FAC3701/102/3/2013

Tutorial letter 102/3/2013

General Financial Reporting
FAC3701

Semesters 1 & 2

Department of Financial Accounting


IMPORTANT INFORMATION:
This tutorial letter contains important information
about your module.


2

CONTENTS


Page
1. INTRODUCTION AND WELCOME ................................................................................... 3
2. LECTURERS AND CONTACT DETAILS ......................................................................... 3
3. MAY 2010 EXAMINATION PAPER WITH SOLUTION .................................................. 4
4. OCTOBER 2010 EXAMINATION PAPER WITH SOLUTION ...................................... 17
5. MAY 2011 EXAMINATION PAPER WITH SOLUTION ................................................ 30
6. OCTOBER 2011 EXAMINATION PAPER WITH SOLUTION ...................................... 43
7. MAY 2012 EXAMINATION PAPER WITH SOLUTION ................................................ 55




FAC3701/102

3

1 INTRODUCTION AND WELCOME
Dear Student,

Attached please find the examination papers for May 2010, October 2010, May 2011,
October 2011 and May 2012 with the suggested solution. We suggest that you do these
examination papers under exam conditions. Once you have completed the examination
papers, you should then compare your answer to the suggested solution. Your answers to
these examination papers must not be submitted to Unisa. These examination papers will
indicate to you the standard required of you and will help you to identify areas of weaknesses
that you must pay attention to.

2 LECTURERS AND CONTACT DETAILS


Please use only the following e-mail address for all communication with
the lecturers:

Students registered for first semester: FAC3701-13-S1@[Link]

Students registered for second semester: FAC3701-13-S2@[Link]




Please use the following telephone number for all communication with
the lecturers:

012 429-4266




Lecturers Office number
Mrs R Horn AJH van der Walt building 2-48
Mrs L Labuschagne
Mr Y Mohamed
Mr J Oberholzer
Mr JWC Riekert
AJH van der Walt building 2-49
AJH van der Walt building 2-51
AJH van der Walt building 2-50
AJH van der Walt building 2-52




4
3. MAY 2010 EXAMINATION PAPER WITH SOLUTION



QUESTION 1 (35 marks) (42 minutes)


Capresso Limited is a manufacturer and retailer of coffee machines which are either leased to
customers or sold, with a one year warranty, for cash.

The current issued share capital of Capresso Limited consists of:
R
500 000 ordinary shares 500 000
200 000 10% redeemable preference shares 200 000
700 000

The 200 000 redeemable preference shares were issued on 1 March 2009 and are
compulsory redeemable on 28 February 2012. On 28 February 2010 R20 000 preference
dividends were declared and paid to all preference shareholders.

Included in the profit before tax of Capresso Limited for the year ended 28 February 2010
amounting to R1 650 000 are the following items:

R
Foreign income received from the United Kingdom
(Capresso Limited paid foreign taxes of R10 000 on this income)
40 000
Profit on sale of equipment 777 500
Provision for warranty costs 200 000
Reversal for provision for warranty costs (2009:R Nil) 50 000

The manufacturing process of the coffee machines is mainly performed by equipment which
was purchased on 1 March 2007 for R2 100 000. The carrying amount and tax base of this
equipment at 28 February 2009 amounted to R1 680 000 and R1 260 000 respectively. On
30 November 2009 the directors of Capresso Limited sold this equipment for R2 300 000. On
the date of sale the carrying amount and tax base of this equipment amounted to R1 522 500
and R840 000 respectively. No other equipment was purchased or disposed of during the
year.

Subsequently, the directors decided to lease all equipment used to manufacture the coffee
machines in future rather than to purchase them due to the difficulties to finance the capital
required. On 1 December 2009 a contract was concluded with Marks Limited for the lease of
equipment. The lease, payable six monthly in advance, in respect of this equipment
amounted to R60 000 per month, and was paid on 1 December 2009.

On 1 February 2009, Capresso Limited received rental income of R40 000 for coffee
machines relating to March 2009. For the year ended 28 February 2010 there was no rental
income received in advance in respect of coffee machines rented out.

The provision for warranty costs in respect of the coffee machines which were sold for cash
during the current financial year was calculated consistently with the past years. It is based on
the expected frequency of returns and the corresponding cost of repairs, assuming that 40%
of the items sold are returned with defects.
FAC3701/102

5
QUESTION 1 (continued)

The balance of the provision for warranty costs in the statement of financial position of
Capresso Limited for the respective years was as follows:

Year ended
28 February 2010
Year ended
28 February 2009
Year ended
28 February 2008
R R R
200 000 110 000 105 000

Actual warranty costs paid are debited directly to the provision for warranty costs account.

The SA Revenue Service general ledger account in the books of Capresso Limited on
28 February 2010 consisted of the following:

Dr SA Revenue Service Current tax Cr
30/8/2009 Bank (for 2009 tax year) 60 000 1/3/2009 Opening balance b/d 65 000
31/8/2009 Bank (for 2010 tax year) 60 000 28/2/2010 Current tax expense ?
28/2/2010 Bank (for 2010 tax year) 60 000
28/2/2010 Closing balance c/d ?
? ?
1/3/2010 Opening balance b/d ?


Capresso Limited accepted the 2009 tax assessment and paid it on 30 August 2009.

The SA Normal tax rate changed from 29% in 2009 to 28% in 2010. 66.6% of all capital gains
are taxable.

The company provides for deferred tax on all temporary differences according to the
statement of financial position approach. There are no other exempt or temporary differences
except those mentioned in the question. There is certainty beyond any reasonable doubt, that
the company will have sufficient taxable profit in future against which any deductible
temporary differences can be utilised.

Assume all amounts are material.




REQUIRED:


1. Motivate with reasons, why the issue of the preferences shares on 1 March 2009 should
be recorded as a liability in the books of Capresso Limited for the year ended
28 February 2010, according to the requirements for a liability in terms of the Conceptual
Framework for Financial Reporting 2010. (5)

2. Disclose the provision for warranty costs in the notes to the annual financial statements of
Capresso Limited for the year ended 28 February 2010 according to the requirements of
IAS 37 Provisions, contingent liabilities and contingent assets.

6
QUESTION 1 (continued)

Comparative amounts are required.
No other notes are required.
No accounting policy notes are required. (7)

3. Calculate the current tax due to the SA Revenue Service by Capresso Limited for the
year ended 28 February 2010. (12)

4. Calculate the deferred tax balance in the statement of financial position of Capresso
Limited for the year ended 28 February 2009, using the statement of financial
position approach. Indicate if the balance is a deferred tax asset or deferred tax
liability. (3)

5. Disclose the tax rate reconciliation, using R-values only in the annual financial
statements of Capresso Limited for the year ended 28 February 2010, according to the
requirements of IAS 12 Income taxes.

All calculations must be shown.
Comparative amounts are not required. (7)




QUESTION 2 (32 marks)(38 minutes)



Flex Limited sells and repairs classic, collectable cars, as well as accessories for these
collectable classic cars. The profit before tax of Flex Limited for the year ended
28 February 2010 amounted to R1 750 000, before taking into account the following
information:

1. A Computer Virus in the general ledger software computer programme arose during the
current financial year. This Computer Virus resulted in 10% of all income from repairs
rendered during the current financial year to be allocated to the income from the
accessories account. This error was compounded by the fact that every financial year
Flex Limited pays royalties of 2% on all income generated from the sale of motor
accessories at the end of the year. The royalties payable are not directly debited to the
income from sale of accessories account but allocated as royalties expenses in the
statement of profit and loss and other comprehensive income.

The following amounts are included in the above profit before tax of Flex Limited on
28 February 2010:

R
Income from sale of collectable classic cars (including VAT of 14%) 1 400 000
Income from sale of accessories account (excluding VAT of 14%) 350 000
Income from repairs of collectable classic cars (excluding VAT of 14%) 630 000

FAC3701/102

7
QUESTION 2 (continued)

2. On 1 March 2007 modification costs to machinery were incurred at a cost of R600 000.
During the interim audit the auditors discovered that these modification costs were
expensed in the statement of profit and loss and other comprehensive income of Flex
Limited for the financial year ended 28 February 2008 instead of being capitalised.

The current depreciation that the company claims on machinery is 20% p.a. according to
the straight-line method, which is in agreement with the policy applied by the SA Revenue
Service. The effect of this is considered material. The SA Revenue Service indicated that
they will re-open the previous years tax assessments.

3. On 1 December 2009 Flex Limited paid R60 000 to Castro Media Limited for
advertisements that will be broadcast on its radio station during January 2010. From the
past sales history Flex Limited expects to receive the following benefits from the
advertising campaign:

During January 2010 40%
During February 2010 25%
During March 2010 20%
During April 2010 15%

4. As a result of the significant decline of car sales in the motor industry and Flex Limiteds
recent sales history, Flex Limited decided to also sell its classic cars on an instalment
sales agreement. On 1 February 2010 Flex Limited sold a vintage classic car to
Mr Claasens to be paid in 2 annual instalments of R250 000 each, payable in arrears, at
an interest rate of 7,32125%. The cash price of the vintage car is R450 000, excluding
14% VAT. This vintage car was sold at a gross profit of 25% on cost price.

5. A letter of notification was received from the lawyers of Jabulani Limited that on
10 March 2010 the company which they represent was placed under liquidation as its
liabilities far exceeds its assets and no cash was available to pay its creditors. Flex
Limited currently holds a 15% share in Jabulani Limited. The liquidation of Jabulani
Limited arose as a result of years of mismanagement of the company and
misappropriation of its assets. During the financial year 28 February 2010 the amount
owing by Jabulani Limited to Flex Limited amounted to R40 000 for sales made by
Flex Limited to Jabulani Limited. The investment in Jabulani Limited is disclosed at a cost
of R290 000 in the statement of financial position at 28 February 2010.

6. The tax rate has remained unchanged at 28% for the past few years.

7. The financial statements of Flex Limited for the financial year ended 28 February 2010
were presented to the board of directors for authorisation for issue on 30 April 2010.

8. Assume all amounts are material.

8
QUESTION 2 (continued)




REQUIRED:



1. State the amount of revenue in (3) that Castro Media Limited should recognise as
revenue from the advertisement campaign it has entered into with Flex Limited for the
financial year ended 31 December 2009. Give reasons to support your answer. Your
answer should comply with the requirements of IAS 18 Revenue. (2)

2. Prepare the journal entries for transaction (2) in the books of Flex Limited for the financial
year ended 28 February 2010. No journal narrations are required. Ignore any tax
implications. (7)

3. Calculate the profit before tax of Flex Limited for the year ended 28 February 2010. (10)

4. Disclose (2) in the notes to the annual financial statements of Flex Limited for the year
ended 28 February 2010 according to the requirements of only IAS 8 Accounting
policies, changes in accounting estimates and errors.

No accounting policy notes are required. (12)




QUESTION 3 (33 marks)(40 minutes)


Roma Limited is an importer of Italian ceramic tiles and distributes and sells them through
their own chain of stores throughout South Africa.

1. The following information is an extract from the draft financial statements of Roma Limited
for the year ended 28 February 2010:
2010 2009
R R
Dr/(Cr) Dr/(Cr)
Profit before tax (470 000) (750 000)
Inventory 190 000 280 000
Delivery trucks - Cost 900 000 900 000
Accumulated depreciation ? (170 000)

2. Roma Limited has a fleet of delivery trucks, acquired on 1 March 2008, which are used to
transport the tiles from the harbour to the different retail stores and then to the clients.
After a physical inspection of the delivery trucks at 28 February 2010 to determine their
roadworthiness, the operations manager of Roma Limited indicated that the remaining
useful life of these trucks are only 3 years due to the fact that they are used to their full
capacity. The financial director therefore decided to change the depreciation method for
the current year for these trucks from the reducing balance method at 20% p.a. to the
straight-line method.
FAC3701/102

9
QUESTION 3 (continued)

Based on the operations managers assessment of the trucks, the financial director also
decided to change the residual value of the trucks from R50 000 to R10 000 to reflect the
increased usage of the trucks.

No depreciation charge for these trucks has been accounted for in the current financial
year. No other delivery trucks were acquired or disposed of since 1 March 2008. The
SA Revenue Service allows a 20% p.a. wear and tear allowance on the trucks according
to the straight-line method.

3. Roma Limited keeps a limited quantity of tiles as inventory, due to the fact that the tiles
can be imported and delivered to the client within 6 weeks after order date. Exchange
rate fluctuations also have a direct effect on the cost and sales price of these tiles. After
the draft financial statements for the year ended 28 February 2010 had been prepared,
the directors decided to change the valuation method of the tiles held as inventory
because it does not give a reliable presentation of the effect of exchange rate fluctuations
on the companys profits. The valuation method was therefore changed from the
weighted average method to the first-in-first-out method

The value of inventory based on the different valuation methods was as follows:

Weighted
average
First-in-
first-out

Difference
R R R
28 February 2007 164 000 220 000 56 000
29 February 2008 170 000 240 000 70 000
28 February 2009 280 000 344 000 64 000
28 February 2010 190 000 220 000 30 000

The SA Revenue Service indicated that they will accept the new inventory valuation
method and will reopen the 2009 tax assessment but not the tax assessments before
2009.

4. Due to the fact that their own delivery trucks did not have the capacity to transport the
load of tiles, Roma Limited used outside transport contractors to deliver tiles to a faraway
destination in Limpopo. The tiles were to be used for the tiling of the floors of an exclusive
bush lodge. Unfortunately, due to the poor road conditions, approximately 15% of the tiles
were already cracked on arrival at the bush lodge. On 15 January 2010, the client
instituted a claim of R150 000 against Roma Limited for the damaged tiles they were
unable to use. At year end the legal advisor of Roma Limited is of the opinion that it is
probable that Roma Limited will not be found liable for the claim.

As a result of the above mentioned claim, Roma Limited decided on 31 January 2010 to
sue the relevant outside transport contractor for R95 000 for damages incurred. Due to
the lack of the necessary packaging material used by the outside transport contractor to
compensate for the poor condition of the roads, the financial manager of Roma Limited is
of the opinion that it is probable that Roma Limited will be successful with their claim.

10
QUESTION 3 (continued)

5. The taxable income/(loss) of Roma Limited before taking into account the change in
inventory valuation method amounted to income of R220 000 and a loss of R125 000 for
the years ended 28 February 2010 and 28 February 2009 respectively. The wear and
tear allowance on the delivery trucks has already been taken into account in taxable
income/(loss) for the years ended 28 February 2009 and 28 February 2010.

6. The company provides for deferred tax on all temporary differences according to the
statement of financial position approach. These are no other exempt or temporary
differences except those mentioned in the question. There is certainty beyond any
reasonable doubt, that the company will have sufficient taxable profit in future against
which any deductible temporary differences can be utilised.

7. The SA normal tax rate has remained unchanged at 28% for the past few years.

8. Assume all amounts are material.




REQUIRED:


1. Calculate the profit before tax of Roma Limited for both the years ended
28 February 2010 and 28 February 2009. (5)

2. Calculate the current tax expense (if any) of Roma Limited for both the years ended
28 February 2010 and 28 February 2009. In your answer start with the taxable income of
R220 000 and loss of R125 000. (4)

3. Calculate the deferred tax balance of Roma Limited for the year ended
28 February 2009, using the statement of financial position approach. Indicate if it is a
deferred tax asset or liability. (3)

4. Disclose (3) and (4) in the notes to the annual financial statements of Roma Limited for
the year ended 28 February 2010, according to the requirements of IAS 8 Accounting
policies, changes in accounting estimates and errors and IAS 37 Provisions, contingent
liabilities and contingent assets.

No accounting policy notes are required.
Comparative figures are required. (20)



Please note:

For all the capital gains tax calculations use 28% x 66,6% to ensure that
rounding does not affect your answer.
Do not round the CGT rate.


FAC3701/102

11




SOLUTION



QUESTION 1

In order to recognise the preference shares as a liability both the definition of a liability as well
as the recognition criteria of a liability must be met in terms of the Conceptual Framework for
Financial Reporting 2010

In terms of the liability definition
There must be a present obligation
As a result of a past event
The settlement of which is expected to result in an outflow of future economic
benefits (Par.4.4(b))

In terms of the recognition criteria a liability which meets the definition of a liability may only
be recognised if:
It is probably that future economic benefits will flow from the entity.
The element has a cost or value that can be measured reliably. (Par.4.46)

Discussion

The issue of the shares meets the definition of a liability
Capresso Limited has a present obligation since the preference shares are
compulsory redeemable.
As a result of the past event the past event is the issue of the shares on
1 March 2009.
There will be a settlement in the form of future economic benefits flowing from
Capresso Limited in respect of the value of the shares and the annual dividend of
R20 000 x 3 = R60 000

The issue of the shares meets the recognition criteria.
The outflow of future economic benefits is probable.
The value can be measured reliably.

Conclusion
Since the definition and the recognition criteria are met the preference shares should be
treated as a liability in the financial statements.


12

QUESTION 1 (continued)

2. CAPRESSO LIMITED

NOTES FOR THE YEAR ENDED 28 FEBRUARY 2010

Provision for warranty costs
2010 2009
R R
Carrying amount beginning of year 110 000 105 000
Amount used during the year (110 000 50 000) (60 000) (105 000)
Reversal of unused amounts (50 000) -
Provision created for the year 200 000 110 000
Carrying amount end of year 200 000 110 000

Provision for warranty costs is made based on the expected value of the cost of repairs,
assuming that 40% of the coffee machines are returned with defects.

3. Calculation of current tax due to the SA Revenue Service for the year ended
28 February 2010

R
Profit before tax 1 650 000
Exempt differences (106 800)
Foreign income (40 000)
Capital profit on sale of equipment (2 300 000 2 100 000) x (100%-66.6%) (66 800)
Profit after exempt differences 1 543 200
Temporary differences 290 000
Depreciation equipment (1680 000 1 522 500) 157 500
Wear and tear on equipment (1 260 000 840 000) (420 000)
Rent prepaid (3 x 60 000) (180 000)
Profit on sale of equipment (2 100 000 1 522 500) (577 500)
Recoupment on sale of equipment (2 100 000 840 000) 1 260 000
Provision for warranty costs (200 000 50 000) 150 000
Rental received in advance in 2009 (40 000)
Actual warranty costs paid(110 000 50 000) (60 000)

Taxable income 1 833 200

Current tax expense (1 833 200 x 28%) 513 296
Less: Provisional tax payments made (60 000 + 60 000) (120 000)
Tax due to South African Revenue Service 393 296


FAC3701/102

13
QUESTION 1 (continued)

4. Calculation of the deferred tax balance of Capresso Limited for the year ended
28 February 2009.

Carrying
amount

Tax base

Temporary
differences
Deferred tax
asset/(liability)
@ 29%
R R R R
Equipment 1 680 000 1 260 000 420 000 (121 800)
Provision for warranty costs 110 000 - 110 000 31 900
Rent received in advance 40 000 - 40 000 11 600
Deferred tax liability (78 300)

5. Tax rate reconciliation
R
Standard tax rate (1 650 000 x 28%) 462 000
Adjusted for exempt differences:
Overprovision prior year (65 000 60 000) (5 000)
Foreign income (40 000 x 28%) 10 000 (1 200)
Capital profit on sale of machinery (66 800 x 28%) (18 704)
Tax rate change (78 300 x
1
/
29
) (2 700)
434 396

QUESTION 2

1. Revenue from advertising commissions are recognised when an advert appears before
the public (par 12 IAS 18). Since the advert is broadcasted during January 2010, which
forms part of the next financial year of Castro Media Limited no amount should be
recognised as revenue.

2. Journal entries for the financial year ended 28 February 2010

Dr Cr
R R
J1. Depreciation 120 000
Accumulated depreciation: Property, plant and equipment 120 000
Accounting for depreciation on modification costs to machinery
(600 000 x 20%)

J2. Machinery 600 000
Retained earnings
(600 000 (600 000 x 20% x 2))
360 000
Accumulated depreciation: Property, plant and equipment
(600 000 x 20% x 2)

240 000
Accounting for depreciation on modification costs to machinery
and capitalisation of machinery



14
QUESTION 2 (continued)

3. Calculation of profit before tax for the year ended 28 February 2010

R
Profit before tax before adjustments 1 750 000
VAT portion on sale of collectable cars (1 400 000 x 14/114) (171 930)
Royalties incorrectly calculated (630 000/90% x 10% x 2%) 1 400
Credit losses written off Jabulani Limited (40 000)
Cost of investment written off Jabulani Limited (290 000)
Advertisement expense (60 000 x 40%) + (60 000 x 25%) (39 000)
Sale of motor vehicle Mr Claasens 450 000
Interest recognised (450 000 x 7,32125% x
1
/
12
) 2 745
Cost of sales on inventory (450 000 x 100/125) (360 000)
Depreciation on motor vehicle claimed (600 000 x 20%) (120 000)
1 183 215

4. FLEX LIMITED

NOTES FOR THE YEAR ENDED 28 FEBRUARY 2010.

1. Prior period error

The company incorrectly expensed modification costs on machinery rather than being
capitalized in its accounting records. The effect of the correction has been accounted for
retrospectively and comparative amounts have been appropriately restated:

2009 1/3/2008
R R
Increase in depreciation (600 000 x 20%) (120 000)
Decrease in current tax (120 000 x 28%) 33 600
Decrease in profit (86 400)

Increase in property plant and equipment
(600 000 (600 000 x 20% x 2)); 600 000 (600 000 x 20% )
360 000 480 000
Increase in current tax due
(360 000 x 28%); (480 000 x 28%)
(100 800) (134 400)
Increase in equity 259 200 345 600
Adjustment to retained earnings beginning of 2009
(480 000 (480 000 x 28%)

345 600









FAC3701/102

15

QUESTION 3

1. Profit before tax
2010 2009
R R
Profit before tax (given) 470 000 750 000
Change in accounting policy
(30 000 64 000) (34 000)
(64 000 70 000) (6 000)
Depreciation ((900 000 170 000) 10 000) /3 (240 000) -
196 000 744 000

2. Current tax 2010 2009
R R
Taxable income / (loss) 220 000 (125 000)
(Decrease)/Increase in profit due to change in closing inventory
(64 000 30 000)
(34 000) 64 000
Loss carried forward to 2010 - (61 000)
Less: assessed loss: 2009 (61 000)
Taxable income 125 000
Current tax @ 28% (125 000 x 28%) 35 000

3. Calculation of deferred tax balance of Roma Limited for the year ended
28 February 2009

Carrying
amount
Tax base Temporary
difference
Deferred tax
asset/
(liability) @
28%
R R R R
Delivery trucks 730 000
1
720 000
2
10 000 (2 800)
Assessed loss - 61 000 61 000 17 080
Deferred tax asset
14 280
1
900 000 170 000
2
900 000 (900 000 x 20%)



4. ROMA LIMITED
NOTES FOR THE YEAR ENDED 28 FEBRUARY 2010

1. Change in accounting policy

During the year the company changed the inventory valuation method from the weighted
average method to the first-in-first-out method in order to give a reliable presentation of the
effect of exchange rate fluctuations on the companys profits. This change in accounting
policy has been accounted for retrospectively and the comparative amounts have been
appropriate restated:

16
QUESTION 3 (continued)

2010 2009 1/3/2008
R R R
Increase in cost of sales (34 000) (6 000)
(64 000 30 000); (70 000 64 000)
Decrease in current tax expense
(34 000 x 28%); (6 000 x 28%) 9 520 1 680
Decrease in profit 24 480 4 320

Increase in inventory 30 000 64 000 70 000
Increase in current tax liability
(30 000 x 28%); (64 000 x 28%)
(8 400) (17 920)
Increase in deferred tax liability (70 000 x 28%) (19 600)
Increase in equity 21 600 46 080 50 400
Adjustment to retained earnings at beginning of 2009 50 400

2. Contingent liability

A client instituted a claim of R150 000 against Roma Limited for delivering damaged tiles that
they were unable to use. At year end the legal advisor of Roma Limited is of the opinion that it
is probable that Roma Limited will not be found liable.

3. Contingent asset

Roma Limited sued the outside transport contractor for R95 000 for damages incurred, due to
the lack of the necessary packaging material used by the outside transport contractor to
compensate for the poor condition of the roads. The financial manager of Roma Limited is of
the opinion that it is probable that Roma Limited will be successful with their claim.
FAC3701/102

17
4. OCTOBER 2010 EXAMINATION PAPER WITH SOLUTION



QUESTION 1 (50 marks) (60 minutes)


Zakare Limited is a company that manufactures and sells health equipment and is situated in
Parys in the Free State.

Mr Swahile, an article clerk has drawn up the annual financial statements for the year ended
31 December 2009 of Zakare Limited. Your assistance is required to finalise these annual
financial statements according to the requirements of International Financial Reporting
Standards.

Additional information

1. The profit before tax of Zakare Limited for the year ended 31 December 2009 amounted
to R986 000. The profit before tax includes the following:
R
Income
Foreign income received from the United Kingdom (refer 1.1) 100 000
Reversal of unused provision for cost of repairs (refer 2) 38 000

Expenses
Depreciation (refer 4) 362 000
Traffic fines (not tax deductible) 10 500
Allowance for credit losses (refer 1.2) 120 000
Provision for cost of repairs created (refer 2) 87 000
Subscription fees for health magazines (refer 1.3)

300
1.1. Foreign income received from the United Kingdom is not taxable in the RSA in terms of a
double taxation agreement. Zakare Limited paid foreign taxes of R18 000 on this income.

1.2. The SA Revenue Service allows 25% of the allowance for credit losses as a deduction. In
previous financial years Zakare Limited made no allowance for credit losses because the
company had no credit sales.

1.3. Subscription fees for health magazines relates to health magazines which was received
during the period January 2009 to June 2009. The subscription fees were paid on
1 December 2008.

2. During the previous year, an intrinsic defect was discovered in the slimming health
machines manufactured by Zakare Limited. As a result thereof slimming health machines
sold, on hand and already manufactured will have to be repaired by Zakare Limited free
of charge to customers. The financial manager of Zakare Limited therefore raised a
provision for these costs to be incurred from the financial year ended 31 December 2008.
The balance of the provision for the cost of these repairs for the year ended
31 December 2008 and 31 December 2009 amounted to R103 000 and R87 000
respectively. Actual repair costs incurred are debited directly against the provision for cost
of repairs.

18
QUESTION 1 (continued)

3. During your discussions with Mr Swahile the following matters come to your attention:

3.1. The following journal entry was recorded in the accounting records of Zakare Limited for
the financial year ended 31 December 2009:

Dr Insurance (P/L) R180 000
Cr Insurance liability loss (SFP) R180 000

On requesting the supporting invoices for the insurance charge, Mr Swahile explained
that the financial director had cancelled the insurance policy as of 1
st
of January 2009 and
would in future self insure. This was due to the fact that although Zakare Limited made
the insurance payments no claim for any moneys had ever been instituted against the
insurance company. Zakare Limited will therefore bear all possible future losses. Instead
of paying the insurance company R15 000 per month the above liability has been
created.

3.2. Zakare Limited has an investment portfolio whereby it invests excess cash on the stock
exchange. At 31 December 2009 the cost and the market value of the investments
amounted to R550 000. Mr Swahile informed you that the market value of the
investments on 31 January 2010 had decreased to R425 000. The investments were
disclosed at R550 000 in the statement of financial position as at 31 December 2009.

4. Property, plant and equipment

4.1. Mr Swahile has finalised schedules relating to the carrying amounts and tax base of the
assets of Zakare Limited before taking into account 4.2 below.

Administration
building
Distribution
vehicles

Total
R R R
Carrying amount
31 December 2008

950 000

1 248 000

2 198 000
31 December 2009 900 000 936 000 1 836 000
Depreciation rate (straight-line) 5% 20%
Tax base
31 December 2008

N/A

1 170 000

1 170 000
31 December 2009 N/A 780 000 780 000
Capital allowances (straight-line) None 25%

The distribution vehicles are used to distribute health equipment to customers of
Zakare Limited.

4.2. Sale of distribution vehicle

On 31 December 2009 Zakare Limited sold a distribution vehicle with a cost price of
R110 000 for R76 900.

Mr Swahile had prepared the above schedules (refer 4.1) before the sale of the
distribution vehicle (refer 4.2) had taken place.
FAC3701/102

19
QUESTION 1 (continued)

The only journal entry recorded by Mr Zwahile in respect of the sale of the distribution
vehicle in the accounting records of Zakare Limited for the financial year ended
31 December 2009 was as follows:
Dr Bank R76 900
Cr Sales of distribution vehicle R76 900

Details of the distribution vehicle sold are as follows on 31 December 2009:
R
Cost - 1 January 2008 110 000
Accumulated depreciation - 31 December 2009 44 000

During the current financial year no other assets were purchased or sold.

5. On 30 November 2009 the production manager of Zakare Limited informed the
management of Zakare Limited of the possibility that the appearance of its health
treadmills will have to change after complaints were received from its main competitor,
Flex Limited. Flex Limited claims that the appearance of its treadmills is similar to those
manufactured by Zakare Limited and started legal proceedings of R50 000 against
Zakare Limited. However, on 31 December 2009 the legal advisors of Zakare Limited are
of the opinion that it is not probable that Flex Limited will be successful with their claim
against the company.

6. The SA Normal rate changed from 29% in 2008 to 28% in 2009.

7. The annual financial statements of Zakare Limited for the year ended 31 December 2009
were presented to the board of directors for authorisation for issue on 20 February 2010.

8. The company provides for deferred tax on all temporary differences according to the
statement of financial position approach. There are no other exempt or temporary
differences except those mentioned in the question. It is probable that future taxable
profits will be available against which any deductible temporary differences can be
utilised.

9. Assume all amounts are material.




REQUIRED:


1. Discuss, with reasons, if you agree with the financial director (refer 3.1) whether the
insurance liability loss should be treated as a liability in the statement of financial
position of Zakare Limited for the financial year ended 31 December 2009 according to
the requirements of a liability in terms of the Conceptual Framework for Financial
Reporting 2010. (5)

20
QUESTION 1 (continued)

2. Motivate, with reasons, why the decrease in market value of investments (refer 3.2) will
not require an adjustment to the financial statements of Zakare Limited for the financial
year ended 31 December 2009. In your answer also motivate any disclosure
requirements that may be necessary. Your answer must comply with the requirements of
IAS 10 - Events after the reporting period. (3)

3. Using the additional information points (1) (3) and (4) calculate the correct profit before
tax of Zakare Limited for the year ended 31 December 2009. (3)

4. Calculate the current tax expense of Zakare Limited for the year ended
31 December 2009. Use the profit before tax as calculated in (3) above as your starting
point. (12)

5. Calculate the deferred tax balance in the statement of financial position for both the years
ended 31 December 2008 and 31 December 2009 using the statement of financial
position approach. Indicate if the balance is a deferred tax asset or deferred tax
liability. (10)

6. Disclose the tax rate reconciliation, using R-values only, in the notes to the annual
financial statements of Zakare Limited for the year ended 31 December 2009, according
to the requirements of IAS 12 - Income taxes.

All calculations must be shown.
Calculations are to be done to the nearest R1
Comparative amounts are not required. (7)

7. Disclose additional information points (2) and (5) above in the notes to the annual
financial statements of Zakare Limited for the year ended 31 December 2009 according
to the requirements of IAS 37 - Provisions, contingent liabilities and contingent assets.

Comparative figures are required.
No other notes are required.
No accounting policy notes are required. (8)



QUESTION 2 (50 marks) (60 minutes)



The annual financial statements of Maximor Limited, a retailer and manufacturer of new motor
vehicles, for the year ended 28 February 2010, were presented to the board of directors for
authorisation for issue on 25 April 2010.

The profit before tax of Maximor Limited (including the provision for obsolete inventory at 5%
(Refer 1) for the years ended 28 February 2010 and 28 February 2009 amounted to
R950 000 and R650 000 respectively.
FAC3701/102

21
QUESTION 2 (continued)

The company provides for deferred tax on all temporary differences according to the
statement of financial position approach. There are no other exempt or temporary differences
except those mentioned in the question. There is certainly beyond reasonable doubt that
there will be sufficient taxable profit in future against which deductible temporary differences
can be utilised.

The SA normal tax rate has remained unchanged at 28% for the past three years.

Assume all amounts to be material.

Additional information

1. After the draft financial statements for the year ended 28 February 2010 had been
prepared, the directors decided at a board meeting held on 5 April 2010 that the current
inventory valuation method does not give a realistic presentation of the effect of inflation
on the company's profit. Hence the directors decided to change the accounting policy in
respect of the valuation of inventory from the last-in, first-out method to the first-in, first-
out method. Due to a change in the materials used to manufacture the motor vehicles the
directors also decided to increase the provision for obsolete inventory to 10%, while the
provision in previous years was based on 5% of the value of inventory. The SA Revenue
Service will not reopen the previous years tax assessments but they will accept the new
inventory valuation method from the 2010 financial year.

A summary of the value of inventory based on the different valuation methods after taking
into account the applicable provision for obsolete inventory is as follows:

2008
Inventory value
after provision
for obsolete
inventory @ 5%
R
2009
Inventory value
after provision
for obsolete
inventory @ 5%
R
2010
Inventory value
after provision
for obsolete
inventory @ 5%
R
2010
Inventory value
after provision
for obsolete
inventory @ 10%
R
First-in, first-
out method

375 250

399 000

437 000

414 000
Last-in, first-
out method

(362 900)

(375 250)

(399 000)

(378 000)
12 350 23 750 38 000 36 000

2. On 15 August 2009 Maximor Limited introduced its new range of apache motor vehicles.
On 1 September 2009 an apache motor vehicle was sold to Mr. Wild for R147 500
including a 90 000 km service plan. The amount charged for each service within the
90 000 km service plan period is R880. The cost of each service is marked up at 33%
on the cost of labour. The apache motor vehicle is required to be serviced every
15 000 km in order for the guarantees on the apache motor vehicle to be valid. Maximor
Limited realises a gross profit percentage of 25% on the sale of new apache motor
vehicles

On 28 February 2010 Mr Wild brought his apache motor vehicle to the premises of
Maximor Limited for its first service.

22
QUESTION 2 (continued)

As a result of the production of the apache motor vehicles the current premises were
inadequate and the directors decided to terminate the current operating lease agreement
and to move to bigger premises on the outskirts of the city. The terms of the current lease
agreement state that early termination would result in a penalty payment of 80% of the
remaining lease payments. The current lease agreement would have terminated on
28 February 2011. The lease rental is R50 000 per annum payable in arrears. All the
lease payments for the year ended 28 February 2010 are up to date. The
abovementioned has not yet been recorded in the accounting records of Maximor Limited
for the year ended 28 February 2010.

3. During the current years audit of the PAYE records it was discovered that PAYE for the
staff in the customer service department, had not been recorded since incorporation of
the company four years ago. The PAYE system of this department was not linked to the
salaries and wages account of the mainframe computer. The salaries and wages account
in the statement of profit and loss and other comprehensive income for the four years
respectively is as follows:

28 February 2010
R
28 February 2009
R
28 February 2008
R
28 February 2007
R
690 000 640 000 520 000 410 000

The PAYE due to the SA Revenue Service in respect of staff in the customer service
department for the four years is as follows:
28 February 2010
R
28 February 2009
R
28 February 2008
R
28 February 2007
R
75 900 60 500 48 000 42 500

The effect thereof is considered to be material. The SA Revenue Service indicated that
they will reopen the tax assessment for the prior years in respect of this matter.




REQUIRED:



1. Motivate with reasons why the sale of the service plan as per additional information (2)
should be recognised as "Revenue" over the duration of the service plan in the
accounting records of Maximor Limited. Calculations need not form part of your answer.
Your answer should comply with the requirements of IAS 18 - Revenue. (6)

2. Prepare all the necessary journals as per additional information (2) to record the
transactions in the accounting records of Maximor Limited for the year ended
28 February 2010. Journal narrations are not required. Ignore the tax implications. (10)

3. Calculate the deferred tax movement in the statement of profit and loss and other
comprehensive income of Maximor Limited for the year ended 28 February 2010 using
the statement of financial position approach. Indicate if your answer is a debit or
credit movement to the statement of profit and loss and other comprehensive income. (5)
FAC3701/102

23
QUESTION 2 (continued)

4. Disclose the information as per additional information (1) and (3) in the notes to the
annual financial statements of Maximor Limited for the year ended 28 February 2010
according to the requirements of IAS 8 - Accounting policies, changes in accounting
estimates and errors.

No accounting policy notes are required.
Comparative figures are required.
All calculations are to be done to the nearest Rand. (28)




SOLUTION



QUESTION 1

1. Discussion in terms of the Conceptual Framework for Financial Report 2010

In terms of the liability definition:

There must be a present obligation
As a result of a past event
The settlement of which is expected to result in a outflow of future economic benefits.
(Par.4.4(b))

In terms of the recognition criteria a liability which meets the definition of a liability may only
be recognised in the financial statements if:

It is probable that future economic benefits will flow to/from the entity and
The element has a cost or value that can be measured reliably. (Par.4.46)

Discussion

Although a possible outflow of economic benefits would result in the event of damages and
theft, this outflow is not expected since:
No past transaction has occured, and no insurance contract has been signed, requiring
the payment of insurance premiums.
There is no present obligation. Furthermore, there is no obligation as the company is not
obliged,legally or otherwise, to repair or replace any items that may have been damaged.
It can be argued that the cost of R180 000 is reliably measured, as it represents the best
estimate of the insurance expense based on past experience. Although the liability has
been estimated based on past insurance contributions, this can be argued to be
acceptable on the grounds that this is a prudent approach.
However the outflow of economic benefits is not probable since no past event has
occured; the outflow is only possible at this stage.

24
QUESTION 1 (continued)

Conclusion
Since the recognition criteria and definition of a liability is not met the liability cannot be
recognised in the accounting records of Zakare Limited. The journal entry will therefore have
to be reversed in the accounting records of Zakare Limited.

2. Discussion of decrease in the market value of investments

The decrease in the market value of investments is a non adjusting event. Non adjusting
events are those events that are indicative of conditions that arose after the reporting date.

The decline in market value of investments is indicative of an event that occured after the
reporting period. No condition of the decline in market value was apparent at the end of the
reporting period and the decline in value is clearly indicative of a post reporting period event.

Although no adjustment is required to the market value of investments disclosure of the
decrease in market value must be made in the notes to the annual financial statements of
Zakare Limited for the year ended 31 December 2009.

Disclosure must include:
The nature of the event and
An estimate of its financial effect.

3. Calculation of profit before tax for the year ended 31 December 2009 R
Profit before tax (given) 986 000
Insurance paid reversed (refer 1) 180 000
Sales reversed (76 900)
Profit on sale of distribution vehicle (76 900 (110 000 44 000)) 10 900
Profit before tax - 31 December 2009 1 100 000

4. Calculation of current tax expense for the year ended 31 December 2009
R
Profit before tax 1 100 000
Exempt differences (39 500)
Traffic fines 10 500
Depreciation admin building (950 000 900 000) 50 000
Foreign income (100 000)
Profit after exempt differences 1 060 500
Temporary differences 7 300
Depreciation: distribution vehicles (1 248 000 936 000) 312 000
Wear and tear:distribution vehicles (1 170 000 780 000) (390 000)
Profit on sale of distribution vehicle (10 900)
Recoupment on sale of distribution vehicle
(76 900 (110 000 - (110 000 x 25% x 2))

21 900
Allowances for credit losses (acc) 120 000
Allowances for credit losses (tax) (120 000 x 25%) (30 000)
Subscriptions paid in advance 300
Provision for cost of repairs (87 000 38 000) 49 000
Actual repair costs incurred (103 000 38 000) (65 000)
Taxable income 1 067 800
Current tax (1 067 800 x 28%) 298 984
FAC3701/102

25
QUESTION 1 (continued)

5. Calculation of the deferred tax balance in the statement of financial position of
Zakare Limited for the year ended 31 December 2008 and 31 December 2009.





Carrying
amount


Tax base


Temporary
difference
Deferred
tax asset/
(liability)
@ 29%
R R R R
2008
Distribution vehicles 1 248 000 1 170 000 78 000 (22 620)
Provision for cost of repairs 103 000 - 103 000 29 870
Subscription prepaid 300 - 300 (87)
Deferred tax asset - 31 December 2008 7 163



Carrying
amount



Tax base


Temporary
difference
Deferred
tax asset/
(liability)
@ 28%
R R R R
2009
Distribution vehicles 870 000
1
725 000
2
145 000 (40 600)
Provision for cost of repairs 87 000 - 87 000 24 360
Allowance for credit losses 120 000 30 000
3
90 000 25 200
Deferred tax asset - 31 December 2009 8 960

1
936 000 (110 000 44 000)
2
780 000 [110 000 (25% x 2 x 110 000)]
3
120 000 x 25%

6. Tax rate reconciliation
R
Standard tax rate (110 000 x 28%) 308 000
Adjusted for excempt differences
Fines paid (10 500 X 28%) 2 940
Depreciation admin building (50 000 x 28%) 14 000
Foreign income [(100 000 x 28%) 18 000] (10 000)
Tax rate change (7 163 x 1/29) 247
315 187


26
QUESTION 1 (continued)

7. ZAKARE LIMITED

NOTES FOR THE YEAR ENDED 31 DECEMBER 2009

1. Provision for repairs

R R
Carrying amount beginning of year 103 000 -
Provision created for the year 87 000 103 000
Provision used for the year (103 000 38 000) (65 000) -
Unused provision reversed (38 000) -
Carrying amount end of year 87 000 103 000

During December 2009 an intrinsic defect was discovered in the slimming health machines
manufactured by Zakare Limited. A provision of R87 000 has been recognised for the current
year for expected costs to repair these slimming health machines.

2. Contingent liability

On 30 December 2009 the production director informed management that the appearance of
its health treadmills will have to change after complaints were received from its main
competitor, Flex Limited, and they started legal proceedings against the company for
R50 000. They claim that the appearance of the health treadmills are similar to those
manufactured by them. On 31 December 2009 the legal advisors of Zakare Limited is of the
opinion that it is not probable that Flex Limited wil win their legal action.

QUESTION 2

1. In terms of IAS 18.20, revenue from the sale of the service plan can be accounted for as
revenue since the following conditions are met:

1.1. It is possible to measure the amount of revenue reliably. Customers are usually charged
R880 for each service performed for them and therefore, the amount measurable is
reliable.

1.2. It is probable that economic benefits will flow to the entity since R147 500 is received
from Mr Wild.

1.3. It is possible to measure the stage of completion of the transaction reliably. Stage of
completion is measured when a customer brings in his motor vehicles for a service.

1.4. The cost incurred for the transaction can be measured reliably as Maximor limited marks
up costs on labour of 33%.
FAC3701/102

27
QUESTION 2 (continued)

2. Journals




2.1 Bank
Revenue 147 500 (880 x )
Deferred maintenance liability
Debit
R

147 500

Credit
R


142 220
5 280

2.2 Deferred maintenance liability
Revenue

880


880

2.3 Cost of sales (142 220 x 75%)
Labour costs 880 x
Inventory

106 665
660




107 325

2.4 Penalty (50 000 x 80%)
Provision for onerous contract

40 000


40 000

3. Calculation of deferred tax movement




2009


Carrying
amount
R



Tax base
R


Temporary
difference
R
Deferred
tax asset /
(liability) @
28%
R
Inventory 399 000 375 250 23 750 (6 650)
Deferred tax liability 6 650

2010
Income received in advance
(5 280 - 880)

4 400

-

4 400

1 232
Provision for onerous contract 40 000 - 40 000 11 200
Deferred tax asset 12 432

Deferred tax movement
R
Deferred tax liability 1 March 2009 6 650
Deferred tax asset 28 February 2010 12 432
Deferred tax movement (credit to statement of profit and loss and other
comprehensive income)

19 082


28
QUESTION 2 (continued)

4. MAXIMOR LIMITED

NOTES FOR THE YEAR ENDED 28 FEBRUARY 2010

4.1. Profit before tax

Included in cost of sales is a change in estimate regarding the provision for obsolete
inventory. The provision is now based on 10% of the value of inventory compared to 5% as in
the past. The effect of the change in estimate is a decrease in profit of R23 000
(R437 000 R414 000). Since future inventory values are not known it is not possible to
calculate the future effect of the change.

4.2. Change in accounting policy

During the year the company changed its accounting policy in respect of the valuation of
inventory from the last in first out method to the first in first out method. This change was
necessary to ensure fair presentation of the effects of inflation on the company's statement of
financial position. The change in policy was accounted for retrospectively and comparative
amounts have been appropriately restated.

The effect of this change is as follows:

2010
R


2009
R


1/3/2008
R
Decrease in cost of sales
(36 000 23 750) ; (23 750 12 350)

12 250



11 400

Increase in income tax expense
(12 250 x 28%) ; (11 400 x 28%)

(3 430)



(3 192)

Increase in profit 8 820 8 208

Increase in inventory 36 000 23 750 12 350
Increase in current tax liability
(36 000 x 28%)

(10 080)

-

-
Increase in deferred tax liability
(23 750 x 28%) ; (12 350 x 28%)

-

(6 650)

(3 458)
Increase in equity 25 920 17 100 8 892
Adjustment retained earnings at the beginning of
2009
(12 350 - (12 350 x 28%))

8 892

4.3. Correction of error

Correction of error in respect of PAYE due to the SA Revenue in respect of Employees PAYE
in the customer service department. The effect of the correction has been accounted for
retrospectively and comparative amounts have been appropriately restated.

FAC3701/102

29
QUESTION 2 (continued)

2009
R
1/3/2008
R
Increase in expenses (salaries and wages) 60 500
Decrease in current tax expense (60 500 x 28%) (16 940)
Decrease in profit 43 560


Increase in accounts payable/creditors/SA Revenue Service
(60 500 + 48 000 + 42 500) ; (48 000 + 42 500)

151 000

90 500
Decrease in current tax due/liability (SA Revenue Service)
(151 000 x 28%) ; (90 500 x 28%)

(42 280)

(25 340)
Decrease in equity 108 720 65 160


30

5. MAY 2011 EXAMINATION PAPER WITH SOLUTION



QUESTION 1 (54 marks) (65 minutes)



LTea Limited bottles and distributes ice tea. The financial manager of LTea Limited,
Mr G Nhamo, completed the draft financial statements for the year ended 30 September 2010
on 15 November 2010. On 30 November 2010 the board of directors reviewed and authorised
the financial statements for issue.

Included in the profit before tax of LTea Limited for the year ended 30 September 2010,
amounting to R1 450 000, are the following items:
2010
R
Income
Annual agency fees (refer 4) 600 000
Profit on sale of machine (refer 1) 80 000

Expenses
Depreciation - administration building (refer 2) 90 000
Depreciation machinery (refer 1) 74 000
Depreciation - furniture and fittings (refer 2) 150 000

Additional information:

1. On 31 December 2009 the directors of LTea Limited decided to replace an old machine
used for the bottling of ice tea with a new machine. On 31 December 2009 the old
machine was sold for R290 000. The old machine was acquired on 1 October 2008 at a
cost of R280 000. On the date of sale the carrying amount and tax base of the old
machine amounted to R210 000 and R192 500 respectively. On 2 January 2010 a new
machine was acquired for R400 000 and immediately brought into use. The carrying
amount and tax base of the newly acquired machine on 30 September 2010 amounted to
R340 000 and R325 000 respectively. Depreciation on machinery is written off at 20% per
annum according to the straight-line method. Wear and tear on machinery is written off
over 4 years (pro-rata) according to the straight-line method. Wear and tear on machinery
for the year ended 30 September 2010 amounted to R92 500. No other machinery were
acquired or sold during the year.

2. On 1 August 2009, LTea Limited signed a contract with Lester Limited to repair all the
office furniture in their eight storey administration building. The contract stipulated the
contract price to be R200 000, payable on completion of the contract. Lester Limited
estimated that the total cost to repair all the furniture in the administration building of
LTea Limited would amount to R120 000. At 30 September 2009, Lester Limited
completed 25% of the repairs of the furniture (based on the costs incurred to date to total
expected costs). On 30 June 2010 Lester Limited completed the remainder of the
contract. After inspection of the repair work done, LTea Limited issued a cheque on
2 July 2010 for the work completed. The repair expense has been recorded in the
accounting records of LTea Limited according to the requirements of International Finan-
FAC3701/102

31
QUESTION 1 (continued)

cial Reporting Standards. The SA Revenue Service will allow the repair costs as a
deduction when these costs are actually paid. Depreciation on the administration building
is written off at 2% per annum according to the straight-line method. The SA Revenue
Service does not allow any capital allowances on the administration building. Furniture
and fittings are depreciated at 20% per annum according to the straight-line method
which is consistent with the capital allowance on furniture and fittings allowed by the SA
Revenue Service.

3. As a result of the increase in the demand for ice tea, the current warehouse used by
LTea Limited to store the ice tea has become too small. On 30 September 2010 the
directors decided to relocate to a bigger warehouse in a nearby town. Upon cancellation
of the operating lease agreement of the current warehouse, which only expires on
30 September 2011, a penalty of 60% of the outstanding amounts will be payable. The
rental of the warehouse currently amount to R3 500 per month, payable in arrears. The
lease payments for the year ended 30 September 2010 have been paid up to date. The
lease contract stipulates that LTea Limited cannot sublet the warehouse.

4. LTea Limited use independent distribution agents to distribute their ice tea throughout
Africa. These agents need to sign a contract and pay a special agency fee of R90 000 for
the exclusive right to distribute the ice tea in a specific area. These agency fees are
payable in advance in three equal annual instalments over the contract period. The first
instalment of R30 000 is payable on the commencement date of the contract. The annual
agency fees included in profit before tax of LTea Limited for the year ended
30 September 2010 consist of the following:
R
First instalments received relating to contracts commencing on
1 October 2009
240 000
Second instalments received relating to contracts commencing on
1 October 2008
360 000
600 000

The first instalment of agency fees in respect of contracts which only commences on
1 October 2010, amounting to R180 000, was also received in advance in the current
year.

5. LTea Limited increases their inventory levels of ice tea closer to September in order to
provide for the increased demand for ice tea during the summer months. After the draft
financial statements for the year ended 30 September 2010 had been prepared, the
directors decided to change the inventory valuation method of the ice tea in order to
comply with International Financial Reporting Standards. The valuation method was
changed from the last-in-first-out method to the first-in-first-out method. The change in the
inventory valuation method has not been accounted for yet in the accounting records of
LTea Limited for the year ended 30 September 2010.

32
QUESTION 1 (continued)

The value of inventory based on the different valuation methods was as follows:

Last-in,
First-out
First-in,
First-out
Difference
R R R
30 September 2008 190 000 230 000 40 000
30 September 2009 296 000 344 000 48 000
30 September 2010 305 000 355 000 50 000

The SA Revenue Service indicated that they will accept the new inventory valuation
method for tax purposes and that they will not reopen the previous years tax
assessments.

6. The company provides for deferred tax on all temporary differences according to the
statement of financial position approach. There is certainty beyond any reasonable doubt,
that the company will have sufficient taxable profit in future against which any deductible
temporary differences can be utilised. There are no other exempt or temporary
differences except those mentioned in the question.

7. The SA Normal tax rate has remained unchanged at 28% for the past few years. All
capital gains are taxable at 66.6%.

8. The tax assessment of LTea Limited for the year ended 30 September 2009, which was
received on 31 January 2010, showed that the company had an assessed loss of
R130 000, which was in agreement with the accounting records of the company.

9. LTea Limited made the following provisional tax payments for the financial year ended
30 September 2010:
R
31 March 2010 110 000
30 September 2010 70 000
180 000

10. Assume that all amounts are material.




REQUIRED:



1. Prepare the relevant journal entries for additional information (2) above to recognise
revenue in the accounting records of Lester Limited for both the financial years ended
30 September 2009 and 30 September 2010 according to the requirements of IAS 18
Revenue.

The accounting policy of Lester Limited states that the percentage of completion method
is used to recognise revenue. The stage of completion is determined based on the total
costs incurred to date to the total estimated costs.
FAC3701/102

33
QUESTION 1 (continued)

Journal narrations are not required. Ignore the implications of tax. (5)

2. Motivate, with reasons, why the repairs to the office furniture in the administration building
in additional information (2) above should be recognised as an expense in the statement
of profit and loss and other comprehensive income of LTea Limited for the year ended
30 September 2010, according to the requirements of an expense in terms of the
Conceptual Framework for Financial Reporting 2010. (5)

3. Calculate the current tax due by LTea Limited to the SA Revenue Service for the year
ended 30 September 2010. (14)

4. Calculate the deferred tax balance in the statement of financial position of LTea Limited
using the statement of financial position approach for both the years ended
30 September 2009 and 30 September 2010. Indicate if the balance is a deferred tax
asset or deferred tax liability. (10)

5. Disclose the tax rate reconciliation, using R-values only, in the annual financial
statements of LTea Limited for the year ended 30 September 2010, according to the
requirements of IAS 12 Income taxes.
All calculations must be shown.
Comparative figures are not required. (4)

6. Disclose only additional information (5) above in the notes to the annual financial
statements of LTea Limited for the year ended 30 September 2010 according to the
requirements of IAS 8 Accounting policies, changes in accounting estimates and errors.
Comparative figures are required.
No other notes are required.
No accounting policy notes are required. (14)



QUESTION 2 (46 marks) (55 minutes)


Stoneridge Limited is a manufacturer and retailer of car polish and tyres. The annual financial
statements of Stoneridge Limited for the year ended 28 February 2011 were presented to the
board of directors for authorisation for issue on 30 April 2011.

The profit before tax of Stoneridge Limited, before taking into account the additional
information below, for the years ended 28 February 2011 and 28 February 2010 amounted to
R980 000 and R890 000 respectively.

The SA Normal tax rate has remained unchanged at 28% for the past three years.

The company provides for deferred tax on all temporary differences according to the
statement of financial position approach. There is certainty beyond any reasonable doubt, that
the company will have sufficient taxable profit in future against which any deductible
temporary differences can be utilised. There are no other exempt or temporary differences
except those mentioned in the question

34
QUESTION 2 (continued)

Assume that all amounts are material.

Additional information:

1. The accounts receivable balance in the draft statement of financial position of Stoneridge
Limited comprised of the following debtors:
28 February
2011
R
28 February
2010
R
Dash Limited 80 000 90 000
Save Security Limited 120 000 120 000
Glow Limited 110 000 -
Glasstop Limited 60 000 -
370 000 210 000

When the auditors performed the current years debtors circulation it was discovered that
no monies were owed by Save Security Limited (refer above). Stoneridge Limited made
a payment of R120 000 on 1 November 2009 for security services rendered for the period
from 1 November 2009 to 31 October 2010. This payment was then incorrectly allocated
to the accounts receivable account. The effect of this is considered to be material. The
SA Revenue Service indicated that they will re-open the previous years tax assessments.

On 1 November 2010 Stoneridge Limited cancelled the security services arrangement
with Save Security Limited and instituted a claim of R50 000 against Save Security
Limited for failing to protect the premises and warehouse of Stoneridge Limited (refer 3).
The court case is scheduled for 5 April 2011. According to the legal advisors of
Stoneridge Limited there is sufficient evidence against Save Security Limited to prove
that they were negligent when they rendered their services and it is probable that
Stoneridge Limited will be successful with their claim.

2. Stoneridge Limited sells its tyres with a six month warranty against all material defects,
excluding normal wear and tear. The tyres returned will then either be repaired or
replaced free of charge to the customer. The provision for warranty costs for the current
year, which has already been recorded in the accounting records of Stoneridge Limited,
amounted to R100 000 and is based on the following assumptions:
80% of the tyres sold will have no defects,
15% of the tyres sold will have minor defects, and
5% of the tyres sold will have major defects.

However, the recent quality control surveys conducted by Stoneridge Limited during the
financial year ended 28 February 2011 showed that the tyres sold are actually returned
as follows:
90% of the tyres sold will have no defects,
6% of the tyres sold will have minor defects, and
4% of the tyres sold will have major defects.
FAC3701/102

35
QUESTION 2 (continued)

Subsequently the directors decided at a recent board meeting that the warranty provision
does not give an appropriate presentation of the actual warranty costs incurred and that it
should rather be based on the results of the recent quality control surveys. According to
recent quality control surveys, if minor defects are detected in all tyres sold, repair costs
will amount to R400 000 and if major defects are detected in all tyres sold, repair costs
will amount to R800 000.

Actual warranty costs paid in respect of tyres sold with a material defect for the year
ended 28 February 2011 amounted to R90 000 (2010 R70 000). Actual warranty costs
and reversals for warranty costs are debited against the provision for warranty costs and
have already been recorded in the accounting records of Stoneridge Limited. The
balance of the provision for warranty costs for the years ended 28 February 2010 and
28 February 2009 amounted to R120 000 and R80 000 respectively.

3. After recent unrest amongst employees at the premises of Stoneridge Limited three
employees of Stoneridge Limited were dismissed. Subsequently, the trade union to which
these employees belonged instituted a claim of R55 000 against Stoneridge Limited for
the unfair dismissal of these employees. At year end on 28 February 2011 the lawyers of
Stoneridge Limited indicated that the claim against them will probably not succeed. The
recent unrest at the premises of Stoneridge Limited also resulted in extensive damage to
Stoneridge Limiteds warehouse as well as the neighbouring company, Glasstop
Limiteds warehouse. Unfortunately Glasstop Limited was not insured and the damage to
their warehouse led to the company filing for insolvency on 10 April 2011. Glasstop
Limited was also a debtor of Stoneridge Limited and R60 000 relating to Glasstop Limited
(also refer to 1 above) is included in the accounts receivable balance in the statement of
financial position of Stoneridge Limited on 28 February 2011. The liquidators of Glasstop
Limited announced on 20 April 2011 that 0,20 cents in the R1 will be paid on liquidation.
On 1 April 2011 Stoneridge Limited concluded a contract, amounting to R100 000, with
Max Contractors Limited to repair the damage to Stoneridge Limiteds warehouse.

4. The following transactions for the current financial year with National Tyres Limited, a new
customer of Stoneridge Limited, have not been accounted for yet in the accounting
records of Stoneridge Limited:
Tyres with a cost price of R20 000 were sold to National Tyres Limited on consignment.
These tyres are sold at a gross profit of 20% on sales price. At year end on
28 February 2011 National Tyres Limited had not sold 60% of these tyres supplied to
them.

On 1 June 2010 Stoneridge Limited acquired tyre tubes from National Tyres Limited in
exchange for a wheel alignment machine. The fair value of the tyre tubes and wheel
alignment machine amounted to R80 000 and R82 000 respectively. The selling price and
cost price of the wheel alignment machine amounted to R90 000 and R70 000
respectively.
On 24 February 2011, Stoneridge Limited sold polish drums with a cost price
of R16 000 for R22 000 on a cash on delivery basis to National Tyres Limited. At
year end on 28 February 2011 payment for the full order was received. However, on
28 February 2011 only 70% of the polish drums had actually been delivered to the
premises of National Tyres Limited due to transport problems.

36
QUESTION 2 (continued)




REQUIRED:


1. Prepare the necessary correcting journal entry for additional information (2) above in the
accounting records of Stoneridge Limited for the year ended 28 February 2011.

Journal narrations are not required. All calculations must be done to the nearest Rand.
Ignore the effects of taxation. (3)

2. Calculate the profit before tax of Stoneridge Limited for both the years ended
28 February 2011 and 28 February 2010, taking into account all the additional information
above. (11)

3. Calculate the deferred tax balance of Stoneridge Limited for the year ended
28 February 2011, using the statement of financial position approach. Indicate if the
balance is a deferred tax asset or liability. (4)

4. Disclose additional information (1), (2) and (3) above in the notes to the annual financial
statements of Stoneridge Limited for the year ended 28 February 2011, according to the
requirements of IAS 8 Accounting policies, changes in accounting estimates and errors,
IAS 10 Events after the reporting period and IAS 37 Provisions, contingent liabilities
and contingents assets.

Comparative figures are required.
No other notes are required.
No accounting policy notes are required. (27)



Please note:

For all the capital gains tax calculations use 28% x 66,6% to ensure that
rounding does not affect your answer.
Do not round the CGT rate.


FAC3701/102

37




SOLUTION


QUESTION 1

1. Relevant Revenue Journal Entries
R R
Debit Credit
2009
Accounts receivable (25% x 200 000) 50 000
Revenue from services 50 000


2010
Bank 200 000
Accounts receivable 50 000
Revenue (200 000 50 000) 150 000

2. In terms of the definition of an expense it represents:

A decrease in economic benefits
During the accounting period
In the form of outflows (through a decrease (depletion) in assets or an increase
(incurrence) in liabilities)
That result in decreases in equity.(par. 4.25 (b))

Recognition criteria for an expense:

Recognised in the statement of profit and loss and other comprehensive income when a
decrease in future economic benefit related to a decrease in an asset or an increase of a
liability has arisen.
That can be measured reliably.(par. 4.49)

Discussion of the expense:

The amount of the payment is reliably measured in terms of a contract.
The payment for the repairs is made during the current accounting period.
There is a decrease in the bank (assets).
There is a decrease in equity and therefore the payment could be expensed.

Conclusion

The payment for the repairs of the furniture meets both the definition and recognition criteria
and therefore should be expensed in the statement of profit and loss and other
comprehensive income.

38

QUESTION 1 (continued)

3. Calculation of current tax expense for the year ended 30 September 2010
R
Profit before tax 1 450 000
Change in accounting policy accounting (50 000 48 000) 2 000
Adjusted profit before tax 1 452 000
Exempt differences: 86 660
Depreciation administration building 90 000
Capital gain of machine [(290 000 280 000) x (100%-66.6%)] (3 340)
Profit after exempt differences 1 538 660
Temporary difference: 202 200
Depreciation (150 000 + 74 000) 224 000
Wear and tear (150 000 + 92 500) (242 500)
Profit on sale of asset (280 000 210 000) (70 000)
Recoupment on sale of asset (280 000 192 500) 87 500
Provision onerous contract ((3 500 x 12) x 60%) 25 200
Agency fees received in advance 180 000
Change in accounting policy accounting (50 000 48 000) (2 000)
Change in accounting policy tax 50 000
Actual repairs incurred (given) (200 000)
Repairs debited to P/L [200 000 (200 000 x 25%)] 150 000
Taxable income 1 740 860
Less: Assessed loss (130 000)
Taxable income 1 610 860

Current tax @ 28% (R1 610 860 x 28%) 451 041
Provisional tax payments (110 000 + 70 000) (180 000)
Amount due to the SA Revenue Service 271 041

FAC3701/102

39
QUESTION 1 (continued)

4. Calculation of deferred tax balance
2009
Carrying
amount
Tax
base
Temporary
difference
Deferred
tax asset/
(liability)@
28%
R R R R
Provision for repairs
(25% x 200 000)
50 000 - 50 000 14 000
Inventory 344 000 296 000 48 000 (13 440)
Machinery 224 000 210 000 14 000 (3 920)
Assessed loss - 130 000 130 000 36 400
Deferred tax asset 33 040
280 000 (280 000 x 20%)
280 000 (280 000 x 25%)



2010
Carrying
amount
Tax base Temporary
difference
Deferred
tax asset/
(liability)@
28%
R R R R
Machinery 340 000 325 000 15 000 (4 200)
Agency fees received in
advance

180 000

-

180 000

50 400
Provision onerous contract 25 200 - 25 200 7 056
Deferred tax asset 53 256
(3 500 x 12) x 60%

5. Tax rate reconciliation
R
Standard rate of tax (1 452 000 x 28%) 406 560
Adjusted for exempt differences:
Depreciation administration building (90 000 x 28%) 25 200
Capital profit on sale of machinery (3 340 x 28%) (935)
430 825

6. LTEA LIMITED
NOTES FOR THE YEAR ENDED 30 SEPTEMBER 2010

1. Change in accounting policy
During the year the company changed its accounting policy in respect of the valuation of
inventory from the last-in-first-out method to the first-in-first-out method. This change was
necessary to ensure that the company complies with International Financial Reporting
Standards . The change in policy was accounted for retrospectively and comparative amounts

40
QUESTION 1 (continued)

have been appropriately restated.

The effect of this change is as follows:

2010 2009 1/10/2008
R R R
Decrease in cost of sales
(50 000 48 000); (48 000 40 000)
2 000 8 000
Increase in income tax expenses
(2 000 x 28%); (8 000 x 28%)
(560) (2 240)
Increase in profit 1 440 5 760

2010 2009 1/10/2008
R R R

Increase in inventory

50 000

48 000

40 000
Increase in current tax liability/SA Revenue Service
(50 000 x 28%)

(14 000)

-

-
Increase in deferred tax liability
(48 000 x 28%);(40 000 x 28%)

-

(13 440)

(11 200)
Increase in equity 36 000 34 560 28 800
Adjustment to retained earnings at the beginning of
2009 (40 000 x 72%)

28 800

QUESTION 2

1. Correcting journal entry
R R
Debit Credit

Provision for warranty costs 44 000
1

Warranty Costs 44 000

1
[100 000 (400 000 x 6%) (800 000 x 4%)]
FAC3701/102

41
QUESTION 2 (continued)

2. Calculation of profit before tax
2011 2010
R R
Profit before tax (given) 980 000 890 000
Security services incorrectly allocated
(120 000 x );(120 000 x )
(80 000) (40 000)
Provision for warranties 44 000 -
[100 000 (6% x 400 000) (4% x 800 000)]
Bad debts written off neighbouring warehouse (48 000) -
(60 000 x (100 - 20))
Consignment sales (20 000 x x (100 60)) 10 000 -
Cost of sales (20 000 x (100 60)) (8 000) -
Sales recognised at fair value tyre tubes 80 000 -
Cost of sales on wheel alignment machine (given) (70 000) -
Sales COD sales (22 000 x 70%) 15 400 -
Cost of sales COD Sales (16 000 x 70%) (11 200) -
912 200 850 000

3. Calculation of deferred tax balance at 28 February 2011
Carrying
Amount
Tax
base
Temporary
difference
Deferred tax
asset/
(liability)@28%
R R R R
COD sales 6 600 - 6 600 1 848
Provision for warranties 56 000 - 56 000 15 680
Deferred tax asset 17 528

22 000 x (100% - 70%)
(400 000 x 6%) + (800 000 x 4%)

4. STONERIDGE LIMITED

NOTES FOR THE YEAR ENDED 28 FEBRUARY 2011.

Profit before tax

1. Change in warranty provision

Included in profit before tax is a change in accounting estimate that arose from the decision to
change the estimates used as a basis for making the provision for warranty costs due to the
results of recent quality control surveys. This change in estimate resulted in a decrease in
provision for warranty claims created of R44 000. The cumulative effect of this on future
periods is unknown.

42
QUESTION 2 (continued)

2. Prior year error

Correction of security expenses incorrectly accounted for as debtors. The comparative
amounts have been appropriately restated. The effect of this error on the results of 2010 is as
follows:

2010
R
Increase in expenses (120 000 x )
40 000
Decrease in tax expense (40 000 x 28%) (11 200)
Decrease in profit 28 800
Decrease in accounts receivable 120 000
Increase in expenses prepaid (120 000 x )
(80 000)
40 000
Decrease in current tax liability/SARS (40 000 x 28%) (11 200)
Decrease in equity 28 800

3. Provision for warranty cost
2011 2010
R R
Carrying amount beginning of the year 120 000 80 000
Amount used during the year (90 000) (70 000)
Reversal of unused provision (30 000) (10 000)
(120 000 - 90 000), ( 80 000 - 70 000)
Provision created for the year
(6% x 400 000) + (4% x 800 000) 56 000 120 000
Carrying amount end of year 56 000 120 000

A provision of R56 000 has been recognised for the current year for expected warranty costs
for tyres sold based on recent quality control surveys.

4. Events after reporting period.

Contracts for capital expenditure/repairs.

On 1 April 2011 a contract was concluded with Max Contractors limited to repair damages to
a warehouse for R100 000 due to labour unrest.

5. Contingent liability

During the year, the employees trade union of Stoneridge limited instituted a claim of R55 000
for dismissal of its three employees. At year end the lawyers of Stoneridge Limited have
indicated that the claim against Stoneridge Limited will probably not succeed.

6. Contingent asset

Stoneridge Limited instituted a claim against Save Security Limited during the financial year of
R50 000 for failing to protect the premises of Stoneridge Limited. The companys legal
advisors are of the opinion that Stoneridge Limiteds claim will probably succeed.
FAC3701/102

43
6. OCTOBER 2011 - EXAMINATION PAPER WITH SOLUTION




QUESTION 1 (46 marks) (55 minutes)


The following information relates to Rainbow Limited, a manufacturer and retailer of paints, for
the year ended 28 February 2011:

1. The profit before tax of Rainbow Limited for the year ended 28 February 2011 amounted
to R690 000, according to the draft financial statements compiled by an inexperienced
accounting clerk. The revenue of Rainbow Limited for the year ended 28 February 2011
consisted of the following: royalties received amounting to R485 000 (2010: R220 000),
cash on delivery sales amounting to R350 000 (2010: R50 000) and credit sales
amounting to R250 000 (2010: R40 000).
Included in cash on delivery sales above is an amount of R40 000 received on
2 February 2011 from Glow Limited in respect of an order for paints which was only
despatched to Glow Limited on 10 March 2011.
Included in credit sales above is an amount of R10 000 owing by Stone Limited to
Rainbow Limited. However on 10 April 2011 Stone Limited indicated that they are
unable to pay the moneys due as they were placed under liquidation and its creditors
will probably only receive 10 cent in the rand as a liquidation dividend.

Included in other income of Rainbow Limited for the year ended 28 February 2011 are
dividends received from an unlisted investment amounting to R60 000 (2010: R20 000)
and an amount of R12 000 in respect of a profit realised on the sale of Machine Max.
Machine Max was originally purchased on 1 March 2008 at a cost of R20 000 and sold on
1 March 2010 for R24 000. The carrying amount and tax base of Machine Max on date of
sale amounted to R12 000 and R10 000 respectively.

2. Rainbow Limited purchased all its machinery on 1 March 2008 at a cost of R500 000
(excluding Machine Max) on which date it was estimated that the machinery will have a
useful life of 5 years and a Rnil residual value. After the draft financial statements have
been prepared, the directors of Rainbow Limited re-estimated the remaining useful life of
machinery and determined that their remaining useful life is actually only 2 years as they
are already used to their full capacity. The residual value of the machinery remained
unchanged at Rnil. On 28 February 2010 the carrying amount and the tax base of the
machinery (excluding Machine Max) amounted to R300 000 and R250 000 respectively.
This change in the useful life of machinery has not been recorded yet in the draft financial
statements of Rainbow Limited for the year ended 28 February 2011. The
SA Revenue Service allows a capital allowance on machinery over 4 years according to
the straight-line method. No other machinery were purchased or sold during the year
except for Machine Max.

3. Included in current liabilities in the statement of financial position of Rainbow Limited at
28 February 2011 is an amount of R20 000 in respect of royalties received for the period
from 1 March 2011 to 30 June 2011 for the patent rights of quick dry paint manufactured
by Rainbow Limited.

44
QUESTION 1 (continued)
4. The inexperienced accounting clerk made the following entries for the current year in the
current tax due to the SA Revenue Service account in the general ledger of Rainbow
Limited:
Dr SA Revenue Service current tax Cr
31/08/2010


30/09/2010
Bank (1
st
provisional
tax payment for
2011)
Bank (final payment
of assessment for
2010, including
R4 000 interest and
R6 000 penalties for
the late submission
of tax return)
50 000


15 000
01/03/2010 Balance
(relating
to 2010
tax year)
b/d 20 000





28/02/2011 Balance c/d 115 000
28/02/2011 Bank (2
nd
provisional
tax payment for
2011)
70 000

135 000

135 000
01/03/2011 Balance b/d 115 000


No provision for current tax has been made yet in the draft financial statements for the
year ended 28 February 2011.
5. The SA Normal tax rate changed from 29% in 2010 to 28% in 2011. 66.6% of all capital
gains are taxable. The company provides for deferred tax on all temporary differences
according to the statement of financial position approach. There are no other exempt or
temporary differences except those mentioned in the question. There is certainty beyond
any reasonable doubt, that the company will have sufficient taxable profit in the future
against which any deductible temporary differences can be utilised. The deferred tax
liability balance on 28 February 2010 amounted to R15 080, which you can assume to
be correct.
6. The financial statements of Rainbow Limited for the year ended 28 February 2011 were
presented to the board of directors for authorisation for issue on 20 April 2011.
7. Ignore any VAT implications.
8. Assume all amounts to be material.
FAC3701/102

45
QUESTION 1 (continued)




REQUIRED:



1. Calculate the correct profit before tax in the statement of profit or loss and other
comprehensive income of Rainbow Limited for the year ended 28 February 2011 taking
into account all the above mentioned information. (5)

2. Calculate the current tax due to the SA Revenue Service by Rainbow Limited for the year
ended 28 February 2011. Use the profit before tax in the statement of profit or loss and
other comprehensive income as calculated in (1) above as your starting point. (10)

3. Calculate the deferred tax balance in the statement of financial position of Rainbow
Limited for the year ended 28 February 2011 using the statement of financial position
approach, according to the requirements of IAS 12 Income taxes. Indicate if your
answer is a deferred tax asset or deferred tax liability. (6)

4. Disclose the tax rate reconciliation, using R-values only, in the annual financial
statements of Rainbow Limited for the year ended 28 February 2011, according to the
requirements of IAS 12 Income taxes.

All calculations must be shown.
Comparative figures are not required. (11)

5. Disclose (1) and (2) in the notes to the annual financial statements of Rainbow Limited for
the year ended 28 February 2011, according to the requirements of only IAS 8
Accounting policies, changes in accounting estimates and errors and IAS 18 Revenue.
Comparative figures are required.
No other notes are required.
No accounting policy notes are required. (14)



QUESTION 2 (54 marks) (65 minutes)


Bemington Limited is a manufacturer and retailer of cosmetic products and appliances. Their
products are sold at their own retail outlet in Isipingo, Durban as well as to various chain
stores. The annual financial statements of Bemington Limited for the year ended
28 February 2011 were presented to the board of directors for authorisation for issue on
25 April 2011.

The company provides for deferred tax on all temporary differences according to the
statement of financial position approach. There are no other exempt or temporary differences

46
QUESTION 2 (continued)

except those mentioned in the question. There is certainty beyond reasonable doubt that
there will be sufficient taxable profit in future against which any deductible temporary
differences can be utilised.

The SA Normal tax rate has remained unchanged at 28% for the past three years.

Ignore any VAT implications.

Assume all amounts to be material.

Additional information

1. Bemington Limited has a policy to refund purchases of electric shavers sold within 2
months from the date of sale to dissatisfied customers. This refund policy is generally
known and advertised in the insert packages of the electric shavers sold. A provision for
refunds amounting to R25 000 was made in the annual financial statements of Bemington
Limited for the year ended 28 February 2010 (2009: Rnil), based on the past sales and
refund history of these electric shavers. During the current financial year R30 000 was
paid to dissatisfied customers for electric shavers sold of which R9 000 related to sales of
electric shavers for the year ended 28 February 2010. The financial director estimated,
based on the sales for the year and the refund history, that R40 000 will most probably be
refunded to dissatisfied customers in the first two months of the next financial year for
electric shavers sold during the year ended 28 February 2011. The manufacturer of the
electric shavers also provides a guarantee to Bemington Limited for any manufacturing
defects on these electric shavers. At year end on 28 February 2011 it is probable, but not
virtually certain, that 60% of these estimated costs will be refunded by the manufacturer
of these electric shavers to Bemington Limited.

2. During February 2011 Blue Cross Limited, an animal activist group, instituted a claim of
R100 000 against Bemington Limited. The group claims that Bemington Limited tested
cosmetic products on animals, resulting in animals being injured in the process. At year
end on 28 February 2011, the legal advisor of Bemington Limited is of the opinion that it
is probable that Bemington Limited will not be found liable for the claim.

3. Bemington Limited valued all its inventory according to the last-in, first-out method. After
the draft financial statements for the year ended 28 February 2011 had been prepared,
the directors decided at a board meeting that the current inventory valuation method
should be changed to the first-in, first-out method in order to improve the matching of
revenue and expenses. Unfortunately the inventory valuations according to the first-in,
first-out method for all the years prior to 2011 could not be determined due to a
malfunction in the computer program which is used for the costing of inventory.

The inventory valuation according to the different methods on 28 February 2011 is as
follows:

Raw
Materials
Work in
progress
Finished
goods

Total
R R R R
First-in, first out method 88 000 120 000 370 000 578 000
Last-in, first out method 78 000 108 000 340 000 526 000

FAC3701/102

47
QUESTION 2 (continued)

The SA Revenue Service has indicated that they will accept the new inventory valuation
method for tax purposes.
During the current years audit it was discovered that finished goods inventory located at
the Isipingo retail outlet, was inadvertently excluded in the abovementioned inventory
valuations since the 2009 financial year.
The value of finished goods inventory located at the Isipingo retail outlet on the respective
dates was as follows:
Last-in,
first-out
First-in,
first-out
R R
28 February 2009 115 000 ?
28 February 2010 20 000 ?
28 February 2011 110 000 120 000

The SA Revenue Service has already indicated that they will re-open all the previous
years tax assessments as both the change in the inventory valuation method and the
exclusion of finished goods located at the Isipingo retail outlet are considered material.
During the first week of April 2011 a water pipe burst in the Isipingo retail outlet resulting
in damage to finished goods with a cost price of R60 000. The company was not insured
for these damages at the time.
4. Mr Wiseman, an inexperienced accountant recently employed by Bemington Limited,
recorded the following journal entries in the accounting records of Bemington Limited for
the year ended 28 February 2011:
Journal
no
Description Debit
R
Credit
R
(i)
Debtors (SFP)
#

Revenue (P/L)*
Recording of generic products supplied to various
chain stores.

800 000
800 000
(ii)
Bank (SFP)
#

Revenue (P/L)*
Recording of gift vouchers sold in exchange for
merchandise at discounted prices.
50 000
50 000

(SFP)
#
: Statement of financial position
(P/L)*: Statement of profit of loss and other comprehensive income

48
QUESTION 2 (continued)
During a review of the journal entries and subsequent discussions with the inexperienced
accountant, Mr Wiseman, it was confirmed that the above journal entries were the only
entries made in the accounting records of Bemington Limited for the year ended
28 February 2011 in respect of the information detailed below:
(i) During January 2011, Bemington Limited started to manufacture generic cosmetic
products. These generic cosmetic products are sold on consignment basis. Generic
cosmetic products with a sales price of R800 000 were supplied on a consignment basis
in January 2011 to the various chain stores at a gross profit of 25% on cost price. At year
end on 28 February 2011, the various chain stores had only sold 40% of the consignment
inventory supplied to them during the current year by Bemington Limited, but no moneys
have been received from the chain stores in respect of these consignment sales yet.

(ii) During the current year the Isipingo retail outlet in Durban sold gift vouchers amounting to
R50 000, in exchange for the issue of cosmetic products to the bearer at a discount of
25% on selling price, in an attempt to increase the turnover of the company. At year end
on 28 February 2011, no cosmetic products have been issued at discounted prices yet as
no gift vouchers have been redeemed.



REQUIRED:


1. Motivate with reasons, why a provision for refunds in additional information (1) should be
raised in the accounting records of Bemington Limited for the year ended
28 February 2011 according to the requirements of a liability in terms of the The
Conceptual Framework for Financial Reporting 2010. (5)
2. Disclose additional information (1) and (2) above in the notes to the annual financial
statements of Bemington Limited for the year ended 28 February 2011, according to the
requirements of only IAS 37 Provisions, contingent liabilities and contingent assets.
No accounting policy notes are required.
Comparative figures are required. (14)

3. Disclose additional information (3) above in the notes to the annual financial statements
of Bemington Limited for the year ended 28 February 2011, according to the
requirements of only IAS 8 Accounting policies, changes in accounting estimates and
errors and IAS 10 Events after the reporting period.

No accounting policy notes are required.
Comparative figures are required. (24)

4. Prepare the additional and correcting journals in the books of Bemington Limited
taking into account all the additional information in (4) above, for the year ended
28 February 2011. Use the journal number provided in the question as your point of
reference. Indicate if it is a statement of financial position (SFP) or statement of profit or
loss and other comprehensive income (P/L) general ledger account in your journal.
FAC3701/102

49

QUESTION 2 (continued)
Journal narrations are not required.
Ignore all tax implications. (7)

5. Calculate the deferred tax balance in the statement of financial position of
Bemington Limited for the year ended 28 February 2011 using the statement of
financial position approach. Indicate if your answer is a deferred tax asset or deferred
tax liability in the statement of financial position. (3)


Please note:

For all the capital gains tax calculations use 28% x 66,6% to ensure that
rounding does not affect your answer.
Do not round the CGT rate.





SOLUTION



QUESTION 1

1. Calculation of profit before tax for the financial year ended 28 February 2011:

R
Profit before tax (given) 690 000
Change in estimate depreciation
2
) 00 0 300 (
-
5
) 00 0 500 (
(50 000)
Cash on delivery sales - reversed (40 000)
Bad debts written off (10 000 x 90%) (9 000)
Interest tax 2010 (4 000)
Penalties tax 2010 (6 000)
581 000


50
QUESTION 1 (continued)

2. Calculation of current tax due to SA Revenue Service for the financial year ended
28 February 2011:


Profit before tax (from required 1)
R
581 000
Exempt differences (51 336)
Dividends received (60 000)
Interest on tax 4 000
Penalties on late submission of return 6 000
Capital profit on sale of machine (24 000 - 20 000) x (100% - 66.6%) (1 336)
Temporary differences 87 000
Depreciation 150 000
Wear and tear - machinery (500 000 /4) (125 000)
Cash on delivery sales 40 000
Royalties received in advance 20 000
Recoupment on sale of machine (20 000 - 10 000) 10 000
Profit on sale of machine (20 000 - 12 000) (8 000)
Taxable income 616 664

Current tax (616 664 x 28%) 172 666
Provisional tax paid (50 000 + 70 000) (120 000)
52 666

3. Calculation of the deferred tax balance in the statement of financial position of
Rainbow Limited for the financial year ended 28 February 2011:
Carrying
amount


R
Tax
base


R
Temporary
difference


R
Deferred
tax asset/
(liability)
@ 28%
R
Royalties received in
advance
20 000 - 20 000 5 600
Machinery 150 000
1
125 000
2
25 000 (7 000)
Cash on delivery sales 40 000 - 40 000 11 200
Deferred tax asset 9 800
1
300 000 150 000
2
250 000 (500 000 x 25%

4. Tax rate reconciliation
R
Standard tax rate (581 000 x 28%) 162 680
Adjusted for exempt differences
Dividends received (60 000 x 28%) (16 800)
Change in tax rate (15 080 x 1/29) (520)
Interest on tax (4 000 x 28%) 1 120
Penalties (6 000 x 28%) 1 680
Capital profit on sale of machine (1 336 x 28%) (374)
Overprovision 2010 (20 000 (15 000 4 000 6 000)) (15 000)
132 786

FAC3701/102

51

QUESTION 1 (continued)

5. RAINBOW LIMITED
NOTES FOR THE YEAR ENDED 28 FEBRUARY 2011

Profit before tax

Revenue

2011
R
2010
R
Royalties received 485 000 220 000
Sale of goods 560 000 90 000
(250 000 + (350 000 40 000); (40 000 + 50 000)
Other income
Dividends received 60 000 20 000
Profit on sale of machinery 12 000 -
Expenses
Depreciation (500 000 + 20 000)/5 150 000 104 000

Included in depreciation for 2011 is a change in estimate resulting in an increase in
depreciation in machinery for the year of R50 000 (150 000 100 000) that arose from
the decision to change the remaining useful life of machinery in the current year to two
years as the machinery are already used to full capacity. This change will result in a
decrease of depreciation in future periods of R50 000.

QUESTION 2
1. Discussion in terms of the Conceptual Framework for Financial Reporting 2010
In order to recognise the provision for refunds as a liability both the definition of a liability as
well as the recognition criteria of a liability must be met in terms of the Conceptual Framework
for Financial Reporting 2010.

In terms of the liability definition
There must be a present obligation,
As a result of a past event, and
The settlement of which is expected to result in an outflow of future economic benefits
(par.4.25(b))

In terms of the recognition criteria a liability which meets the definition of a liability may only
be recognised as a liability in the financial statements if:

It is probable that future economic benefits will flow from the entity, and
The element has a cost or value that can be measured reliably (par 4.49)

Discussion
The provision for refunds meets the definition of a liability.

52
QUESTION 2 (continued)

The past event is the selling of electric shavers during the current year to customers by
Bemington Limited.
There is a present obligation as the guarantee of refunds is advertised in the package
insert and it is generally known.
The settlement of the obligation will result in outflow of cash (refunds) when customers
return the electric shavers to Bemington Limited.

The provision for refunds meets the recognition criteria

The value can be measured reliably as it is based on past sales and refund history of
Bemington Limited.
The outflow of future economic benefits is probable.

Conclusion

Since both the definition and the recognition criteria have been met, the provision for refunds
should be treated as a liability in the financial statements.

2. BEMINGTON LIMITED
NOTES FOR THE YEAR ENDED 28 FEBRUARY 2011
2.1 Provisions for refunds
2011
R
2010
R
Carrying amount beginning of year 25 000 -
Amount used during the year (9 000) -
Unused amount reversed during the year/(transferred to
income)
(16 000) -
(25 000 9 000)
Provision made during the year 40 000 25 000
Carrying amount end of year 40 000 25 000


Provision has been made for the refund of purchases for electric shavers sold to
dissatisfied customers within two months of the date of sale. It is expected to be incurred
within the first two months of the next financial year.

2.2 Contingent liability

A claim of R100 000 was received during the year for animal abuse from Blue Cross
Limited. The companys legal advisor is of the opinion that it is probable that the company
will not be found liable for the claim.

2.3 Contingent asset

Bemington Limited sells its electric shavers, with a guarantee against manufacturing
defects by the supplier/ manufacturer of the electric shavers. It is probable but not
virtually certain that R24 000 (60% x 40 000) of the electric shavers sold will be
reimbursed by the manufacturer.
FAC3701/102

53
QUESTION 2 (continued)

3. BEMINGTON LIMITED
NOTES FOR THE YEAR ENDED 28 FEBRUARY 2011

3.1 Events after the reporting period

During the first week of April 2011, finished goods with a cost of R60 000 at the Isipingo
retail outlet were damaged due to a water pipe that burst.

3.2 Error in respect of the prior year

Correction of error relating to the discovery of finished goods located at the Isipingo retail
outlet not included in finished inventories at year end since 2009. The opening balance of
retained earnings at the beginning of 2010 was adjusted while the comparative amounts
were restated accordingly. The effect of the adjustment of this error is as follows:

2010
R
1/3/2009
R
(Increase) in cost of sales ( 115 000 20 000) (95 000)
Decrease in taxation expense (95 000 x 28%) 26 600
(Decrease) in profit (68 400)

Increase in inventory 20 000 115 000
Increase in current taxation due/ SA Revenue Service
(20 000 x 28%); (115 000 x 28%)

(5 600)

(32 200)
Increase in equity 14 400 82 800


Adjustment to retained earnings at the beginning of 2010
(115 000 (115 000 x 28%))

82 800

3.3 Change in accounting policy

The company changed its current inventory valuation method from the last-in, first-out
method to the first-in, first-out method in order to improve the matching of income and
expenses. It is not possible to account for this change retrospectively as the value of
inventories cannot be determined on the first-in, first-out method on 28 February 2010
due to a malfunction in the computer program.

Consequently the change has been accounted for prospectively, without any adjustment
against the opening balance of retained earnings. The effect of the change in policy on
the results for 2011 is as follows:

54
QUESTION 2 (continued)
2011
R
Decrease in cost of sales (578 000 + 120 000 (526 000 + 110 000) 62 000
Increase in income tax expense (62 000 x 28%) (17 360)
Increase in profit for the year 44 640

Increase in inventory 62 000
Increase in current tax liability/SA Revenue Service (62 000 x 28%) (17 360)
Increase in equity 44 640

4. Journal entries for the financial year ended 28 February 2011
Debit Credit
R R
(i) Revenue(P/L) (800 000 x (100 40) 480 000
Debtors(SFP)
Recording correction to consignment
sales incorrectly recognised
480 000

(ii) Cost of Sales (P/L) (800 000 x 40% x 100/125) 256 000
Inventory (SFP)
Recording cost of sales on consignment inventory sold
256 000

(iii) Revenue (P/L) 50 000
Income received in advance(SFP) 50 000
Recording incorrect recognition of revenue reversed for gift
vouchers not redeemed



5. Calculation of deferred tax balance of Bemington Limited in the statement of
financial position for the year ended 28 February 2011.

2011 Carrying
amount
Tax base Temporary
difference
Deferred
tax asset/
(liability)@
28%
R R R R
Provision for claims 40 000 - 40 000 11 200
Income received in advance 50 000 - 50 000 14 000
Deferred tax asset 25 200



FAC3701/102

55

7. MAY 2012 EXAMINATION PAPER WITH SOLUTION


QUESTION 1 (52 marks) (62 minutes)


PastryCook Limited is a manufacturer of biscuit machines which are sold to various retail
stores throughout South Africa. PastryCook Limited also owns various bakeries selling a
range of biscuits and pastries baked at their premises. The profit before tax of PastryCook
Limited in the draft financial statements for the year ended 31 December 2011 amounted to
R1 250 000, before taking into account any adjustments as a result of the additional
information below.

Additional information
1. During the last quarter of the current financial year PastryCook Limited launched the
following two new sales initiatives:
1.1 On 1 October 2011 a customer loyalty programme was launched awarding the
participating customers with one loyalty credit for every R50 spent on the purchase of
biscuits. The management of PastryCook Limited estimate the fair value and cost of
each loyalty credit to be R1,20. The loyalty credits earned during the first three
months of the programme will only be redeemable from 1 January 2012 in exchange
for discounted items. The biscuits are sold at a gross profit of 25% on cost price.
Only the following journals have been recorded in the accounting records of
PastryCook Limited for the year ended 31 December 2011, relating to the sales of
biscuits for the period 1 October 2011 to 31 December 2011:


Debit
R
Credit
R
Bank 225 000
Sales 225 000

Cost of sales 180 000
Inventory 180 000

1.2 In November 2011 PastryCook Limited signed a contract with Publications Limited to
provide PastryCook Limited with two of the most popular recipe magazines monthly
on a consignment basis from 1 December 2011. Recipe magazines are sold to
customers at a gross profit percentage of 30% on cost. At year end on
31 December 2011 only 80% of the recipe magazine stock had been sold to
customers and all the unsold recipe magazines returned to Publications Limited.
Only the following journal entry has been recorded in the accounting records of
PastryCook Limited for the year ended 31 December 2011, relating to the
consignment stock supplied by Publications Limited at cost:


Debit
R
Credit
R
Inventory 70 000
Accounts Payable 70 000

56
QUESTION 1 (continued)

2. On 30 April 2011, a new more advanced biscuit baking oven was acquired and installed
at PastryCook Limiteds premises in order to reduce the baking time of the biscuits and
increase capacity. It was immediately put into use on this date. Subsequently, on
1 July 2011, the old baking oven, originally acquired on 1 January 2009 was sold
resulting in an accounting loss of R50 000. The details of the new and old baking ovens
are as follows:
New baking
oven
R
Old baking
oven
R
Cost 240 000 120 000
Carrying amount 31 December 2010 N/A 72 000
Carrying amount 30 April 2011 240 000 64 000
Carrying amount 1 July 2011 232 000 60 000
Carrying amount 31 December 2011 208 000 N/A
Tax base 31 December 2010 N/A 60 000

The depreciation on both of the baking ovens as well as the accounting loss on the sale
of the old baking oven have already been recorded in the draft financial statements of
PastryCook Limited for the year ended 31 December 2011. The tax allowance on baking
ovens is 4 years (pro-rata) according to the straight-line method.
3. After the draft financial statements for the year ended 31 December 2011 had been
prepared, the directors decided to change the inventory valuation method as this will
result in a fair presentation of the financial position and operating results of the company
because of fluctuations in inventory prices. The valuation method was changed from the
last-in, first-out method to the first-in, first-out method. The change in the inventory
valuation method has not been accounted for yet in the accounting records of
PastryCook Limited for the year ended 31 December 2011.
The value of inventory based on the different valuation methods was as follows:
Last-in,
First-out
First-in,
First-out
Difference
R R R
31 December 2009 380 000 389 000 9 000
31 December 2010 420 000 445 000 25 000
31 December 2011 470 000 508 000 38 000

The SA Revenue Service indicated that they will accept the new inventory valuation
method for tax purposes, but they will not reopen the previous years tax assessments.
FAC3701/102

57

QUESTION 1 (continued)

4. On 1 November 2010 PastryCook Limited discovered a material manufacturing defect in
a specific range of biscuit machines manufactured. The company decided to repair all the
defective biscuit machines already sold to customers free of charge. At the time
management estimated that costs of R110 000 would have to be incurred to repair these
defective biscuit machines already sold and subsequently raised a provision for these
costs on 1 November 2010. On 1 December 2010 and 31 March 2011, costs of R28 000
and R102 000 respectively were paid cash to repair these defective biscuit machines
manufactured. At 31 December 2011 it is expected that no further costs to repair these
defective biscuit machines manufactured will have to be incurred in the next financial
year.

Only the following entries have been made by the inexperienced accounting clerk in the
provision for manufacturing defects account in the general ledger of PastryCook
Limited:

Dr Provision for manufacturing defects Cr
01/12/2010 Bank 28 000 01/11/2010 Claims (P/L) 110 000
31/03/2011 Bank 102 000 31/12/2011 Balance c/d 20 000
130 000 130 000
01/01/2012 Balance b/d 20 000

5. During the current financial year, PastryCook Limited made the following payments to the
SA Revenue Service in respect of the 2011 tax year:
R
30 August 2011 (1
st
provisional tax payment) 120 000
30 August 2011 (fines for late submission of 1
st
provisional tax payment) 5 500
31 December 2011 (2
nd
provisional tax payment) 110 000
235 500

6. The financial manager agreed with the tax assessment of PastryCook Limited for the year
ended 31 December 2010, which showed an underprovision of R8 000 for the 2010 tax
year due to an incorrect tax calculation by PastryCook Limited.

7. The profit before tax of PastryCook Limited for the year ended 31 December 2011
includes foreign income of R50 000, which is not taxable in South Africa in terms of a
double taxation agreement. The company paid foreign taxes of R6 500 on this income.

8. Deferred tax is provided for on all temporary differences according to the statement of
financial position approach. The company will have sufficient taxable profit in future
against which any unused tax losses can be utilised. There are no other items causing
temporary or exempt differences except those identified in the question.

9. The SA Normal tax rate is 28%.

10. Assume that all amounts are material.

58

QUESTION 1 (continued)




REQUIRED:


1. Prepare the correcting journal entry for additional information (1.1) above in the
accounting records of PastryCook Limited for the year ended 31 December 2011
according to the requirements of IAS 18 Revenue.
The accounting policy of PastryCook Limited states that the award credits are measured
at the fair value of the credits.
Journal narrations are not required.

No abbreviations for the general ledger account names in your journal must be used.

Ignore the implications of tax. (2)
2. Calculate the correct profit before tax in the statement of profit or loss and other
comprehensive income (statement of comprehensive income) of PastryCook Limited for
the year ended 31 December 2011 taking into account all the additional information
above. (4)

3. Calculate the current tax due by PastryCook Limited to the SA Revenue Service for the
year ended 31 December 2011. Use the profit before tax calculated in (2) above as your
starting point. (13)

4. Calculate the deferred tax balance in the statement of financial position of PastryCook
Limited using the statement of financial position approach for both the years ended
31 December 2010 and 31 December 2011. Indicate if the balance is a deferred tax asset
or liability in the statement of financial position of PastryCook Limited. (6)

5. Disclose the tax rate reconciliation, using R-values only, in the annual financial
statements of PastryCook Limited for the year ended 31 December 2011, according to
the requirements of IAS 12 Income taxes.
All calculations must be shown.
Comparative figures are not required. (5)

6. Disclose additional information (3) and (4) above in the notes to the annual financial
statements of PastryCook Limited for the year ended 31 December 2011 according to the
requirements of only IAS 8 Accounting policies, changes in accounting estimates and
errors and IAS 37 Provisions, contingent liabilities and contingent assets.
Comparative figures are required.
No other notes are required.
No accounting policy notes are required. (20)
FAC3701/102

59



QUESTION 2 (48 marks) (58 minutes)


THIS QUESTION CONSISTS OF 2 INDEPENDENT PARTS

PART A

MallWart Limited is an international retail company specializing in the sale of numerous
consumer goods. Their aim is to maximize profit through increased sales volumes at low profit
margins. MallWart Limited entered the South African retail market four years ago after a
takeover of SmallCart Limited, a company operating various retail stores across South Africa.

The SA Normal tax rate is 28%.

Assume all amounts to be material.

Additional information

1. Customers in the retail stores of MallWart Limited sign a 36 month 3G internet contract
with an independent company NCC Cellular to purchase a 1Gig internet bundle. The
contracts also have an option for the customer to purchase a Bell Laptop, with a retail
value of R10 000 each, for an additional R350 per month over the 36 month contract
period. MallWart Limited supplies the laptop to the customer and is subsequently fully
reimbursed by NCC Cellular for the retail value on inception date of the contract. NCC
Cellular provides all the warranties and technical assistance to customers. The cost price
of the Bell Laptops amount to R8 000 each. NCC Cellular pays MallWart Limited
commission amounting to R500 per contract. During the current financial year customers
signed 110 3G contracts in the retail stores of MallWart Limited of which 60 included a
laptop.

During the audit finding meeting the financial manager of MallWart Limited indicated that
the commission earned on the 3G contracts as well as the sale of the laptops, subject to
the 3G contracts, have not been recorded yet in the accounting records of MallWart
Limited as he was unsure about the accounting treatment thereof. At year end on
29 February 2012 both the commission as well as the reimbursement of the laptops are
still outstanding and due by NCC Cellular.

2. On 1 March 2010 MallWart Limited purchased and installed wage clock machines at their
retail stores as a result of irregular claims made by employees for overtime hours worked.
During the current financial years audit it was discovered that MallWart Limited
incorrectly debited the costs of the wage clock machines amounting to R850 000 to the
wages account in the previous financial year. MallWart Limited depreciates the wage
clock machines over 5 years according to the straight-line method. The SA Revenue
Service allows a tax allowance over 3 years on wage clock machines according to the
straight-line method.

The tax effect of the above misallocation is considered to be material and the SA
Revenue Service indicated that they will reopen the tax assessment for the prior year.

60

QUESTION 2 (continued)

3. MallWart Limited recognize a provision for expected warranty costs to be incurred relating
to all electronic products sold during the past 3 years with a 3 year warranty against any
manufacturing defects. This policy is well advertised in the product brochures distributed
by MallWart Limited. During the current financial year, the directors of MallWart Limited
decided to change the policy for warranty provisions. This decision was based on the
continuous improved quality of MallWart Limiteds products, which resulted in a significant
decrease in warranty claims from clients of MallWart Limited. The new policy will give a
more realistic valuation of expected future warranty costs.

The warranty provision already provided and accounted for in the draft financial
statements for the year ended 29 February 2012 was calculated as follows:
The sum of:
4% of sales in the current financial year; and
3% of sales that took place in the previous financial year; and
2% of sales in the year preceding the previous financial year.

In future the warranty provision will be based on the assumption that only 5% of sales of
electronic products in the current financial year will be returned in the future due to
manufacturing defects. This change in the basis of the calculation of the warranty
provision has not been accounted for yet in the draft financial statements for the current
year.

The total sales value of electronic products sold with a 3 year warranty were as follows:

R

29 February 2012 4 600 000
28 February 2011 3 300 000
28 February 2010 2 500 000

4. On 31 January 2012 the Labour Union representing MallWart Limiteds employees
instituted a claim of R400 000 against MallWart Limited for not adhering to the original
terms as agreed upon during the takeover of SmallCart Limited. MallWart Limited
decreased their employee numbers by 15% during the current financial year which is 5%
more than agreed upon at the time of the takeover of SmallCart Limited. At
29 February 2012 the legal advisors of MallWart Limited are of the opinion that it is not
probable that the Labour Union will be successful with their claim against MallWart
Limited.

5. On 10 February 2012 MallWart Limited instituted a claim of R740 000 against FlamFlung
Limited. The claim relates to defective 3D High Definition LED televisions which were sold
to MallWart Limited during the current financial year. MallWart Limited was obliged to
recall all FlamFlung Limited televisions sold to customers during the current year and to
refund the full purchase price to the customers. The court case is scheduled for
19 March 2012. According to the legal advisors of MallWart Limited there is sufficient
evidence against FlamFlung Limited to prove that they were aware at the time that their
products were defective and therefore it is probable but not virtually certain that MallWart
Limited will be successful with their claim.
FAC3701/102

61
QUESTION 2 (continued)




REQUIRED:



1. Motivate with reasons if the laptops given to clients with the sale of the 3G contracts in
additional information (1) above can be recognized by MallWart Limited as Revenue for
the year ended 29 February 2012 according to the requirements of IAS 18 Revenue.
Calculations need not form part of your answer. (6)
2. Prepare all the necessary journal entries for additional information (1) to (5) above in the
accounting records of MallWart Limited only for the year ended 29 February 2012.
Journal narrations are not required.
No abbreviations for general ledger account names in your journal must be used.
Ignore the implications of tax (16)
3. Motivate with reasons what the correct accounting treatment for the wage clock machines
in additional information (2) should be according to the requirements of an asset in terms
of the Conceptual Framework for Financial Reporting 2010. (6)

4. Disclose additional information (2), (4) and (5) above in the notes to the annual financial
statements of MallWart Limited for the year ended 29 February 2012, according to the
requirements of only IAS 8 Accounting policies, changes in accounting estimates and
errors and IAS 37 Provisions, contingent liabilities and contingent assets.

Comparative figures are required.
No other notes are required.
No accounting policy notes are required. (13)

PART B

The following information relating to Prague Limited, a company with a 31 March year end,
was obtained after a review of the minutes of Prague Limited:

On 4 April 2011 the board of directors of Prague Limited declared an ordinary dividend of
R650 000 for the year ended 31 March 2011, subject to the approval of the annual
general meeting. At the annual general meeting held on 15 May 2011, the proposed
ordinary dividends were approved.
The annual financial statements of Prague Limited for the year ended 31 March 2011
were authorized for issue on 15 May 2011.
On 15 April 2012 the board of directors of Prague Limited declared a preference dividend
of 10 cents per share for the year ended 31 March 2012. There are 100 000 preference
shares in issue.
The annual financial statements of Prague Limited for the year ended 31 March 2012
were authorized for issue on 5 May 2012.

62
QUESTION 2 (continued)

The following is an extract from the statement of profit or loss and other comprehensive
income of Prague Limited for the year ended 31 March 2012:

PRAGUE LIMITED
EXTRACT FROM STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE
INCOME FOR THE YEAR ENDED 31 MARCH 2012

R
Gross profit
Other income
Administration expenses
1 867 500
130 000
(225 000)
Profit before tax
Income tax expense
1 772 500
(458 000)
Profit for the year 1 314 500
Other comprehensive income:
Items that will not be reclassified to profit or loss:
Gains on property revaluation
Actuarial gains on defined benefit pension plans.


32 500
25 000
Other comprehensive income for the year, net of tax 57 500

TOTAL COMPREHENSIVE INCOME FOR THE YEAR 1 372 000

The retained earnings of Prague Limited on 1 April 2011 amounted to R1 490 000.




REQUIRED:



Using the information presented above prepare only:
the retained earnings section of the statement of changes in equity as well as
the relevant dividend note to the annual financial statements
of Prague Limited for the year ended 31 March 2012. Your answer must comply with the
requirements of only IAS 1 Presentation of financial statements and IAS 10 Events after
the reporting period.

No comparative figures are required.
Accounting policy notes are not required.
No other notes are required. (6)
FAC3701/102

63




SOLUTION



QUESTION 1

1. Correcting Journal Entry
Debit Credit
R R

Revenue [(225 000 / 50) x R1,2)] (P/L) 5 400
Deferred revenue / Income received in advance (SFP) 5 400

2. Calculation of correct profit before tax for the year ended 31 December 2011
R
Profit before tax 1 250 000
Customer loyalty programme (5 400)
Consignment sales (56 000 x
130
/
100
) 72 800
Consignment cost of sales (70 000 x 80%) (56 000)
Change in accounting policy accounting (38 000 25 000) 13 000
Additional costs not provided for Provision for manufacturing defects (20 000)
Fines provisional tax (5 500)
Adjusted profit before tax 1 248 900


64
QUESTION 1 (continued)

3. Calculation of current tax expense for the year ended 31 December 2011
R
Adjusted profit before tax 1 248 900
Exempt differences: (44 500)
Fines provisional tax 5 500
Foreign income (50 000)
Profit after exempt differences 1 204 400
Temporary difference: (47 600)
Customer loyalty programme 5 400
Depreciation old oven (72 000 60 000) 12 000
Depreciation new oven (240 000 208 000) 32 000
Wear and tear old oven (120 000/4 x 6/12) (15 000)
Wear and tear new oven (240 000/4 x 8/12) (40 000)
Accounting loss on sale of oven 50 000
Scrapping allowance on sale of oven
(50 000 60 000) (60 000 15 000)
(35 000)
Additional costs not provided for Provision for manufacturing defects 20 000
Actual manufacturing defect costs incurred (given) (102 000)
Change in accounting policy accounting (38 000 25 000) (13 000)
Change in accounting policy tax 38 000

Taxable income 1 156 800

Current tax @ 28% (R1 156 800 x 28%) 323 904
Provisional tax payments (120 000 + 110 000) (230 000)
Amount due to the SA Revenue Service 93 904

4. Calculation of deferred tax balance
2010
Carrying
amount
Tax
base
Temporary
difference
Deferred
tax asset/
(liability)@
28%
R R R R
Inventory 445 000 420 000 25 000 (7 000)
Provision for manufacturing
defects
82 000
1
- 82 000 22 960
Oven (old) 72 000 60 000 12 000 (3 360)
Deferred tax asset 12 600

1
(110 000 28 000)
FAC3701/102

65
QUESTION 1 (continued)

2011
Carrying
amount
Tax base Temporary
difference
Deferred
tax asset/
(liability)@
28%
R R R R
Oven (new) 208 000 200 000
1
8 000 (2 240)
Deferred income 5 400 - 5 400 1 512
Deferred tax liability (728)
1
(240 000 40 000)

5. Tax rate reconciliation
R
Standard rate of tax (1 248 900 x 28%) 349 692
Adjusted for exempt differences:
Foreign income (50 000 x 28%) 6 500 (7 500)
Fines (5 500 x 28%) 1 540
Under provision of tax prior year 8 000
Effective rate of tax 351 732

6. PASTRYCOOK LIMITED
NOTES FOR THE YEAR ENDED 31 DECEMBER 2011

1. Change in accounting policy
During the year the company changed its accounting policy in respect of the valuation of
inventory from the last-in, first-out method to the first-in, first-out method. This change was
necessary as the directors are of the opinion that this will result in a fair presentation of the
financial position and operating results because of fluctuations in inventory prices. The
change in policy was accounted for retrospectively and comparative amounts have been
appropriately restated. The effect of this change is as follows:
2011 2010 1/01/2010
R R R
Decrease in cost of sales (38 000- 25 000);
(25 000 9 000)
13 000 16 000
Increase in current tax expense (13 000 x 28%);
(16 000 x 28%)
(3 640) (4 480)
Increase in profit 9 360 11 520
Increase in inventory 38 000 25 000 9 000
Increase in current tax liability/SARS (38 000 x 28%) (10 640)
Increase in deferred tax liability (25 000 x 28%);
(9 000 x 28%)
(7 000) (2 520)
Increase in equity 27 360 18 000 6 480

Adjustment to retained earnings at the beginning of 2010
(9 000 x 28%)

6 480


66
QUESTION 1 (continued)

2. Provision for manufacturing defects
2011 2010
R R
Carrying amount beginning of the year 82 000 -
Provision created for the year - 110 000
Amount used during the year 82 000 (28 000)
Carrying amount end of year - 82 000

A manufacturing defect was discovered during November 2010 in a specific range of biscuit
machines manufactured. The manufacturing defect was repaired for customers free of
charge. At year end it is expected that no further costs will be incurred to repair these biscuit
machines in the next financial year.

QUESTION 2

PART A

1. Revenue recognition

Revenue from the sale of laptops will be recognized when:
The entity has transferred all the risks and rewards of ownership of the goods
The entity retains neither continuing managerial involvement to the degree usually
associated with ownership, nor effective control over the goods sold
Amount of revenue can be measured reliably
Probable that economic benefits will flow to the entity
Costs incurred or to be incurred in respect of the transaction can be measured reliably
(Refer: IAS 18 par 14 (a e))

In the scenario relating to the laptops given to clients signing a 3G contract:

All risks and rewards of ownership have been transferred to the client NCC provides
warranties to customers and NCC cellular reimburses MallWart Limited with the full
selling price for the laptops given to customers.
All elements of ownership have been transferred to the client as MallWart Limited has no
longer any managerial involvement nor effective control over the laptop after the sale.
Revenue can be measured reliably at R10 000.
Costs incurred (given) can be measured reliably at R8 000 per laptop.

Conclusion:
Revenue from the sale of laptops on 3G contracts can be recognized as all the criteria for
revenue from the sale of laptops is fulfilled.
FAC3701/102

67
QUESTION 2 (continued)

2. Journals for the year ended 29 February 2012
Debit Credit
R R

Accounts receivable (60 x R10 000) (SFP) 600 000
Sales (P/L) 600 000

Cost of sales (60 x R8 000) (P/L) 480 000
Inventory (SFP) 480 000

Accounts receivable (110 x 500) (SFP) 55 000
Commission Income (P/L) 55 000

Depreciation (P/L) 170 000
Accumulated depreciation(SFP) 170 000
(850 000 x 20%)

PPE Machinery (SFP) 850 000
Accumulated depreciation(SFP)
(850 000 x 20%)
170 000
Retained earnings (SFP) 680 000

Provision for warranty claims (SFP) 103 000
Warranty claims (P/L) 103 000
(4 600 000 x 4%) + (3 300 000 x 3%) +
(2 500 000 x 2%) (4 600 000 x 5%)


3. The R850 000 wage clock machines costs should be capitalized if it meets the definition
of an asset, as well as the recognition criteria of assets as set in the Conceptual
Framework for financial reporting 2010. If the definition and recognition criteria are not
met, the item should be expensed.

The Conceptual Framework for financial reporting 2010 defines an asset as:
a resource controlled by the enterprise,
as a result of past events, and
from which future economic benefits are expected to flow to the enterprise.

According to the Conceptual Framework for financial reporting 2010 an asset is
recognized:
when it is probable that future economic benefits will flow to the enterprise, and
the asset has a cost or value that can be measured reliably.

The definition and recognition criteria of an asset are met as:
The wage clock machines are under MallWart Limiteds control as they are on the
premises of MallWart Limited.
The past event is the purchase of the wage clock machines.
It is expected that economic benefits will flow to the entity in the form of decreased
overtime claims.
The cost of the wage clock machines can be reliably measured at R850 000.

68
QUESTION 2 (continued)

Conclusion:

Since the wage clock machines meet the definition and recognition criteria of an asset it
should be capitalized.

4. MALLWART LIMITED

NOTES FOR THE YEAR ENDED 29 FEBRUARY 2012

1. Prior period error

Correction of error in respect of the new wage clock machines installed and incorrectly
expensed rather than being capitalized in the 2011 financial year. The effect of the
correction of this error on the results of 2011 is as follows:

2011
R
Decrease in expenses (850 000 170 000) 680 000
Increase in tax expense (680 000 x 28%) (190 400)
Increase in profit 489 600

Increase in Property, plant and equipment (850 000 170 000) 680 000
Increase in current tax due/SARS (190 400)
Increase in equity 489 600

2. Contingent liability

On 31 January 2012 a claim of R400 000 was instituted against MallWart Limited by the
labour union representing the employees of the company. The claim relates to MallWart
Limited allegedly not adhering to the terms as agreed upon during the takeover of
SmallCart Limited by decreasing employee numbers by more than 10%. The legal
advisors of MallWart Limited are of the opinion that it is not probable that the labour union
representing the employees of MallWart Limited will be successful with their claim against
the company.

3. Contingent asset

On 10 February 2012 a claim of R740 000 was instituted by MallWart Limited against
Flamflung limited. The claim relates to defective products sold by FlamFlung limited to
MallWart Limited. According to the companys legal advisors it is probable but not virtually
certain that the claim will succeed.
FAC3701/102

69
QUESTION 2 (continued)

PART B

PRAGUE LIMITED

EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 MARCH 2012.

Retained
earnings
R
Balance at 1 April 2011 1 490 000
Changes in equity for 2012
Total comprehensive income for the year 1 372 000
Dividends paid (650 000)
Balance at 31 March 2012 2 212 000

NOTES FOR THE YEAR ENDED 31 MARCH 2012

10. Events after the reporting period

The board of directors of the company declared a preference dividend of 10 cents per
share for the year ended 31 March 2012 on 15 April 2012. The effect of the dividends
declared is that retained earnings are reduced by R10 000 (100 000 X 10c).




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