HKICPA QP

Final Examination

June 2021
Additional Mock
Questions

http://www.kaplan.com.hk
 Final Examination

Time allowed 3 Hours

(plus ½ hour reading time)
Examination Assessment Allocation
Section A – Case Questions 75 marks
Section B – Essay/ Short Questions 25 marks
YOU SHOULD ANSWER ALL THE QUESTIONS IN THIS PAPER.

Copyright © Kaplan Financial (HK) Limited 2021

All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any
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CASE – Prime Properties Holding Limited

Prime Properties Holding Limited (“PPHL”) is a company incorporated in Hong Kong and has been
listed on the Main Board of the Hong Kong Exchanges and Clearing Limited (“HKEX”) since
1980.The core business of PPHL and its subsidiaries (“the Group”) is property development and
investment, and as well as facilities management business. PPHL was founded by Mr. Leo Wong
who developed his company first into a leading real estate developer in Hong Kong and
subsequently expanded its business in Mainland China. The Group has a financial year end on 31
December 2020.

Operations of the Group

It is the mission of PPHL’s management to build a company with business portfolio that could deliver
good returns to the shareholders in the long term. The Group continues to strengthen its local market
position and is still profitable in its core business during the last few years. Nevertheless, the
economic and business environment in global markets have negative impacts on the Group’s
expansion in its business in Mainland China and overseas. PPHL’s principal activities focuses on
building construction and facility management services, while PPHL’s subsidiaries are mainly
engaged in property investment activities.

• Property Development

PPHL is a market leader with a well-known brand name in property development and management.
PPHL have earned a reputation over the years in rapid construction of quality high-rise apartments
and office towers and has completed several landmark commercial buildings and high-class
residential properties in Hong Kong. On top of the property development business in Hong Kong,
PPHL has diversified its property portfolio in Mainland China. In view of the downturn of the economic
environment in recent years and have negative impact on the property industry, PPHL would like to
maintain a conservative leverage level. Therefore, management of PPHL is reviewing its property
portfolio in Hong Kong and Mainland China and is expected to adopt a more prudent approach in
this in the coming few years.

PPHL builds apartment blocks which normally take two years to complete from the date of signing
the contract. The title and possession, and therefore control, of the apartment blocks pass to the
customer upon completion of construction. The price which is payable on completion of each
apartment block is $9.55 million.

To improve cash flow, customers can pay $8.5 million cash on the day that the contract is signed.
The chief accountant has calculated that this represents an appropriate borrowing rate of 6% for
PPHL. PPHL immediately recognises $8.5 million as revenue if customers pay when they sign the
contract. On 1 January 2021, PPHL sold one apartment block on these terms.

• Facilities management services

PPHL offers full range of facility management services and continue to maintain good reputation in
the local market. The facilities management services are mainly focus on areas of property
management, facilities development, facilities maintenance and repair activities, and consultancy
services. In relation to the facilities management services, there are positive contribution to the
Group’s financial performance. Nevertheless, the contribution margin of facilities management is not
high due to competitions among companies of the same industry.

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PPHL has engaged ABC Training Limited to provide training to its staff to ensure they are able to
provide a high quality of facilities management service and 1% of PPHL’s total facilities management
service income will be charged by ABC Training Limited.

• Property investment and other investment activities

Excellent Investment Corporation, the wholly owned subsidiary of PPHL, focus on the investment in
real estate projects located in Hong Kong and Mainland China. Due to the occurrence of Coronavirus
disease, the global economy has slowed down and has resulted in a decrease in private
consumption and investment globally. There are challenges in maintaining good financial
performance and this is the driving force for the company to globalize the core business to new
geographical areas and as well as expand its business in market segments other than property
investment.

Global Investment Corporation is a newly established subsidiary of PPHL, focus on the investment
in financial instruments such as bonds, hedge funds, unlisted shares, etc. It commenced its
operation from 1 July 2020 and only accounts for 5% of the Group’s total assets and net profits. This
subsidiary is in the United States and is adopting the US GAAP for the preparation of financial
statements.

Finance its globalization strategy

To raise funding to expand its core business to new geographical areas, PPHL is considering to offer
a new class of share, B Share, in the market. B Share allows the holders to request redemption at
specified dates and amounts. The legal terms of B shares states that PPHL has a choice whether
or not to accept the request for repayment of the B shares. Yet, PPHL does not plan to refuse the
request of redemption and it has factored in the repayment in its internal cash flow forecast. There
are no other conditions attached to the B shares. In all other respects the instruments have the
characteristics of equity.

PPHL also has preference shares in issue which are puttable by the holders at any time after 31
October 2025. In other words, the holders have the rights to demand PPHL to redeem the preference
shares. However under the terms of the shares, PPHL has to satisfy the obligation for the preference
shares only if it has sufficient distributable reserves. Hong Kong legislation is quite restrictive in
defining the profits available for distribution as dividends and PPHL is unlikely to satisfy this stringent
definition in the near future.

Acquisition of a startup company

To improve facilities management services, PPHL acquired a startup company, Startup Consultancy
Limited (“Startup”), at HK$3 million. It is developing a ‘Smart Home’ app which allows the home
owners to manage lighting, air conditioning and other electronic appliances of their homes through
internet of things. As the development of the app has not been completed, there is no revenue
generated by Startup yet. Up to the date of acquisition, Startup has incurred significant losses which
mainly represent the costs spent on developing the app. It is expected that Startup will further incur
losses in the coming year. Yet, management is very optimistic about the success of the app and the
benefit it can bring to enhance the service level and financial performance of its facility management
business.

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Takeover of a company for the expansion in Facility Management

As heard from the market, there would be an opportunity in the facility management market by
expanding the market share quicker to acquire the small property management companies. For
example, Zhong Ao Home Group Ltd (1538.HK), a new and small property and facility management
company was partly acquired by Greentown Service Group Co Ltd (2869.HK).

A target Company is called Small Facility Management Company (“SFM”) in Mainland China. SFM
is identified to be acquired, which would then become a 100% owned subsidiary after acquisition.
PPHL is planning to takeover SFM and now doing the due diligence for the acquisition.

Mr. Chan is a qualified accountant and has just been appointed to the position of assistant financial
controller of PPHL. Mr. Chan had accounting working experience only in the unlisted company. And
he would like to consult with Mr. KK, the experienced treasurer in the group about the due diligence
and risk management.

After several months, Mr. Chan has been assigned to take in charge of the acquisition of SFM.

Share option

Excellent Investment Corporation is currently recruiting a senior executive to fill the position of
director for Hong Kong and mainland China. After a series of interviews, Mr. Kam has been
established shortlisted and the Human Resources (HR) director has initiated negotiations with Mr.
Kam on his employment terms. Mr. Kam has made a specific request for the share option as follows:

“Upon signing the employment contract, Excellent Investment Corporation would grant him a share
option to acquire at least 100,000 shares in the Group’s ultimate holding company (PPHL) at an
exercise price equivalent to 30% of the share market price at the date of signing the employment
contract.”

In considering the request for the share option, the HR director of Excellent Investment Corporation
intends to insert a vesting period of two years to ensure that any benefit would only accrue to Mr.
Kam two years after he started to serve the Group. In addition, PPHL would recharge Excellent
Investment Corporation for the related costs incurred when the share option is granted and exercised.

Before concluding the terms, the HR director is obliged to explore both the Hong Kong salaries tax
position arising from the above staff benefits to Mr. Kam and the Hong Kong profits tax deductions
available to Excellent Investment Corporation in respect of the above staff cost.

Sale of properties through internet

Due to the popularity of e-commerce, one of the subsidiaries of PPHK , PP-Sub, located in mainland
China recently established a website for the property sale. The subsidiary sells properties located in
mainland China to customers all over the world including Hong Kong. It operated a server at its
disposal in Hong Kong which hosted a website used exclusively for advertising, displaying properties
and providing information to potential customers. The core operations typically related to a sale (for
example, the conclusion of contracts with the customer, the processing of the payment, etc.) were
not performed through the server.

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SECTION A – CASE QUESTIONS (Total: 75 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation / calculation
and appropriate presentation of the answers.

Question 1 (15 marks – approximately 27 minutes)

(a) Discuss how PPHL should have accounted for the sale of the apartment blocks in
accordance with HKFRS 15 Revenue from Contracts with Customers and HKAS 23
Borrowing Costs.
(10 marks)

(b) Provide the accounting entries that would be required to record the contractual sale of an
apartment block sold on 1 January 2021 at the discounted amount and the relevant entries
over the next two-year construction period.
(5 marks)

Question 2 (5 marks – approximately 9 minutes)

Advise the director how to account for Share B and the preference shares in the group
financial statements of PPHL.
(5 marks)

Question 3 (5 marks – approximately 9 minutes)

Advise the director whether the investment in the Startup should be tested for impairment at
the end of reporting period.
(5 marks)

Question 4 (15 marks – approximately 27 minutes)

For operation due diligence, we should include strategy formulation process, including SWOT
analysis and PESTEL analysis.

Small Facility Management Company (“SFM”) is a very high-tech company using Artificial
Intelligence and Cloud Company for the self-developed 24-hour online automated facility
management system, which is used by all the staff member and the users as well. Unluckily, there
was an incident that the system was hacked. They hired the IT expert to rectify the system in 10
hours’ time.

After doing the finance due diligence, Mr. Chan has found that SFM borrowed in long term with
variable interest rate. And at the same time, Mr. Chan has no experience or idea to know whether
the market interest rate will be up or down in the future. A research report says that there may be a
higher chance of interest rate up in the future.

(a) Based on PESTEL analysis, describe the ONE most significant factor that support the
strategic move in this acquisition. And Identify ONE potential non-financial risk faced by
SFM.
(4 marks)

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(b) Based on the above information, identify and explain ONE financial risk faced by SFM and
recommend TWO strategies to manage the identified risk.
(4 marks)

(c) In order to perform due diligence, PPHL is really concerned about the Debt / Equity ratio
(D/E), because of the bad acquisition experience of a highly leveraged company it had
before. Explain TWO areas which PPHL has to pay attention to when performing the
acquisition due diligence exercises in order to meet its acquisition objective of having a
reasonable leveraged company to be acquired.
(4 marks)

After consulting with Mr. KK, the experienced treasurer, PPHL would like to issue a bond for
normal operation and for current and potential acquisitions. Mr. KK have forecasted the market
interest rate would be down in the future.

(d) PPHL is considering whether it should issue a callable bond. Please explain whether
PPHL should issue a callable bond based on Mr. KK’s forecast.

(3marks)

Question 5 (10 marks – approximately 18 minutes)

As mentioned before, Mr. KK and Mr. Chan are considering several new projects.

Based on financial due diligence report, a 10% rate of return is required on the new investment.

Details of the new investment project are stated as follows:

It is considering investing HK$50 million this year (Yr. 0) and then invest HK$ 30 million next year
(Yr. 1) and HK$ 5 million the year after next year (Yr. 2). It is expected that the new investments will
generate annual earnings of HK$ 3 million (Yr3), beginning three years from now. Assume cash
flows take place at the end of the year and a constant annual growth rate of 6% until Year 5. And
after year 6, annual earnings are expected to be constant in amount of HK$10 million, in perpetuity
forever.

Cashflow (in million)

Yr. 0 1 2 3 4 5 6 7 …
Cashflow
(in million) -50 -30 -5 3 3*(1.06) 3*(1.06)*(1.06) 10 10 ….

Required:

(a) Consider and evaluate whether PPHL should invest in the project.
(6 marks)

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And Mr. KK and Mr. Chan are discussing the idea about sensitivity analysis.

For a new project, after calculating the sensitivity of the project to changes in variables, here are
the calculated results of initial investment sensitivity and variable cost sensitivity.

Initial investment sensitivity = 15%

Variable cost sensitivity = 30%

(b) Which one of the above is more sensitive to NPV of the project? Provide a reason to justify
your answer.
(2 marks)

(c) Aside from financial consideration, sometimes the new project is tempted to be
implemented as advised by Mr. KK. Advise on ONE relevant behavioral factor to capital
budgeting that all the approvers and reviewers have to consider when they review the
new project, especially for the new IT project which may not be fully understood by them.
(2 marks)

Question 6 (20 marks – approximately 36 minutes)

Assume you are Rita Chan, the audit manager of the Group and received the following email from
the Group Engagement Partner.

“Hi Rita,

For the newly established subsidiary of the Group – “Global Investment Corporation”,

(i) Can you suggest the type of audit work that should be performed?

(ii) I am considering not appointing a component auditor and would like to have our group
engagement team to perform the audit of this component. What is your opinion?

Moreover, I had a planning meeting with the Group’s management, and they confirmed that there
are no related party transactions in current year.

(iii) Based on your assessment, please identify any possible related party transactions.

(iv) If you have identified any related party transactions, discuss how the discovery of the
transactions may affect our audit work.

Regards,
Ivan Lam”

Required:
Draft a reply email to Ivan Lam.

Note: Mark(s) will be awarded for proper email format with logical presentation.
(20 marks)

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Question 7 (5 marks – approximately 9 minutes)

Due to the economic downturn, management has performed an impairment review for the property
held for sales by using a model – “The market price model” by discounting the average market price
of similar properties located in the same locations to be the fair value of the property held for sales.

Required:

Propose risk assessment procedures for the impairment of property held for sales.
(5 marks)

* * * END OF SECTION A * * *

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SECTION B – ESSAY QUESTIONS (Total: 25 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation / calculation
and appropriate presentation of the answers.

Refer to the Case information.

Question 8 (14 marks – approximately 25 minutes)

Regarding the grant and exercise of the share option and subsequent share disposal by Mr.
Kam, discuss:

(i) the Hong Kong salaries tax position for Mr. Kam; and
(ii) the Hong Kong profits tax position of Excellent Investment Corporation in terms of the
related costs incurred.
(14 marks)

Question 9 (11 marks – approximately 20 minutes)

Assuming that the disposal of property made by PP-Sub to a third party via the internet is
considered to constitute a “trade”.

(i) Based on the Inland Revenue Ordinance and revised version of Departmental
Interpretation and Practice Note (DIPN) 39, discuss the principles of the tax consequences
of e-commerce transactions. Your answer should focus on the determination of whether
a non-resident has a permanent establishment in Hong Kong and the locality of profits
due to the location of server maintained in Hong Kong.
(8 marks)

(ii) Discuss whether the property sale through internet by PP-Sub should be chargeable to
Hong Kong profits tax.
(3 marks)

* * * END OF EXAMINATION PAPER * * *

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