National University of Science and

Technology

FACULTY OF COMMERCE

DEPARTMENT OF ACCOUNTING

SECOND SEMESTER EXAMINATION: 2014

DATE: MAY 2014

SUBJECT: FINANCIAL ACCOUNTING 2B: CAC 2201

TIME ALLOWED: THREE (3) HOURS

MARKS: 100

INSTRUCTION TO THE CANDIDATES

1. Answer all questions
2. Begin each Full question on a new page

INFORMATION FOR CANDIDATES

1. All workings should be shown
2. All answers should be presented in good style

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Question one [25 Marks]

On 1 April 2013, ABC acquired 75% of the equity share capital of DEF. DEF had been
experiencing difficult trading conditions and making significant losses. In allowing for DEF’s
difficulties, ABC made an immediate cash payment of only $1·50 per share. In addition,
ABC will pay a further amount in cash on 30 September 2014 if DEF returns to profitability
by that date. The value of this contingent consideration at the date of acquisition was
estimated to be $1·8 million, but at 30 September 2013 in the light of continuing losses, its
value was estimated at only $1·5 million. The contingent consideration has not been
recorded by ABC Overall; the directors of ABC expect the acquisition to be a bargain
purchase leading to negative goodwill.
At the date of acquisition shares in DEF had a listed market price of $1·20 each. Below are
the summarised draft financial statements of both companies
Statements of profit or loss for the year ended 30 September 2013

ABC DEF
$’000 $’000
Revenue 110,000 66,000
Cost of sales (88,000) (67,200)
–––––––– –––––––
Gross profit (loss) 22,000 (1,200)
Distribution costs (3,000) (2,000)
Administrative expenses (5,250) (2,400)
Finance costs (250) nil
–––––––– –––––––
Profit (loss) before tax 13,500 (5,600)
Income tax (expense)/relief (3,500) 1,000
–––––––– –––––––
Profit (loss) for the year 10,000 (4,600)
–––––––– –––––––
Statements of financial position as at 30
September 2013
Assets
Non-current assets
Property, plant and equipment 41,000 21,000
Financial asset: equity investments (note (iii)) 16,000 nil
–––––––– –––––––
57,000 21,000
Current assets 16,500 4,800
–––––––– –––––––
Total assets 73,500 25,800
–––––––– –––––––
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 Equity and liabilities
Equity
Equity shares of 50 cents each 30,000 6,000
Retained earnings 28,500 12,000
–––––––– –––––––
58,500 18,000
Current liabilities 15,000 7,800
–––––––– –––––––
Total equity and liabilities 73,500 25,800
–––––––– –––––––

The following information is relevant:

(i) At the date of acquisition, the fair values of DEF’s assets were equal to their carrying
amounts with the exception of a leased property. This had a fair value of $2 million
above its carrying amount and a remaining lease term of 10 years at that date. All
depreciation is included in cost of sales.
(ii) ABC transferred raw materials at their cost of $4 million to DEF in June 2013. DEF
processed all of these materials incurring additional direct costs of $1·4 million and sold
them back to ABC in August 2013 for $9 million. At 30 September 2013 ABC had $1·5
million of these goods still in inventory. There were no other intra-group sales.
(iii) ABC has recorded its investment in DEF at the cost of the immediate cash payment;
other equity investments are carried at fair value through profit or loss as at 1 October
2012. The other equity investments have fallen in value by $200,000 during the year
ended 30 September 2013
(iv) ABC’s policy is to value the non-controlling interest at fair value at the date of
acquisition. For this purpose, DEF’s share price at that date can be deemed to be
representative of the fair value of the shares held by the non-controlling interest.
(v) All items in the above statements of profit or loss are deemed to accrue evenly over
the year unless otherwise indicated.
Required:
(a) Prepare the consolidated statement of profit or loss for ABC for the year ended 30
September 2013. [12]
(b)Prepare the consolidated statement of financial position for ABC as at 30 September 2013.
[13]

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Question two [25 Marks]

Transaction one
Bertrand issued $10 million convertible loan notes on 1 October 2013 that carry a nominal
interest (coupon) rate of 5% per annum. They are redeemable on 30 September 2016 at par for
cash or can be exchanged for equity shares in Bertrand on the basis of 20 shares for each $100
of loan. A similar loan note, without the conversion option, would have required Bertrand to pay
an interest rate of 8%.
When preparing the draft financial statements for the year ended 30 September 2014, the
directors are proposing to show the loan note within equity in the statement of financial position,
as they believe all the loan note holders will choose the equity option when the loan note is due
for redemption. They further intend to charge a finance cost of $500,000 ($10 million x 5%) in
the income statement for each year up to the date of redemption.
The present value of $1 receivable at the end of each year, based on discount rates of 5% and
8%,
Required:

(a) (i) Explain why the nominal interest rate on the convertible loan notes is 5%, but for non-
convertible loan notes it would be 8%. [2]

(ii) Briefly comment on the impact of the directors’ proposed treatment of the loan notes on the
financial statements and the acceptability of this treatment. [3]

(b) Prepare extracts to show how the loan notes and the finance charge should be treated by
Bertrand in its financial statements for the year ended 30 September 2014. [5]

Transaction two

Bertrand issued 5 million 6% redeemable $1 preference shares 2018 at their nominal value on
1 January 2012. The issue costs associated with the share issue is $200,000.

Required:

(a) In accordance with IAS 32 Financial Instruments: Presentation and IAS 39 Financial
Instruments: Recognition and Measurement:

(i) Explain how this instrument should be classified and prepare the journal for the year ended
31 December 2012; and

(ii) Explain how the preference dividend should be treated in the financial statements of
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Bertrand. [7]

Transaction three
Bertrand made an investment in a financial instrument on 1 January 2012 at its nominal value
of $2,000,000. The instrument carries a fixed coupon interest rate of 7%, which is receivable
annually in arrears. The instrument will be redeemed for $2,265,000 on 31 December 2015.
Transaction costs of $100,000 were paid on acquisition. Bertrand intends to hold this
investment until its redemption date.

Required:

(i) Explain how this investment should be classified; and

(ii) Prepare journal entries for the four years up to 31 December 2015 [8]

Question three [25 Marks]

BN acquired 75% of the 1 million issued $1 ordinary shares of AB on 1 January 2012 for
$1,850,000 when AB’s retained earnings were $885,000.

The carrying value of AB’s net assets was considered to be the same as their fair value at the
date of acquisition with the exception of AB’s property, plant and equipment. The book value of
these assets was $945,000 and their market value was $1,100,000. The property, plant and
equipment of AB had an estimated useful life of 5 years from the date of acquisition. BN
depreciates all assets on a straight line basis.

AB sold goods to BN with a sales value of $400,000 during the year ended 31 December 2013.
All of these goods remain in BN’s inventories at the year end. AB makes a 20% gross profit
margin on all sales.

The retained earnings reported in the financial statements of BN and AB as at 31 December

2013 are $4,200,000 and $1,300,000 respectively.

The group policy is to measure non-controlling interest at fair value at the acquisition date. The
fair value of the non-controlling interest was $570,000 on 1 January 2012.

An impairment review performed on 31 December 2013 indicated that goodwill on the

acquisition of AB had been impaired by 20%. No impairment was recognised in the year ended
31 December 2012.

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Required:

Calculate the amounts that will appear in the consolidated statement of financial position of the
BN group as at 31 December 2013 for:

(i) Goodwill;

(ii) Consolidated retained earnings; and

(iii) Non-controlling interest. [10]

(b)Define the term control in accordance with IFRS 10: Consolidated Financial Statements and
state instances when control can be achieved. [7]
(c)Outline the audit procedures that need to carried out when you determine that you have a
gain from a bargain purchase [8]

Question four [25 Marks]

On 1 October 2012, Leopard Ltd acquired 75% of Tiger’s equity shares by means of a share
exchange of two new shares in Leopard for every five acquired shares in Tiger. In addition,
Leopard issued to the shareholders of Tiger a $100 10% loan note for every 1,000 shares it
acquired in Tiger. Leopard has not recorded any of the purchase consideration, although it does
have other 10% loan notes already in issue.
The market value of Leopard’s shares at 1 October 2012 was $2 each

The summarrised Statement of Financial Position of the two companies at 31 March 2013 were
as follows:

Leopard Tiger
$’000 $’000
Assets
Non-current assets
Property, plant and equipment 47,400 25,500
Financial asset: equity investment notes (i) and (iv) 7500 3,200
Current assets
Inventory (note ii) 20,400 8,400
Trade receivables (note iii) 14,800 9,000
Bank 2,100 nil
Total assets 92,200 46,100

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Equity and liabilities
Equity
Equity shares of $1 each 40,000 8,400
Retained earnings/ (losses) 1 April 2012 19,200 (4000)
For year ended 31 March 2013 7,400 8,000
Non- current liabilities
10% loan notes 8,000 nil
Current liabilities
Trade payables note iii 17,600 13,000
Bank overdraft nil 9,100
Total equity and liabilities 92,200 46,100
The following information is relevant:
(i) At the date of acquisition, Tiger’s produced a draft statement of profit or loss which
showed it had made a net loss after tax of $2 million at that date. Leopard
accepted this figure as the basis for calculating the pre- and post-acquisition split
of Tiger’s profit for the year ended 31 March 2013.

Also at the date of acquisition, Leopard conducted a fair value exercise on Tiger’s
net assets which were equal to their carrying amounts (including Tiger’s financial
asset equity investments) with the exception of an item of plant which had a fair
value of $3 million below its carrying amount. The plant had a remaining economic
life of three years at 1 October 2012.

Leopard’s policy is to value the non-controlling interest at fair value at the date of
acquisition. For this purpose, a share price for Tiger of $1·20 each is representative
of the fair value of the shares held by the non-controlling interest.

(ii) Each month since acquisition, Leopard’s sales to Tiger were consistently $4·6
million. Leopard had marked these up by 15% on cost. Tiger had one month’s
supply ($4·6 million) of these goods in inventory at 31 March 2013. Leopard’s
normal mark-up (to third party customers) is 40%.

(iii) Tiger’s current account balance with Leopard at 31 March 2013 was $2·8 million,
which did not agree with Leopard’s equivalent receivable due to a payment of
$900,000 made by Tiger on 28 March 2013, which was not received by Leopard
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 until 3 April 2013.
(iv) The financial asset equity investments of Leopard and Tiger are carried at their fair
values as at 1 April 2012. As at 31 March 2013, these had fair values of $7·1 million and
$3·9 million respectively.
(v) There was no impairment losses within the group during the year ended 31 March 2013.

Required

Prepare the consolidated Statement of Financial Position as at 31 March 2013 [20]

(b) Discuss how an asset can be recognised in the annual financial statements. [5]

End of examination paper

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