5/9/2018 ACCA - FR Financial Reporting - CBEs 18-19: FR - CBE Mock - 1

ACCA FR Mock 1 (0618)

Section A
Question 1 of 34

If an entity revalues its land upwards, what will be the effect on the following ratios?

ROCE Gearing
A. Decrease Decrease
B. Decrease Increase
C. Increase Decrease
D. Increase Increase
A.
B.
C.
D.

2 out of 2

The correct answer is:

ROCE Gearing
A. Decrease Decrease

Higher property values will increase capital employed and so decrease ROCE. The
revaluation surplus will increase equity and therefore reduce gearing.

Syllabus area C2c

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Question 2 of 34

Which of the following statements about the earnings per share ratio is correct?

All entities must disclose earnings per share in their financial statements.
Earnings per share represents the return on the investment for all capital providers.
Earnings per share is calculated as profit after tax divided by the total number of
ordinary shares at the year end.
The denominator of the earnings per share ratio is the weighted average number of
ordinary shares outstanding during the period.

2 out of 2

The correct answer is:

The denominator of the earnings per share ratio is the weighted average number of
ordinary shares outstanding during the period.

The other answers are incorrect because:

Only an entity whose shares are traded in a public market (ie listed entity) is required to
disclose earnings per share.
Earnings per share only represents the return for ordinary shareholders not all capital
providers.
Preference dividends must also be deduced from profit after tax to arrive at earnings and
the weighted average not the year end total of ordinary shares should be used.

Syllabus area B9e

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Question 3 of 34

Which of the following statements is correct regarding the restatement of foreign

currency assets and liabilities in the financial statements of a single entity at the
reporting date?

Non-monetary assets and all long-term liabilities should not be restated.

Monetary assets and liabilities should be restated at the average rate for the period.
Non-monetary assets and liabilities should be restated at the closing rate.
Monetary assets and liabilities should be restated at the closing rate.

2 out of 2

The correct answer is: Monetary assets and liabilities should be restated at the closing rate.

Non-monetary assets should not be restated at the reporting date.

The average rate is only used to restate profit and loss items.

Syllabus area B12b

Question 4 of 34

Which of the following is the correct process via which a new IFRS is produced?

Issues paper/Exposure draft/Discussions paper/Issue IFRS.

Exposure draft/Issues paper/Issue IFRS/Discussions paper.
Issues paper/Discussions paper/Exposure draft/Issue IFRS.
Discussions paper/Issues paper/Exposure draft/Issue IFRS.

0 out of 2

The correct answer is: Issues paper/Discussions paper/Exposure draft/Issue IFRS.

The IASB issues IFRSs and publishes exposure drafts and discussions papers for public
comment prior to issuing an IFRS.

Syllabus area A3d

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Question 5 of 34

Which of the following is a possible reason why a company’s inventory holding

period decreases from one year to the next?

An increase in price resulting in a fall in demand for its products.

A reduction in selling prices resulting in an increase in demand for its products.
Several inventory lines which have become obsolete.
Seasonal fluctuations in sales needing higher at year end.

0 out of 2

The correct answer is: A reduction in selling prices.

A reduction in selling prices can increase sales, leading to a fall in the holding period. A fall
in demand or obsolete inventory are likely to increase the holding period. Seasonal
fluctuations may alter the holding period during the year, but are unlikely to affect the year-
on-year picture.

Syllabus area C2d

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Question 6 of 34

On 1 July 20X3 Wood plc acquired a machine for $76,000 with a useful life of 8 years.
Depreciation is charged on a proportionate basis. An impairment review on 31 March 20X6
concluded that the machine had a fair value of $35,200 and would incur selling costs of
$1,400. On the same date, its value in use was measured at $43,440.

What impairment cost should be charged to the statement of profit or loss for the
year ended 31 March 20X6?

Please give your answer to the nearest $.

$ 6435

2 out of 2

The correct answer is: $6,435

The carrying value of the asset at 31 March 20X6:

$
Cost 76,000
Accumulated depreciation (76,000/8 years × 2¾) (26,125)
49,875

Then the recoverable amount needs to be determined as the higher of value in use and fair
value less cost of disposal:

Fair value less of disposal

(35,200 – 1,400) = $33,800

Value in use = $43,440

Impairment expense = 49,875 – 43,440 = 6,435

Syllabus area B3

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Question 7 of 34

Which THREE of the following are elements from the Conceptual Framework?

Asset
Other comprehensive income
Income
Retained earnings
Liabilities

0 out of 2

The correct answers are:

Asset
Income
Liabilities

These are three of the five elements from the Conceptual Framework, the others being
Expense and Equity.

Syllabus area A2b

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Question 8 of 34

On 31 March 20X6 Haskin factored (sold) trade receivables with a carrying amount of $10
million to Easyfinance. Haskin received an immediate payment of $8.7 million and will pay
Easyfinance 2% per month on any uncollected balances. Any of the factored receivables
outstanding after six months will be refunded to Easyfinance. Haskin has derecognised the
receivables and charged $1.3 million to administrative expenses.

What journal should be used to correct the accounting error above?

Loan CR 8700000
Cash DR 8700000
Admin expenses CR 1300000

2 out of 3

The correct answer is:

Trade receivables DR 10000000

Admin expenses CR 1300000
Loan CR 8700000

The company has recorded the following journal:

DEBIT cash 8.7m

DEBIT admin 1.3m
CREDIT trade receivables 10m

It should have instead recorded the cash receipt as a loan as the risk and rewards
associated with the trade receivables have not been transferred to Easyfinance as Haskin
retains the bad debt risk (any uncollected debts can be returned to Haskin after six
months).

DEBIT cash 8.7m

CREDIT loan 8.7m

Therefore a correction is needed as follows:

DEBIT trade receivables 10m

CREDIT Admin 1.3m
CREDIT Loan 8.7m

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Syllabus area B5c

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Question 9 of 34

The following balances appear in statement of financial position of Peterson Co. year
ending 30 June:

20X7 20X8
$’000 $’000
Property, plant and equipment 206 333

During the year to 30 June 20X8 Peterson disposed of some machinery for sale proceeds
of $44,000 realising a profit on disposal of $15,000. A piece of land was also revalued
realising a gain of $60,000 Depreciation has been correctly calculated for the year at
$32,000.

What is the net cashflow used in investing activities that would be recorded in the
statement of cashflows for year ended 30 June 20X8?

$ 143000

0 out of 2

The correct answer is: $84,000

$’000
B/f PPE at 30 June 20X7 206
Revaluation 60
Depreciation (32)
Purchases (β) 128
Disposal (44-15) (29)
C/f PPE at 30 June 20X8 333

Then the sale proceeds need to be included at $44,000.

Statement of cashflow for year ended 30 June 20X8

Net cashflow from investing activities: $’000

Proceeds from sale of PPE 44
Purchase of PPE (128)
(84)

Syllabus area D1c

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Question 10 of 34

Creative accounting measures are often aimed at reducing gearing.

Which of these is not a strategy to reduce gearing?

Making a rights issue during the year.

Reversing a provision for legal costs made the previous year.
Renegotiating a loan to secure a lower interest rate.
Repaying a loan just before the year end and taking it out again at the beginning of the
next year.

0 out of 2

The correct answer is: Renegotiating a loan to secure a lower interest rate.

The interest rate will have no effect on gearing, which is based on the amount of the loan.
The other measures can be used to either increase equity or reduce loans.

Syllabus area C1b

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Question 11 of 34

Kington is preparing its financial statements for the year ended 30 September 20X1. At 30
September 20X0 Kington had equity investments which had a carrying amount of $18
million. At 30 September 20X1, the equity investments had a fair value of $17.4 million.
There were no purchases or disposals of any of these investments during the year. The
shares are held for trading and no election has been made.

What will be recognised in the statement of profit or loss and other comprehensive
income for the year ended 30 September 20X1 in relation to the equity investments?

0 out of 2

The correct answers are:

As no election had been made the equity investment should be updated to the new fair
value of 17.4 million at the year end with any gains or losses being recorded through the
profit or loss. If an election had been made these gains or losses would instead go through
other comprehensive income.

Syllabus area B5d

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Question 12 of 34

Heather’s financial statements for the year ended 31 December 20X8 were approved for
publication on 8 April 20X9.

Which one of the following material items would be classified as a non-adjusting

event in Heather's financial statements for the year ended 31 December 20X8
according to IAS 10 Events after the reporting period?

On 1 March 20X9, Heather's auditors discovered that, due to an error during the count,
the closing inventory had been undervalued by $250,000.
Lightning struck one of Heather's production facilities on 31 January 20X9 and caused a
serious fire. The fire destroyed half of the factory and its machinery. Output was severely
reduced for six months. The business remained a going concern.
One of Heather's customers commenced court action against Heather on 1 December
20X8. At 31 December 20X8, Heather did not know how the case would be decided. On
1 March 20X9, the court found against Heather and awarded damages of $150,000 to
the customer.
On 15 March 20X9, Heather was advised by the liquidator of one of its customers that it
was very unlikely to receive any payments for the balance of $300,000 that was
outstanding at 31 December 20X8.

0 out of 2

The correct answer is:

Lightning struck one of Heather's production facilities on 31 January 20X9 and caused a
serious fire. The fire destroyed half of the factory and its machinery. Output was severely
reduced for six months. The business remained a going concern.

An adjusting event is an event that provides further evidence of a condition that already
existed at the reporting date.

A non-adjusting event relates to the situation where the condition did not exist at the
reporting date.

Syllabus area B7g

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Question 13 of 34

Westland negotiated a new loan to fund the construction of a power generation plant.

Westland's cost of capital is 9%.

Construction began on 1 January 20X8. Funds drawn down were $40 million on 1 January
20X8 and a further $30 million on 1 July 20X8. The construction was still ongoing at the
year-end date of 31 December 20X8.

Calculate the amount of borrowing costs that can be capitalised for the year.

$ 4950

0 out of 2

The correct answer is: $4,950,000

$m
$40m × 9% 3.6
$30m × 9% × 1.35
4.95

Syllabus area B1a

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Question 14 of 34

Under IFRS 15 Revenue there is a five step model of revenue recognition.

Place the steps below in the correct order in which IFRS 15 states they should be
carried out.

1. Identify the contract

2. Determine the transaction price
3. Identify the perdivance conditions
4. Allocate the price to perdivance obligation
5. Recognise revenue when perdivance conditions satisfied

0 out of 2

The correct answers are:

1 Identify the contract.

2 Identify the perdivance conditions.
3 Determine the transaction price.
4 Allocate the price to perdivance obligation.
5 Recognise revenue when perdivance conditions satisfied.

IFRS 15 sets out a very clear process for recognizing revenue which is broken into these
five steps.

Syllabus area B10a

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Question 15 of 34

Joseph Ltd vacated an office building and let it out to a third party on 31 January 20X9. The
building had originally cost $800,000 on 1 August 20X0 and was being depreciated over 40
years. Depreciation is charged on a proportionate basis. It had a fair value on 31 January
20X9 of $850,000. At the year end date the fair value of the building was estimated to be
$925,000. Joseph uses the fair value model for investment property.

What amount of the gain on the building will be reported in to the statement of profit
and loss for the year ended 31 July 20X9?

$0
$75,000
$125,000
$295,000

2 out of 2

The correct answer is: $75,000

At 31 January 20X9 the building must be transferred from PPE to investment property at FV
being $850,000. Any gain on transfer should be held in a revaluation surplus and not in the
profit or loss.

At the year end the building must be updated to the FV of $925,000 from $850,000 with the
any gain/loss being shown in the profit or loss. Therefore the only gain in the profit or loss
for the year would be $75,000.

Syllabus area B1g

Section B

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Question 16 of 34

On 1 April 20X9 Pandar purchased 80% of the equity shares in Salva. The acquisition was
through a share exchange of three shares in Pandar for every five shares in Salva. The
market prices of Pandar's and Salva's shares at 1 April 20X9 were $6 per share and $3.20
respectively. On the same date Pandar acquired 40% of the equity shares in Ambra paying
$2 per share.

An extract of the statements of profit or loss for the three companies for the year ended 30
September 20X9 is below:

Pandar Salva Ambra

$'000 $'000 $'000
Revenue 210,000 150,000 50,000
Cost of sales (126,000) (100,000) (40,000)
Gross profit 84,000 50,000 10,000

The following indivation for the equity of the companies at 30 September 20X9 is available:

Pandar Salva Ambra

$'000 $'000 $'000
Equity shares of $1 each 200,000 120,000 40,000
Profit (loss) for the year ended 30 September 20X9 47,200 21,000 (5,000)

The following indivation is relevant:

i. After the acquisition, Pandar sold goods to Salva for $15 million on which Pandar
made a gross profit of 20%. Salva had one third of these goods still in its inventory at
30 September 20X9. There are no intragroup current account balances at 30
September 20X9.
ii. All items in the above statements of profit or loss are deemed to accrue evenly over
the year unless otherwise indicated.

What is the value of the consideration transferred by Pandar to acquire its

investment in Salva?

$ 345600000

2 out of 2

The correct answer is: $345,600,000

Consideration transferred (120m × 80% × 3/5 x $6) = $345,600,000

Syllabus area D2a

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Question 17 of 34

On 1 April 20X9 Pandar purchased 80% of the equity shares in Salva. The acquisition was
through a share exchange of three shares in Pandar for every five shares in Salva. The
market prices of Pandar's and Salva's shares at 1 April 20X9 were $6 per share and $3.20
respectively. On the same date Pandar acquired 40% of the equity shares in Ambra paying
$2 per share.

An extract of the statements of profit or loss for the three companies for the year ended 30
September 20X9 is below:

Pandar Salva Ambra

$'000 $'000 $'000
Revenue 210,000 150,000 50,000
Cost of sales (126,000) (100,000) (40,000)
Gross profit 84,000 50,000 10,000

The following indivation for the equity of the companies at 30 September 20X9 is available:

Pandar Salva Ambra

$'000 $'000 $'000
Equity shares of $1 each 200,000 120,000 40,000
Profit (loss) for the year ended 30 September 20X9 47,200 21,000 (5,000)

The following indivation is relevant:

i. After the acquisition, Pandar sold goods to Salva for $15 million on which Pandar
made a gross profit of 20%. Salva had one third of these goods still in its inventory at
30 September 20X9. There are no intragroup current account balances at 30
September 20X9.
ii. All items in the above statements of profit or loss are deemed to accrue evenly over
the year unless otherwise indicated.

How much would the investment in associate in the statement of financial position
be at 30 September 20X9?
$33 million
$31 million
$30 million
$32 million

2 out of 2

The correct answer is: $31 million.

$’000
Cost (40m × 40% × $2) 32,000
Share of post-acquisition loss (5,000 × 40% × 6/12) (1,000)
31,000

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Syllabus area D2a

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Question 18 of 34

On 1 April 20X9 Pandar purchased 80% of the equity shares in Salva. The acquisition was
through a share exchange of three shares in Pandar for every five shares in Salva. The
market prices of Pandar's and Salva's shares at 1 April 20X9 were $6 per share and $3.20
respectively. On the same date Pandar acquired 40% of the equity shares in Ambra paying
$2 per share.

An extract of the statements of profit or loss for the three companies for the year ended 30
September 20X9 is below:

Pandar Salva Ambra

$'000 $'000 $'000
Revenue 210,000 150,000 50,000
Cost of sales (126,000) (100,000) (40,000)
Gross profit 84,000 50,000 10,000

The following indivation for the equity of the companies at 30 September 20X9 is available:

Pandar Salva Ambra

$'000 $'000 $'000
Equity shares of $1 each 200,000 120,000 40,000
Profit (loss) for the year ended 30 September 20X9 47,200 21,000 (5,000)

The following indivation is relevant:

i. After the acquisition, Pandar sold goods to Salva for $15 million on which Pandar
made a gross profit of 20%. Salva had one third of these goods still in its inventory at
30 September 20X9. There are no intragroup current account balances at 30
September 20X9.
ii. All items in the above statements of profit or loss are deemed to accrue evenly over
the year unless otherwise indicated.

How much would the consolidated revenue be in the group statement of profit or
loss for the year ended 30 September 20X9?
$270 million
$345 million
$360 million
$315 million

0 out of 2

The correct answer is: $270 million

$’000
Revenue (210,000 + (150,000 × 6/12) – 15000) 270,000

Syllabus area D2d

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Question 19 of 34

On 1 April 20X9 Pandar purchased 80% of the equity shares in Salva. The acquisition was
through a share exchange of three shares in Pandar for every five shares in Salva. The
market prices of Pandar's and Salva's shares at 1 April 20X9 were $6 per share and $3.20
respectively. On the same date Pandar acquired 40% of the equity shares in Ambra paying
$2 per share.

An extract of the statements of profit or loss for the three companies for the year ended 30
September 20X9 is below:

Pandar Salva Ambra

$'000 $'000 $'000
Revenue 210,000 150,000 50,000
Cost of sales (126,000) (100,000) (40,000)
Gross profit 84,000 50,000 10,000

The following indivation for the equity of the companies at 30 September 20X9 is available:

Pandar Salva Ambra

$'000 $'000 $'000
Equity shares of $1 each 200,000 120,000 40,000
Profit (loss) for the year ended 30 September 20X9 47,200 21,000 (5,000)

The following indivation is relevant:

i. After the acquisition, Pandar sold goods to Salva for $15 million on which Pandar
made a gross profit of 20%. Salva had one third of these goods still in its inventory at
30 September 20X9. There are no intragroup current account balances at 30
September 20X9.
ii. All items in the above statements of profit or loss are deemed to accrue evenly over
the year unless otherwise indicated.

What is the adjustment required in the consolidated statement of financial position to

eliminate any unrealised profit in inventory?

0 out of 2

The correct answers are:

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Unrealised profit 15,000 × 1/3 × 20% = 1,000,000

Syllabus area D2d

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Question 20 of 34

On 1 April 20X9 Pandar purchased 80% of the equity shares in Salva. The acquisition was
through a share exchange of three shares in Pandar for every five shares in Salva. The
market prices of Pandar's and Salva's shares at 1 April 20X9 were $6 per share and $3.20
respectively. On the same date Pandar acquired 40% of the equity shares in Ambra paying
$2 per share.

An extract of the statements of profit or loss for the three companies for the year ended 30
September 20X9 is below:

Pandar Salva Ambra

$'000 $'000 $'000
Revenue 210,000 150,000 50,000
Cost of sales (126,000) (100,000) (40,000)
Gross profit 84,000 50,000 10,000

The following indivation for the equity of the companies at 30 September 20X9 is available:

Pandar Salva Ambra

$'000 $'000 $'000
Equity shares of $1 each 200,000 120,000 40,000
Profit (loss) for the year ended 30 September 20X9 47,200 21,000 (5,000)

The following indivation is relevant:

i. After the acquisition, Pandar sold goods to Salva for $15 million on which Pandar
made a gross profit of 20%. Salva had one third of these goods still in its inventory at
30 September 20X9. There are no intragroup current account balances at 30
September 20X9.
ii. All items in the above statements of profit or loss are deemed to accrue evenly over
the year unless otherwise indicated.

Which of the following statements is correct in respect of the non-controlling

interest (NCI) to be included in the consolidated statement of financial position of
the Pandar group for the year ended 30 September 20X9?
NCI will be included in the non-current liabilities of Pandar group.
20% of Salva’s post acquisition profit and 60% of Ambra’s post acquisition profit will be
included in NCI.
The unrealised profit in inventories adjustment will impact the post-acquisition profit
share attributable to the NCI.
20% of Salva’s post acquisition profit will be included in NCI.

2 out of 2

The correct answer is: 20% of Salva’s post acquisition profit will be included in NCI.

'NCI will be included in the non-current liabilities of Pandar group' is incorrect as the NCI
balance is shown in equity.

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'20% of Salva’s post acquisition profit and 60% of Ambra’s post acquisition profit will be
included in NCI' is incorrect as the associate is not included in the NCI balance.

'The unrealised profit in inventories adjustment will impact the post-acquisition profit share
attributable to the NCI' is incorrect as Pandar (the parent) is the seller so the unrealised
profit adjustment does not affect the subsidiary Salva and therefore has no impact on the
NCI profit share.

Syllabus area D2a

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Question 21 of 34

Whilst preparing the financial statements for the year ended 30 September 20X8 for Candel
the following issues are still outstanding:

Research and development

Research and development costs were incurred on a new project which commenced on 1
October 20X7. From that date the project incurred development costs of $800,000 per
month. On 1 April 20X8 the directors became confident that the project would be successful
and yield a profit well in excess of its costs. The project is still in development at 30
September 20X8. Capitalised development expenditure is amortised at 20% per annum
using the straight-line method.

Legal case

At 30 September 20X8, Candel is being sued by a customer for $2 million for breach of
contract. Candel has obtained legal opinion that there is a 20% chance that Candel will lose
the case. The unrecoverable legal costs of defending the action are estimated at $100,000.

Issue of preference shares

On 1 April 20X8 Candel issued 20 million 8% $1 redeemable preference shares at par.

They are redeemable at a large premium which gives them an effective finance cost of 12%
per annum. Interest is paid annually in arrears.

Which of the following are included in the criteria for recognising an intangible asset
for development expenditure on a project?

i. Technically feasible.
ii. Technical and financial resources available to complete.
iii. Orders for the output of the project have been received by the company.
iv. Possible future economic benefits.

All four
(i) and (ii)
(i), (ii) and (iv) only
(ii) and (iv) only

0 out of 2

The correct answer is: (i) and (ii).

Per IAS38 the following six criteria should be met to recognize and intangible asset on a
development project:

(a) the technical feasibility of completing the intangible asset so that it will be available for
use or sale.
(b) its intention to complete the intangible asset and use or sell it.
(c) its ability to use or sell the intangible asset.
(d) how the intangible asset will generate probable future economic benefits. Among other
things, the entity can demonstrate the existence of a market for the output of the intangible
asset or the intangible asset itself or, if it is to be used internally, the usefulness of the
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intangible asset.
(e) the availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset.
(f) its ability to measure reliably the expenditure attributable to the intangible asset during its
development.

Syllabus area B2c

Question 22 of 34

Whilst preparing the financial statements for the year ended 30 September 20X8 for Candel
the following issues are still outstanding:

Research and development

Research and development costs were incurred on a new project which commenced on 1
October 20X7. From that date the project incurred development costs of $800,000 per
month. On 1 April 20X8 the directors became confident that the project would be successful
and yield a profit well in excess of its costs. The project is still in development at 30
September 20X8. Capitalised development expenditure is amortised at 20% per annum
using the straight-line method.

Legal case

At 30 September 20X8, Candel is being sued by a customer for $2 million for breach of
contract. Candel has obtained legal opinion that there is a 20% chance that Candel will lose
the case. The unrecoverable legal costs of defending the action are estimated at $100,000.

Issue of preference shares

On 1 April 20X8 Candel issued 20 million 8% $1 redeemable preference shares at par.

They are redeemable at a large premium which gives them an effective finance cost of 12%
per annum. Interest is paid annually in arrears.

What is the value of the development expenditure for Candel in its statement of
financial position for 30 September 20X8?

$ 4800000

2 out of 2

The correct answer is: $4,800,000

The additional expenditure capitalized is $800,000 per month for the six months between 1
April 20X8 and 30 September 20X8.

Syllabus area B2a

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Question 23 of 34

Whilst preparing the financial statements for the year ended 30 September 20X8 for Candel
the following issues are still outstanding:

Research and development

Research and development costs were incurred on a new project which commenced on 1
October 20X7. From that date the project incurred development costs of $800,000 per
month. On 1 April 20X8 the directors became confident that the project would be successful
and yield a profit well in excess of its costs. The project is still in development at 30
September 20X8. Capitalised development expenditure is amortised at 20% per annum
using the straight-line method.

Legal case

At 30 September 20X8, Candel is being sued by a customer for $2 million for breach of
contract. Candel has obtained legal opinion that there is a 20% chance that Candel will lose
the case. The unrecoverable legal costs of defending the action are estimated at $100,000.

Issue of preference shares

On 1 April 20X8 Candel issued 20 million 8% $1 redeemable preference shares at par.

They are redeemable at a large premium which gives them an effective finance cost of 12%
per annum. Interest is paid annually in arrears.

In accordance with IAS 37 provisions, contingent liabilities and contingent assets

which of the following criteria must exist before a provision would be required?
Present obligation from a past event, probable outflow and no reliable estimate.
Possible obligation from a past event, probable outflow and a reliable estimate.
Present obligation from a past event, possible outflow and a reliable estimate.
Present obligation from a past event, probable outflow and a reliable estimate.

0 out of 2

The correct answer is: Present obligation from a past event, probable outflow and a reliable
estimate.

The definition of a provision from IAS 37:

A provision shall be recognised when:

(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required
to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision shall be recognised.

Syllabus area B7c

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Question 24 of 34

Whilst preparing the financial statements for the year ended 30 September 20X8 for Candel
the following issues are still outstanding:

Research and development

Research and development costs were incurred on a new project which commenced on 1
October 20X7. From that date the project incurred development costs of $800,000 per
month. On 1 April 20X8 the directors became confident that the project would be successful
and yield a profit well in excess of its costs. The project is still in development at 30
September 20X8. Capitalised development expenditure is amortised at 20% per annum
using the straight-line method.

Legal case

At 30 September 20X8, Candel is being sued by a customer for $2 million for breach of
contract. Candel has obtained legal opinion that there is a 20% chance that Candel will lose
the case. The unrecoverable legal costs of defending the action are estimated at $100,000.

Issue of preference shares

On 1 April 20X8 Candel issued 20 million 8% $1 redeemable preference shares at par.

They are redeemable at a large premium which gives them an effective finance cost of 12%
per annum. Interest is paid annually in arrears.

How should the legal claim by the customer be recorded in the financial statements
for the year ended 30 September 20X8?
A provision is required for $100,000 in respect of the legal costs only.
A provision is required for $2,100,000 in respect of the compensation and legal costs.
A disclosure note only is required in respect of the compensation and legal costs.
Neither a provision nor a disclosure is required.

2 out of 2

The correct answer is: A provision is required for $100,000 in respect of the legal costs only.

The damages are not probable and therefore do not need to be provided for at the year
end. The legal costs however should be provided for as they results from a past event (the
claim).

Syllabus area B7d

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Question 25 of 34

Whilst preparing the financial statements for the year ended 30 September 20X8 for Candel
the following issues are still outstanding:

Research and development

Research and development costs were incurred on a new project which commenced on 1
October 20X7. From that date the project incurred development costs of $800,000 per
month. On 1 April 20X8 the directors became confident that the project would be successful
and yield a profit well in excess of its costs. The project is still in development at 30
September 20X8. Capitalised development expenditure is amortised at 20% per annum
using the straight-line method.

Legal case

At 30 September 20X8, Candel is being sued by a customer for $2 million for breach of
contract. Candel has obtained legal opinion that there is a 20% chance that Candel will lose
the case. The unrecoverable legal costs of defending the action are estimated at $100,000.

Issue of preference shares

On 1 April 20X8 Candel issued 20 million 8% $1 redeemable preference shares at par.

They are redeemable at a large premium which gives them an effective finance cost of 12%
per annum. Interest is paid annually in arrears.

How should the preference shares be recorded in Candel’s statement of financial

position for year ended 30 September 20X8?

Non-current liability $ 21200000

2 out of 2

The correct answer is: $21,200,000

$'000
Financial liability b/d 20,000
Effective interest (× 12% × 6/12) 1,200
Financial liability c/d 21,200

Syllabus area B5d

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Question 26 of 34

Shawler is a small manufacturing company specialising in making alloy casings. During the
year ended 30 September 20X2 Shawler had the following transactions in non-current
assets.

Furnace

Shawler’s main item of plant is a furnace which was purchased on 1 October 20X1. The
furnace has two components: the main body (cost $45,000) which has a ten-year life, and a
replaceable liner (cost $10,000) with a two-year life.

The manufacturing process produces toxic chemicals which pollute the nearby
environment. Legislation requires that a clean-up operation must be undertaken by Shawler
in ten years’ time. The estimated cost of this clean up in ten years’ time will be $33,000.

The present value of $33,000 in ten years’ time discounted at the appropriate discount rate
for Shawler of 8% is $15,180.

Shawler received a government grant of $12,000 relating to the cost of the main body of the
furnace only. Shawler’s policy is to record grants as deferred income.

Machinery

To afford the new furnace Shawler decided to sell a piece of machinery and lease it back
under a five year lease on 1 October 20X1. At the date of sale the machine had a useful life
of six years. The machine was sold for $40,000 being the fair value of the machine on 1
October 20X1 when its carrying amount in the financial statements of Shawler was
$25,000. Under the five year lease Shawler will pay five instalments of $10,000 in arrears.
The lease has an implicit rate of interest of 8%. The transaction constitutes a sale in
accordance with IFRS 15.

What finance charge should be recorded in the statement of profit or loss of Shawler
for the year ended 30 September 20X2 in relation to the furnace?
$1,124
$1,214
$1,680
$2,640

2 out of 2

The correct answer is: $1,214.

Unwind discount to 30 September 20X2 (15,180 x 8%)

Syllabus area B6d

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Question 27 of 34

Shawler is a small manufacturing company specialising in making alloy casings. During the
year ended 30 September 20X2 Shawler had the following transactions in non-current
assets.

Furnace

Shawler’s main item of plant is a furnace which was purchased on 1 October 20X1. The
furnace has two components: the main body (cost $45,000) which has a ten-year life, and a
replaceable liner (cost $10,000) with a two-year life.

The manufacturing process produces toxic chemicals which pollute the nearby
environment. Legislation requires that a clean-up operation must be undertaken by Shawler
in ten years’ time. The estimated cost of this clean up in ten years’ time will be $33,000.

The present value of $33,000 in ten years’ time discounted at the appropriate discount rate
for Shawler of 8% is $15,180.

Shawler received a government grant of $12,000 relating to the cost of the main body of the
furnace only. Shawler’s policy is to record grants as deferred income.

Machinery

To afford the new furnace Shawler decided to sell a piece of machinery and lease it back
under a five year lease on 1 October 20X1. At the date of sale the machine had a useful life
of six years. The machine was sold for $40,000 being the fair value of the machine on 1
October 20X1 when its carrying amount in the financial statements of Shawler was
$25,000. Under the five year lease Shawler will pay five instalments of $10,000 in arrears.
The lease has an implicit rate of interest of 8%. The transaction constitutes a sale in
accordance with IFRS 15.

The furnace liner will need to be replaced in approximately 12 months.

What is the correct accounting treatment when the liner is replaced?

Capitalise new liner as an asset and depreciate over useful life.
Expense cost of replacement to the statement of profit or loss.
Derecognise old linear from assets and record a profit/loss on disposal and capitalise
new liner as an asset and depreciate over useful life.
Ignore as original liner already capitalised.

0 out of 2

The correct answer is:

Derecognise old liner from assets and record a profit/loss on disposal and capitalise
new liner as an asset and depreciate over useful life.

As the liner is a separate tangible asset it will be derecognised when it is replaced and a
new liner capitalized as a separate tangible asset.

Syllabus area B1b

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Question 28 of 34

Shawler is a small manufacturing company specialising in making alloy casings. During the
year ended 30 September 20X2 Shawler had the following transactions in non-current
assets.

Furnace

Shawler’s main item of plant is a furnace which was purchased on 1 October 20X1. The
furnace has two components: the main body (cost $45,000) which has a ten-year life, and a
replaceable liner (cost $10,000) with a two-year life.

The manufacturing process produces toxic chemicals which pollute the nearby
environment. Legislation requires that a clean-up operation must be undertaken by Shawler
in ten years’ time. The estimated cost of this clean up in ten years’ time will be $33,000.

The present value of $33,000 in ten years’ time discounted at the appropriate discount rate
for Shawler of 8% is $15,180.

Shawler received a government grant of $12,000 relating to the cost of the main body of the
furnace only. Shawler’s policy is to record grants as deferred income.

Machinery

To afford the new furnace Shawler decided to sell a piece of machinery and lease it back
under a five year lease on 1 October 20X1. At the date of sale the machine had a useful life
of six years. The machine was sold for $40,000 being the fair value of the machine on 1
October 20X1 when its carrying amount in the financial statements of Shawler was
$25,000. Under the five year lease Shawler will pay five instalments of $10,000 in arrears.
The lease has an implicit rate of interest of 8%. The transaction constitutes a sale in
accordance with IFRS 15.

What is the carrying amount of the main body of the furnace (excluding the lining) for
the year ended 30 September 20X2?

$ 40500

0 out of 2

The correct answer is: $54,162

$
Cost of main body (45,000 + 15,180) 60,180
Depreciating of main body (60,180/10 years) (6,018)
Carrying amount at 30.9.X2 54,162

Syllabus area B1e

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Question 29 of 34

Shawler is a small manufacturing company specialising in making alloy casings. During the
year ended 30 September 20X2 Shawler had the following transactions in non-current
assets.

Furnace

Shawler’s main item of plant is a furnace which was purchased on 1 October 20X1. The
furnace has two components: the main body (cost $45,000) which has a ten-year life, and a
replaceable liner (cost $10,000) with a two-year life.

The manufacturing process produces toxic chemicals which pollute the nearby
environment. Legislation requires that a clean-up operation must be undertaken by Shawler
in ten years’ time. The estimated cost of this clean up in ten years’ time will be $33,000.

The present value of $33,000 in ten years’ time discounted at the appropriate discount rate
for Shawler of 8% is $15,180.

Shawler received a government grant of $12,000 relating to the cost of the main body of the
furnace only. Shawler’s policy is to record grants as deferred income.

Machinery

To afford the new furnace Shawler decided to sell a piece of machinery and lease it back
under a five year lease on 1 October 20X1. At the date of sale the machine had a useful life
of six years. The machine was sold for $40,000 being the fair value of the machine on 1
October 20X1 when its carrying amount in the financial statements of Shawler was
$25,000. Under the five-year lease Shawler will pay five instalments of $10,000 in arrears.
The lease has an implicit rate of interest of 8%. The transaction constitutes a sale in
accordance with IFRS 15.

How would the grant be recorded in the statement of financial position of Shawler as
at 30 September 20X2?

Current liabilities $1200

Non-current liabilities $9600

2 out of 2

The correct answer is:

Current liabilities $1,200

Non-current liabilities $8,400

The grant needs to be recognised in line with the asset it was received in relation to. The
grant should therefore be recognised straight line to the profit or loss over the ten year life
of the main body of the furnace.

Syllabus area B11a

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5/9/2018 ACCA - FR Financial Reporting - CBEs 18-19: FR - CBE Mock - 1

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5/9/2018 ACCA - FR Financial Reporting - CBEs 18-19: FR - CBE Mock - 1

Question 30 of 34

Shawler is a small manufacturing company specialising in making alloy casings. During the
year ended 30 September 20X2 Shawler had the following transactions in non-current
assets.

Furnace

Shawler’s main item of plant is a furnace which was purchased on 1 October 20X1. The
furnace has two components: the main body (cost $45,000) which has a ten-year life, and a
replaceable liner (cost $10,000) with a two-year life.

The manufacturing process produces toxic chemicals which pollute the nearby
environment. Legislation requires that a clean-up operation must be undertaken by Shawler
in ten years’ time. The estimated cost of this clean up in ten years’ time will be $33,000.

The present value of $33,000 in ten years’ time discounted at the appropriate discount rate
for Shawler of 8% is $15,180.

Shawler received a government grant of $12,000 relating to the cost of the main body of the
furnace only. Shawler’s policy is to record grants as deferred income.

Machinery

To afford the new furnace Shawler decided to sell a piece of machinery and lease it back
under a five year lease on 1 October 20X1. At the date of sale the machine had a useful life
of six years. The machine was sold for $40,000 being the fair value of the machine on 1
October 20X1 when its carrying amount in the financial statements of Shawler was
$25,000. Under the five-year lease Shawler will pay five instalments of $10,000 in arrears.
The lease has an implicit rate of interest of 8% and the present value of future lease
payments is $39,927. The transaction constitutes a sale in accordance with IFRS 15.

What is the non-current lease liability that should be presented in the statement of
financial position of Shawler at 30 September 20X2?

$25,771

2 out of 2

The correct answer is: $25,771.

$
Initial liability at 1.10.X1 39,927
Interest (X2) 3,195
Payment (10,000)
Liability at 30.9.X2 33,121
Interest (X3) 2,650
Payment (10,000)
Liability at 30.9.X3 25,771

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5/9/2018 ACCA - FR Financial Reporting - CBEs 18-19: FR - CBE Mock - 1

Syllabus area B6c

Section C

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5/9/2018 ACCA - FR Financial Reporting - CBEs 18-19: FR - CBE Mock - 1

Question 31 of 34

The following trial balance relates to Highwood at 31 March 20X6:

$'000 $'000
Equity shares of 50 cents each 56000
Retained earnings 1400
8% convertible loan note (note (i)) 30000
Property – at cost 1 April 20X0 (land element $25 million (note (ii)) 75000
Plant and equipment – at cost 74500
Accumulated depreciation – 1 April 20X5 – property 10000
– plant and equipment 24500
Current tax (note (iii)) 800
Deferred tax (note (iii)) 2600
Inventory – 4 April 20X6 (note (iv)) 36000
Trade receivables 47100
Bank 9100
Trade payables 24500
Revenue 339650
Cost of sales 207750
Distribution costs 27500
Administrative expenses 30700
498550 498550

The following notes are relevant.

(i) The 8% $30 million convertible loan note was issued on 31 March 20X6 at par. Interest is
payable annually in arrears on 31 March each year. The loan note is redeemable at par on
31 March 20X9 or convertible into equity shares at the option of the loan note holders on
the basis of 30 equity shares for each $100 of loan note. Highwood's finance director has
calculated that to issue an equivalent loan note without the conversion rights it would have
to pay an interest rate of 10% per annum to attract investors.

The present value of $1 receivable at the end of each year, based on discount rates of 8%
and 10% are:

8% 10%
End of year 1 0.93 0.91
2 0.86 0.83
3 0.79 0.75

(ii) Non-current assets:

On 1 April 20X5 Highwood decided for the first time to value its property at its fair value. A
qualified property valuer reported that the market value of the property on this date was $80
million, of which $30 million related to the land. At this date the remaining estimated life of
the property was 20 years. Highwood does not make a transfer to retained earnings in
respect of excess depreciation on the revaluation of its assets. Deferred tax is provided for
on revaluations.
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Depreciation for the year ended 31 March 20X6 has not yet been charged. Plant is
depreciated at 20% per annum on the reducing balance method.

Property depreciation should be charged to admin expenses and plant depreciation to cost
of sales.

(iii) The balance on current tax represents the under/over provision of the tax liability for the
year ended 31 March 20X5. The required provision for income tax for the year ended 31
March 20X6 is $19.4million. In addition to the revaluation above there is a further difference
between the carrying amounts of the net assets of Highwood and their (lower) tax base at
31 March 20X6 making a total difference of $27 million. Highwood's rate of income tax is
25%.

(iv) The inventory of Highwood was not counted until 4 April 20X6 due to operational
reasons. At this date its value at cost was $36 million and this figure has been used in the
cost of sales calculation above. Between the year end of 31 March 20X6 and 4 April 20X6,
Highwood received a delivery of goods at a cost of
$2.7 million and made credit sales of $7.8 million at a mark-up on cost of 30%. Neither the
goods delivered nor the sales made in this period were included in Highwood's purchases
(as part of cost of sales) or revenue in the above trial balance.

Required

(a) Prepare the statement of profit or loss and other comprehensive income for Highwood
for the year ended 31 March 20X6.

Your answers and workings should be presented to the nearest $1000; notes to the
financial statements are not required.

(8 marks)

Unanswered

Question not answered

0 out of 0
This question has not yet been scored.

Marking scheme

Marks
(a) Statement of profit or loss and other comprehensive income
Revenue ½
Cost of sales 3½
Distribution costs ½

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Administrative expenses 1
Income tax expense 1½
Other comprehensive income 1½
8

(a) STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

FOR THE YEAR ENDED 31 MARCH 20X6
$’000
Revenue 339650
Cost of sales (W1) (214450)
Gross profit 122700
Distribution costs (27500)
Administrative expenses (W1) (33200)
Profit before tax 64500
Income tax expense (19400 + (W4) 400 –
(19000)
800)
Profit for the year 45500
Other comprehensive income:
Revaluation gain on property (W2) 11250
Total comprehensive income for the year 56750

Workings
1 Expenses
Cost of Distribution Administrative
sales costs expenses
$’000 $’000 $’000

Per question 207750 27500 30700

Depreciation – buildings (W2) 2500
– plant (W2) 10000
Increase in inventories (W5) (3300)
214450 27500 33200

2 Property, plant and equipment

Plant and
Land Buildings Total
equipment
$’000 $’000 $’000
$’000
Per TB – cost 25000 50000 74500 149500
Acc’d depreciation 1.4.20X5 (10000) (24500) (34500)
Carrying amount 1.4.20X5 25000 40000 50000 115000
Revaluation surplus 5000 10000 – 15000
Revalued amount 1.4.20X5 30000 50000 50000 130000
Depn – bldgs (50000 / 20yrs) (2500) (2500)

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– plant (50000 × (10000) (10000)

20%)
30000 47500 40000 117500

The deferred tax on the revaluation (15000 × 25%) will be charged to the revaluation
surplus, leaving a balance of 11250 (15000 – 3750).

3 Loan note
As this is a convertible loan note, it has to be split between debt and equity at 30
March 20X6:

$’000
Interest years 1–3 (2400 x (0.91 + 0.83 +
5976
0.75)
Repayment year 3 (30000 x 0.75) 22500
Liability component 28476
Equity component 1524
Cash received 30000

4 Deferred tax
$’000
Balance required at 31.3.X6 (27m x 25%) 6750
Current balance (2600)
Deferred tax on revaluation (15m x 25%) (3750)
Charge to current tax 400

5 Inventory $’000
Per TB 36000
Received after year end (2700)
Sold after year end (7800 x
6000
100/130)
Correct balance 39300

Adjustment required – deduct 3300 from cost of sales.

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Question 32 of 34

The following trial balance relates to Highwood at 31 March 20X6:

$'000 $'000
Equity shares of 50 cents each 56000
Retained earnings 1400
8% convertible loan note (note (i)) 30000
Property – at cost 1 April 20X0 (land element $25 million (note (ii)) 75000
Plant and equipment – at cost 74500
Accumulated depreciation – 1 April 20X5 – property 10000
– plant and equipment 24500
Current tax (note (iii)) 800
Deferred tax (note (iii)) 2600
Inventory – 4 April 20X6 (note (iv)) 36000
Trade receivables 47100
Bank 9100
Trade payables 24500
Revenue 339650
Cost of sales 207750
Distribution costs 27500
Administrative expenses 30700
498550 498550

The following notes are relevant.

(i) The 8% $30 million convertible loan note was issued on 31 March 20X6 at par. Interest is
payable annually in arrears on 31 March each year. The loan note is redeemable at par on
31 March 20X9 or convertible into equity shares at the option of the loan note holders on
the basis of 30 equity shares for each $100 of loan note. Highwood's finance director has
calculated that to issue an equivalent loan note without the conversion rights it would have
to pay an interest rate of 10% per annum to attract investors.

The present value of $1 receivable at the end of each year, based on discount rates of 8%
and 10% are:

8% 10%
End of year 1 0.93 0.91
2 0.86 0.83
3 0.79 0.75

(ii) Non-current assets:

On 1 April 20X5 Highwood decided for the first time to value its property at its fair value. A
qualified property valuer reported that the market value of the property on this date was $80
million, of which $30 million related to the land. At this date the remaining estimated life of
the property was 20 years. Highwood does not make a transfer to retained earnings in
respect of excess depreciation on the revaluation of its assets. Deferred tax is provided for
on revaluations.
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Depreciation for the year ended 31 March 20X6 has not yet been charged. Plant is
depreciated at 20% per annum on the reducing balance method.

Property depreciation should be charged to admin expenses and plant depreciation to cost
of sales.

(iii) The balance on current tax represents the under/over provision of the tax liability for the
year ended 31 March 20X5. The required provision for income tax for the year ended 31
March 20X6 is $19.4million. In addition to the revaluation above there is a further difference
between the carrying amounts of the net assets of Highwood and their (lower) tax base at
31 March 20X6 making a total difference of $27 million. Highwood's rate of income tax is
25%.

(iv) The inventory of Highwood was not counted until 4 April 20X6 due to operational
reasons. At this date its value at cost was $36 million and this figure has been used in the
cost of sales calculation above. Between the year end of 31 March 20X6 and 4 April 20X6,
Highwood received a delivery of goods at a cost of
$2.7 million and made credit sales of $7.8 million at a mark-up on cost of 30%. Neither the
goods delivered nor the sales made in this period were included in Highwood's purchases
(as part of cost of sales) or revenue in the above trial balance.

Required

(b) Prepare the statement of financial position of Highwood as at 31 March 20X6.

Your answers and workings should be presented to the nearest $1000; notes to the
financial statements are not required.

(12 marks)

Unanswered

Question not answered

0 out of 0
This question has not yet been scored.

Marking scheme

Marks
(a) Statement of financial position
Property, plant and equipment 2½
Inventory 1½
Trade receivables ½
Retained earnings 1

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Revaluation surplus 1
Other component of equity 1
Deferred tax 1
Issue of 8% loan note 1½
Bank overdraft ½
Trade payables ½
Current tax payable 1
12

(a) STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X6

$’000 $’000
Non-current assets
Property, plant and equipment (W2) 117,500
Current assets
Inventory (W5) 39,300
Receivables 47,100
86,400
Total assets 203,900
Equity
Share capital 56,000
Other component of equity (W3) 1,524
Revaluation surplus (W2) 11,250
Retained earning (1,400 + 45,500) 46,900
115,674
Non-current liabilities
Deferred tax (W4) 6,750
Convertible loan note (W3) 28,476
35,226
Current liabilities
Trade payables 24,500
Tax payable 19,400
Overdraft 9,100
53,000
Total equity and liabilities 203,900

Workings
1 Expenses
Cost of Distribution Administrative
sales costs expenses
$’000 $’000 $’000

Per question 207750 27500 30700

Depreciation – buildings (W2) 2500
– plant (W2) 10000
Increase in inventories (W5) (3300)
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214450 27500 33200

2 Property, plant and equipment

Plant and
Land Buildings Total
equipment
$’000 $’000 $’000
$’000
Per TB – cost 25000 50000 74500 149500
Acc’d depreciation 1.4.20X5 (10000) (24500) (34500)
Carrying amount 1.4.20X5 25000 40000 50000 115000
Revaluation surplus 5000 10000 – 15000
Revalued amount 1.4.20X5 30000 50000 50000 130000
Depn – bldgs (50000 / 20yrs) (2500) (2500)
– plant (50000 ×
(10000) (10000)
20%)
30000 47500 40000 117500

The deferred tax on the revaluation (15000 × 25%) will be charged to the revaluation
surplus, leaving a balance of 11250 (15000 – 3750).

3 Loan note
As this is a convertible loan note, it has to be split between debt and equity at 30
March 20X6:

$’000
Interest years 1–3 (2400 x (0.91 + 0.83 +
5976
0.75)
Repayment year 3 (30000 x 0.75) 22500
Liability component 28476
Equity component 1524
Cash received 30000

4 Deferred tax
$’000
Balance required at 31.3.X6 (27m x 25%) 6750
Current balance (2600)
Deferred tax on revaluation (15m x 25%) (3750)
Charge to current tax 400

5 Inventory $’000
Per TB 36000
Received after year end (2700)
Sold after year end (7800 x
6000
100/130)

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Correct balance 39300

Adjustment required – deduct 3300 from cost of sales.

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5/9/2018 ACCA - FR Financial Reporting - CBEs 18-19: FR - CBE Mock - 1

Question 33 of 34

Victular is a public company that would like to acquire 100% of a suitable private company.
It has obtained the following draft financial statements for two companies, Grappa and
Merlot. They operate in the same industry and their managements have indicated that they
would be receptive to a takeover.

STATEMENTS OF PROFIT OR LOSS FOR THE YEAR ENDED 30 SEPTEMBER 20X8

Grappa Merlot
$'000 $'000
Revenue 12000 20500
Cost of sales (10500) (18000)
Gross profit 1500 2500
Operating expenses (240) (500)
Finance costs – loan (210) (300)
– overdraft nil (10)
– lease nil (290)
Profit before tax 1050 1400
Income tax expense (150) (400)
Profit for the year 900 1000

Dividends paid during the year. 250 700

STATEMENTS OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X8

Grappa Merlot
$'000 $'000 $'000 $'000
Non-current assets
Factory (note (i)) 4400 Nil
Owned plant (note (ii)) 5000 2200
Right of use asset (note (ii)) Nil 5300
9400 7500
Current assets
Inventory 2000 3600
Trade receivables 2400 3700
Bank 600 Nil
5000 7300
Total assets 14400 14800
Equity and liabilities
Equity shares of $1 each 2000 2000
Property revaluation reserve 900 Nil
Retained earnings 2600 800
5500 2800
Non-current liabilities
Lease obligations (note (iii)) Nil 3200
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7% loan notes 3000 Nil

10% loan notes Nil 3000
Deferred tax 600 100
Government grants 1200 Nil
4800 6300
Current liabilities
Bank overdraft nil 1200
Trade payables 3100 3800
Government grants 400 Nil
Lease obligations (note (iii)) Nil 500
Taxation 600 200
4100 5700
Total equity and liabilities 14400 14800

The following indivation is relevant.

(i) Both companies operate from similar premises.

(ii) Additional details of the two companies' plant are:

Grappa Merlot
$'000 $'000
Owned plant – cost 8000 10000
Right of use asset – original fair value Nil 7500

There were no disposals of plant during the year by either company.

(iii) The interest rate implicit within Merlot's leases is 7.5% per annum. For the purpose
of calculating ROCE and gearing, all lease obligations are treated as long-term
interest bearing borrowings.

Required

(a) Calculate appropriate ratios and assess the relative perdivance and financial position of
Grappa and Merlot for the year ended 30 September 20X8 to indiv the directors of Victular
in their acquisition decision.

(15 marks)

Question not answered

0 out of 0
Marks

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(a) 1 mark per valid point (up to 6 for ratios) 15

Assessment of relative position and perdivance of Grappa and Merlot

Profitability
At first sight it appears that Victular would see a much greater return on its investment
if it acquired Merlot rather than Grappa. A closer analysis of the figures suggests that
this may not be the case.

Merlot has an ROCE over 40% higher than Grappa's and an ROE more than double
Grappa's ROE. However, the difference is due more to the lower level of equity in
Merlot than to the superiority of its profit. Merlot's equity (2800) is only half that of
Grappa (5500). This reduces the denominator for ROCE and doubles the ROE. A
closer look at the profits of both companies shows that the operating profit margin of
Grappa is 10.5% and that of Merlot is 9.75%.

The net asset turnover of Merlot (2.3 times) suggests that it is running the more
efficient operation. Merlot has certainly achieved a much greater turnover than
Grappa and with a lower level of net assets. The problem is that, on a much higher
level of turnover, its net profit is not much higher than Grappa's.

Further analysis of net assets shows that Grappa owns its factory, while Merlot's
factory must be rented, partly accounting for the higher level of operating expenses.
Grappa's factory is carried at current value, as shown by the property revaluation
reserve, which increases the negative impact on Grappa's ROCE.

Gearing
Merlot has double the gearing of Grappa, due to its finance lease obligations. At 7.5%
Merlot is paying less on the finance lease than on its loan notes, but this still amounts
to a doubling of its interest payments. Its interest cover is 3.4 times compared to six
times for Grappa, making its level of risk higher. In a bad year Merlot could have
trouble servicing its debts and have nothing left to pay to shareholders. However, the
fact that Merlot has chosen to operate with a higher level of gearing rather than raise
funds from a share issue also increases the potential return to shareholders.

Liquidity
Grappa and Merlot have broadly similar current ratios, but showing a slightly higher
level of risk in the case of Merlot. Merlot is also running an overdraft while Grappa
has $1.2m in the bank. Grappa is pursuing its receivables slightly less aggressively
than Merlot, but taking significantly longer to pay its suppliers. As this does not
appear to be due to shortage of cash, it must be due to Grappa being able to
negotiate more favourable terms than Merlot.

Summary
Merlot has a higher turnover than Grappa and a policy of paying out most of its
earnings to shareholders. This makes it an attractive proposition from a shareholder
viewpoint. However, if its turnover were to fall, there would be little left to distribute.
This is the risk and return of a highly geared company. Merlot is already running an
overdraft and so has no cash to invest in any more plant and equipment. In the light
of this, its dividend policy is not particularly wise. Grappa has a lower turnover and a
much more conservative dividend policy but may be a better long-term investment.
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Victular's decision will probably depend upon its attitude to risk and the relative
purchase prices of Grappa and Merlot

Ratios – only 6 needed for maximum marks (1/2 mark per correct calculation)
Grappa Merlot
Return on year end capital employed (ROCE) 14.8% 20.9%
Pre-tax return on equity (ROE) 19.1% 50%
Net asset (total assets less current liabilities) turnover 1.2 times 2.3 times
Gross profit margin 12.5% 12.2%
Operating profit margin 10.5% 9.8%
Current ratio 1.2:1 1.3:1
Closing inventory holding period 70 days 73 days
Trade receivables' collection period 73 days 66 days
Trade payables' payment period (using cost of sales) 108 days 77 days
Gearing 35.3% 71%
Interest cover 6 times 3.3 times
Dividend cover 3.6 times 1.4 times

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Question 34 of 34

Victular is a public company that would like to acquire 100% of a suitable private company.
It has obtained the following draft financial statements for two companies, Grappa and
Merlot. They operate in the same industry and their managements have indicated that they
would be receptive to a takeover.

STATEMENTS OF PROFIT OR LOSS FOR THE YEAR ENDED 30 SEPTEMBER 20X8

Grappa Merlot
$'000 $'000
Revenue 12000 20500
Cost of sales (10500) (18000)
Gross profit 1500 2500
Operating expenses (240) (500)
Finance costs – loan (210) (300)
– overdraft nil (10)
– lease nil (290)
Profit before tax 1050 1400
Income tax expense (150) (400)
Profit for the year 900 1000

Dividends paid during the year. 250 700

STATEMENTS OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X8

Grappa Merlot
$'000 $'000 $'000 $'000
Non-current assets
Factory (note (i)) 4400 Nil
Owned plant (note (ii)) 5000 2200
Right of use asset (note (ii)) Nil 5300
9400 7500
Current assets
Inventory 2000 3600
Trade receivables 2400 3700
Bank 600 Nil
5000 7300
Total assets 14400 14800
Equity and liabilities
Equity shares of $1 each 2000 2000
Property revaluation reserve 900 Nil
Retained earnings 2600 800
5500 2800
Non-current liabilities
Lease obligations (note (iii)) Nil 3200
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7% loan notes 3000 Nil

10% loan notes Nil 3000
Deferred tax 600 100
Government grants 1200 Nil
4800 6300
Current liabilities
Bank overdraft nil 1200
Trade payables 3100 3800
Government grants 400 Nil
Lease obligations (note (iii)) Nil 500
Taxation 600 200
4100 5700
Total equity and liabilities 14400 14800

The following indivation is relevant.

(i) Both companies operate from similar premises.

(ii) Additional details of the two companies' plant are:

Grappa Merlot
$'000 $'000
Owned plant – cost 8000 10000
Leased plant – original fair value Nil 7500

There were no disposals of plant during the year by either company.

(iii) The interest rate implicit within Merlot's leases is 7.5% per annum. For the purpose
of calculating ROCE and gearing, all lease obligations are treated as long-term
interest bearing borrowings.

The directors of Victular decided to go ahead with the purchase of all of the shares of
Grappa. The acquisition took place on 1 December 20X8 and has been financed by a share
for share exchange. Victular will issue two Victular shares for each five Grappa shares and
an additional cash payment of $2 per share to be made on 1 December 20X9. Victular’s
shares were priced at $5 on 1 December 20X8. Victular has a cost of capital of 9%.

Grappa made after-tax profits of $76000 in October 20X8 and $81000 in November 20X8.
Grappa has an internally-generated brand which Victular estimates has a fair value of
$500000. Victular values non-controlling interests using the fair value method. The fair
value and carrying value of all other assets are equal.

Required

Calculate the goodwill arising on the acquisition of Grappa.

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(Answer in $)

(5 marks)

Unanswered

Question not answered

0 out of 0
$ $
Consideration transferred:
Shares (2m x 2/5 x $5) 4000000
Deferred cash payment (2m x $2 x 1/1.09) 3669725
7669725
Net assets:
Share capital 2000000
Property revaluation surplus 900000
Retained earnings to 30.9.X8 2600000
Profits to 1.12.X8 (76000 + 81000) 157000
Intangible asset – brand 500000
(6157000)
1512725

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