F1 – financial operations - the examiner’s answers - November 2010

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

B

1.2

C

1.3

A

1.4

D

1.5

UF

ZF

1.6

B

1.7

D

1.8

C

1.9

C

1.10

A

Financial Operations

Output tax Input tax VAT Payable

2,875 x 15/115 = 375 1,000 x 15% = 150

Output tax Input tax VAT Payable

6,900 x 15/115 = 900 2,875 x 15/115 = 375

225

525

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November 2010

SECTION B

Answer to Question Two (a) The four methods that a Country can choose from when relieving trading losses of an entity are: (i) Carry forward against future trading profits The effect on ZK would be: Year ended 31 August 2009 taxable profits, chargeable gains of $5,000 Year ended 31 August 2010 no tax payable ($10,000 - $10,000) Year ended 31 August 2011 taxable profits $30,000 ($50,000 – ($30,000 – $10,000)) (ii) Offset against other income and chargeable gains of the same period The effect on ZK would be: Year ended 31 August 2009 no tax payable ($5,000 - $5,000) Year ended 31 August 2010 no tax payable ($10,000 - $10,000) Year ended 31 August 2011 taxable profits $35,000 ($50,000 – ($30,000 – $10,000 - $5,000)) (iii) Offset against other income and chargeable gains of the previous period As ZK has traded profitably for a number of years it should be possible to offset at least some of the $30,000 loss against last years taxable profits this could result in a refund of tax previously paid. (iv) Group relief As ZK is part of a group, group relief may be available. ZK would transfer its loss to another group entity so that entity could offset it against taxable profits. As a result the total group tax payable would be reduced for the year.

(b) (i)

A withholding tax is a tax deducted from a payment at source, before it is made to the recipient abroad.

As a tax authority cannot tax individuals in foreign countries, a withholding tax ensures that the tax authority gains some tax revenues from the payment before it is sent out of the country.

(ii)

Withholding Tax Receipt $3,375,000 = 90% Tax deducted at 10% = $3,375,000 x 10/90 = $375,000 Gross amount $3,375,000 x 100/90 = $3,750,000

November 2010

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Financial Operations

Underlying Tax $1,875,000 x 3,750,000/(12,500,000-1,875,000) = $661,765 Total $375,000 + $661,765 = $1,036,765 Tax due in Country X $3,750,000 x 25% = $937,500 Tax to pay in Country X = $937,500 - $1,036,765 = $0

(c) The four qualitative characteristics are: • Relevance • Reliability • Understandability • Comparability Relevance Information must be relevant to the needs of the user, it is relevant if it influences the economic decisions of the user.

Reliability Information must be reliable to be useful. To be reliable it must be free from material error and bias and be a faithful representation of the underlying transactions. Reliable information must be prepared using economic substance rather than legal form and be complete. Any estimates required must be made on a prudent basis.

Understandability To be useful Information needs to be understood by users. Users can be assumed to have a reasonable knowledge of business and accounting.

Comparability Comparability is essential, information should be able to be compared within the entity over time and with other entities. The inclusion of prior period comparative figures and disclosure of accounting policies helps comparability.

(d) (i) Cost of shares

$000 (180 x $2.50)

Acquired: Equity shares Retained earnings Share premium Revaluation of land

180 40 60 70 350 100

Goodwill

Financial Operations

$000 450

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November 2010

(ii) IFRS 3 Business combinations requires that goodwill is calculated and recognised in the Statement of financial position as an intangible non-current asset. Goodwill is not amortised but must be subjected to impairment reviews at least once a year.

HB should record goodwill as $100,000 in its intangible non-current assets and not provide for any amortisation. An impairment review should be carried out on or before 31 August 2010.

(e) (i)

The acquisition of 80,000 non-voting preferred shares will not give control or any influence over ABC, therefore this would be classified as a non-current asset investment in HI’s financial statements.

(ii)

The preferred shares will be ignored as they do not add any influence to the equity shares. (½) The 40,000 equity shares would give a 40% holding. Without any further information, a 40% holding of equity shares would be assumed to give significant influence (½) over the entity and would be classified as an associated entity, according to IAS 28 Investments in Associates.

(iii)

The 70,000 equity shares will give HI a 70% interest in ABC, this would be sufficient to give control of ABC. As HI would gain control of ABC, ABC would be classified as a subsidiary, according to IAS 27 Consolidated and separate financial statements.

(f) (i)

IAS 37 Provisions, contingent liabilities and contingent assets requires that future costs of reinstatement be provided for as soon as they become an unavoidable commitment. The mine’s license requires the work to be done, so there is a commitment as soon as the mine starts operations.

The present value of the full cost must be provided for. $3 million will be credited to provisions and added to the cost of the non-current asset.

(ii)

The earthquake occurred after the end of the accounting period. Assets and liabilities at 31 August 2010 were not affected. The earthquake is indicative of conditions that arose after the reporting period and does not give any further evidence in relation to assets and liabilities in existence at the reporting date. Therefore according to IAS 10 Events after the reporting period it will be classified as a non-adjusting event after the reporting period. The cost of the repairs will be charged to the Statement of comprehensive income in the period when it is incurred. Due to the impact on MN, i.e. closure and loss of earnings for 6 months, the earthquake and an estimate of its effect will need to be disclosed by way of a note in MN’s financial statements for the year ended 31 August 2010.

November 2010

4

Financial Operations

SECTION C Answer to Question Three (a) XB - Statement of comprehensive income for the year ended 31 October 2010 $000 Revenue Cost of sales Gross Profit Administrative expenses Distribution costs Profit from operations Finance cost Profit before tax Income tax expense Profit for the period

$000 690 323 367

W3 W3 W3

(202) (62)

(264) 103 (6) 97 (34) 63

W9 W7

(b) XB – Statement of changes in equity for the year ended 31 October 2010

Balance at 1 November 2009 New share issue Statement of Comprehensive Income Dividend paid Balance at 31 October 2010

Financial Operations

Equity shares

Share premium

Retained Earnings

Total

$000

$000

$000

$000

300 330

0 99

168 63

468 429 63

(50) 181

(50) 910

630

99

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November 2010

XB – Statement of Financial Position at 31 October 2010 $000 Non-current assets Land Property, plant and equipment

W2

$000

730 152 882

Current assets Inventory Trade receivables Cash and cash equivalents Total assets

18 109 216

Equity and liabilities Equity 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 Accrued interest Total current liabilities Total equity and liabilities

343 1,225

630 99 181 910

W8

200 7 207

(77-3)

74 31 3 108 1,225

Workings (All figures in $000) (W1)

Property Plant and Equipment – Depreciation and Net Book Value

Cost Less depreciation to 31 Oct 2009 Net book value at 31 Oct 2009 Depreciation for year (20% x 320) Purchased during year Depreciation for year (20% x 110) Net book value at 31 Oct 2010

320 192 128 64 64 110 22

88 152

(W2) PPE Balance per trial balance Purchases Depreciation charge for year (W1) (64 +22) Balance at 31 Oct 2010

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Cost 320 110 .

430

Depreciation 192 (86) 278

NBV 128 110 (86) 152

Financial Operations

(W3)

Cost of sales

Administration

Distribution

237

185 5 12 .

202

62

Trial balance Donations Entertaining Depreciation (W1) Total

86 323

(W4) PPE - Tax Written down Value Tax written down value at 31 Oct 2009 Tax allowance for year to 31 Oct 2010 - 25% Purchased during year Tax allowance at 50%

.

62

90 (22.5) 67.5

110 (55) 55 122.5

Tax written down value at 31 Oct 2010

(W5) Income Tax Expense Tax Calculation for year ended 31 October 2010 Profit per Statement of Comprehensive Income Add back: Entertaining Donations Depreciation (W2) Less tax depreciation (W3) (22.5 + 55) Taxable profit TAX AT 25%

$000 97 12 5 86 200 (77.5) 122.5 30.625

Provide for taxation of $31,000 for the year

(W6)

Deferred tax

Temporary difference at 31 Oct 2009 Temporary difference at 31 Oct 2010 Change in year Decrease deferred tax by $3,000

(128-90) 38 (152 (W1) - 122.5 (W4)) 29.5

@25% = 9.5 rounded to 10 @25% = 7.375 rounded to 7 (3)

See W8 for SoFP

(W7) Income tax expense for year ended 31 Oct 10 Balance b/f Income tax for year (W5) Deferred tax reduction (W6)

Financial Operations

6 31 (3) 34

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November 2010

(W8)

Deferred Tax – Statement of Financial Position

Temporary difference at 31/10/10 (W6) 7.375 rounded to 7 Or Balance 1 September 2009 Reduction Balance 31 October 2010

10 (3) 7

(W9) Finance cost Interest on long term borrowings 200 x 3% = 6

SoCI

Half year 6 x 6/12 = 3 current liability SoFP

November 2010

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Financial Operations

Answer to Question Four (a) YG - Statement of Cash Flows for the year ended 31 October 2010 $000 Cash flows from operating activities Profit before taxation

$000

266

Adjustments for: Redundancy cost provision Depreciation Development expenditure amortisation (W5) Finance cost Loss on disposal of non-current tangible asset (W1) Operating profit before working capital changes Increase in inventory Increase in trade receivables Increase in trade payables

(150) 250 145 16 4 531 (97) (84) 115 (66) 465

Cash generated from operations Interest paid (W2)** Income taxes paid (W3) Net cash from operating activities Cash flows from investing activities Purchase of property, plant and equipment (W4) Proceeds from sale of equipment Development expenditure (W5) Net cash used in investing activities Cash flows from financing activities Proceeds from issue of share capital (W6) Repayment of long term borrowings Equity dividends paid* Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at 1 November 2009 Cash and cash equivalents at 31 October 2010

(14) (180)

(194) 271

(448) 66 (68) (450) 2,400 (355) (82) 1,963 1,784 205 1,989

* this could also be shown as an operating cash flow ** this could be shown as a financing cash flow Workings (All figures in $000) W1 – Loss on disposal of property plant and equipment Net book value Cash Gain

70 66 4

W2 – Interest Paid Balance B/F SoCI Balance C/F Paid

Financial Operations

3 16 19 5 14

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November 2010

W3 – Income Taxes paid Balance b/f – corporate income tax - deferred tax

170 170 340 120 460

Income statement Balance c/f – corporate income tax - deferred tax Tax paid

70 210

Alternative Method: Balance b/f – corporate income tax Income statement

280 180

170 80 250 (70) 180

Balance c/f – corporate income tax Tax paid

W4 – Purchase of plant and equipment Balance b/f Revaluation Disposals

4,248 300 (70) 4,478 (250) 4,228 4,676 448

Depreciation for year Balance c/f Purchases

W5 – Development expenditure Balance b/f Amortised in year

494 (145) 349 417 68

Balance c/f New expenditure

W6 – Proceeds from issue of share capital Shares Share premium Received

1,600 800 2,400

W7 – Dividend paid Retained earnings b/f Add profit for the year

1,250 146 1,391 1,314 82

Less retained earnings c/f Dividend paid in year

November 2010

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Financial Operations

(b) Confidentiality is one of the fundamental principles of the CIMA Code of Ethics for Professional Accountants.

A professional accountant should respect the confidentiality of information acquired as a result of business relationships and should not disclose any such information to third parties unless there is a legal or professional right or duty to disclose. If there is no right or duty to disclose, the principle of confidentiality requires the professional accountant to not disclose confidential information outside the employing entity without specific authority. In addition it is usually illegal to use this type of information for personal gain. In most countries this would be classified as insider trading. The CIMA Code requires that the professional accountant does not use confidential information to their personal advantage or the advantage of third parties.

You would therefore have to respond by either not accepting the invitation or accepting the invitation but make it clear in advance that you are unable to discuss any confidential information relating to your employer and the employer’s activities.

Financial Operations

11

November 2010