- Information
- AI Chat
SBR ME J22 A - Mock exam answer
ACCA accounting (SBR P3)
Sunway University
Related documents
- P6mys 2016 dec q - P6 ATX MYS 2016SD Q
- AAA PT A Mar 23 - Advanced audit and assurance
- SBR PT J22 Q - PT June 2022
- SBR ME J22 Q - Mock exam june 2022 question
- The following five-year loan interest rates are available to Stentor Ltd, an AA credit rated company in the Macawber group, and to Evnor Ltd, a BB+ rated company. Stentor wants to borrow at a floatin
- F5 PM ACCA Past Year paper
Preview text
STRATEGIC PROFESSIONAL
ESSENTIAL EXAMINATION
Strategic Business Reporting
ACADEMIC SESSION 3 JUNE 2022
MOCK EXAMINATION 3 JUNE 2022
LECTURER: MS MENON & MS JEIN
GROUP: SBR-G11 & SBR-G12 & SBR PART TIME
EXAM DATE:
MARKING SCHEME
Solution 1
(a) Purchases of shares in Monkei The initial purchase of shares on 1 December 20X6 does not result in control and therefore this is not a business combination and the acquisition method of accounting is not applied. The 8% shareholding is a financial asset investment and is recognised at fair value as required by IFRS 9 Financial Instruments.
Monkei has elected to measure the investment at FVTOCI. This election is available at initial recognition where the shares are not held for trading.
On 1 December 20X7, Chimpz achieves control over Monkei and, therefore, the acquisition method must be applied in accordance with IFRS 3 Business Combinations. This means that Chimpz should recognise in its consolidated financial statements the assets and liabilities of Monkei as well as the non-controlling interest (NCI) and goodwill on acquisition.
Goodwill is calculated as the difference between the consideration paid plus the NCI less the fair value of identifiable net assets of the acquiree. The previously held 8% interest is treated as part of the consideration paid; it is remeasured to fair value at the date on which control is obtained to reflect the position as if the 8% shareholding were sold and repurchased again at its fair value. In this case, the 8% is remeasured from $4 million cost to $5 million fair value, resulting in $1 million income in OCI. This amount is not reclassified to profit or loss because it would not be reclassified if the shares had been sold.
The 40% NCI in the goodwill calculation can be measured at fair value or as a proportion of the net assets acquired. This choice is available on an acquisition-by-acquisition basis. As Chimpz has chosen to measure the NCI at fair value, the goodwill calculated includes goodwill attributable to the parent and to the NCI (i. <full= goodwill).
Net assets of the acquiree are recognised at fair value on acquisition. Therefore a fair value adjustment of $3 million must be made to the property.
Net assets include all identifiable assets, including intangible assets that are not recognised by the acquiree in its separate financial statements but are separable (capable of separate sale) or meet the contractual-legal criterion. A customer list is separable and is therefore recognised at acquisition at its fair value of $2 million.
Contingent liabilities are recognised at acquisition if they arise from a present obligation whose fair value can be reliably measured. Therefore the $500,000 present legal obligation forms part of Monkei9s net assets at acquisition even though it is not recognised as a provision by Monkei because the likelihood of payment is considered not probable.
Fair value adjustments result in a new carrying amount in the consolidated financial statements. This gives rise to deferred tax where the tax base is not the same as the new carrying amount. Taxable temporary differences arise in respect of the fair value uplift to the property and the intangible assets and a deductible temporary difference arises in respect of the contingent liability.
IAS 7 also requires disclosure of changes in liabilities arising from financing activities. Changes disclosed are both cash changes and non-cash changes, including those arising from the effect of foreign exchange rates, changes in fair values and changes from obtaining or losing control of subsidiaries. Chimpz should therefore disclose an increase in bank loans of $12 million due to financing cash flows (i. the loan taken out by Chimpz to purchase Monkei) and $10 million due to the acquisition of a subsidiary. This allows users to evaluate changes in financing liabilities and understand the economic impact of the acquisition of Monkei. They can, for example compare the acquisition of Monkei with the acquisition of other subsidiaries which cost more, but did not bring debt into the group.
There is a 40% non-controlling interest in Monkei. Any dividends paid to this NCI are reported in the consolidated statement of cash flows as a cash flow from either financing or operating activities. This provides useful information; it can be used to predict future dividend payments. Dividends paid from Monkei to Chimpz are eliminated in the consolidated financial statements and are not reported.
(C) Indirect method The vast majority of companies use the indirect method for the preparation of statements of cash flow. Most companies justify this on the grounds that the direct method is too costly. The direct method presents a list of operating cash inflows and outflows, categorised according to type, whereas the indirect method is essentially a reconciliation of the net income reported in the statement of profit or loss with the cash flow from operations. The adjustments include non-cash items reported in the statement of profit or loss and adjustments to reverse the accrual basis of accounting. The direct method shows net cash from operations made up from individual operating cash flows.
Users often prefer the direct method because it shows clearly understandable categories of cash flows. The complicated adjustments required by the indirect method are difficult to understand and provide entities with more leeway for manipulation of cash flows. The adjustments made to reconcile net profit before tax to cash from operations are confusing to users. In many cases these cannot be reconciled to observed changes in the statement of financial position. Thus users will only be able to understand the size of the difference between net profit before tax and cash from operations. The direct method allows for reporting operating cash flows by understandable categories as they can see the amount of cash collected from customers, cash paid to suppliers, cash paid to employees and cash paid for other operating expenses. Users can gain a better understanding of the major trends in cash flows and can compare these cash flows with those of the entity9s competitors.
Whilst in general the statement of cash flows is more easily understandable than other financial statements, an issue for users is the abuse of the classifications of specific cash flows. Misclassification can occur amongst the sections of the statement. Cash outflows that should have been reported in the operating section may be classified as investing cash outflows with the result that companies enhance operating cash flows. The complexity of the adjustments to net profit before tax can lead to manipulation of cash flow reporting.
Information about cash flows should help users to understand the operations of the entity, evaluate its financing activities, assess its liquidity or solvency or interpret earnings information. A problem for users is the fact that entities can choose the method used and there is not enough guidance on the classification of cash flows in the operating, investing and financing sections of the indirect method used in IAS 7. IAS 7 specifically allows a choice of presentation in respect of dividend and interest payments and receipts, so reducing comparability and understandability of the statement of cash flows.
(d) Franchise licence Chimpz has entered into a contract with a customer, RIlla Co; IFRS 15 Revenue from Contracts with Customers therefore applies. Chimpz has promised to grant a licence to RIlla and provide additional activities including advertising and market analysis. As these additional activities are not distinct and are part of Chimpz9s promise to grant a licence, there is a single performance obligation within the contract.
The total transaction price over the ten years of the franchise agreement is $1,000,000 with payments made annually, in advance. Depending on when the performance obligation is satisfied, the contract price may include a significant financing component.
The performance obligation may be satisfied at a point in time or over time: ÷ It is satisfied at a point in time if the licence provides a right to access intellectual property as it exists at the time when the licence is granted; ÷ It is satisfied over time if the licence provides a right to access intellectual property as it exists throughout the licence period.
Chimpz is required to perform market analysis, develop products accordingly and engage in advertising and marketing activities. These activities significantly affect the intellectual property that RIlla has rights to throughout the ten years and, as a result, RIlla is exposed to any positive or negative effects of these activities. Even though RIlla may benefit from the activities, these activities do not transfer a good or service to RIlla.
Therefore, the nature of the performance obligation is to provide access to intellectual property as it exists throughout the franchise period and Chimpz should recognise revenue over time.
A time-based method is likely to be the most appropriate to determine performance because the contract provides RIlla with unlimited access to the Chimpz brand and intellectual property over a fixed period.
As equal payments are made annually it is unlikely that a significant financing component exists in the contract. Therefore, revenue is based on a contract price of $1,000,000. For the year ended 30 November 20X8, Chimpz should recognise revenue of $25,000 (100,000 × 3/12 months). Then, as RIlla9s payment of $100,000 has been received in advance, Chimpz reports a contract liability of $75,000 at 30 November 20X8.
Solution 2
(a) (i) Equity method IFRS 10 Consolidated Financial Statements identifies that when one company has control over another company, a parent-subsidiary relationship exists. If there is control, the subsidiary must be consolidated, unless it is to be sold immediately after acquisition.
Potter owns 45% of the voting shares for Malfoy and from a legal perspective this may indicate that control does not exist. The definition of control states that control exists if an investee is exposed to variable returns from its investee and has the power to affect those returns. As Potter clearly has the ability to influence management (given its right to appoint key personnel) and has options which can be exercised currently and would result in it owning greater than 50%, it would appear that Potter does control Malfoy. Malfoy should therefore be consolidated.
(ii) Acquisitions during the year The Ginger acquisition is another example of Potter acquiring a company that is struggling financially. Given the intent of the acquisition, it appears that Ginger had experienced losses and had long-term liabilities that Potter is hoping to re-negotiate. IFRS 3 Business Combinations covers the accounting for these acquisitions, and even though Ginger was not acquired until late in the year, its financial statements must be included in the consolidated financial statements. Ginger's results post- acquisition must be included in the consolidated statement of profit or loss and other comprehensive income and the consolidated statement of financial position must reflect the assets and liabilities of the group at the reporting date, including those of Ginger.
It is not known what amount was paid for Ginger or its financial position at the date of acquisition; however, given the circumstances, it is likely that a gain on a bargain purchase arose. As this would be recognised directly in profit or loss it would counter some of the negative effects of consolidating Ginger.
A bargain purchase did indeed arise on the acquisition of the controlling interest in Ron. The calculation of the <negative= goodwill should be reassessed and, assuming it is correct, the excess should be recognised as an immediate gain in consolidated profit or loss. Although Potter intends to implement a turnaround plan in Ron, a provision for associated costs cannot be recognised in Ron's statement of financial position at the acquisition date because Ron has no obligation for these costs. When a subsidiary is acquired exclusively with a view to resale it is classified as a discontinued operation in accordance with IFRS 5 Non-Current Assets held for Sale and Discontinued Operations and its results are presented separately from those of continuing operations. Here Potter has future plans for Ron and it is clearly not acquired exclusively with a view to resale. Potter cannot classify it as discontinued operations and present its results separately as this would have the effect of removing ongoing losses from reported profits for continuing operations.
(iii) Related party transaction Related parties, and the transactions that qualify as related party transactions, are covered in IAS 24 Related Party Disclosures. As a member of key management personnel, the chief investment officer (CIO) is a related party of Potter. As a close family member of the CIO, the wife is also related to Potter. As an entity controlled by the wife, Newark is also related to Potter.
Any transaction between Potter and Newark will be a related party transaction and require disclosure in the notes to the financial statements.
The standard requires this transaction to be disclosed, regardless of whether a price was charged. Omitting this information means that stakeholders cannot understand the effect of related party dealings. The shareholders have a right to know all relevant and reliable information relating to transactions that have taken place during the year.
(b) Ethical issues It must be remembered that the directors are acting as stewards of the owners9 money and must act in a manner that has the owner9s interest at the forefront of any actions that they take.
Potter9s strategy of acquiring companies in the hopes of improving their financial status has caused concerns with their shareholders. It is in the best interests of management to show that the acquisitions improve both the subsidiary and consolidated financial statements.
Non-consolidation of Malfoy, Ginger and Ron will each contribute to a more positive financial picture and to potentially alleviate shareholder concerns about the company9s strategy. The directors have a self-interest in keeping their positions on the board, as <several prominent shareholders= could seek their removal.
The director9s decisions about if and when to recognise subsidiaries in the consolidated financial statements and non-disclosure of related party transactions are questionable and concerning. There is strong evidence that the directors are willing to manipulate the financial statements in a way directly contrary to the ethical principles of integrity and objectivity. The directors9 treatments are not justified; although it is in the shareholders9 interests for the company to be profitable, this should not be at the expense of the credibility and transparency of the financial statements. Deliberate manipulation of financial statements will reduce stakeholders9 confidence in the reliability of the financial statements and the accountancy profession as a whole.
Professional accountants are bound by the ethical principles and standards prescribed in the ACCA Code of Ethics and Conduct and IESBA International Code of Ethics for Professional Accountants. Mrs Hermoine has identified several areas of concern and these issues must be raised with management in the first instance. If she feels unable to approach the directors directly (e. because the finance director has been dismissive of the concerns she has already raised), she could consider talking to those charged with governance and, in particular, non-executive directors to explain the situation. She could also seek help from the ACCA ethical helpline and take legal advice. Ultimately, if the situation cannot be resolved, the accountant could consider resigning and seeking employment elsewhere.
Solution 3
(a) IFRS 9 uses an Expected Credit Loss (ECL) model which requires a calculation of the expected value decrease in a financial asset. Essentially, a provision is required for expected credit losses on the financial asset over a period of time. Expected losses should be discounted to the reporting date using the effective interest rate of the financial asset that was determined at initial recognition.
The loan provided to Penny Co could be assessed with the impairment model of IFRS 9, with the three- stage approach:
" Stage 1 deals with financial instruments that have not had a significant increase in credit risk since they were first recognised or that have low credit risk at the financial year end. For these assets, 12-month ECL of $30,000 ($300,000 × 10%) are recognised which means that the entity has to calculate the expected losses in the next 12 months considering the risk of default. The interest revenue of $400,000 (5% × $8m) is calculated on the gross carrying amount of the asset without the deduction of the credit loss.
" Stage 2 deals with financial instruments that have had a significant increase in credit risk since they were first recognised unless the credit risk is still low at the financial year end. These instruments are not credit-impaired. The expected losses over the life of the financial instrument are recognised (lifetime ECL) considering the risk of default, where lifetime ECL is computed at $250,000 ($500,000 × 50%). The change of $220,000 in the cumulative impairment allowance is recognised in profit or loss. Interest revenue of $400,000 (5% × $8m) is still calculated on the gross carrying amount of the asset.
" Stage 3 deals with financial assets that are credit-impaired, which is where events have occurred that have a detrimental impact on the estimated future cash flows from the financial asset. For these assets, lifetime ECL of $1 million ($8 - $7m) are also recognised. The change of $1m ($1 -$0) in the cumulative impairment allowance is recognised in profit or loss. Interest revenue of $400,000 (5% × $8m) is still calculated on the gross carrying amount of the asset.
" The interest revenue for 20X9 is calculated on the carrying amount less the ECL allowance, to be at $350,000 (5% x ($8-$1)) which is based on gross carrying amount minus loss allowance.
For trade receivables or contract assets that do not contain a significant financing component, the loss allowance should be measured, at initial recognition and throughout the life of the receivable, at an amount equal to lifetime ECL. As an exception to the general model, if the credit risk of a financial instrument is low at the reporting date, management can measure impairment using 12-month ECL, and so it does not have to assess whether a significant increase in credit risk has occurred.
(b) Deferred tax According to IAS 12 Income Taxes, an entity should recognise a deferred tax asset in respect of the carry-forward of unused tax losses to the extent that it is probable that future taxable profit will be available against which the losses can be utilised. IAS 12 stresses that the existence of unused losses is strong evidence that future taxable profit may not be available. For this reason, convincing evidence is required about the existence of future taxable profits.
IAS 12 says that entities should consider whether the tax losses result from identifiable causes which are unlikely to recur. Wealthy Co has now made losses in three consecutive financial years, and therefore significant doubt exists about the likelihood of future profits being generated.
Although Wealthy Co is forecasting an improvement in its trading performance, this is a result of new products which are currently under development. It will be difficult to reliably forecast the performance of these products especially during the present covid-19 pandemic for which the uncertainty and risk surrounding the business environment is not easily predictable. More emphasis should be placed on the performance of existing products and existing customers and the existing business environment of the pandemic when assessing the likelihood of future trading profits.
Finally, Wealthy Co breached a bank loan covenant and some uncertainty exists about its ability to continue as a going concern. Many companies facing a bane during the pandemic have raised concerns about the uncertainty of companies9 ability to continue as a going concern. This, again, places doubts on the likelihood of future profits and suggests that recognition of a deferred tax asset for unused tax losses would be inappropriate.
Based on the above, it would seem that Wealthy Co is incorrect to recognise a deferred tax asset in respect of its unused tax losses.
Covenant breach Wealthy Co is currently presenting the loan as a non-current liability. IAS 1 Presentation of Financial Statements states that a liability should be presented as current if the entity: ÷ settles it as part of its operating cycle, or ÷ is due to settle the liability within 12 months of the reporting date, or ÷ does not have an unconditional right to defer settlement for at least 12 months after the ÷ reporting date.
Wealthy Co breached the loan covenants before the reporting date but only received confirmation after the reporting date that the loan was not immediately repayable. As per IAS 10 Events after the Reporting Period, the bank confirmation is a non-adjusting event because, as at the reporting date , Wealthy Co did not have an unconditional right to defer settlement of the loan for at least 12 months. In the statement of financial position as at 30 September 20X6 the loan should be reclassified as a current liability.
Going concern Although positive forecasts of future performance exist, management must consider whether the breach of the loan covenant and the recent trading losses place doubt on Wealthy Co 9s ability to continue as a going concern. The covid-19 pandemic is an unpredicted natural disaster and has impact on many areas of accounting like deferred tax, impairment of financial and nonfinancial assets, recognition of provisions for onerous contracts etc.
These lead to many uncertainties and risk which needs to be appropriately disclosed to ensure that the primary users especially the investors are not mislead and can rely on the financial statements.
c) Costs of fulfilling the contract
Solution 4
4 (a) Legal action by airport operator IAS 37 Provisions, Contingent Liabilities and Contingent Assets , states that a provision must be recognised if, and only if: ÷ a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event); ÷ payment to settle the obligation is probable (<more likely than not=); and ÷ the amount can be estimated reliably.
An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an entity having no realistic alternative but to settle the obligation.
At the date of the financial statements, there was no present obligation for FlyAsia because no legal action had been brought in connection with the accident. Therefore a provision cannot be made.
FlyAsia may need to disclose a contingent liability. IAS 37 defines a contingent liability as: ÷ a possible obligation that has arisen from past events and whose existence will be confirmed by the occurrence or not of uncertain future events; or ÷ a present obligation that has arisen from past events but is not recognised because: ÷ it is not probable that an outflow of resources will occur to settle the obligation; or ÷ the amount of the obligation cannot be measured with sufficient reliability.
Contingent liabilities cannot be recognised but must be disclosed, unless the possibility of an outflow of economic resources is remote. It appears that FlyAsia should disclose a contingent liability in respect of the legal action that will be taken against it (a possible obligation). The fact that the real nature and extent of the damages, including whether they qualify for compensation and details of any compensation payments remained to be established all indicated the level of uncertainty attaching to the case. The degree of uncertainty is not such that the possibility of an outflow of resource could be considered remote. Had this been the case, no disclosure under IAS 37 would have been required.
Thus the conditions for establishing a liability are not fulfilled. However, a contingent liability should be disclosed as required by IAS 37.
The possible recovery of these costs from the insurer gives rise to consideration of whether a contingent asset should be disclosed. Given the status of the expert report, any information as to whether judicial involvement is likely will not be available until 20X9.
Thus this contingent asset is more possible than probable. As such no disclosure of the contingent asset should be included.
(c) Advance payment
IFRS 9 Financial Instruments applies to those contracts to buy or sell a non-financial item which can be settled net in cash with the exception of contracts which are held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity9s expected purchase, sale or usage requirements (own use contract). In other words, it will result in physical delivery of the commodity. Contracts which are for an entity9s <own use= are exempt from the requirements of IFRS 9. Such a contract can be irrevocably designated as measured at fair value through profit or loss even if it was entered into for the above purpose. This designation is available only at inception of the contract and only if it eliminates or significantly reduces a recognition inconsistency (sometimes referred to as an <accounting mismatch=) which would otherwise arise from not recognising that contract because it is excluded from the scope of IFRS 9.
There are various ways in which a contract to buy or sell a non-financial item can be settled net in cash or another financial instrument or by exchanging financial instruments. These include: ÷ when the terms of the contract permit either party to settle it net in cash; ÷ when the ability to settle net in cash is not explicit in the terms of the contract, but the entity has a practice of settling similar contracts net in cash; ÷ when, for similar contracts, the entity has a practice of taking delivery of the underlying and selling it within a short period after delivery , for the purpose of generating a profit; ÷ when the non-financial item which is the subject of the contract is readily convertible to cash.
These contracts are accounted for as derivatives. A level of judgment will be required in this area as net settlements caused by unique events beyond management9s control may not necessarily prevent the application of the <own use= exemption to all similar contracts.
The contract entered into by FlyAsia with Oily seems to be an own use contract which falls outside IFRS 9 and therefore would be treated as an executory contract. However, it could be argued that the contract is net settled because the penalty mechanism requires Oily to compensate FlyAsia at the current prevailing market price. Further, if natural gas is readily convertible into cash in the location where the delivery takes place, the contract could be considered net settled. Additionally, if there is volume flexibility, the contract could be regarded as a written option, which falls within the scope of IFRS 9.
However, the contract will probably still qualify as <own use= as long as it has been entered into and continues to be held for the expected counterparties9 sales/usage requirements.
Additionally, the contract entity has not been irrevocably designated as measured at fair value through profit or loss, thus adding weight to the <own use= designation.
(d) Experimental drilling Since there were no indicators of impairment at the period end, all costs incurred up to 31 August 20X8 amounting to $7 million should remain capitalised in the financial statements for the year ended on that date. However, if material, disclosure should be provided in the financial statements of the additional activity during the subsequent period which determined the exploratory drilling was unsuccessful. This represents a non-adjusting event as defined by IAS 10 Events after the Reporting Period as an event which is indicative of a condition which arose after the end of the reporting period. The asset of $7 million and additional drilling costs of $3 million incurred subsequently would be expensed in the following year9s financial statements.
Discussion of the following accounting issues and application to the scenario 3 Provision (IAS 37) 3 3 Contingent liability (IAS 37) 3 3 Contingent asset (IAS 37) 2 %%% Maximum 5
(i) Explanation and application to the scenario of the usefulness of recognising deferred tax 4 (ii) Explanation and application to the scenario of the deferred tax implications of the two transactions 6 % Maximum 10
Discussion and application of the following to the scenario (i) Advance payment 3 under IFRS 9 6 (iii) Exploratory drilling 3 under IAS 10 4 %%% Maximum 10
SBR ME J22 A - Mock exam answer
Course: ACCA accounting (SBR P3)
University: Sunway University
- Discover more from:
Students also viewed
Related documents
- P6mys 2016 dec q - P6 ATX MYS 2016SD Q
- AAA PT A Mar 23 - Advanced audit and assurance
- SBR PT J22 Q - PT June 2022
- SBR ME J22 Q - Mock exam june 2022 question
- The following five-year loan interest rates are available to Stentor Ltd, an AA credit rated company in the Macawber group, and to Evnor Ltd, a BB+ rated company. Stentor wants to borrow at a floatin
- F5 PM ACCA Past Year paper