The Examiner's Answers F1 - Financial Operations

Some of the answers that follow are fuller and more comprehensive than would be expected from a well-prepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike.

SECTION A
Answer to Question One
1.1 C

1.2

1.3

Under the OECD model an entity will have residence in the country of its effective management.

1.4

Cost Excise duty VAT 15% Duty VAT Answer = D

$15 $3 $18 $2.7 $3 $2.7 $5.7 x 2,000 = 11,400

1.5

1.6

1.7

Financial Operations

May 2011

1.8 $000 Cost Acquired: Equity shares Share premium Retained earnings Fair value adjustment Goodwill $000 185

150 15 (22) 10

153 32

1.9

Cost Share of profit for the year to 31 March 2011 Less dividend received Investment

6.5 x 30% = 3.5 x 30% =

$ 25,000 1,950 26,950 (1,050) 25,900

1.10 $33,000 x 25/125 x 50% = 3,300

May 2011

Financial Operations

SECTION B

Answer to Question Two

(a)
(i) 31 March 2010 Tax depreciation $500,000 x 50% = $250,000 Tax written down value = $250,000 FGs corporate income tax due 31 March 2011 Profit Add depreciation Less tax depreciation ($250,000x25%) Taxable profits Tax at 25%

$192,000 $100,000 ($62,500) $229,500 $57,375

(ii) Deferred tax balance at 31 March 2011: Carrying Value Cost 500 Year to 31 March 2010 (100) 400 Year to 31 March 2011 (100) 300 At 31 March 2010: $400,000 - $250,000 = $150,000 At 31 March 2011: $300,000 - $187,500 = $112,500 $38,000 Tax at 25% = $9,500 Credit to income statement of $9,500

Tax base 500 (250) 250 (62.5) 187.5

(b)
(i) A capital gain is a gain made when an asset not covered by income tax rules, is disposed of. E.g. Gains on disposal of investments and non-current assets. 1the selling price. Some tax authorities allow an element of inflation to be used to adjust the purchase price (indexation) and thus reduce tax. Capital gains tax seeks to tax capital gains.

Financial Operations

May 2011

(ii) Sale proceeds Tax allowable costs Net proceeds Cost of land Purchase price Surveyors fees Legal fees Clearance Profit on disposal Capital gains tax at 25% $000 1,000 6 994

850 5 8 15 878 116 29

(c)
(i) Underlying tax is tax on the profits out of which of an overseas entity has paid a dividend to its holding entity. E.g. A subsidiary or associated entity pays a dividend out of its taxed profits. The underlying tax is the tax on its profits. $000 After tax profits Before tax profits Tax After tax profits Gross Dividend Net dividend After tax of 20% 650 (130) 520

(ii)

156 156/0.8 = 195

Underlying tax is 195/520 x 130 = 48.75

(d)
The possible advantages of having principle-based accounting standards include: It will be harder to construct ways of avoiding the detailed requirements of individual standards. For example, a prescriptive standard may set out specific values that should be used when applying a standard. If an actual value is specified it may be possible for some entities to construct various means of avoiding the application of that requirement. Whereas if the standard sets out general principles it is much harder to avoid the standards requirements as a principle will apply no matter what value is put on it. A prescriptive standard would require a certain treatment to be used, regardless of the situation, which could lead to similar items being treated the same way even if the circumstances are very different. Principle based standards will require a standard to be applied using professional judgment, which can help ensure that the correct application is used.

Principles-based GAAP should ensure that the spirit of the regulations is adhered to, whereas the prescriptive system is more likely to lead to the letter of the law being followed rather than the spirit. IFRSs are principle-based standards.

May 2011

Financial Operations

(e)
(i) The Framework states that the objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. The underlying assumptions in the Framework are going concern and accruals basis of accounting.

(ii)

Going concern Financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Any intention to liquidate or significantly reduce the scale of its operations would require the accounts to be prepared on a different basis and this basis would have to be disclosed. Accruals basis of accounting Financial statements are prepared on the accruals basis of accounting where the effects of transactions are recognised when they occur and are recorded and reported in the accounting periods to which they relate, irrespective of cash flows arising from these transactions.

(f)
According to CIMAs Code of ethics for professional accountants CX is in a position where she may be compromising her integrity and objectivity. Integrity This principle imposes an obligation to be truthful and honest on the accountant. A professional accountant should not be associated with reports and other information where she/he believe that the information contains misleading statements. This seems to be the case with the revised forecasts, CX believes that the revised forecasts are grossly overstated. Objectivity A professional accountant should not allow conflict of interest or undue influence of others to override professional or business judgements or to compromise their professional judgements. The management board are overriding CXs professional and business judgement as they are imposing their assumptions on the forecast profits. The possible options for CX in this situation would be: (i) To refuse to remain associated with the forecasts and disassociate herself from them as much as possible. (ii) To consider reporting the situation to appropriate authorities possibly after taking legal advice. (iii) To consider resignation of her post as a professional accountant.

Financial Operations

May 2011

SECTION C
Answer to Question Three MN - Statement of comprehensive income for the year ended 31 March 2011
Continuing Operations Revenue (1120-80) Cost of sales Gross Profit Administrative expenses Distribution costs Profit from operations Finance cost Profit before tax Income tax expense Profit for the period from continuing operations Discontinued Operations Loss for the period from discontinued operations Profit for the period $000 W3 W3 W3 W5 W4 (120) (80) $000 1,040 (553) 487 (200) 287 (12) 275 (72) 203 (189) 14

W2

MN Statement of Financial Position at 31 March 2011

$000 Non-current assets Property, plant and equipment Current assets Inventory Trade receivables Non-current assets classified as held for sale Total assets Equity and liabilities Equity Share capital Share premium Retained earnings Total equity Non-current liabilities Long term borrowings Deferred tax Total non-current liabilities Current liabilities Trade payables Tax payable Bank overdraft Provision for warranty Interest payable Total current liabilities Total equity and liabilities $000

W1

1,823

65 101 166 W2 176 2,165

600 200 761 1,561

300 78 378

W6 W5

51 67 14 82 12 226 2,165

May 2011

Financial Operations

MN Statement of changes in equity for the year ended 31 March 2011 Equity Share Accumulated shares Premium Profits $000 $000 $000 Balance at 1 April 2010 600 200 777 Statement of comprehensive income 14 for year Dividend paid . . (30) Balance at 31 March 2011 600 200 761 Workings (All figures in $000) (W1) Depreciation Buildings Balance b/fwd Year deprec @ 5% Total depreciation NBV Plant and equipment Balance b/fwd cost Balance b/fwd deprec NBV Year 20% NBV c/f Land Total P, P&E c/f

Total $000 1,577 14 (30) 1,561

Continuing 700 35 175 525

Discontinued 40 2 22 18

240 142 98 20 78 1,220 1,823

60 35 25 5 20 150 188

W2)

Discontinued Activity Net book value 188 Impairment 12 Revised book Value 176

NCA Available for sale Balance c/f

Income Statement Revenue Cost of sales (130+7) Gross loss Administrative expenses Distribution costs Loss before tax Income tax credit Impairment of assets Loss for the period

$000 80 (137) (57) (40) (90) (187) 10 (177) (12) (189)

Financial Operations

May 2011

(W3) Cost of sales 622 (130) 35 20 6 553 Administration 160 (40) Distribution 170 (90)

Trial balance Less discontinued Depreciation buildings W1 Depreciation plant and equipment W1 Increase in warranty provision W6 Totals

. 120

. 80

(W4)

Tax Year Discontinued - tax credit add back Decrease in deferred tax (83-78)

67 10 77 (5) 72

(W5)

Interest Years loan interest (300 x 4%)

12

(W6)

Warranty Expected Values 190 x 10%= 20 x 15%= 80 x 75%= Bal c/f Bal b/f Charge for year $000 19 3 60 82 76 6

May 2011

Financial Operations

Answer to Question Four

(a)
OP Statement of Cashflows for the year ended 31 March 2011 $000 Cash flows from operating activities Profit before taxation Adjustments for: Legal claim provision Depreciation (W1) Development expenditure amortisation (W6) Brand name impairment Finance cost Loss on disposal of non-current tangible asset (W2) Operating profit before working capital changes Decrease in inventory Increase in trade receivables Increase in trade payables Cash generated from operations Interest paid (W3) Income taxes paid (W4) Net cash from operating activities Cash flows from investing activities Purchase of property, plant and equipment (W8) Proceeds from sale of equipment (W2) Development expenditure (W6) Net cash used in investing activities Cash flows from financing activities Proceeds from issue of share capital (W7) Repayment of long term borrowings Equity dividends paid* (W5) Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at 1 April 2010 Cash and cash equivalents at 31 March 2011 * this could also be shown as an operating cash flow $000 1,089

40 42 15 10 15 6 4 (70) 55

128 1,217

(11) 1,206 (25) (280) (305) 901

(432) 5 (10) (437) 300 (150) (580) (430) 34 35 69

Financial Operations

May 2011

Workings
W1 Depreciation for the year Plant and equipment Buildings $000 25 17 42

W2 Cash received on disposal of property plant and equipment $000 $000 Net book value 11 6 Loss on disposal Cash received 5 W3 Interest Paid Balance B/F SoCI Balance C/F Paid $000 20 15 35 10 25

W4 Income Taxes paid Balance b/f corporate income tax - deferred tax Income statement Balance c/f corporate income tax - deferred tax Tax paid W5 Dividends Paid Retained earnings Balance b/f Profit for year Retained earnings Balance c/f Dividends paid W6 Development expenditure paid Balance b/f Amortised in year Balance c/f New expenditure W7 Proceeds from issue of share capital Shares Share premium Received $000 200 100 300 $000 423 809 1,232 652 580 $000 65 (15) 50 60 10 250 130 $000 260 120 $000

380 280 660 380 280

May 2011

10

Financial Operations

W8 Non-current asset acquisitions Land Balance b/f Impairment Balance c/f Acquired in year Buildings Balance b/f Balance c/f Acquired in year

320 (65) 255 426 171

610 840 230

Plant and equipment Balance b/f 180 Disposal (45) 135 Balance c/f 166 Acquired in year Total acquired in year

31 432

Part (b)
Finance Lease Workings $ Fair value 248,610 Interest 29,833 Payment (44,000) Bal 31 Mar 12 234,443 Interest 28,133 Payment (44,000) 218,576

Non-current liability

Current liability = 218,576 234,443 = 15,867 Depreciation = 248,610 x 10% = 24,861 Non-current assets = 248,610 24,861 = 223,749 Interest 29,833 Finance Lease $000 24.8 29.8 223.8 218.6 15.9

Statement of Comprehensive Income:

Depreciation Interest Non-current assets Non-current liability Current liability Added back to cash flows from operating activities: Depreciation Interest Investment Activities: Finance lease payments

Statement of Financial Position:

Statement of Cashflows:

24.8 29.8 44.0

Financial Operations

11

May 2011