credit given to an entity for sales tax paid on purchases.

VAT is a multi-stage tax, taxing sales at every stage of the transaction cycle. However most VAT paid by an entity is reimbursed by the tax authorities, usually by deducting from VAT collected. (ii) Output tax product Z = $207,000 x 15 / 115 = Input tax on purchases = $200,000 x 15% = Tax reimbursable by tax authorities $27,000 $30,000 $3,000

Answer to (b)
(i) A temporary difference arises when an expense is allowed for both accounting and tax purposes, but there is a difference in the timing of the allowance. A temporary difference is the difference between the carrying amount of an asset in the statement of financial position and its tax base. The temporary difference times the tax rate is the amount of deferred tax required to be recognised by IAS12 Income Taxes. (ii) A deferred tax debit balance can arise from the following: deductible temporary difference, unused tax losses,

unused tax credits. A deductible temporary difference is a temporary difference that will result in a deduction from future taxable profits when sold or realised. Some tax authorities may permit the tax effect of losses to be carried forward and offset against future taxable profits. IAS 12 requires that these unused tax losses be recognised as assets, where it is probable that the entity will make future profits against which these losses can be offset. Deferred tax debit balances should be recognised in the financial statements provided that it is probable that future taxable profits will be available for the asset to be utilised, that is future tax payable can be reduced.

Answer to (c)
(i) The worldwide approach is where a country claims the right to tax income earned outside its border if that income is received by an entity deemed resident for tax purposes within the country. The problem with the worldwide approach is that it leads to double taxation as income will usually be taxed in the country where it is earned and again in the country where the holding entity is resident.

(ii)

Double tax relief exists to reduce the total amount of tax payable on tax income earned in other countries. The effect of double tax relief is to reduce the total tax payable to the higher of the two, the home country or overseas tax rate. Most countries applying the worldwide approach grant some form of relief from double taxation. Double tax relief is given according to double tax agreements that a country has entered into.

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September 2011

Answer to (d)
The main factors that may influence accounting regulations in a country are: The legal system and tax legislation Taxable profits are based on accounting profit but the number and type of adjustments required to compute taxable profits varies from country to country. Part of this variation is due to the differences in the tax regulations but part of them is due to the different approaches to the calculation of accounting profit. In some countries taxable income is closely linked to the accounting profit and accounting rules are largely driven by taxation laws. These countries are usually known as code law countries; countries where the legal system originated in Roman law. Accounting regulation in these countries is usually in the hands of the government and financial reporting is a matter of complying with a set of legal rules. In other countries the common law system is used. Common law is based on case law and tends to have less detailed regulations. In countries with common law systems the accounting regulation within the legal system is usually kept to a minimum; with detailed accounting regulations produced by professional organisations or other private sector accounting standard setting bodies. Sources of finance and capital markets There is more demand for financial information and disclosure where a higher proportion of capital is raised from external shareholders rather than from banks or family members. Banks and family members are usually in a position to be able to demand information directly from the entity, whereas stock market and shareholders have to rely on published financial information. The political system The nature of regulation and control exerted on accounting will reflect political philosophies and objectives of the ruling party. Entity ownership The need for public accountability and disclosure will be greater where there is a broad ownership of shares as opposed to family or government ownership. Cultural differences The culture within a country can influence societal and national values which can influence accounting regulations.

Answer to (e)
(i)

Asset - An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Liability - A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources from the entity.
(ii) To be recognised the item must meet the definition of an element and the two criteria set by the Framework. The criteria are: 1. it is probable that any future economic benefit associated with the item will flow to or from the entity; and 2. the item has a cost or value that can be measured with reliability.

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September 2011

Answer to (f)
According to CIMAs Code of ethics for professional accountants WZ is in a position where he may be compromising his integrity and objectivity. Integrity This principle imposes an obligation to be truthful and honest on the accountant. A professional accountant should not be associated with reports and other information where she/he believes that the information contains misleading statements. This seems to be the case with the revised treatment of the property, WZ believes that the revised financial statements will not follow IFRS 5 and may not show a true and fair view of the situation. Objectivity A professional accountant should not allow conflict of interest or undue influence of others to override professional or business judgements or to compromise her/his professional judgements. The management board is overriding WZs professional and business judgement as it is imposing its business judgement over the professional accountants (WZ) professional judgement. If WZ were to accept the change outsiders may interpret this as a lack of professional judgement by WZ as IFRS5 will not be applied correctly. The possible options for WZ in this situation would be: (i) To try and persuade the management board that IFRS 5 must be followed and the property treated correctly in the financial statements. (ii) To refuse to remain associated with the financial statements if IFRS 5 is not followed and to disassociate himself from them as much as possible. (iii) To consider reporting the situation to the external auditors or other appropriate authorities possibly after taking legal advice. (iv) To consider resignation from his post as a professional accountant.

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September 2011

SECTION C

Answer to Question Three ZY - Statement of comprehensive income for the year ended 30 June 2011
$000 Revenue (2,084 30) Cost of sales Gross Profit Administrative expenses Distribution costs Profit from operations Finance cost Profit before tax Income tax expense Profit for the period from continuing operations W3 W3 386 221 $000 2,054 1,136 918 607 311 29 282 64 218

W8 W5

ZY Statement of Financial Position at 30 June 2011

$000 Non-current assets Property, plant and equipment Current assets Inventory Trade receivables Cash and cash equivalents Total assets Equity and liabilities Equity Share capital Other components of equity Retained earnings Total equity Non-current liabilities Long term borrowings 4% Cumulative, Redeemable Preferred shares Finance lease Deferred tax Total non-current liabilities Current liabilities Trade payables Tax payable Finance lease Interest payable Total current liabilities Total equity and liabilities $000

W1

1,385

W9 W6

385 202 229

816 2,201

500 490 416 1,406

320 150 78 38 586

W7

W7 W8

120 56 22 11 209 2,201

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September 2011

ZY Statement of changes in equity for the year ended 30 June 2011 Share Revaluation Equity shares premium reserve $000 $000 $000 Balance at 1 July 2010 500 270 220 New share issue Profit for period Dividend paid Balance at 30 June 2011 500 270 220 Workings (All figures in $000) (W1) Depreciation Property Balance b/fwd Year depreciation @ 1% Balance c/fwd Plant and equipment Balance b/fwd Less disposal Finance lease Depreciation charge for year @ 20% 889

Retained earnings $000 288 218 (90) 416

Total $000 1,278 218 (90) 1,406

Cost 844 . 844

Depreciation 8 8 16

NBV

828

864 (95) 769 120 889

249 (95) 154

178 332

557 1,385

(W2)

Gain on disposal Cost less depreciation Cash received Gain on disposal

0 10 10

(W3) Cost of sales Trial balance Inventory b/f Purchases Closing inventory (W9) Gain on disposal NCA Bad debt Depreciation (178+8) 358 987 (385) (10) 48 186 1136 386 Administration 338

(W5)

Tax Balance b/f Year Decrease in deferred tax (45 - 38)

15 56 7 64

(W6) Trade Receivables Trial balance Less bad debt Less goods on sale or return

280 48 232 30 202

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September 2011

(W7) Finance Lease Cost Interest @ 7.93%= 9.5 ~ Rental payment Interest @ 7.93%= 7.9 ~ Rental payment Current liability Non-Current liability (W8) Interest

120 10 130 (30) 100 8 108 (30) 78 22 78

Interest on long term borrowings Finance charge on lease Dividend on Preferred shares

SoCI 16 10 3 29

SoFP 8 0 3 11

(W9) Inventory @ 30 June 2011

Balance @ 30 June 2011 Inventory write down (100 (110-30) Sale or return goods Adjusted balance 30 June 2011

390 (20) 15 385

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September 2011

Answer to Question Four

(a)
UV Tangible Non-current Asset note
Non-current assets Cost or valuation At 30 June 2010 Additions Disposals Adjustment on revaluation At 30 June 2011 Depreciation At 30 June 2010 Disposals Charge for year Adjustment on revaluation At 30 June 2011 Net book value at 30 June 2011 Net book value at 30 June 2010 Property $000 4,150 0 0 350 4,500 (450) 0 (50) 450 (50) 4,450 3,700 Plant $000 2,350 215 (90) 0 2,475 (1,350) 60 (280) 0 (1,570) 905 1,000 Equipment $000 985 275 0 0 1,260 (900) 0 (40) 0 (940) 320 85 Total $000 7,485 490 (90) 350 8,235 (2,700) 60 (370) 450 (2,560) 5,675 4,785

(b) UV Statement of Cash flows for the year ended 30 June 2011
$000 $000 1,540 30 370 13 (100) 95 15 (15) (45) (25) (122) (229) (351) 1,527 (490) 15 (114) (589) 938 415 (1,250) (168) (1,003) (65) 160 95

Cash flows from operating activities

Profit before taxation Adjustments for: Increase in legal claim provision Depreciation (part a) Amortisation of development expenditure (W4) Restructuring provision (W6) Finance cost Loss on disposal of non-current tangible asset Operating profit before working capital changes Increase in inventory Increase in trade receivables Decrease in trade payables Cash generated from operations Interest paid (W5) Income taxes paid (W1) Net cash from operating activities Cash flows from investing activities Purchase of property, plant and equipment (part a) Proceeds from sale of equipment Development expenditure Net cash used in investing activities Cash flows from financing activities Proceeds from issue of share capital (W3) Repayment of long term borrowings Equity dividends paid* (W2) Net cash used in financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at 1July 2010 Cash and cash equivalents at 30 June 2011

423 1,963

(85) 1,878

Financial Operations

September 2011

Workings
W1 Income Taxes paid
$000 Balance b/f corporate income tax Income statement Other comprehensive income deferred tax Balance c/f corporate income tax - Deferred tax Tax paid (321) (410) $000 305 455 200 960 (731) 229

W2 Dividends Paid
Retained earnings Balance b/f Profit for year Retained earnings Balance c/f Dividends paid $000 1,982 1,085 3,067 2,899 168

W3 Proceeds from issue of share capital

Shares Share premium Received $000 150 265 415

W4 Deferred development expenses

Balance b/f Additions Balance c/f Amortised in year $000 69 114 183 170 13

W5 Interest paid
Balance b/f Income Statement Less balance c/f $000 32 95 127 (5) 122

W6 Restructuring costs
Provision balance at 30 June 2010 Paid during year Net charge to income statement Cos Additional charge to cash flow $000 100 160 60 100

Financial Operations

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September 2011