SOLUTIONS MANUAL for International Financial Reporting, 8th Edition by Alan Melville ISBN 9781292439

Answers Manual International Financial Reporting: A Practical Guide Eighth edition

Alan Melville

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Contents (* Marked Questions Answers)

Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Chapter 13 Chapter 14 Chapter 15 Chapter 16 Chapter 17

Preface Acknowledgements

v vi

The regulatory framework Solutions 1.8 and 1.9

1

The IASB® conceptual framework Solutions 2.7 and 2.8

3

Presentation of financial statements Solution 3.7

5

Accounting policies, estimates and errors Solution 4.7, 4.8 and 4.9

8

Property, plant and equipment Solutions 5.7 and 5.8

10

Intangible assets Solutions 6.8 and 6.9

13

Impairment of assets Solutions 7.7 and 7.8

15

Non-current assets held for sale and discontinued operations Solution 8.7

16

Leases Solutions 9.7 and 9.8

17

Inventories Solutions 10.5 and 10.6

19

Financial instruments Solution 11.6

21

Provisions and events after the reporting period Solution 12.8

23

Revenue from contracts with customers Solutions 13.7 and 13.8

24

Employee benefits Solutions 14.6 and 14.7

26

Taxation in financial statements Solutions 15.7, 15.8 and 15.9

28

Statement of cash flows Solutions 16.8, 16.9 and 16.10

34

Financial reporting in hyperinflationary economies Solution 17.5

39

iii © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 18 Chapter 19 Chapter 20 Chapter 21 Chapter 22 Chapter 23 Chapter 24

Groups of companies (1) Solutions 18.6 and 18.7

40

Groups of companies (2) Solutions 19.5 and 19.6

45

Associates and joint arrangements Solution 20.5

51

Related parties and changes in foreign exchange rates Solution 21.4

53

Ratio analysis Solutions 22.5, 22.6 and 22.7

54

Earnings per share Solutions 23.6, 23.7, 23.8 and 23.9

59

Segmental analysis Solution 24.6

61

iv © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 1 The regulatory framework 1.8 The advantages of adopting IFRS® Accounting Standards might include: (a) Application of the international standards should ensure that the company's financial statements provide high-quality, transparent and comparable information. This should help investors, lenders and other users of the financial statements to make sound economic decisions. If potential investors and lenders feel that they can trust Baxen's financial statements, this should make it easier for the company to raise fresh capital in the form of share issues or borrowings. (b) Furthermore, adoption of IFRS should allow Baxen to obtain a listing on stock exchanges around the world, most of which now require listed companies to comply with international standards. This would also provide new opportunities for raising capital. (c) Many of the foreign companies with which Baxen trades will also use IFRS. This should help Baxen to compare its own financial statements with theirs and perhaps to identify foreign companies that might be suitable candidates as prospective subsidiaries. Baxen would also be able to compare its own financial statements much more easily with those of its competitors. (d) Once Baxen has subsidiaries, it will need to prepare group accounts. This involves combining all of the financial statements of the group members into a single set of consolidated financial statements (see Chapter 18). This task will be a great deal easier (and cheaper) if all of the companies in the group are applying the same financial reporting standards. There would also be less work for the group's auditors to do, so that the audit fee should be lower. (e) Within the group, the use of consistent standards would make it easier to assess each subsidiary's performance and to compare subsidiaries with each other. (f) Accounting staff working for the Baxen group would all become familiar with the international standards and would not need retraining if they moved around the group from one company to another. This would certainly reduce staff training costs.

1 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

1.9 (a) The objective of IFRS1 is to ensure that an entity's first financial statements that comply with international standards should contain high-quality information that: – is transparent for users and comparable for all periods presented – provides a suitable starting point for accounting under international standards – can be generated at a cost that does not exceed the benefits to users. (b) An entity's "first IFRS reporting period" is the reporting period covered by the first IFRS financial statements. The first IFRS financial statements are the first financial statements in which the entity adopts international standards and makes an explicit and unreserved statement of compliance with those standards.

The "date of transition" to international standards is the date at the beginning of the earliest period for which an entity presents comparative information in its first IFRS financial statements. (c) The company's first IFRS reporting period is the year to 31 October 2023. The earliest period for which comparative figures are presented in the first IFRS financial statements is the year to 31 October 2018. Therefore the date of transition is 1 November 2017. The company must: (i)

prepare an IFRS statement of financial position as at the start of business on 1 November 2017 (i.e. as at the close of business on 31 October 2017) (ii) use identical accounting policies in this "opening" IFRS statement of financial position and in the financial statements for the year to 31 October 2023 and in the comparative figures provided for the previous five years; these accounting policies (and all these financial statements) must comply with international standards in force for periods ending on 31 October 2023 (iii) provide a reconciliation of equity as reported under previous GAAP with equity reported under international standards, for 31 October 2017 and 31 October 2022 (iv) provide a reconciliation of total comprehensive income as reported under previous GAAP with total comprehensive income as it would have been reported under international standards, for the year to 31 October 2022.

2 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 2 The IASB® conceptual framework 2.7 (a) £1 invested at 7% per annum will become £1 ´ 1.07 ´ 1.07 ´ 1.07 after three years. So the present value on 1 January 2023 of an amount to be received on 1 January 2026 (assuming a discount rate of 7%) is equal to that amount divided by (1.07)3. This is the same as multiplying the amount by a discounting factor (to three decimal places) of 0.816 (1/1.073).

So the present value of £50,000 to be received on 1 January 2026 is £40,800 (£50,000 ´ 0.816). (b) Similarly, the discounting factor over a five-year period is 0.713 (1/1.075) and so the present value of £100,000 to be received on 1 January 2028 is £71,300 (£100,000 ´ 0.713). (c) With a discount rate of 7%, discounting factors for one, two, three and four years are 0.935, 0.873, 0.816 and 0.763 respectively (the calculation of these factors is left to the reader). So the present value of £10,000 to be received on 1 January each year from 2024 to 2027 inclusive is £33,870 (£9,350 + £8,730 + £8,160 + £7,630).

3 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

2.8 (a) Lakeview has a liability because it has a present obligation to transfer economic benefits as a result of past events. The event which creates the obligation is the sale of furniture to a customer. From that point onward (and for the next two years) Lakeview in under an obligation to honour its warranty if the furniture turns out to be faulty in some way. Even if the warranty is not legally enforceable, a liability still exists if Lakeview has a constructive obligation.

The liability will be recognized as such in Lakeview's financial statements as long as it is possible to obtain a reasonable estimate of the monetary amount involved. (See Chapter 12 for more details). (b) If Carson is responsible for cleaning up the polluted area (which is highly likely) it has a liability of £3m. It also has a £1m asset, since the mine and surrounding land can be sold for that sum once the pollution has been dealt with. If Carson is not responsible (legally or constructively) for cleaning up the pollution, it will presumably not do so. In these circumstances, the £3m liability will not exist but nor will the £1m asset. (c) The event which causes Astoria to incur a liability to the marketing manager is the fact that he or she performs the duties of the employment. The signing of the contract does not create an obligation to transfer economic benefits, so no liability should be recognized at that time. (d) Oxnard now has an asset because it has a present economic resource (the software) controlled by the entity (the company is entitled to use the software) as a result of past events (the purchase of the software). A "present economic resource" is a right that has the potential to produce economic benefits (the reduction of inventory storage costs).

The software will be recognized as an intangible asset (see Chapter 6) and will then be amortised over a four-year period. However, if the expected cost savings are lower than expected, it may be necessary to conduct an impairment review in relation to the software (see Chapter 7) and perhaps recognize an impairment loss. (e) As at 31 July 2023, Stockton has an £850,000 liability to its members. This liability arises because the company has a present obligation to transfer economic benefits (the use of its fitness clubs) to these members for the next 12 months. Furthermore, if the clubs were to close down, the subscriptions paid in advance would be repayable to the members concerned.

It is not permissible to recognise revenue from members until the company satisfies its performance obligations to those members in return for receiving their subscriptions (see Chapter 13).

4 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 3 Presentation of financial statements 3.7 (a) Chilwell Ltd Statement of comprehensive income for the year to 31 October 2022 £ 998,310 465,900 ———532,410

Sales revenue (£1,025,420 - £27,110) Cost of sales (W1) Gross profit Distribution costs (W2) Administrative expenses (W3)

173,610 259,250 ———-

Other operating income Profit from operations Finance costs (£6,220 + £3,600) Profit before taxation Taxation expense (£20,000 + £8,400) Profit for the year Other comprehensive income for the year: Items that will not be reclassified to profit or loss: Gain on revaluation of land Total comprehensive income for the year

432,860 ———99,550 10,270 ———109,820 9,820 ———100,000 28,400 ———71,600

30,000 ———101,600 ———-

(b) Chilwell Ltd Statement of changes in equity for the year to 31 October 2022 Share Revaluation Retained capital reserve earnings £ £ £ Balance at 1 November 2021 80,000 75,000 247,060 Total comprehensive income 30,000 71,600 Dividend paid (35,000) Bonus issue 40,000 (40,000) —————————Balance at 31 October 2022 120,000 105,000 243,660 —————————-

5 © 2022 Pearson Education Limited. All Rights Reserved.

Total equity £ 402,060 101,600 (35,000) ———468,660 ———-

Melville: International Financial Reporting, Instructor's Manual, 8th edition

(c) Chilwell Ltd Statement of financial position as at 31 October 2022 £ Assets Non-current assets Property, plant and equipment (W4) Current assets Inventories Trade receivables (£69,500 ´ 98%)

£

565,550 92,280 68,110 ———-

Total assets Equity Share capital Other reserves Retained earnings

120,000 105,000 243,660 ———-

Liabilities Non-current liabilities Long-term borrowings Current liabilities Trade and other payables (£103,290 + £3,600) Bank overdraft Current tax payable

160,390 ———725,940 ———-

468,660

120,000 106,890 10,390 20,000 ———-

Total equity and liabilities

137,280 ———725,940 ———-

6 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Workings W1 Cost of sales Opening inventory Purchases Returns outwards Closing inventory

£ 87,520 483,230 (12,570) (92,280) ———465,900 ———-

W2 Distribution costs Per trial balance Wages and salaries (50%) Buildings depreciation (W4) (30%) Equip't depreciation (W4) (60%) Loss on disposal (W4)

£ 107,050 51,200 2,400 10,710 2,250 ———173,610 ———-

W3 Administrative expenses Per trial balance Directors' fees Wages and salaries (50%) Buildings depreciation (W4) (70%) Equip't depreciation (W4) (40%) Bad debts Reduction in allowance for receivables: (2% ´ £69,500) - £1,520

£ 143,440 50,000 51,200 5,600 7,140 2,000 (130) ———259,250 ———-

W4 Property, plant and equipment Land at valuation Buildings at cost Depreciation to 31/10/2021 Depreciation for year (£240,000 ÷ 30) Equipment at cost (£197,400 - £64,000) Depreciation to 31/10/2021 (£105,750 - £43,750) Depreciation for year (25% ´ £71,400)

£

£

£ 280,000

300,000 60,000 8,000 ———62,000 17,850 ———-

68,000 ———133,400

232,000

79,850 ———-

53,550 ———565,550 ———-

Notes re sold vehicle: (i) WDV of sold vehicle was £64,000 ´ 75% ´ 75% ´ 75% ´ 75% = £20,250. (ii) Accumulated depreciation was £43,750 (£64,000 - £20,250). (iii) The loss on disposal was £2,250 (£20,250 - £18,000).

7 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 4 Accounting policies, estimates and errors 4.7 (a) IAS8 permits a change of accounting policy only if this change is required by an international standard (or an IFRIC® Interpretation) or if the change results in reliable and more relevant information being provided to the users of the financial statements.

A change in accounting policy which arises from the initial application of an international standard or an IFRIC Interpretation should be accounted for in accordance with the transitional provisions of that standard or interpretation.

A change in accounting policy which is made voluntarily so as to improve the relevance of the financial statements should be accounted for retrospectively. Comparative figures for the previous period(s) must be adjusted and presented as if the new policy had always been applied. (b) (restated) 2022 £000 5,400 3,900 ––––– 1,500 300 ––––– 1,200 –––––

2023 £000 5,200 4,100 ––––– 1,100 220 ––––– 880 –––––

Revenue Operating expenses Profit before taxation Taxation expense Profit after taxation (c)

Retained earnings £000 1,605 760 ––––– 2,365 880 ––––– 3,245 –––––

Balance b/f as previously reported Change in accounting policy (950 ´ 80%) Restated balance Profit for the year to 31 March 2023 Balance c/f

(d) The draft statement of comprehensive income suggested that revenue and profits both increased in the year to 31 March 2023. The revised statement improves comparability between 2022 and 2023 and makes it clear that revenue and profits actually fell in the year to 31 March 2023. The provision of more comparable information is the main aim of IAS8 in relation to changes in accounting policy and is, of course, one of the qualitative characteristics identified by the Conceptual Framework.

8 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

4.8 The reclassification of R&D costs as administrative expenses rather than as cost of sales is a change in accounting policy. Therefore, assuming that the company applies IFRS Accounting Standards, the change in policy must comply with the requirements of IAS8 Accounting Policies, Changes in Accounting Estimates and Errors.

First of all, the company is not permitted to make a change in accounting policy unless: (a) the change is required by an IFRS Accounting Standard (or an IFRIC interpretation), or (b) the change results in reliable and more relevant information being provided to the users of the company's financial statements.

It is clear that (a) does not apply in this situation. However, it is possible that (b) does apply and that the reclassification of R&D costs provides more relevant information to users, though the directors of the company would need to present a convincing argument to support this view. This is especially true in the case of amortised development costs, which are generally treated as a component of cost of sales and matched against the revenue earned from the development projects concerned.

If neither (a) nor (b) applies, the change in accounting policy cannot be allowed to go ahead and the draft financial statements must be revised so as to re-apply the previous policy.

But if it is accepted that (b) applies, then the change must be accounted for retrospectively so as to maintain comparability. In the financial statements for the year to 31 March 2023, the comparative figures given for the previous year (for cost of sales and administrative expenses) must be restated so that they show the figures which would have been shown if the new accounting policy had applied in the year to 31 March 2022 as well as in the year to 31 March 2023.

4.9 Statement of changes in equity for the year to 31 December 2023 Share Share Revaluation capital premium reserve £000 £000 £000 Balance at 1 January 2023 600 200 75 Changes in equity for 2023 Correction of prior period error ——— ——— ——— Restated balance 600 200 75 Disposal of revalued asset (25) Bonus issue of shares 30 (30) Issue of share capital 120 96 Total comprehensive income 38 Dividend paid ——— ——— ——— Balance at 31 December 2023 750 266 88 ——— ——— ———

Retained earnings £000 357

Total equity £000 1,232

(83) ——— 274 25

(83) ——— 1,149

89 (15) ——— 373 ———

216 127 (15) ——— 1,477 ———

Workings: (1) Profit for the year is (£112,000 – £23,000) = £89,000.

(2) The final dividend payable in March 2024 is not recognized in the 2023 financial statements.

9 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 5 Property, plant and equipment 5.7 (a) Non-current assets Broadly, a non-current asset is an asset which is acquired for long-term use within a business. Such an asset is not acquired for sale to a customer (though it may be sold at the end of its useful life) but for use in the business over a number of accounting periods.

Strictly speaking, a non-current asset is any asset which does not qualify as a current asset. The full definition of a current asset is given below.

Typical examples of non-current assets are property, plant and equipment, intangible assets (such as patents and trademarks) and long-term investments.

Current assets Broadly, current assets comprise short-term assets which continually flow through the business and are constantly being realised. IAS1 defines a current asset as an asset which satisfies any of the following criteria: (i) it is expected to be realised, or is intended for sale or consumption, within the entity's normal operating cycle (ii) it is held primarily for the purpose of being traded (iii) it is expected to be realised within twelve months after the reporting period (iv) it is cash or a cash equivalent as defined by international standard IAS7, unless it is restricted from being exchanged or being used to settle a liability for at least twelve months after the reporting period.

Typical examples of current assets are inventories, trade receivables and cash. (b) Capital expenditure is expenditure which results in the acquisition of a non-current asset or in an improvement to the earning capacity of an existing non-current asset. For example, expenditure on acquiring business premises (or building an extension to existing premises) would be classed as capital expenditure.

Revenue expenditure is expenditure which results in the acquisition of a current asset (e.g. inventory) or expenditure on things such as selling and distribution expenses, administrative expenses and finance charges. The cost of repairs or maintenance to a non-current asset (but not the cost of improvements) would be classed as revenue expenditure. (c) In general, capital expenditure is shown initially in the statement of financial position and is then transferred to the statement of comprehensive income over a period of years by means of depreciation charges. In contrast, revenue expenditure is wholly written off to the statement of comprehensive income in the year to which it relates.

Therefore, if an item of capital expenditure is incorrectly classified as revenue expenditure, this will reduce the reported profit of the company for the year in which the expenditure is incurred and will also reduce the non-current assets figure shown in the statement of financial position. However, assuming that the asset is depreciable, the absence of depreciation charges in subsequent years will increase the reported profit of those years so that the company's total profits over the entire useful life of the asset will in fact be unaffected by the error.

10 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

(d) The cost of the machine (and therefore the amount which should be treated as capital expenditure) is £378,400 (£342,000 + £6,800 + £29,600).

One-half of the maintenance charge (£13,500) should be recognised as an expense in the company's statement of comprehensive income for the year to 31 December 2022. The other half should be treated as a prepayment and should be shown as a current asset in the statement of financial position at 31 December 2022. This £13,500 will then be recognised as an expense in the company's statement of comprehensive income for the year to 31 December 2023.

The cost of the small spare parts (£14,600) should be treated as the acquisition of a current asset (inventory) and should be shown as such in the company's statement of financial position. As the spares are used, their cost should be removed from inventory and recognised as an expense in the statement of comprehensive income. (e) Freehold land Revaluation reserve Allowance for depreciation of buildings Freehold buildings at cost or valuation Revaluation reserve

£000 100

£000 100

125 50 75

Depreciation of buildings for the year to 31 December 2023 is £15,000 (£450,000 ÷ 30).

Notes: (i)

Accumulated depreciation of the buildings as at 1 January 2023 (ten years after their acquisition) was (£500,000 ´ 10/40) = £125,000. Therefore the carrying amount of the buildings on that date was (£500,000 – £125,000) = £375,000.

(ii) The revaluation of the buildings gives rise to a gain of (£450,000 – £375,000) = £75,000. (iii) The above journal entry removes the accumulated depreciation, reduces freehold buildings (at cost or valuation) by £50,000 to £450,000 and records the revaluation gain.

11 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

5.8 A summary of the situation with regard to each asset is as follows: Item A £000 Year to 31 March 2023 Carrying amount as at 1 April 2022 180,000 Revaluation loss (recognized as an expense) (20,000) Revaluation gain (credited to revaluation reserve) –––––– 160,000 Depreciation year to 31 March 2023 (1/5th) (32,000) –––––– Carrying amount as at 31 March 2023 128,000 –––––– Year to 31 March 2024 Carrying amount as at 1 April 2023 128,000 Subsequent expenditure capitalised –––––– 128,000 Depreciation year to 31 March 2024 (1/4th) (32,000) Sold 31 March 2024 Loss on sale (recognized as an expense)

–––––– 96,000 ––––––

Carrying amount as at 31 March 2024

Item B £000 80,000 32,000 –––––– 112,000 (22,400) –––––– 89,600 –––––– 89,600 14,400 –––––– 104,000 (26,000) –––––– 78,000 (70,000) –––––– 8,000 ––––––

The revaluation of Item B on 1 April 2022 causes the depreciation on that item for the year to 31 March 2023 to be £6,400 more than it otherwise would have been. So £6,400 is transferred from the revaluation reserve to retained earnings on 31 March 2023. Similarly, when the item is sold on 31 March 2024, the remainder of the revaluation gain (£25,600) is transferred to retained earnings.

Extracts from the financial statements are as follows: Statements of profit or loss Year to 31 March 2023 Loss on revaluation Depreciation expense (32,000 + 22,400) Year to 31 March 2024 Loss on disposal Depreciation expense (32,000 + 26,000)

£000 20,000 54,400 8,000 58,000

Statements of financial position As at 31 March 2023 Property, plant and equipment (128,000 + 89,600) Revaluation reserve (32,000 – 6,400) As at 31 March 2024 Property, plant and equipment Revaluation reserve (25,600 – 25,600)

£000 217,600 25,600 96,000 nil

12 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 6 Intangible assets 6.8 If the revaluation model is adopted, intangible assets are carried at a revalued amount. This comprises the asset's fair value at the date of revaluation, less any subsequent amortisation and less any subsequent impairment losses. The conditions under which this model may be used are as follows: (i)

The revaluation model cannot be applied to an intangible asset unless its fair value can be measured reliably, by reference to an active market in that type of asset. (ii) If the revaluation model is applied to an intangible asset, then it must be applied to the entire class to which the asset belongs. (iii) Revaluations should be made with sufficient regularity to ensure that the carrying amount of an intangible asset does not differ materially from fair value. All of the items within a class of intangible assets should be revalued simultaneously.

The intangible assets of Companies W, X and Y should be dealt with as follows: (a) Company W. In 2022, the revaluation loss of £25,000 should be recognised as an expense when calculating the company's profit or loss for the year. In 2023, £25,000 of the revaluation gain should be recognised as income when calculating the company's profit or loss. The remaining £20,000 of the gain should be credited to a revaluation reserve and recognised as other comprehensive income. (b) Company X. In 2023, £60,000 may be transferred (in the statement of changes in equity) from revaluation reserve to retained earnings. The profit on disposal of £35,000 should be recognised as income when calculating the company's profit or loss for the year. (c) Company Y. In 2022, the gain on revaluation of £10,000 should be credited to a revaluation reserve and recognised as other comprehensive income. In 2023, £10,000 should be debited to revaluation reserve and recognised (as a negative figure) in other comprehensive income. The remaining £15,000 of the revaluation loss should be recognised as an expense when calculating the company's profit or loss for the year.

13 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

6.9 (a) Goodwill is defined by IFRS3 as "an asset representing the future economic benefits arising from ... assets acquired in a business combination that are not individually identified and separately recognised". This definition refers only to the goodwill acquired in a business combination (i.e. when an entity acquires control of a business). A broader definition might state that goodwill is an asset that arises from factors such as an entity's good reputation and may be generated internally as well as being acquired in a business combination.

IAS38 does not allow internally generated goodwill to be recognised as an asset. This is because the cost (and value) of such goodwill cannot be determined reliably and therefore one of the recognition criteria specified in the IASB Conceptual Framework is not satisfied. (b) In general, goodwill acquired in a business combination is initially measured as the excess of: (i) the price paid by the acquirer in the business combination, over (ii) the acquirer's interest in the net fair value of the acquiree's identifiable assets and liabilities at the acquisition date.

Goodwill acquired in a business combination should be tested for impairment in each subsequent accounting period and should be measured at the amount initially recognised less any accumulated impairment losses. (c) If the goodwill acquired in a business combination appears to have a negative value, IFRS3 requires that the fair value of the price paid by the acquirer (the "consideration") and the fair values of the identifiable assets and liabilities acquired should be reassessed. Any negative goodwill which still remains after this reassessment has been performed should be treated as income from a bargain purchase and should be included in the acquirer's profit or loss. (d) See Chapter 6 of the textbook for a list of the main disclosure requirements of IFRS3 in relation to goodwill.

14 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 7 Impairment of assets 7.7 (a)

2023 2024 2025

Inflows

Outflows

£000 45 35 60

£000 5 5 5

Net cash flows £000 40 30 55

Discount factors 0.926 0.857 0.794

Value in use

Present value £000 37 26 44 –––– 107 ––––

Note: The discount factor for 2023 is 1/1.08 = 0.926. The discount factor for 2024 is 1/(1.08)2 and so forth. The calculation of present value for each year has been performed to the nearest £000. (b) Fair value less costs of disposal is £104,000 (£110,000 – £6,000). Therefore recoverable amount is £107,000, which is the higher of £104,000 and £107,000. (c) Depreciation in 2021 and 2022 is (£200,000 – £40,000)/5 = £32,000 in each year. The accumulated depreciation at 31 December 2022 is £64,000 and so the asset's carrying amount at that date is £136,000 (£200,000 – £64,000). Since recoverable amount is only £107,000, there is an impairment loss of £29,000.

The impairment loss should be recognised as an expense when calculating the company's profit or loss for the year to 31 December 2022. This is in addition to the depreciation charge of £32,000 for the year. The asset's carrying amount in the statement of financial position at 31 December 2022 is £107,000. (d) The asset's depreciable amount is now £67,000 (£107,000 – £40,000). Therefore the depreciation charges in 2023, 2024 and 2025 should each be equal to one-third of £67,000 i.e. approximately £22,333 per annum.

7.8 (i)

Depreciation for the year to 30 November 2023 is £2,400,000, so the asset's carrying amount at that date is £21,600,000 (£24,000,000 – £2,400,000).

(ii) Value in use is £20,500,000. Fair value less costs of disposal is £14,000,000. Recoverable amount is the higher of these two figures i.e. £20,500,000. (iii) There is an impairment loss of £1,100,000 (£21,600,000 – £20,500,000). This should be recognised as an expense when calculating the company's profit or loss for the year to 30 November 2023. (iv) The asset's carrying amount at 30 November 2023 is reduced to £20,500,000. Assuming that the previous estimates of useful life and residual value remain unchanged, this amount should be written off in the form of depreciation charges over the following nine years. However, the asset is clearly being used in an area of manufacturing which is subject to rapid technological change and the company should be alert to the possibility of further impairment losses in the future.

15 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 8 Non-current assets held for sale and discontinued operations 8.7 (a) A disposal group is a group of assets (perhaps with some directly associated liabilities) which are to be disposed of in a single transaction. A disposal group may consist of a number of cash-generating units, a single cash-generating unit or part of a cash-generating unit. In general, a disposal group should be classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. For this to be the case, the disposal group must be available for immediate sale in its present condition (subject only to terms that are usual and customary) and the sale must be highly probable. A sale is regarded as "highly probable" if: (i)

the entity's management is committed to a plan to sell the disposal group and an active programme has been initiated to locate a buyer and complete the plan; and (ii) the disposal group is being actively marketed at a sale price that is reasonable in relation to its current fair value; and (iii) a completed sale is expected within one year from the date of classification (although this period may be extended if delay is caused by circumstances beyond the entity's control); and (iv) it is unlikely that there will be any significant changes to the plan or that the plan will be withdrawn.

Assuming that these conditions are all satisfied, the cash-generating unit which Bakewall Ltd has classified as held for sale qualifies as a disposal group. (b) A discontinued operation is a component of an entity that either has been disposed of or is classified as held for sale. For this purpose, a component consists of operations and cash flows that can be clearly distinguished from the rest of the entity and usually comprises a single cash-generating unit or a group of cash-generating units. The operation which Bakewall Ltd has closed down satisfies this definition and so qualifies as a discontinued operation. (c) On 1 August 2022, the carrying amount of the disposal group is £3m and its fair value less costs to sell is £2.6m. There is an impairment loss of £0.4m. On 31 December 2022, fair value less costs to sell has fallen to £2.35m and so there is a further impairment loss of £0.25m. The total impairment losses of £0.65m should be recognised as an expense when calculating the company's profit or loss for the year to 31 December 2022.

The revenue and expenses of the discontinued operation should be shown separately from the company's other revenue and expenses in the statement of comprehensive income for the year to 31 December 2022. This statement should include a single amount of £770,000 (expense) in relation to discontinued operations, comprising impairment losses of £650,000 and a trading loss of £120,000 (£520,000 – £400,000). This single amount of £770,000 should be analysed, either in the statement of comprehensive income or in the notes to the financial statements.

In the statement of financial position at 31 December 2022, the assets of the disposal group should be presented separately from the company's other assets (under a heading such as "Non-current assets held for sale") and should be measured at £2.35m.

16 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 9 Leases 9.7 (a) The main factors which indicate that this is a finance lease are: (i) The lease term (five years) is the whole of the remaining economic life of the underlying asset. (ii) It is likely that the present value of the lease payments (total £137,500) is substantially all of the fair value of the underlying asset (£112,500). (iii) The substance of the transaction seems to be the provision of finance to enable the lessee to use the asset for the next five years. (b) The present value of the lease payments receivable by Conston Ltd after the commencement date is £27,500 ´ (1/1.125 + 1/1.1252 + 1/1.1253 + 1/1.1254) = £82,655. The present value of the asset's residual value at the end of the lease term is £5,000 ´ 1/1.1255 = £2,775. Therefore the net investment in the lease at the commencement date is (£82,655 + £2,775) = £85,430.

Note: The net investment in the lease is also equal to the fair value of the underlying asset at the commencement of the lease (£112,500), less the lease payment received on the commencement date (£27,500), plus the lessor's direct costs (£430). (c) Year to 30 Sept

Receivable b/f

Lease payment

Balance

2023 2024 2025 2026 2027

£ 85,430 96,109 77,185 55,896 31,945

£ 0 27,500 27,500 27,500 27,500

£ 85,430 68,609 49,685 28,396 4,445

Finance income @ 12.5% £ 10,679 8,576 6,211 3,549 555

Receivable c/f £ 96,109 77,185 55,896 31,945 5,000

The remaining balance of £5,000 at the end of the lease term is equal to the expected scrap value of the asset. When Conston Ltd disposes of the asset, any amount by which the proceeds differ from £5,000 will be recognised as a profit or loss on disposal.

Note: In effect, there are two distinct assets here. Conston Ltd has the right to receive £27,500 per annum on 1 October 2023, 2024, 2025 and 2026. This receivable reduces to zero when the final payment is received on 1 October 2026. But the company also regains use of the underlying asset at the end of the lease term. The present value of the asset's residual value is £2,775 at the commencement of the lease but the "unwinding" of the discount increases this to £5,000 by the end of the lease term.

17 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

9.8 (a) IFRS16 requires lessees to recognise "right-of-use" assets and lease liabilities in relation to the rights and obligations created by most types of lease, although there are exemptions for certain short-term leases and for leases of low-value assets (see below).

Prior to IFRS16, it was possible (in some cases) for lease payments to be recognised simply as an expense. In these circumstances, there was no recognition of the fact that the lessee had acquired the right to use the underlying asset over the lease term and had incurred a corresponding liability to make lease payments throughout that term. It could be argued that this did not provide a faithful representation of the lessee's financial position.

The omission of lease liabilities from the statement of financial position (known as "off-balance sheet financing") was especially serious. The financial obligations of the lessee were understated and the capital gearing ratio (see Chapter 22) was distorted. IFRS16 remedies this situation. (b) A lessee may elect not to recognise right-of-use assets and lease liabilities in relation to short-term leases (i.e. leases of 12 months or less) and leases of low-value assets. However, the lessee is not obliged to make this election and may prefer to recognise assets and liabilities for such leases.

The election for short-term leases (if made) should be made by class of underlying asset. The election for leases of low-value assets is made on a lease-by-lease basis. (c) The lease liability is measured initially at the present value of the three lease payments of £42,500.

With a discount rate of 11%, discount factors for one, two and three years are 0.901, 0.812 and 0.731.

The sum of these factors is 2.444, so the initial lease liability is (£42,500 ´ 2.444) = £103,870. The interest expense for each year of the lease and the outstanding liability at the end of each year are calculated as follows: Year

2023 2024 2025

Liability b/f £ 103,870 72,796 38,304

Interest @ 11% £ 11,426 8,008 4,196

Lease payment £ (42,500) (42,500) (42,500)

Liability c/f £ 72,796 38,304 0

Current £ 34,492 38,304 0

Noncurrent £ 38,304 0 0

Notes: (i) The interest expense for 2025 has been rounded down to ensure that the lease liability reduces to exactly zero after the final payment. (ii) The liability at the end of each year should be split into a current liability and a non-current liability as shown in the final two columns of the table.

On 1 April 2022, Triste Ltd should also recognise a right-of-use asset of £154,810 (£103,870 + £50,000 + £940). This asset should be depreciated over the useful life of the lorry. (d) The lessor should classify this lease as a finance lease, since legal title is transferred to the lessee at the end of the lease term. The lorry should be derecognised and a receivable of £103,870 should be recognised instead (with £50,000 paid into the bank). This "net investment" in the lease consists of the present value of all the lease payments to be received from the lessee after the commencement date. Note that (as required) the interest rate implicit in the lease (11%) is the rate of interest that causes the present value of all the lease payments (including the initial £50,000) to be equal to the fair value of the asset plus the lessor's direct costs (£153,000 + £870).

The income element of each payment made by the lessee (see above table) is recognised as finance income and the remainder of the payment is subtracted from the receivable.

18 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 10 Inventories 10.5 (a) Broadly, inventories are stocks of goods. More precisely, IAS2 defines inventories as assets that are held for sale in the ordinary course of business, or assets that are in the process of production for such sale, or assets that are in the form of materials or supplies to be consumed in the production process or in the rendering of services. (b) The cost of inventories includes costs of purchase, costs of conversion and any other costs incurred in bringing the inventories to their present location and condition. See Chapter 10 of the textbook for a more detailed explanation of how the cost of inventories should be determined. (c) Net realisable value (NRV) is defined by IAS2 as estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. (d) IAS2 states that inventories should be measured at the lower of cost and NRV. The costs and NRV of inventories are normally compared item by item, but it is sometimes appropriate to group similar or related items together and to compare the total cost of the group with total NRV. (e) The cost per unit of Product X is £8. NRV per unit is £6 (£15 – £7 – £2). The lower of cost and NRV is £6 per unit. The 6,400 units of this product should be measured at £38,400 (6,400 ´ £6).

The cost per unit of Product Y is £12. NRV per unit is £18 (£30 – £8 – £4). The lower of cost and NRV is £12 per unit. The 3,800 units of this product should be measured at £45,600 (3,800 ´ £12).

10.6 (a) Vehicle W Costs to date are £11,430 (£9,470 + £1,080 + £880).

Abnormal wastage of £44 (5% ´ £880) is excluded, leaving £11,386.

NRV is £13,160 (94% ´ £14,000) so the lower of cost and NRV is £11,386.

Vehicle X Costs to date are £15,310 (£12,830 + £940 + £1,540).

Abnormal wastage of £77 (5% ´ £1,540) is excluded, leaving £15,233.

NRV is £17,992 (94% ´ £19,300, less £150) so the lower of cost and NRV is £15,233.

Vehicle Y Costs to date are £5,560 (£3,550 + £750 + £1,260).

Abnormal wastage of £63 (5% ´ £1,260) is excluded, leaving £5,497.

NRV is £5,040 (94% ´ £6,000, less £600) so the lower of cost and NRV is £5,040.

Vehicle Z Costs to date are £8,140 (£7,680 + £460).

There is no abnormal wastage.

NRV is £8,892 (94% ´ £11,800, less £2,200) so the lower of cost and NRV is £8,140.

Total The inventory of vehicles at 29 February 2024 should be measured at £39,799, which is the sum of £11,386, £15,233, £5,040 and £8,140. (b) The total cost of abnormal wastage was £184 (£44 + £77 + £63).

19 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

(c) FIFO Used Jan 7 Used Jan 28

Kilos 19 18

Used Feb 7 Used Feb 29

4 3

4 @ £26 3 @ £26

16

1 @ £26 15 @ £21

19 @ £22 6 @ £22 12 @ £26

Cost (£) 418 132 312 –––

104 78 –––– 1,044 ––––

Total usage cost Inventory Feb 29 AVCO Bought Jan 5 Used Jan 7 Bought Jan 20 Used Jan 28 Used Feb 7 Bought Feb 15 Used Feb 29

Kilos 25 @ £22 19 @ £22 ––– 6 20 @ £26 ––– 26 18 @ £25.08 ––– 8 4 @ £25.08 ––– 4 15 @ £21 ––– 19 3 @ £21.89

Total cost (£) 550 418 ––– 132 520 ––– 652 451 ––– 201 100 ––– 101 315 ––– 416 66

––– 16 @ £21.89 –––

––– 350 –––

Total usage cost Inventory Feb 29

444

26 315 ––– Weighted average £22.00

341 ––– Cost (£) 418

£25.08 451 100

£21.89 66 –––– 1,035 ––––

20 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 11 Financial instruments 11.6 (a) Broadly, a financial instrument is a means of raising or providing finance and will usually consist of a share issue or a loan. More precisely, IAS32 defines a financial instrument as any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.

The acquisition of the loan stock by Querk plc establishes a contract between the company and the issuer of the stock. By virtue of this contract, Querk plc acquires a financial asset (a contractual right to receive cash from another entity). The issuer of the loan stock incurs a financial liability (a contractual obligation to deliver cash to another entity). Therefore the issue of the loan stock falls within the IAS32 definition of a financial instrument. (b) A financial asset is any asset that consists of either cash, an equity instrument of another entity (e.g. ordinary shares) or a contractual right to receive cash or another financial asset from another entity.

A financial liability is any liability that consists of a contractual obligation to deliver cash or another financial asset to another entity.

As explained above, the loan stock is a financial asset for Querk plc but a financial liability for the issuer of the stock (i.e. the borrower). (c) IFRS9 classifies the loan stock as a financial asset measured at amortised cost. The investment should be measured initially at fair value (which is normally equal to the price paid) and should be measured subsequently at amortised cost, using the effective interest method.

The amortised cost of an asset is equal to the amount at which it was initially recognised, plus the interest earned to date, minus any repayments received to date. The effective interest method takes into account not only interest receivable, but also items such as premiums and discounts. (d) Year

b/f

2023 2024 2025 2026 2027

£ 490,420 504,558 519,968 536,765 555,074

Interest at 9% £ 44,138 45,410 46,797 48,309 49,926 ––––––– 234,580 –––––––

Received

c/f

£ (30,000) (30,000) (30,000) (30,000) (605,000)

£ 504,558 519,968 536,765 555,074 0

The amount received in each of the first four years is equal to 6% of £500,000. The amount that is received in 2027 comprises interest of £30,000, loan stock repayment of £500,000 and a premium of £75,000 (15% of £500,000).

The total interest over the five years (£234,580) comprises interest at 6% on the nominal value of the stock for five years (£150,000) plus the premium of £75,000 and the acquisition discount of £9,580 (£500,000 – £490,420).

Note that interest calculated at 9% in 2027 is actually £49,957. This has been adjusted to £49,926 to ensure that the balance at the end of the loan term is zero. It is apparent that the effective rate of interest is in fact very slightly less than 9% per annum.

21 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

The interest income that should be shown in the company's statement of comprehensive income for each year is shown in the column headed "Interest at 9%". The figures that should appear in the statement of financial position are shown in the rightmost column. (e) As stated above, the effective interest method takes into account not only interest receivable, but also items such as premiums and discounts. Querk plc benefits from a discount when the loan stock is acquired and a premium when it is repaid. These amounts are each received in a single year but are in fact earned over the term of the loan. The effective interest method spreads them fairly over the term of the loan and so gives a fair measure of the income for each year.

22 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 12 Provisions and events after the reporting period 12.8 (a) This situation meets the three criteria for the recognition of a provision set out in IAS37: – the entity has a present obligation as a result of a past event (the dismissal of Karen) – it is probable that an outflow of economic resources will be required to settle this obligation (the company's legal advisors are suggesting that Karen has a very strong case and will probably be awarded compensation) – a reliable estimate can be made of the amount of the obligation.

The company should recognise a provision at 30 April 2023. The estimated amount of this provision is two years' worth of salary (including bonuses) plus Karen's legal costs. This gives a provision of (£50,000 ´ 2) + (5,000 ´ £5 ´ 2) + £15,000 = £165,000. (b) This situation meets the definition of a contingent asset set out in IAS37: – the entity has a possible asset arising from a past event (the supply of faulty goods) – the existence of this asset will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the entity's control (the outcome of the claim).

IAS37 requires that contingent assets should not be recognized in the financial statements unless an inflow of economic benefits is virtually certain. However, contingent assets should be disclosed in the notes if an inflow on economic benefits is judged to be probable. Therefore Stella plc should disclose this contingent asset in the notes to the financial statements. (c) This is an example of an event after the reporting date, as defined by IAS10. Furthermore, this event provides evidence of conditions that existed at the reporting date and is therefore an adjusting event. Stella plc should recognise an impairment loss of (120,000 ´ 88p) = £105,600 in the financial statements for the year to 30 April 2023 and reduce trade receivables by the same amount. (d) This is also an example of an event after the reporting date, but does not provide evidence of conditions that existed at the reporting date. This is therefore a non-adjusting event. The reduction in closing inventory at 30 April 2023 made by the Finance Director should be reversed. But this is a material non-adjusting event and should therefore be disclosed in the notes. (e) Depreciation for the year to 30 April 2023 is £12,500 (£500,000 ´ 1/40) and the carrying amount of the building at that date (before considering impairment) is £412,500 (£500,000 ´ 33/40). But the building's recoverable amount is equal to the greater of £391,000 and £375,000 which is only £391,000. This is an example of an asset whose carrying amount exceeds its recoverable amount, so that the company has suffered an impairment loss, as defined in IAS36.

As well as the year's depreciation expense of £12,500, the company should also recognise an impairment loss of £21,500 (£412,500 – £391,000) in the year to 30 April 2023 and write the asset down to a carrying amount of £391,000. This amount will then be depreciated over the asset's remaining useful life of 33 years.

23 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 13 Revenue from contracts with customers 13.7 This is a repurchase agreement. Although the legal form of the agreement is that a sale has occurred, the substance of the transaction seems to be a secured loan. It is unlikely that a finance company would wish to buy this inventory and it seems much more likely that the finance company is expecting Triangle to repurchase the inventory in due course. Logically, Triangle will do this if the sales value of the inventory at the time of repurchase is greater than £5m plus compound interest at 10% p.a. (from 1 April 2022) plus accumulated storage costs.

The application guidance provided by IFRS15 states that such agreements should be treated as financing arrangements if the repurchase price exceeds the original selling price (as in this case).

The £5m should be removed from sales revenue and recognised as a non-current liability. Also, £3m should be added to closing inventory and removed from cost of sales. A further £300,000 should be added to closing inventory and removed from trade receivables.

Interest of £500,000 should be shown as an expense in the statement of comprehensive income and should be added to the carrying amount of the loan.

24 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

13.8 (a) Estimated total contract costs are £500,000 (£190,000 + £30,000 + £280,000). Costs incurred for the work performed to date (£190,000) are 38% of this total, so the company measures its progress on the contract to be 38%. The statement of comprehensive income for the year to 31 May 2023 should include revenue of £228,000 (38% of £600,000) in relation to this construction contract and expenses (cost of sales) of £190,000. This means that contract profit recognised in the year is £38,000.

The statement of financial position at 31 May 2023 should show inventory of £30,000 and a contract asset of £53,000 (£228,000 – £175,000) for the amount not yet invoiced to the customer for the work done to date. The £45,000 which has been invoiced to the customer but has not yet been received (£175,000 – £130,000) should be shown as a trade receivable.

Check: Assuming that all of the costs have been paid in full out of the company's bank account, the changes in the assets shown in the statement of financial position are as follows: Inventory Trade receivables Bank balance (130 - 220) Contract asset Total increase in assets

£000 30 45 (90) 53 ––– 38 (which equals the recognised profit) –––

(b) With a contract price of only £480,000, contract revenue for the year is £182,400 (38% of £480,000).

Contract expenses are £202,400 (£190,000 plus an impairment loss of £12,400 (see below)). So the recognized loss for the year is £20,000 (£182,400 – £202,400). This reflects the fact that an overall loss of £20,000 is expected on the contract (£480,000 – £500,000).

As regards the impairment loss, contract costs recognised as an asset at the year-end (inventory) are £30,000. However, the remaining consideration which the company expects to receive is £297,600 (£480,000 – £182,400) and the remaining costs are £280,000. Remaining consideration less costs is only £17,600, so there is an impairment loss of £12,400 (£30,000 – £17,600).

The statement of financial position at 31 May 2023 should show inventory of £30,000 and a contract liability of £5,000. This comprises £7,400 (£182,400 – £175,000) for the amount not yet invoiced to the customer, less provision for the impairment loss of £12,400.

As before, the £45,000 (£175,000 – £130,000) which has been invoiced to the customer but has not yet been received is shown as a trade receivable.

Check: Assuming that all of the costs have been paid in full out of the company's bank account, the changes in the assets and liabilities shown in the statement of financial position are as follows: Inventory Trade receivables Bank balance (130 - 220) Contract liability Total decrease in net assets

£000 30 45 (90) (5) ––– (20) (which equals the recognised loss) –––

25 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 14 Employee benefits 14.6 (a) A defined benefit pension plan is one where the employer is obliged to provide an agreed level of pension benefits. The employer's contributions are not limited to any fixed amount and these contributions may need to be increased if the pension fund has insufficient assets to pay the agreed level of benefits.

A defined contribution pension plan is one where the employer pays fixed contributions into the pension fund each year and is not required to make any further contributions, even if the pension fund's assets are insufficient to pay the expected level of pension benefits. (b) In relation to a defined benefit pension plan, the "defined benefit obligation" is the amount of the accumulated benefits which past and present employees have earned in return for their services to date and which will be payable to them in the future. The "current service cost" is the extra amount of such benefits that employees have earned in return for their services during the current period.

These amounts can only be estimated since they involve the making of assumptions with regard to such matters as employee mortality rates and future salary increases. (c) "Interest cost" is equal to the increase (during the current period) in the present value of the defined benefit obligation that was calculated at the end of the previous period. This increase arises because the accumulated benefits which employees had earned at the end of the previous period are now one period closer to being paid.

"Actuarial gains and losses" consist of adjustments arising either because there are some differences between actuarial assumptions and actual events, or because actuarial assumptions are revised. (d) In summary, the defined benefit obligation and the plan assets are as follows: £m Present value of DB obligation at 31 March 2023 140.0 Interest cost 9.8 Present value of current service cost for the year 19.2 Benefits paid during the year (19.6) –––– 149.4 Actuarial loss (balancing figure) 8.6 –––– Present value of DB obligation at 31 March 2024 158.0 –––– Fair value of plan assets at 31 March 2023 Interest income Return on plan assets (after deducting interest income) Employer contributions Employee contributions Benefits paid during the year Fair value of plan assets at 31 March 2024

£m 147.0 10.3 (4.4) 18.4 7.3 (19.6) –––– 159.0 ––––

26 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

The defined benefit expense which should be shown in the statement of comprehensive income for the year to 31 March 2024 is calculated as follows: £m Present value of current service cost for the year 19.2 Less: employee contributions (7.3) –––– 11.9 Interest cost 9.8 Interest income (10.3) –––– Expense recognised in profit or loss 11.4 –––– Return on plan assets 4.4 Actuarial losses 8.6 –––– Expense recognised in other comprehensive income 13.0 –––– Total defined benefit expense

24.4 ––––

This expense is not equal to the £18.4m contributed by the employer because the pension scheme is a defined benefit scheme, not a defined contribution scheme, and so the employer must bear the full cost of providing the agreed level of benefits. The cost for the year to 31 March 2024 is actually £6m more than the amount contributed by the employer (see below). (e) At the end of the year, there is a defined benefit asset of £1m (£159m – £158m). At the start of the year, this asset was £7m (£147m – £140m). The drop of £6m is caused by the fact that the company has contributed only £18.4m during the year, which is £6m less than the actual defined benefit expense for the year.

14.7 On 31 December 2023, the cash payment to which the employees will be entitled on 31 December 2025 is estimated to be £69,600 (29 ´ £2,400). One-third of the vesting period has expired by 31 December 2023. Therefore an expense of £23,200 (1/3rd of £69,600) is recognised as an expense in the financial statements for the year to 31 December 2023, together with a provision for that amount.

On 31 December 2024, the cash payment to which the employees will be entitled on 31 December 2025 is now estimated to be £78,000 (26 ´ £3,000). Two-thirds of the vesting period has expired, so the expense to date is £52,000 (2/3rds of £78,000). An expense of £23,200 was recognised in the previous year.

Therefore a further expense of £28,800 (£52,000 – £23,200) is recognised in the financial statements for the year to 31 December 2024 and the provision is increased to £52,000.

On 31 December 2025, the required cash payment is finally determined at £51,600 (24 ´ £2,150). This is £400 less than the existing provision, so income of £400 is recognised in the financial statements for the year to 31 December 2025. The provision is reduced to £51,600 and then settled in cash.

27 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 15 Taxation in financial statements 15.7 (a) Annual depreciation is £51,200, so the company's profit before depreciation is £551,200 in each year.

Taxable profits and the differences between taxable profits and the profits before tax for accounting purposes are as follows: Year Profit Profit Dep'n Taxable Difference before tax before dep'n allowed profit £ £ £ £ £ 2019 500,000 551,200 102,400 448,800 51,200 2020 500,000 551,200 38,400 512,800 (12,800) 2021 500,000 551,200 28,800 522,400 (22,400) 2022 500,000 551,200 21,600 529,600 (29,600) 2023 500,000 551,200 16,200 535,000 (35,000) The total of the column of differences is £48,600. This is because the asset's tax written down value at the end of 2023 is £48,600 and this amount will be deducted from profits for tax purposes in 2024 onwards. Therefore there is a deferred tax asset of £9,720 (20% of £48,600) at the end of 2023. The tax expense for each year is as follows: 2019 2020 2021 2022 2023 £ £ £ Taxable profit 448,800 512,800 522,400 529,600 535,000 ––––––––––––––––––––––––––––––Profit before tax 500,000 500,000 500,000 500,000 500,000 ––––––––––––––––––––––––––––––Current tax @ 20% 89,760 102,560 104,480 105,920 107,000 Deferred tax 10,240 (2,560) (4,480) (5,920) (7,000) ––––––––––––––––––––––––––––––Total tax expense 100,000 100,000 100,000 100,000 100,000 ––––––––––––––––––––––––––––––The transfers to and from the deferred tax account are each equal to 20% of the difference between accounting profit before tax and taxable profit. As expected, there is a debit balance of £9,720 on the deferred tax account at the end of 2023. This is a form of prepayment and will be written off as part of the tax expense for years 2024 onwards as tax relief is given on the remaining £48,600 of the tax written down value of the asset. (b) A comparison of the carrying amount and tax base of the asset at the end of each year is as follows: Year Carrying Tax Taxable Deductible Deferred tax amount base temp. diffce. temp. diffce. a/c balance £ £ £ £ £ 2019 204,800 153,600 51,200 10,240 2020 153,600 115,200 38,400 7,680 2021 102,400 86,400 16,000 3,200 2022 51,200 64,800 13,600 (2,720) 2023 0 48,600 48,600 (9,720) The balance on the deferred tax account at the end of each year is 20% of the temporary difference outstanding at the end of that year. This balance is a liability apart from at the end of 2022 and 2023 when it becomes an asset. The transfers between the deferred tax account and the statement of comprehensive income in each year are equal to the movement on the deferred tax account during the year.

28 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

15.8 (a) Moston Statement of comprehensive income for the year to 30 June 2023 £000 110,500 95,700 ——— 14,800

Sales revenue (W1) Cost of sales (W2) Gross profit Distribution costs Administrative expenses (6,800 – issue costs 500)

3,600 6,300 ———

Profit from operations Investment income Gain on investments in ordinary shares (9,600 – 8,800) Finance costs (W3) Profit before taxation Taxation expense (1,200 + 800) Profit for the year Other comprehensive income for the year: Items that will not be reclassified to profit or loss: Gain on revaluation of property (W4) Total comprehensive income for the year

9,900 ——— 4,900 300 800 ——— 6,000 1,710 ——— 4,290 2,000 ——— 2,290

2,400 ——— 4,690 ———

(b) Moston Statement of changes in equity for the year to 30 June 2023 Share Other Revaluation capital equity reserve £000 £000 £000 Balance at 1 July 2022 20,000 2,300 3,000 Share issue 10,000 7,000 Total comprehensive income 2,400 Dividend paid (20m ´ 20p) ——— ——— ——— Balance at 30 June 2023 30,000 9,300 5,400 ——— ——— ———

29 © 2022 Pearson Education Limited. All Rights Reserved.

Retained earnings £000 6,200 2,290 (4,000) ——— 4,490 ———

Total equity £000 31,500 17,000 4,690 (4,000) ——— 49,190 ———

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Workings W1 Revenue The substance of the "sale" of maturing goods is a secured loan. The cost of the goods (£2m) should be included in closing inventory and revenue should be reduced by £3m to £110.5m. Loan interest for the year is (£3m ´ 10% ´ 6/12) = £150,000 and this should be included in finance costs.

W2 Cost of sales Per TB Adjustment to closing inventory (W1) Depreciation of property (W4) Depreciation of P&E ((27,100 – 9,100) ´ 15%) R&D costs (see below)

£000 88,500 (2,000) 1,900 2,700 4,600 ——— 95,700 ——— Research costs of £3m must be recognised as an expense. Development costs of £1.6m during April 2023 must also be treated as an expense, since capitalisation cannot begin until the company is confident that the new product will be a commercial success.

W3 Finance costs The loan stock is initially recognised at (£20m – issue costs £500,000) = £19.5m. Interest for the year at effective rate is therefore (8% ´ £19.5m) = £1,560,000. Interest on the secured loan (W1) is £150,000, so total finance costs are (£1,560,000 + £150,000) = £1,710,000.

W4 Revaluation of property Depreciation of the property for the year is one-fifteenth of £28.5m = £1.9m, reducing the carrying amount of the property to £26.6m. Therefore the revaluation at 30 June 2023 gives rise to a revaluation gain of (£29m – £26.6m) = £2.4m.

30 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

15.9 (a) Quincy Statement of comprehensive income for the year to 30 September 2023 £000 211,900 147,300 ——— 64,600

Sales revenue (213,500 – 1,600) (W1) Cost of sales (W2) Gross profit Distribution costs Administrative expenses (19,000 – issue costs 1,000) Profit from operations Investment income Loss on investments in ordinary shares (17,000 – 15,700) Finance costs (W3) Profit before taxation Taxation expense (W4) Profit for the year Other comprehensive income for the year: Items that will not be reclassified to profit or loss: Gain on revaluation of land and buildings (W5) Total comprehensive income for the year

12,500 18,000 ———

30,500 ——— 34,100 400 (1,300) ——— 33,200 1,920 ——— 31,280 8,300 ——— 22,980

18,000 ——— 40,980 ———

(b) Quincy Statement of changes in equity for the year to 30 September 2023 Share Revaluation Retained capital reserve earnings £000 £000 £000 Balance at 1 October 2022 60,000 18,500 Total comprehensive income 18,000 22,980 Transfer to retained earnings (W5) (1,000) 1,000 Dividend paid (60,000 ´ 4 ´ 8p) (19,200) —————————Balance at 30 September 2023 60,000 17,000 23,280 —————————-

31 © 2022 Pearson Education Limited. All Rights Reserved.

Total equity £000 78,500 40,980 (19,200) ———100,280 ———-

Melville: International Financial Reporting, Instructor's Manual, 8th edition

(c) Quincy Statement of financial position as at 30 September 2023 £000 Assets Non-current assets Property, plant and equipment (W5) Investments

£000

99,500 15,700 ———115,200

Current assets Inventories Trade receivables Bank

24,800 28,500 2,900 ———

Total assets Equity Share capital Revaluation reserve Retained earnings

60,000 17,000 23,280 ———

Liabilities Non-current liabilities Long-term borrowings (W3) Deferred tax (W4) Deferred revenue (W1)

24,420 1,000 800 ———

Current liabilities Trade payables Deferred revenue (W1) Current tax payable

36,700 800 7,400 ———

Total equity and liabilities

56,200 ———171,400 ———-

100,280

26,220

44,900 ———171,400 ———-

32 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Workings W1 Revenue With regard to the £10m sale, the price charged for servicing is (3 ´ £600,000 ´ 100/75) = £2.4m. At 30 September 2023, the stage of completion of this work is one-third, so revenue of £1.6m (2/3rds ´ £2.4m) should be deferred. Half of this relates to the year to 30 September 2024 and is presented as a current liability. The remaining half is presented as a non-current liability.

W2 Cost of sales Per TB Depreciation of buildings (W5) Depreciation of P&E ((83,700 – 33,700) ´ 15%)

£000 136,800 3,000 7,500 ——— 147,300 ———

W3 Finance costs The loan stock is initially recognised at (£25m – issue costs £1m) = £24m. Interest for the year to 30 September 2023 at the effective rate of 8% is (8% ´ £24m) = £1,920,000.

Interest actually paid during the year is (£25m ´ 6%) = £1.5m. This is £420,000 less than the interest expense of £1,920,000 for the year. So the carrying amount of the loan stock at 30 September 2023 is (£24m + £420,000) = £24,420,000.

W4 Taxation The current tax expense is (£7.4m + £1.1m) = £8.5m. The provision for deferred tax at 30 September 2023 is £1m (£5m ´ 20%) which is £200,000 lower than the balance brought forward from the previous year.

Therefore the total tax expense for the year is (£8.5m – £200,000) = £8.3m.

W5 Property, plant and equipment The gain on revaluation of land is £2m (£12m – £10m). The carrying amount of the buildings prior to the revaluation was £32m (£40m – £8m) so the gain on revaluation of buildings is £16m (£48m – £32m).

Total revaluation gains are £18m.

Buildings depreciation for the year to 30 September 2023 is £3m (£48m ´ 1/16). If there had not been a revaluation, the depreciation charge would have been £2m (£32m ´ 1/16) so there is excess depreciation of £1m. This is transferred from revaluation reserve to retained earnings.

Plant and equipment depreciation for the year is £7.5m (W2). So the carrying amount of property, plant and equipment at 30 September 2023 is (£60m – £3m) + (£83.7m – £33.7m - £7.5m) = £99.5m.

33 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 16 Statement of cash flows 16.8 Statement of cash flows for the year to 30 November 2023 £000 Cash flows from operating activities Loss before taxation (480 + 20 – 800) (300) Depreciation (850 – 630 + 80) 300 Loss on disposal of plant and equipment (40 – 30) 10 Profit on disposal of investments (20) Interest expense 70 Increase in inventories (740 – 510) (230) Increase in trade receivables (1,010 – 640) (370) Increase in trade payables (660 – 530) 130 –––– Cash generated from operations Interest paid (70) Taxation paid (110 + 20) (130) –––– Net cash outflow from operating activities Cash flows from investing activities Acquisition of plant and equipment (2,470 – 1,790 + 120 – 250) Disposal of plant and equipment Disposal of investments

£000

(410) (200) –––– (610)

(550) 30 70 ––––

Net cash outflow from investing activities

(450)

Cash flows from financing activities Proceeds of share issue Increase in long-term loans

140 400 ––––

Net cash inflow from financing activities

540 –––– (520) 330 –––– (190) ––––

Net decrease in cash and cash equivalents Cash and cash equivalents at 1 December 2022 Cash and cash equivalents at 30 November 2023

34 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

16.9 Statement of cash flows for the year ended 31 May 2024 Cash flows from operating activities Cash receipts from customers (W1) Cash paid to suppliers and employees (W7)

£000

Cash generated from operations Interest paid Income taxes paid (W8) Net cash inflow from operating activities Cash flows from investing activities Purchase of non-current assets (W6) Proceeds from sales of plant and machinery

£000 43,290 (36,530) –––––– 6,760 (812) (261) –––––– 5,687

(23,914) 45 ––––––

Net cash outflow from investing activities

(23,869)

Cash flows from financing activities Proceeds from issue of share capital Issue of long-term borrowings Dividends paid

19,000 2,500 (680) ––––––

Net cash inflow from financing activities

20,820 –––––– 2,638 64 –––––– 2,702 ––––––

Net increase in cash and cash equivalents Cash and cash equivalents at 1 June 2023 Cash and cash equivalents at 31 May 2024

Note: Although the question asks only for the direct method, the cash generated from operations could also be calculated by the indirect method. The calculation is as follows: £000 Profit before tax 1,684 Depreciation (W4) 4,267 Loss on disposal of non-current assets (W5) 11 Increase in inventories (412 – 389) (23) Increase in trade receivables (559 – 468) (91) Increase in prepayments (3 – 2) (1) Increase in trade payables (410 – 310) 100 Increase in accruals (5 – 4) 1 Interest expense 812 –––––– Cash generated from operations 6,760 –––––– Workings W1 Cash received from customers Opening trade receivables Sales Closing trade receivables

£000 468 43,381 (559) –––––– 43,290 ––––––

Cash received from customers 35

© 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

W2 Calculation of purchases Cost of sales Closing inventory Opening inventory

£000 25,051 412 (389) –––––– 25,074 ––––––

Purchases W3 Cash payments to suppliers Opening trade payables Purchases (W2) Closing trade payables

£000 310 25,074 (410) –––––– 24,974 ––––––

Cash paid to suppliers W4 Calculation of depreciation Increase in accumulated depreciation Withdrawn on disposals

£000 3,991 276 –––––– 4,267 ––––––

Depreciation charge for the year W5 Profit or loss on disposal of non-current assets Carrying amount Proceeds Loss on disposal W6 Purchases of non current assets Increase in cost or valuation Withdrawn on disposal Revaluation surplus

£000 56 45 –––––– (11) –––––– £000 23,782 332 (200) –––––– 23,914 ––––––

Purchases of non-current assets W7 Cash paid to suppliers and employees Cash payments to suppliers (W3) Operating expenses Accrued at start of year Accrued at the end of the year Prepaid at the start of the year Prepaid at the end of the year Exclude depreciation (W4) Exclude loss on disposal of non current assets (W5) Cash paid to suppliers and employees W8 Taxation paid Liability at start of year Taxation expense for the year Transferred to deferred taxation Liability at end of year

£000 24,974 15,834 –––––– 40,808 4 (5) (2) 3 –––––– 40,808 (4,267) (11) –––––– 36,530 –––––– £000 390 279 (71) (337) –––––– 261 ––––––

Paid during the year 36

© 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

16.10 Statement of cash flows for the year to 30 September 2023 £000 Cash flows from operating activities Profit before taxation 3,900 Depreciation expense 2,500 Profit on disposal of property (8,100 – 4,000) (4,100) Decrease in provision for warranties (4,000 – 1,600) (2,400) Investment income (1,100) Finance costs 500 Increase in inventories (10,200 – 7,200) (3,000) Decrease in trade receivables (3,500 – 3,700) 200 Decrease in trade payables (3,200 – 4,600) (1,400) ––––– Cash generated from operations Interest paid (500) Taxation paid (W1) (800) ––––– Net cash outflow from operating activities Cash flows from investing activities Acquisition of property, plant and equipment Disposal of property, plant and equipment Disposal of investments Dividends received

£000

(4,900) (1,300) ––––– (6,200)

(8,300) 8,100 3,400 200 –––––

Net cash inflow from investing activities

3,400

Cash flows from financing activities Proceeds of share issue (W2) Repayment of lease liabilities (W3)

2,400 (3,900) –––––

Net cash outflow from financing activities

(1,500) ––––– (4,300) 1,400 ––––– (2,900) –––––

Net decrease in cash and cash equivalents Cash and cash equivalents at 1 October 2022 Cash and cash equivalents at 30 September 2023 Tutorial notes:

(a) Equity investments were £7m at the start of the year. Investments with a carrying amount of £3m were sold and there was an increase in fair value of £0.5m. This leaves a balance of £4.5m, which agrees with the investments figure in the statement of financial position at 30 September 2023. (b) Profit for the year is £2.9m and this is equal to the increase in the retained earnings figure. Therefore the company did not pay any dividends during the year. (c) Workings are shown on the next page.

37 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Workings W1 Taxation Current tax liability at start of year Taxation expense for the year Transferred to deferred taxation Liability at end of year

£000 1,200 1,000 (400) (1,000) –––––– 800 ––––––

Paid during the year W2 Share issues Share capital at start of year Bonus issue (2,000 + (3,600 – 2,000)) Shares issued at par (balancing figure)

£000 8,000 3,600 2,400 –––––– 14,000 ––––––

Share capital at end of year W3 Lease liabilities Liabilities at start of year (6,900 + 2,100) New right-of-use assets acquired Repayments (balancing figure)

£000 9,000 6,700 (3,900) –––––– 11,800 ––––––

Liabilities at end of year (7,000 + 4,800)

Interest will also have been paid in relation to leases, but this cash outflow is already accounted for within the figure for interest paid shown under operating activities.

38 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 17 Financial reporting in hyperinflationary economies 17.5 (a) IAS29 does not establish an absolute rate of inflation at which hyperinflation is deemed to occur, but suggests that hyperinflation is characterised by a number of indicators. One of these is that the cumulative inflation rate over three years is approaching or exceeds 100%. The other indicators identified by IAS29 are listed in Chapter 17 of the textbook. (b) In a hyperinflationary economy, money loses value at such a rapid rate that comparisons of amounts relating to events occurring at different times are misleading. For this reason, the reporting of financial performance and financial position in the local currency without restatement is not useful. (c) (i)

Monetary items in the statement of financial position are not restated, as they are already expressed in current purchasing power terms. (ii) Non-monetary items which are carried at historical cost less accumulated depreciation are restated in accordance with the change in the general price index since the date on which the item was acquired. (iii) Non-monetary items carried at a valuation are restated in accordance with the change in the general price index since the date of the valuation. (iv) Items of income and expense are restated by applying the change in the general price index since the dates on which the items were first recorded in the financial statements.

39 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 18 Groups of companies (1) 18.6 Group statement of financial position as at 31 December 2022 £000 Assets Non-current assets Property and equipment (4,761 + 521 + 411 + 30) Goodwill (W1)

£000

5,723 90 ––––– 5,813

Current assets Inventories (1,532 + 222 + 187 – 3) Trade receivables (1,947 + 258 + 202 – 48) Cash at bank (239 + 30 + 13)

1,938 2,359 282 –––––

Equity Ordinary share capital Revaluation reserve (W3) Retained earnings (W2)

4,579 ––––– 10,392 ––––– 5,000 2,536 518 ––––– 8,054 405 ––––– 8,459

Non-controlling interest (W4) Liabilities Current liabilities Trade payables (1,607 + 211 + 163 – 48)

1,933 ––––– 10,392 –––––

Notes: The goods invoiced to DD Ltd for £8,000 must have cost CC Ltd £5,000 (£8,000 ´ 100/160). So the unrealised profit is £3,000. (ii) A total of £48,000 of intra-group debts (£15,000 + £25,000 + £8,000) must be subtracted from trade receivables and from trade payables. (iii) Workings W1 to W4 are given below. (i)

40 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

W1. Goodwill £000 DD Ltd Price paid by parent Subsidiary's share capital at 1 January 2021 Subsidiary's retained earnings at 1 January 2021 Fair value adjustment

600 500 280 30 ––– 60% ´ 810 –––

Goodwill at 1 January 2021 Less: Impairment (50%) Goodwill at 31 December 2022 HH Ltd Price paid by parent Subsidiary's share capital at 1 January 2022 Subsidiary's retained earnings at 1 January 2022 Subsidiary's revaluation reserve at 1 January 2022

£000

486 ––– 114 57 ––– 57 ––– 575

300 230 60 ––– 90% ´ 590 –––

Goodwill at 1 January 2022 Less: Impairment (25%) Goodwill at 31 December 2022 Total goodwill at 31 December 2022 (57 + 33)

531 ––– 44 11 ––– 33 ––– 90 –––

W2. Group retained earnings £000 Parent's retained earnings at 31 December 2022 DD Ltd Subsidiary's retained earnings at 31 December 2022 Less: Subsidiary's retained earnings at 1 January 2021

HH Ltd Subsidiary's retained earnings at 31 December 2022 Less: Subsidiary's retained earnings at 1 January 2022

320 280 ––– 60% ´ 40 ––– 250 230 ––– 90% ´ 20 –––

Less: Goodwill impairment (57 + 11) Less: Unrealised profit on inventories Group retained earnings at 31 December 2022

41 © 2022 Pearson Education Limited. All Rights Reserved.

£000 547

24

18 (68) (3) ––– 518 –––

Melville: International Financial Reporting, Instructor's Manual, 8th edition

W3. Group revaluation reserve £000 Parent's revaluation reserve at 31 December 2022 HH Ltd revaluation reserve at 31 December 2022 Less: HH Ltd revaluation reserve at 1 January 2022

100 60 ––– 90% ´ 40 –––

Group revaluation reserve at 31 December 2022

£000 2,500

36 ––––– 2,536 –––––

W4. Non-controlling interest £000 DD Ltd Subsidiary's share capital at 31 December 2022 Subsidiary's retained earnings at 31 December 2022 Fair value adjustment

HH Ltd Subsidiary's share capital at 31 December 2022 Subsidiary's retained earnings at 31 December 2022 Subsidiary's revaluation reserve at 31 December 2022

500 320 30 ––– 40% ´ 850 ––– 300 250 100 ––– 10% ´ 650 –––

Non-controlling interest at 31 December 2022

42 © 2022 Pearson Education Limited. All Rights Reserved.

£000

340

65 ––– 405 –––

Melville: International Financial Reporting, Instructor's Manual, 8th edition

18.7 Group statement of financial position as at 31 October 2023 £m Assets Non-current assets Property and equipment (425 + 288) Goodwill (W1) Investments (147 – 120 + 13)

£m

713 9 40 –––– 762

Current assets Inventories (88 + 73 – 2) Trade receivables (147 + 106 – 18) Other current assets (37 + 22) Cash and cash equivalents (36 + 15)

159 235 59 51 ––––

Equity Ordinary share capital Retained earnings (W2)

504 –––– 1,266 –––– 300 188 –––– 488 141 –––– 629

Non-controlling interest (W3) Liabilities Non-current liabilities (150 + 82) Current liabilities Trade payables (184 + 56 – 18) Current tax payable (89 + 69) Bank overdraft

232 222 158 25 ––––

405 –––– 1,266 ––––

Notes: (i)

Tuli's ordinary share capital consists of 150m shares and Multa owns 90m of these shares. This is a 60% holding. (ii) The price of the goods sold by Multa to Tuli included a profit of £10m (40% ´ £25m). 20% of these goods have not yet been sold so the unrealised profit is £2m (20% ´ £10m). (iii) Intra-group debts of £18m must be subtracted from trade receivables and from trade payables. (iv) Workings W1 to W3 are given below.

43 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

W1. Goodwill £m Price paid by parent Subsidiary's ordinary share capital at 1 November 2021 Subsidiary's retained earnings at 1 November 2021

150 30 ––– 60% ´ 180 –––

Goodwill at 1 November 2021 Less: Impairment Goodwill at 31 October 2023

£m 120

108 ––– 12 3 ––– 9 –––

W2. Group retained earnings £m Parent's retained earnings at 31 October 2023 Subsidiary's retained earnings at 31 October 2023 Less: Subsidiary's retained earnings at 1 November 2021

90 30 ––– 60% ´ 60 –––

Less: Goodwill impairment Less: Unrealised profit on inventories

£m 157

36 (3) (2) ––– 188 –––

Group retained earnings at 31 October 2023 W3. Non-controlling interest Subsidiary's ordinary share capital at 31 October 2023 Subsidiary's retained earnings at 31 October 2023

£m 150 90 ––– 40% ´ 240 –––

Subsidiary's preference share capital at 31 October 2023 Non-controlling interest at 31 October 2023

44 © 2022 Pearson Education Limited. All Rights Reserved.

£m

96 45 ––– 141 –––

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 19 Groups of companies (2) 19.5 (a) Group statement of comprehensive income for the year to 30 June 2023 £000 Sales revenue (21,545 + 5,328 – 2,400) 24,473 Cost of sales (13,335 + 3,552 – 2,400 + 192) 14,679 –––––– Gross profit 9,794 Operating expenses (4,085 + 640 + 30) 4,755 –––––– Profit before tax 5,039 Taxation expense (850 + 220) 1,070 –––––– Profit for the year 3,969 Attributable to the non-controlling interest 229 –––––– Attributable to the group 3,740 –––––– Notes: (i)

The intragroup sales of £2,400,000 must be subtracted from group sales and from group cost of sales. There is unrealised profit of £192,000 (£512,000 ´ 60/160) which must be eliminated from inventories and added to cost of sales. (ii) Goodwill arising at acquisition was £300,000 (see Working 1). Impairment in the year to 30 June 2023 is £30,000 (10% ´ £300,000). This has been included in operating expenses. (iii) Dividends of £375,000 (75% ´ £500,000) received by JJ Ltd from KK Ltd have been cancelled out. The remaining £125,000 (£500,000 – £375,000) of dividends paid by KK Ltd were paid to the non-controlling interest. (iv) The profit of KK Ltd for the year to 30 June 2023 is £916,000. So the profit attributable to the non-controlling interest is £229,000 (25% ´ £916,000). (b) Group statement of changes in equity for the year to 30 June 2023

Balance b/f Profit for the year Dividends paid Balance c/f

Share capital

Retained earnings

Total

£000 7,000

£000 1,000 3,740 (1,800) –––– 2,940 ––––

£000 8,000 3,740 (1,800) –––– 9,940 ––––

–––– 7,000 ––––

Noncontrolling interest £000 798 229 (125) –––– 902 ––––

Total equity £000 8,798 3,969 (1,925) –––– 10,842 ––––

Note: The opening and closing figures for group retained earnings and the non-controlling interest are derived in the workings below.

45 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

(c) Group statement of financial position as at 30 June 2023 £000 Assets Non-current assets Property, plant and equipment (5,961 + 2,667 + 600) Goodwill (W1) Current assets Inventories (2,215 + 852 – 192) Trade receivables (1,823 + 629 – 216) Cash at bank (101 + 5)

2,875 2,236 106 –––––

Equity Ordinary share capital Retained earnings (W2)

£000

9,228 180 –––––– 9,408

5,217 –––––– 14,625 –––––– 7,000 2,940 –––––– 9,940 902 –––––– 10,842

Non-controlling interest (W3) Liabilities Current liabilities Trade payables (2,004 + 925 – 216) Taxation (850 + 220)

2,713 1,070 –––––

3,783 –––––– 14,625 ––––––

Workings: W1. Goodwill £000 Price paid by parent Subsidiary's ordinary share capital at 1 July 2019 Subsidiary's retained earnings at 1 July 2019 Fair value adjustment

2,500 704 600 –––– 75% ´ 3,804 ––––

Goodwill at 1 July 2019 Less: Impairment (40%) Goodwill at 30 June 2023

46 © 2022 Pearson Education Limited. All Rights Reserved.

£000 3,153

(2,853) –––– 300 120 –––– 180 ––––

Melville: International Financial Reporting, Instructor's Manual, 8th edition

W2. Group retained earnings £000 Parent's retained earnings at 30 June 2023 Subsidiary's retained earnings at 30 June 2023 Less: Subsidiary's retained earnings at 1 July 2019

508 704 –––– 75% ´ (196) ––––

Less: Goodwill impairment Less: Unrealised profit on inventories

£000 3,399

(147) (120) (192) –––– 2,940 ––––

Group retained earnings at 30 June 2023

Group retained earnings at 30 June 2022 were £1,549,000 + (75% ´ (£92,000 – £704,000)) – impairment £90,000 = £1,000,000. This assumes that there were no unrealised profits at 30 June 2022.

W3. Non-controlling interest Subsidiary's ordinary share capital at 30 June 2023 Subsidiary's retained earnings at 30 June 2023 Fair value adjustment

£000 2,500 508 600 –––– 25% ´ 3,608 ––––

Non-controlling interest at 30 June 2023

£000

902 –––– 902 ––––

Non-controlling interest at 30 June 2022 was (25% ´ (£2,500,000 + £92,000 + £600,000)) = £798,000.

(d) If the intra-group sales were from KK Ltd to JJ Ltd, 25% of the unrealised profit would be deducted from the non-controlling interest. The profit attributable to the non-controlling interest shown in the group statement of comprehensive income would fall by £48,000 (25% ´ £192,000) to £181,000 and the profit attributable to the group would increase by £48,000 to £3,788,000.

These amendments would be reflected in the group statement of changes in equity and in the group statement of financial position. Group retained earnings would rise by £48,000 to £2,988,000. The non-controlling interest would fall by £48,000 to £854,000. (e) In the group statement of comprehensive income, additional depreciation of £40,000 would reduce profit for the year to £3,929,000. Profit attributable to the non-controlling interest would reduce by £10,000 to £219,000 and profit attributable to the group would reduce by £30,000 to £3,710,000.

In the group statement of financial position, additional accumulated depreciation of £160,000 would reduce non-current assets by that amount. Retained earnings would fall by £120,000 and the noncontrolling interest would fall by £40,000.

In the group statement of changes in equity, retained earnings brought forward would fall by £90,000 (75% ´ 3 ´ £40,000). Non-controlling interest brought forward would fall by £30,000. The carried forward figures would fall by £120,000 and £40,000 respectively.

47 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

19.6 (a) Group statement of comprehensive income for the year to 30 September 2023 £000 98,000 72,000 –––––– 26,000

Sales revenue (85,000 + (6/12 ´ 42,000) – 8,000) Cost of sales (63,000 + (6/12 ´ 32,000) – 8,000 + 800 + 200) Gross profit Distribution costs (2,000 + (6/12 ´ 2,000)) Administrative expenses (6,000 + (6/12 ´ 3,200)) Finance costs (300 + (6/12 ´ 400))

3,000 7,600 500 –––––

Profit before tax Taxation expense (4,700 + (6/12 ´ 1,400)) Profit for the year Attributable to the non-controlling interest Attributable to the group

11,100 –––––– 14,900 5,400 –––––– 9,500 200 –––––– 9,300 ––––––

Notes: (i)

The intragroup sales of £8,000,000 must be subtracted from group sales and from group cost of sales. There is unrealised profit of £800,000 (£2,800,000 ´ 40/140) which must be eliminated from inventories and added to cost of sales.

(ii) As a result of the fair value adjustment, Sophistic's depreciation expense rises by (£2,000,000 ´ 1/5th ´ 6/12) = £200,000. This is added to cost of sales. (iii) The profit of Sophistic for the year to 30 September 2023 is £3,000,000, of which 6/12ths refers to the post-acquisition period (£1,500,000). This is reduced by the unrealised profit of £800,000 and by the additional depreciation of £200,000, leaving £500,000. So the profit attributable to the non-controlling interest is £200,000 (40% ´ £500,000). (b) Notes for the statement of financial position: (i)

Pedantic acquired 2,400,000 shares in Sophistic (60% ´ 4,000,000) in a two for three share exchange. Therefore Pedantic issued 1,600,000 shares (2/3 ´ 2,400,000) with a total market value of £9,600,000 (1,600,000 ´ £6). This is equivalent to issuing 1,600,000 £1 shares at a premium of £5 each, so the share premium is £8,000,000.

(ii) Sophistic's retained earnings at 30 September 2023 are £6,500,000. The company's profit for the year is £3,000,000, so retained earnings must have been £3,500,000 at 1 October 2022 and £5,000,000 (£3,500,000 + 6/12 ´ £3,000,000) on the date of acquisition by Pedantic. (iii) The unrealized profit of £800,000 (see above) must be eliminated from group inventories and therefore reduces group current assets by £800,000. (iv) Sophistic's trade receivables include £600,000 due from Pedantic. Similarly, Pedantic's trade payables include £400,000 due to Sophistic. These amounts must be eliminated from group current assets and group current liabilities respectively. But group current assets are increased by the cash in transit of £200,000.

The group statement of financial position, together with detailed workings, is shown below.

48 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Group statement of financial position as at 30 September 2023 £000 Assets Non-current assets Property, plant and equipment (40,600 + 12,600 + 2,000 - depr'n 200) Goodwill (W1)

55,000 4,500 –––––– 59,500 21,400 ––––– 80,900 ––––––

Current assets (16,000 + 6,600 - 600 + CIT 200 - unrealised profit 800) Total assets Equity Ordinary shares of £1 each (10,000 + 1,600) Share premium Retained earnings (W2)

11,600 8,000 35,700 –––––– 55,300 6,100 –––––– 61,400

Non-controlling interest (W3) Liabilities Non-current liabilities 10% loan notes (3,000 + 4,000) Current liabilities (8,200 + 4,700 - 400)

7,000 12,500 –––––– 80,900 ––––––

Total equity and liabilities Workings: W1. Goodwill £000 Price paid by parent Subsidiary's ordinary share capital at 1 April 2023 Subsidiary's retained earnings at 1 April 2023 Fair value adjustment

4,000 5,000 2,000 ––––– 60% ´ 11,000 –––––

Parent's goodwill at 1 April 2023 Non-controlling interest's goodwill at 1 April 2023 Goodwill at 1 April 2023 (and at 30 September 2023)

49 © 2022 Pearson Education Limited. All Rights Reserved.

£000 9,600

(6,600) ––––– 3,000 1,500 ––––– 4,500 –––––

Melville: International Financial Reporting, Instructor's Manual, 8th edition

W2. Group retained earnings £000 Parent's retained earnings at 30 September 2023 Subsidiary's retained earnings at 30 September 2023 Less: Subsidiary's retained earnings at 1 April 2023 Less: Unrealised profit on inventories Less: Additional depreciation

6,500 (5,000) ––––– 1,500 (800) (200) ––––– 60% ´ 500 –––––

Group retained earnings at 30 September 2023

£000 35,400

300 ––––– 35,700 –––––

Check: Assuming no dividends paid during the year, the parent's retained earnings at 1 October 2022 were 26,400 (35,400 – 9,000). Group profit for the year is 9,300, so the group's retained earnings at 30 September 2023 are (26,400 + 9,300) = 35,700.

W3. Non-controlling interest Subsidiary's ordinary share capital at 30 September 2023 Subsidiary's retained earnings at 30 September 2023 Fair value adjustment Less: Unrealised profit on inventories Less: Additional depreciation

£000 4,000 6,500 2,000 ––––– 12,500 (800) (200) ––––– 40% ´ 11,500 –––––

Non-controlling interest's share of goodwill Non-controlling interest at 30 September 2023

£000

4,600 1,500 ––––– 6,100 –––––

Check: NCI created on acquisition was 40% ´ (4,000 + 5,000 + 2,000) = 4,400, plus goodwill 1,500, giving a total of 5,900. The NCI's share of profit for the year is 200, so the NCI at 30 September 2023 is (5,900 + 200) = 6,100.

50 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 20 Associates and joint arrangements 20.5 (a) Pumice has 80% of Silverton's ordinary shares. This gives Pumice control over Silverton and so there is a parent-subsidiary relationship. Group accounts must be prepared in which the results of Silverton as from 1 October 2023 are consolidated with those of Pumice for the year to 31 March 2024. The investment in the loan notes of Silverton is an intra-group loan which is cancelled out on consolidation.

Pumice has 40% of Amok's ordinary shares. Presumably this gives Pumice significant influence over Amok and so Amok is an associate of Pumice. The investment in Amok must be included in the consolidated financial statements using the equity method. (b) The consolidated statement of financial position at 31 March 2024 is as follows: £000 Assets Non-current assets Property, plant and equipment (20,000 + 8,500 + 400 + 1,600 – dep'n 200) Investments: Investment in associate (10,000 + (40% ´ (6/12 ´ 8,000)) – impairment 200) Other investments (26,000 – 13,600 – 1,000 – 10,000) Goodwill (W1) Current assets (15,000 + 8,000 – intragroup debt 1,500 – unrealised profit 1,000)

Equity Ordinary share capital Retained earnings (W2)

30,300 11,400 1,400 3,600 ––––– 46,700 20,500 ––––– 67,200 ––––– 10,000 37,640 ––––– 47,640 2,560 ––––– 50,200

Non-controlling interest (W3) Liabilities Non-current liabilities 8% loan notes 10% loan notes Current liabilities (10,000 + 3,500 – intragroup debt 1,500)

4,000 1,000 12,000 ––––– 67,200 –––––

Notes: (i) Amok's retained earnings have increased by £4m since 1 October 2023, so these must have been £16m on that date. The company's equity on 1 October 2023 was £20m (£4m + £16m) so the price paid by Pumice for goodwill was £2m (£10m – (40% ´ £20m)). This is not negative and so it is not recognised separately. (ii) Workings W1 to W3 are given below.

51 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

W1. Goodwill £000 Price paid by parent Subsidiary's ordinary share capital at 1 October 2023 Subsidiary's retained earnings at 1 October 2023 (8,000 – 6/12 ´ 2,000) Fair value adjustment (400 + 1,600)

£000 13,600

3,000 7,000 2,000

–––––

80% ´ 12,000

–––––

Goodwill at 1 October 2023 Less: Impairment

9,600

–––––

4,000 400

–––––

Goodwill at 31 March 2024

3,600

–––––

W2. Group retained earnings £000 Parent's retained earnings at 31 March 2024 Subsidiary's retained earnings at 31 March 2024 Less: Subsidiary's retained earnings at 1 October 2023

£000 37,000

8,000 7,000

–––––

1,000 (200)

†Additional depreciation (6/12 ´ 1/4 ´ 1,600)

–––––

80% ´ 800

–––––

640

Less: Goodwill impairment Less: Unrealised profit on inventories

(400) (1,000)

Retained earnings of associate (40% ´ (6/12 ´ 8,000)) Less: Impairment of investment in associate

36,240 1,600 (200)

Group retained earnings at 31 March 2024

37,640

–––––

––––– –––––

† If a fair value adjustment is made when a subsidiary is acquired and this relates to depreciable non-current assets, depreciation charges in subsequent accounting periods should be based upon the fair values of those assets. In this case the extra depreciation charge is £200,000. 80% of this is deducted from group retained earnings. The remaining 20% is deducted from the non-controlling interest.

W3. Non-controlling interest £000 3,000 8,000 2,000 (200)

Subsidiary's ordinary share capital at 31 March 2024 Subsidiary's retained earnings at 31 March 2024 Fair value adjustment (400 + 1,600) Additional depreciation (6/12 ´ 1/4 ´ 1,600)

–––––

20% ´ 12,800

–––––

Non-controlling interest at 31 March 2024

£0000

2,560 –––––

2,560

–––––

52 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 21 Related parties and changes in foreign exchange rates 21.4 (a) Person P (or a close family member of P) is related to a reporting entity (R) if P has control, joint control or significant influence over R or if P is a member of the key management personnel of R (or of a parent of R). Entity E is related to R if: – – – – –

E and R are members of the same group.

E is an associate or joint venture of R (or vice versa).

E and R are both joint ventures of the same third party.

E is an associate of entity X and R is a joint venture of X (or vice versa).

E is a pension scheme for the benefit of the employees of R or for the benefit of the employees of any entity which is related to R. – E is controlled or jointly controlled by a person who is related to R. – A person who has control or joint control of R (or is a close family member of such a person) has significant influence over E or is a member of the key management personnel of either E or a parent of E. – E provides key management personnel services to R or to its parent. (b) Related party disclosures are important since a reporting entity's financial performance and position may be affected by transactions with related parties. For example, a transaction with a related party might involve the supply of goods at prices which are above or below their market value. Such a transaction would affect the financial performance/position of the reporting entity.

Even if there are no transactions with a related party, the mere existence of the relationship might affect a reporting entity's financial performance and position. For example, a subsidiary company may obtain increased custom simply because it is a member of a well-known group. (c) Hideaway controls Benedict and Depret and therefore these two companies are under common control. All three companies are related parties to each other.

Assuming that the goods mentioned could indeed have been sold outside the group for £20m, the main effect of the transactions described in the question is to move £5m of profits from Depret to Benedict. This is of benefit to Benedict but has an adverse effect on Depret. In particular: (i)

Benedict's cost of sales will be lower than if the transaction had occurred at full market price and its profits will be increased. By contrast, Depret's sale revenue will be reduced, as will its profits. The financial statements of the two companies will suggest that Benedict is performing well and that Depret is under-performing. (ii) Since Depret is only 55% owned by Hideaway, the minority shareholders of Depret (the noncontrolling interest) will bear 45% of the lost revenue and profits of Depret. It may be that this constitutes "oppression of the minority", which is illegal in some jurisdictions. (iii) If the financial statements are taken at face value, the Depret minority shareholders might be inclined to sell their shares at a lower price than they would otherwise have done. Similarly, the value of Benedict's shares might rise. This may benefit Hideaway if it intends to dispose of its shares in Benedict in the near future. (iv) The directors of Benedict will enjoy a greater profit share than if the transactions had occurred at full market price. The profit shares of the Depret directors will be reduced. (v) There may be tax implications if the purpose of the transactions has been to avoid taxation and reduce the overall tax liability of the group.

53 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 22 Ratio analysis 22.5 (a) Profitability ratios ROCE Gross profit margin Operating profit margin Liquidity ratios Current ratio Quick ratio Efficiency ratios Inv. holding period TR collection period TP payment period Gearing ratio Capital gearing ratio

X Ltd

Y Ltd

1,120/5,320 ´ 100% = 21.1% 1,880/5,720 ´ 100% = 32.9% 1,120/5,720 ´ 100% = 19.6%

990/6,530 ´ 100% = 15.2% 2,070/6,310 ´ 100% = 32.8% 990/6,310 ´ 100% = 15.7%

1,520/770 = 1.97 1,010/770 = 1.31

1,980/1,780 = 1.1 1,090/1,780 = 0.6

510/3,840 ´ 365 = 48 days 670/5,720 ´ 365 = 43 days 450/3,840 ´ 365 = 43 days

890/4,240 ´ 365 = 77 days 1,090/6,310 ´ 365 = 63 days 1,130/4,240 ´ 365 = 97 days

500/5,320 ´ 100% = 9.4%

3,500/6,530 ´ 100% = 53.6%

Note that the trade payables payment period has been calculated with reference to cost of sales, since the figures for purchases are not available. (b) The main points to make are as follows: Profitability (i) X is making a better return on capital. (ii) Both companies have a similar gross profit margin, perhaps indicating that similar prices are charged to customers. (iii) X has a better operating profit margin. This suggests that X has better control over its overheads.

Liquidity (i) X has better liquidity (as measured by both liquidity ratios). (ii) Y's quick ratio is especially worrying. (iii) Y has no cash and high borrowings. X has cash in the bank and comparatively low borrowings.

Efficiency (i) X takes a total of 91 days to turn inventories into cash. (ii) Y takes much longer to turn inventories into cash (140 days) and so is less efficient. However, the company might be deliberately holding larger stocks and offering longer credit so as to attract customers. This is beneficial to Western, so long as it is sustainable in the long term. (iii) Y pays its suppliers much later than X. This may be a sign of efficiency but may also be a sign that Y is struggling to pay its debts and could find it difficult to obtain credit in future.

54 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Gearing (i) X is very low-geared. (ii) Y is comparatively high-geared and may find it difficult to service its high level of debt and/or to obtain further long-term finance.

Conclusion X is the sounder company. Y might offer larger stocks and more generous credit terms but X would seem to be the better choice if Western is seeking a long-term, reliable source of supply. (c) Further information required includes: (i) financial statements for several previous years (to detect trends) (ii) year-average figures for items shown in the statements of financial position (iii) a statement of accounting policies for each company (iv) industry-average accounting ratios (v) projections for the future.

55 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

22.6 (a) ROCE Earnings per share Price earnings ratio Current ratio Quick ratio (acid test) TP payment period Capital gearing ratio Dividend yield

Baker plc 2,280/13,380 ´ 100% = 17.0% 1,320/6,000 ´ 100p = 22p 165p/22p = 7.5 3,300/3,040 = 1.09 1,720/3,040 = 0.57 1,920/10,720 ´ 365 = 65 days 3,500/13,380 ´ 100% = 26.2% 3p/165p ´ 100% = 1.8%

Grant plc 1,960/9,940 ´ 100% = 19.7% 1,440/6,000 ´ 100p = 24p 240p/24p = 10 2,900/1,440 = 2.01 1,640/1,440 = 1.14 960/8,680 ´ 365 = 40 days 500/9,940 ´ 100% = 5.0% 10p/240p = 4.2%

(b) The main points to make are as follows: –

Grant’s ROCE and EPS are both better than Baker’s and these ratios have improved since last year, whilst Baker’s have declined. Grant seems to be the more profitable company.

–

Grant’s PE ratio has risen since last year and is higher than Baker’s (which has declined). This may indicate greater investor confidence in Grant’s future prospects than Baker’s.

–

Grant’s liquidity ratios are roughly the same as in the previous year and appear to be much better than Baker’s (which have declined). Coupled with Baker’s lack of cash, high borrowings and lengthening trade payables payment period, this suggests that Baker may be experiencing liquidity problems.

–

On the other hand, it is possible that Baker’s liquidity problems are caused by a large and recent investment in non-current assets (which are substantially higher than Grant’s). If this is the case, the use of these assets may feed through to greater prosperity in future years.

–

Neither company is high-geared, but Baker has a substantially higher gearing ratio than Grant and this ratio has more than doubled since last year. This indicates that Baker has borrowed during the year. This may have been done as a means of investing in non-current assets, but further substantial borrowing could turn Baker into a high-geared company and prejudice shareholders' interests.

–

Grant’s dividend yield has been maintained since last year and is higher than Baker’s (which has declined). This could be further evidence of Baker’s liquidity problems and could indicate that Baker’s shares may not be a wise choice for an investor seeking dividend income.

–

On the whole, the ratio analysis suggests that Grant plc is more profitable than Baker plc, has better liquidity and is lower-geared. This may indicate that an investment in the shares of Grant plc should be recommended, but further information should be obtained before a final decision is made (see below).

(c) Further information required includes: (i)

more recent financial information (half-year results? is it worth waiting until the September 2024 accounts are available?) (ii) forecasts for the future performance of each company (if possible) (iii) accounts for the last five years, including statements of cash flows (iv) industry average ratios (v) statement of accounting policies for each company.

56 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

22.7 (a) Quartile's ratios in comparison to sector average ratios

ROCE Net asset turnover Gross profit margin Operating profit margin Current ratio Average inventory turnover TP payment period Debt to equity

(14,000 – 9,800)/(26,600 + 8,000) 56,000/(41,800 – 7,200) 14,000/56,000 (14,000 – 9,800)/56,000 11,200/7,200 42,000/((8,300 + 10,200)/2) 5,400/43,900 ´ 365 8,000/26,600

Quartile 12.1% 1.6 25% 7.5% 1.6 4.5 45 days 30%

Sector Average 16.8% 1.4 35% 12% 1.25 3 64 days 38%

(b) Financial and operating performance of Quartile Profitability (i)

It seems that Quartile is less profitable than the sector average. ROCE is lower, gross profit margin is much lower and so is the operating profit margin.

(ii) However, it appears that £5m of Quartile's capital has been used to fund development expenditure which will not generate profits until some time in the future. If this £5m were ignored, ROCE would be (14,000 – 9,800)/(26,600 + 8,000 – 5,000) = 14.2%, which is closer to the sector average. (iii) If (in addition) the property had not been revalued, the ROCE would then be (14,000 – 9,800)/(26,600 + 8,000 – 5,000 – 3,000) = 15.8%, which is very close to the sector average. So it is unclear whether or not Quartile's underlying ROCE is in fact especially low. (iv) As regards the gross profit margin and operating profit margin, there is no doubt that Quartile is under-achieving when compared to the rest of the sector. But the company may have adopted a deliberate policy of selling jewellery at low prices to stimulate sales. (v) One encouraging point is that the gap between Quartile's gross profit margin and operating profit margin (i.e. the percentage of sales revenue taken up by operating expenses) is 17.5%, compared with a sector average of 23%. So perhaps Quartile is running a business with low margins, high sales volumes and low overheads. This theory is borne out by the fact that the company's asset turnover is higher than average. In fact, if the distortions caused by the development expenditure and property revaluation were removed, asset turnover would be 56,000/(41,800 – 5,000 – 3,000 – 7,200) = 2.1, which is 50% better than the sector average. And the company's inventory also moves at a 50% faster rate than is typical in the sector as a whole.

Liquidity (i)

As measured by the current ratio, Quartile's liquidity is rather better than average. If we can assume that the sector average figure is generally acceptable in the retail jewellery trade, it would appear that Quartile has no liquidity problems.

(ii) Furthermore, the company's trade payables period is considerably lower than average. This may be evidence of the fact that Quartile has no trouble in paying its debts when they fall due. On the other hand, it might be the case that the company's creditors offer Quartile less generous credit terms than are typical in the sector.

57 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Gearing Quartile's debt to equity ratio is lower than average. Furthermore, the company is obtaining an ROCE of 12.1% (at least) on funds borrowed at 10%. So there seem to be no gearing concerns.

Conclusion Quartile seems to have no liquidity or gearing problems but is suffering from lower profitability when compared with the sector average. The lower gross profit margin and operating profit margin would not be a worry if only the company's ROCE (the main test of profitability) were higher. However, as stated above, the ROCE might have been depressed by the fact that Quartile has revalued its property and also by the recent development expenditure which has not yet had time to work through to increased profits.

Further investigation is advisable. (c) Possible limitations of this ratio analysis (i)

Lack of standard ratio definitions. As was made clear in Chapter 22, some of the accounting ratios lack a standard definition. Therefore it would not be wise to base important economic decisions on the results of the above analysis without first asking the agency to supply details of the definitions that it has used. If necessary, some of Quartile's own ratios would then need to be recalculated on the same basis as that used by the agency, to ensure that comparisons are valid.

(ii) Accounting policies. It is very unlikely that all companies in the retail jewellery trade will use the same accounting policies. For instance, some companies may adopt the cost model for property whilst others (like Quartile) may adopt the revaluation model. A similar point applies to intangible assets.

And there may be differences in the way in which inventories are measured. Such differences in accounting policy distort the ratio analysis and make it much more difficult to effect meaningful comparisons between Quartile and the rest of the retail jewellery sector. (iii) Different reporting dates. The sector average ratios supplied by the agency are for the year to 30 June 2023, whilst Quartile's financial statements are for the year to 30 September 2023. This may not be terribly significant but it is feasible that seasonal variations may have some impact. For instance, do retail jewellers build up inventories in readiness for the Christmas trade? If so, inventory ratios based on financial statements for the year to 30 June may not be directly comparable with inventory ratios based on financial statements for the year to 30 September. (iv) Variations across the sector. The retail jewellery sector probably consists of a mixture of businesses, ranging from upmarket shops selling very expensive items, through to shops that sell cheaper items to the general public. Average ratios calculated across a disparate range of businesses like this may not be very meaningful and it would be preferable to compare Quartile's ratios with the average for those businesses in the same sector which are of a similar size and type to Quartile.

58 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 23 Earnings per share 23.6 (a) Just before the rights issue, the total market value of the company's shares (and so the worth of the company) was £9m. The rights issue was for 2,250,000 shares and raised £1,125,000 (2,250,000 ´ 50p). Therefore the number of issued shares rose to 11,250,000 and the company's worth increased to £10.125m. This gives a theoretical market price after the rights issue of 90p per share.

If the share price had fallen to 90p as the result of a bonus issue, the number of shares outstanding after this issue would have been 10m (since 10m ´ 90p = £9m). So the size of bonus issue that would have caused a fall in market price to 90p is an issue of 1,000,000 shares. Therefore the rights issue is treated as a bonus issue of 1,000,000 shares followed immediately by an issue of 1,250,000 shares at full price.

Alternatively, the bonus element of the rights issue is 9m ´ ((£1.00/90p) –1) = 1m shares.

The weighted average number of shares outstanding during the year 2023 is (10,000,000 ´ 3/12) + (11,250,000 ´ 9/12) = 10,937,500. Basic EPS is £2,475,000/10,937,500 ´ 100p = 22.63p. (b) Restated basic EPS for 2022 is £1,800,000/10,000,000 ´ 100p = 18p.

23.7 (a) The preference dividend is £180,000, so profit attributable to the ordinary shares in the year to 30 September 2022 is £2,220,000. Basic EPS is £2,220,000/5,000,000 ´ 100p = 44.4p.

Maximum dilution would result in the issue of an extra 880,000 shares. Since the loan stock was issued on 1 January 2022, the weighted average number of ordinary shares outstanding during the year would become (5,000,000 ´ 3/12) + (5,880,000 ´ 9/12) = 5,660,000. Interest saved would be £140,000 ´ 9/12 = £105,000 and profits after tax would rise by 80% of this, which is £84,000. This would increase profit attributable to the ordinary shares to £2,304,000. Therefore diluted EPS is £2,304,000/5,660,000 ´ 100p = 40.71p. (b) Profit attributable to the ordinary shares in the year to 30 September 2023 is £2,020,000. The weighted average number of shares outstanding during the year is (5,000,000 ´ 6/12) + (5,500,000 ´ 6/12) = 5,250,000. Basic EPS is £2,020,000/5,250,000 ´ 100p = 38.48p.

The issue of an extra 880,000 shares would increase the weighted average number of shares outstanding during the year to 5,250,000 + 880,000 = 6,130,000. Profits after tax would rise by 80% of £140,000 (£112,000). So profit attributable to the ordinary shares would become £2,020,000 + £112,000 = £2,132,000. Diluted EPS is £2,132,000/6,130,000 ´ 100p = 34.78p.

59 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

23.8 (a) Just before the rights issue, the total market value of the company's shares (and so the worth of the company) was £8m. The rights issue was 400,000 shares and raised £1,400,000 (400,000 ´ £3.50).

Therefore the number of shares rose to 2,400,000 and the company's worth increased to £9.4m. This gives a theoretical market price after the rights issue of approximately £3.9167 per share.

If the share price had fallen to £3.9167 as the result of a bonus issue, the number of shares outstanding after this issue would have been 2,042,536 (since 2,042,536 ´ £3.9167 = £8m). So the size of bonus issue that would have caused a fall in market price to £3.9167 is an issue of 42,536 shares. Therefore the rights issue is treated as a bonus issue of 42,536 shares followed immediately by an issue of 357,464 shares at full price.

Alternatively, the bonus element of the rights issue is 2m ´ ((£4.00/£3.9167) –1) = 42,536 shares.

The weighted average number of shares outstanding during the year 2023 is (2,042,536 ´ 6/12) + (2,400,000 ´ 6/12) = 2,221,268. Basic EPS is £1,560,000/2,221,268 ´ 100p = 70.23p. (b) The original basic EPS for 2022 was £1,320,000/2,000,000 ´ 100p = 66p. Restated basic EPS for the year is £1,320,000/2,042,536 ´ 100p = 64.62p. (c) The issue of an extra 100,000 shares would increase the weighted average number of shares outstanding during 2023 to 2,321,268. Profits after tax would rise by 80% of £70,000 (£56,000). So profit attributable to the ordinary shares would become £1,560,000 + £56,000 = £1,616,000. Diluted EPS is £1,616,000/2,321,268 ´ 100p = 69.62p.

23.9 (a) The preference dividend is £330,000, so profits attributable to the ordinary shareholders for the year to 31 October 2023 are £3,104,000 (£3,434,000 – £330,000). Therefore basic EPS for the year is £3,104,000/32m ´ 100p = 9.7p.

The issue of an extra 8,000,000 shares at £1.50 per share would raise £12m. The number of shares that could be bought for £12m at the market price of £1.95 is (£12m/£1.95) = 6,153,846. So the potential issue is split into 6,154,846 shares at full market price and an issue of 1,846,154 shares for no consideration. The issue of shares at full market price is not dilutive and so these shares can be ignored. Diluted EPS for the year is £3,104,000/33,846,154 ´ 100p = 9.17p. (b) Just before the rights issue, the total market value of the company's shares (and so the worth of the company) was £70m (25m ´ £2.80). The rights issue was for 10m shares and raised £24m. Therefore the number of shares rose to 35m and the company's worth increased to £94m, giving a theoretical market price after the rights issue of approximately £2.6857 per share.

If the share price had fallen to £2.6857 as the result of a bonus issue, the number of shares outstanding after this issue would have been 26,063,968 (since 26,063,968 ´ £2.6857 = £70m). So the size of bonus issue that would have caused a fall in market price to £2.6857 is an issue of 1,063,968 shares.

Therefore the rights issue is treated as a bonus issue of 1,063,968 shares followed immediately by an issue of 8,936,032 shares at full price.

Alternatively, the bonus element of the rights issue is 25m ´ ((£2.80/£2.6857) –1) = 1,063,968 shares.

The rights issue occurred after eight months of the accounting year had elapsed. So the weighted average number of shares outstanding during the year is (26,063,968 ´ 8/12) + (35,000,000 ´ 4/12) = 29,042,644. Basic EPS is £8,000,000/29,042,644 ´ 100p = 27.55p.

60 © 2022 Pearson Education Limited. All Rights Reserved.

Melville: International Financial Reporting, Instructor's Manual, 8th edition

Chapter 24 Segmental analysis 24.6 (a) Floothair plc Segment report for the year to 31 August 2023

Segment external revenue Unallocated external revenue Total external revenue Inter-segment sales Segment revenue Segment profit/(loss) Profit on sale of assets Unallocated income Profit/(loss) before tax and finance costs

Int'l airline £m 8,104

Domestic airline £m 388

Nonairline £m 260

––-–– 8,104 103 ––-–– 8,207 ––-––

–––– 388 14 –––– 402 ––––

–––– 260 7 –––– 267 ––––

803

(30)

16 32

––-–– 803 ––-––

–––– (30) ––––

–––– 48 ––––

Unallocated £m 22 –––– 22 –––– 22 –––– 4 22 –––– 26 ––––

Net finance costs Taxation expense

Total £m 8,752 22 –––-– 8,774 124 –––-– 8,898 –––-– 789 36 22 –––-– 847 (149) (130) –––-– 568 –––-–

Profit for the year Segment assets

12,050 ––-––

240 ––––

140 ––––

12,430 –––-–

Segment liabilities Unallocated liabilities

4,566

84

350

––-–– 4,566 ––-––

–––– 84 ––––

–––– 350 ––––

5,000 5,420 –––-– 10,420 –––-–

5,420 –––– 5,420 ––––

(b) Valid points include: (i) Over 90% of the company's revenue comes from the international airline segment. (ii) The domestic airline segment has made a loss. (iii) Although it has the smallest revenue, the non-airline segment has made the greatest return on segment assets. (iv) Liabilities exceed assets in the non-airline segment.

61 © 2022 Pearson Education Limited. All Rights Reserved.

!"#$%&#'()'%*%&+,#%# Chapter 1 1.1 The term "regulatory framework" refers to the collection of rules and regulations which govern financial reporting. The regulatory framework applies mainly to companies and consists of legislation, accounting standards and stock exchange regulations. This framework is needed so as to ensure that shareholders and other stakeholders receive financial statements which faithfully represent the financial performance and financial position of the business concerned.

1.2 The structure and functions of these bodies are explained in detail in Chapter 1. A brief summary is as follows: (a) The IFRS Foundation consists of twenty-two Trustees drawn from a diversity of geographical and professional backgrounds. They are responsible for appointing the members of the IASB and ISSB (and associated bodies) and for establishing and maintaining the necessary funding for their work. The Trustees also review the strategy and effectiveness of the IASB and ISSB. (b) The IASB consists of fourteen members chosen for their professional competence and their relevant experience. The function of the IASB is to develop and improve IFRS Accounting Standards (both IFRS Standards and IAS Standards). (c) The IFRS Advisory Council comprises thirty or more members drawn from diverse backgrounds. The main function of the Advisory Council is to provide broad strategic advice to the Trustees, the IASB and the ISSB. (d) The IFRS Interpretations Committee (which has fourteen voting members and a non-voting Chair) interprets the application of IFRS Accounting Standards and provides timely guidance on financial reporting matters which are not specifically addressed by standards.

1.3 The term "generally accepted accounting practice" (GAAP) refers to the accounting regulations which apply in a certain jurisdiction, together with any accounting principles or conventions that are normally followed in that jurisdiction. Accounting rules and practices currently vary between countries and so there is no "global GAAP" at present. However, the International Accounting Standards Board (IASB) is developing and promoting a set of international standards which it hopes will attain global acceptance and form the basis for a global GAAP. Some of the main causes of differences in accounting practice from one country to another are as follows: (a) The legal systems of some countries set out detailed accounting rules; other countries have legal systems which provide only a broad framework of accounting principles.

449

PART 6: Answers

(b)

(c)

(d)

(e)

In some countries, business entities are largely financed by shareholders; in other countries, banks and other lenders are the main providers of business finance. The quantity and types of accounting information that these two groups need from financial reports may differ and this has an effect on the accounting systems of the countries concerned.

In some countries, accounting rules are dictated by the needs of the tax system, since the way in which profits are computed for financial reporting purposes is the same as the way in which they are computed for tax purposes. This is not the case in other countries (e.g. the UK).

Some of the more developed countries have had the opportunity and the resources to develop a strong accounting profession and a body of accounting theory, both of which have had an impact on accounting practice. This is not true of less developed countries.

In some countries, businesses have suddenly collapsed only a short time after publishing apparently healthy financial reports. This has led to attempts to tighten up accounting rules in these countries, generally by the strengthening of accounting standards.

1.4 An IFRS Accounting Standard (IFRS or IAS Standard) consists of a set of numbered paragraphs and is broken down into sections. These sections usually comprise some or all of the following: - objectives and scope of the standard - definitions of terms used - the body of the standard - effective date and any transitional provisions - application guidance or implementation guidance - illustrative examples - basis for conclusions.

1.5 The main purpose of accounting standards is to reduce or eliminate variations in accounting practice and so introduce a degree of uniformity into financial reporting. The advantages of such standardisation include faithful representation and comparability.

One perceived disadvantage of accounting standards might be a lack of flexibility and the worry that a single accounting treatment might not be appropriate in all cases. The IASB overcomes this disadvantage by allowing entities to override a standard in the extremely rare event that compliance with that standard would prevent faithful representation.

1.6 The first IFRS reporting period is the year to 30 June 2023. The date of transition to international standards is 1 July 2020 since this is the beginning of the earliest period reported in the first IFRS financial statements. The company must: (i) prepare an opening IFRS statement of financial position as at 1 July 2020 (or 30 June 2020) (ii) use identical accounting policies in the opening IFRS statement of financial position and in the financial statements for the year to 30 June 2023 and in the comparative figures provided for the two previous years; these accounting policies (and these financial statements) must comply with international standards in force for periods ending on 30 June 2023

450

Answers to Exercises

(iii) provide a reconciliation of equity as reported under previous GAAP with equity recalculated under international standards, for 30 June 2020 and 30 June 2022 (iv) provide a reconciliation of total comprehensive income as reported under previous GAAP with total comprehensive income as recalculated under international standards, for the year to 30 June 2022.

1.7 (a)

The IASB due process may involve any or all of the following steps: – identification and review of all the issues associated with the topic concerned – consideration of the way in which the IASB Conceptual Framework applies to these issues – a study of national accounting requirements in relation to the topic and an exchange of views with national standard-setters – publication of a discussion document and consideration of comments received – publication of an exposure draft and consideration of comments received – approval and publication of the final standard.

Publication of a standard requires approval by at least nine of the fourteen IASB members.

(b)

The Preface to IFRS Standards states that IFRS Accounting Standards are designed to apply to the general purpose financial statements and other financial reporting of "profit-oriented entities", whether these are organised in corporate form or in other forms. In fact, the standards themselves usually refer to "entities" rather than companies.

Chapter 2 2.1 A conceptual framework for financial reporting is a coherent set of fundamental principles which underpin financial accounting and provide a sound theoretical basis for the development of accounting standards. The main purposes of the IASB Conceptual Framework are: (a) to assist the IASB in the development of international standards based on consistent concepts (b) to assist the preparers of financial reports to develop consistent accounting policies if there is no international standard that applies to a particular transaction or event, or if an international standard permits a choice of accounting policy (c) to assist all interested parties to understand the international standards and interpret them.

The Conceptual Framework is not an international standard and does not override the standards. If there is a conflict between the Conceptual Framework and an international standard, the standard prevails. But the Conceptual Framework provides the foundation for principles-based standards which improve the quality of financial information, providing the information needed to assess the stewardship of management and to help investors identify opportunities and risks.

2.2 (a)

The Conceptual Framework states that the objective of general purpose financial reporting is "to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity".

451

PART 6: Answers

(b)

(c)

Main classes of information that should be presented in general purpose financial reports are: (i) information about the financial position of the reporting entity (i.e. information about the entity's economic resources and claims against those resources) (ii) information about changes in financial position caused by the entity's financial performance during the reporting period (e.g. the making of a profit) (iii) information about the entity's cash flows during the reporting period (iv) information about changes in financial position not caused by the entity's financial performance (e.g. changes caused by share issues and the payment of dividends).

The primary users of general purpose financial reports are existing and potential investors, lenders and other creditors. Other parties who may find general purpose financial reports useful include employees, customers, governments (and their agencies) and the public. See Chapter 2 for an explanation of why each user group may be interested in the information provided in general purpose financial reports.

2.3 An asset is "a present economic resource controlled by the entity as a result of past events". An economic resource is "a right that has the potential to produce economic benefits".

A liability is "a present obligation of the entity to transfer an economic resource as a result of past events".

Equity is "the residual interest in the assets of the entity after deducting all its liabilities".

Income is "increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims".

Expenses are "decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims".

An asset or liability should be recognised in the financial statements only if the recognition of that asset or liability (and any resulting income, expenses or changes in equity) would provide users of the financial statements with useful information. The information provided must be relevant to user needs and must offer a faithful representation. Whether recognising an asset or liability provides useful information (at a cost that does not outweigh benefits) is a matter of judgement. (a) A trade receivable meets the definition of an asset because it comprises a right to receive cash and is evidenced by a legally binding contract of sale (i.e. the entity has control). Furthermore, the receivable arises from a past event (the sale of goods or services). (b) A trade payable meets the definition of a liability because it comprises a present obligation (which the entity cannot practically avoid) to transfer cash to a creditor and arises as a result of a past event (the purchase of goods or services). (c)

Inventory meets the definition of an asset because it comprises a right to use or sell physical objects and so generate economic benefits. The inventory is controlled by the entity through legal ownership and arises as a result of a past event (purchase from a supplier).

2.4 The Conceptual Framework identifies the two fundamental qualitative characteristics of useful financial information as relevance and faithful representation. The enhancing characteristics are comparability, verifiability, timeliness and understandability. See Chapter 2 for an explanation of each characteristic and the factors which contribute to its achievement.

452

Answers to Exercises

2.5 (a) (b)

Measurement bases are historical cost and current value (fair value, value in use, current cost).

The capital maintenance concepts are financial capital maintenance (either in nominal units or in units of purchasing power) and physical capital maintenance.

See Chapter 2 for an explanation of each of these.

2.6 Relevance To be useful, financial information must be relevant to the needs of users when they are making economic decisions. Information is relevant if it helps users to predict future events or to confirm (or refute) previous predictions. The relevance of information is affected by its level of materiality.

Information is material if omitting, mis-stating or obscuring it could influence user decisions.

Faithful representation To be useful, financial information must faithfully represent transactions and other events. The information must be complete, free of bias and free from material error. Financial information should also represent the substance of transactions and events rather than their legal form.

Comparability Users should be able to compare financial information for a period with information about the same entity for other periods and with information about other entities for the same period. Comparability is improved if consistent accounting treatments are adopted between periods and entities.

Chapter 3 3.1 (a)

(b)

(c)

(d)

Financial statements must present fairly the financial position, financial performance and cash flows of the entity concerned. This requires that the effects of transactions and other events should be faithfully represented in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Conceptual Framework. It is usually assumed that the application of international standards will achieve a fair presentation.

A fair presentation also requires entities to select and apply appropriate accounting policies, to provide information that is relevant, reliable, comparable and understandable and to provide further information if compliance with international standards is insufficient to enable users to understand the financial statements.

Financial statements should be prepared on the going concern basis unless the entity intends to cease trading or has no realistic alternative but to do so. Financial statements apart from the statement of cash flows should be prepared on the accrual basis.

An item is material if its size or its nature is such that it could influence users' economic decisions. Financial statements are prepared by analysing transactions and other events into classes and then aggregating each class to produce line items. IAS1 requires that each material class of similar items should normally be presented separately in the financial statements.

However, a line item which is not material may be aggregated with other line items.

Assets and liabilities should normally be reported separately in the statement of financial position and not be offset against one another. Similarly, income and expenses should normally be reported separately in the statement of comprehensive income.

453

PART 6: Answers

(e) (f)

Financial statements should normally be presented at least annually.

Comparative information should be disclosed in respect of the previous period for all amounts reported in the financial statements. In order to maintain comparability, the manner in which items are presented and classified in the financial statements should be consistent from one accounting period to the next. The need for consistency is overridden only if it is apparent that a change in presentation or classification would be appropriate, or if such a change is required by an international standard.

3.2 (a)

(b)

(c)

A current asset is one which satisfies any of the following criteria: (i) it is expected to be realised, sold or consumed within the entity's normal operating cycle (ii) it is held primarily for the purpose of being traded (iii) it is expected to be realised within twelve months after the reporting period (iv) it is cash or a cash equivalent.

An asset which satisfies none of these criteria is a non-current asset.

A current liability is one which satisfies any of the following criteria: (i) it is expected to be settled within the entity's normal operating cycle (ii) it is held primarily for the purpose of being traded (iii) it is due to be settled within twelve months after the reporting period (iv) at the end of the reporting period, the entity does not have the right to defer settlement until at least twelve months after the reporting period.

A liability which satisfies none of these criteria is a non-current liability.

The current/non-current separation distinguishes between net assets that are circulating as working capital and those that are used in the long-term. This separation also identifies the assets that are expected to be realised within the current operating cycle and the liabilities that are due for settlement within the same period.

3.3 The draft statement of comprehensive income for the year to 31 March 2023 is as follows: £000 £000 Sales revenue (50,332 – 3,147) 47,185 Cost of sales (7,865 + 29,778 – 8,107) 29,536 ––––– Gross profit 17,649 Distribution costs (8,985 + 157) 9,142 Administrative expenses 7,039 16,181 ––––– ––––– Profit from operations 1,468 Finance costs (200 + 200) 400 ––––– Profit before tax 1,068 Taxation expense 235 ––––– Profit for the year 833 –––––

454

Answers to Exercises

The draft statement of financial position as at 31 March 2023 is as follows: £000 £000 Assets Non-current assets Property, plant and equipment (59,088 – 25,486) 33,602 Current assets Inventories (8,407 – 300) 8,107 Trade receivables (9,045 – 3,147) 5,898 Cash at bank 182 14,187 ––––– ––––– 47,789 ––––– Equity Ordinary share capital 10,000 Share premium account 5,000 Retained earnings (23,457 + 833) 24,290 ––––– 39,290 Liabilities Non-current liabilities Long-term loan 5,000 Current liabilities Trade payables (2,481 + 157 + 426 + 200) 3,264 Taxation 235 3,499 ––––– ––––– 47,789 ––––– Notes: (a) Inventories are valued at the lower of cost and net realisable value (see Chapter 10). (b) Total comprehensive income for the year is equal to the profit for the year, since the company has no "other comprehensive income". In fact the statement of comprehensive income could be referred to as the statement of profit or loss.

3.4 The main purpose of the statement of changes in equity is to show how each component of equity has changed during an accounting period. In the case of a company, these components are share capital, retained earnings and each of the company's other reserves (if any). The main items that should be shown in a statement of changes in equity are as follows: (a) total comprehensive income for the period (b) the effects of any retrospective application of accounting policies or restatement of items (c)

for each component of equity, a reconciliation of the opening and closing balance for that component, separately disclosing changes arising from: (i) profit or loss (ii) other comprehensive income (iii) transactions with the owners of the entity, separately showing distributions to owners and contributions by owners.

455

PART 6: Answers

3.5 The notes should contain: (i) information about the basis of preparation of the financial statements and the entity's accounting policies (disclosing material accounting policy information) (ii) information as required by the international standards, to the extent that this is not presented elsewhere in the financial statements (iii) any additional information which is deemed relevant to an understanding of any of the financial statements.

3.6 (a) Walrus plc Statement of comprehensive income for the year to 31 March 2023 £000 £000 Sales revenue 1,432 Cost of sales (107 + 488 – 119) 476 ––––– Gross profit 956 Other operating income 30 ––––– 986 Distribution costs (see workings) 229 Administrative expenses (see workings) 601 830 –––– ––––– Profit from operations 156 Finance costs 9 ––––– Profit before taxation 147 Taxation expense† (30 – 6) 24 ––––– Profit for the year 123 Other comprehensive income for the year: Items that will not be reclassified to profit or loss: Gain on property revaluation 180 ––––– Total comprehensive income for the year 303 ––––– † The treatment of taxation in financial statements is dealt with in Chapter 15.

456

Answers to Exercises

(b) Walrus plc Statement of financial position as at 31 March 2023 £000 Assets Non-current assets Property, plant and equipment (see workings) Goodwill Current assets Inventory Trade receivables (183 – 8 – 7)

603 300 ––––– 903 119 168 ––––

Equity Share capital Revaluation reserve Retained earnings Liabilities Current liabilities Trade and other payables Bank balance Current tax payable

£000

287 ––––– 1,190 ––––– 200 180 606 ––––– 986

117 57 30 ––––

(c) Walrus plc Statement of changes in equity for the year to 31 March 2023 Share Revaluation capital reserve £000 £000 Balance at 1 April 2022 200 Total comprehensive income 180 Dividend paid ––– ––– Balance at 31 March 2023 200 180 ––– –––

204 ––––– 1,190 –––––

Retained earnings £000 503 123 (20) ––– 606 –––

Total equity £000 703 303 (20) ––– 986 –––

457

PART 6: Answers

Workings Distribution costs Per trial balance Wages and salaries (25%) Buildings depreciation Equipment depreciation Vehicles depreciation

£000 101 69 5 12 42 ––– 229 –––

Administrative expenses Per trial balance Bank overdraft interest Directors' fees Wages and salaries (75%) Buildings depreciation Equipment depreciation Vehicles depreciation Loss on disposal (44 – 33 – 10) Bad debt Reduction in allowance for receivables

Property, plant and equipment Land at valuation Buildings at cost Depreciation to 31/3/2022 Depreciation for year (4% ´ 250) Equipment at cost Depreciation to 31/3/2022 Depreciation for year (40% ´ 120) Motor vehicles at cost (284 – 44) Depreciation to 31/3/2022 (132 – 33) Depreciation for year (25% ´ 240)

458

£000 186 (9) 150 207 5 36 18 1 8 (1) ––– 601 ––– £000

£000

£000 300

250 90 10 ––– 76 48 ––– 99 60 –––

100 ––– 196

150

124 ––– 240

72

159 –––

81 ––– 603 –––

Answers to Exercises

Chapter 4 4.1 (a)

(b)

(c)

Accounting policies are "the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements". For example, an entity can choose between the cost model and the revaluation model for measuring property, plant and equipment. The entity's choice is one of its accounting policies.

Accounting estimates are judgements applied when measuring items that cannot be measured with precision (e.g. the estimated useful life of a non-current asset).

A change in accounting policy should be accounted for retrospectively. Comparative figures for the previous period(s) must be adjusted and presented as if the new accounting policy had always been applied. This approach maintains comparability between accounting periods.

A change in an accounting estimate should be accounted for prospectively. The effect of the change should be dealt with in the financial statements for the period of the change and future periods, but comparative figures for prior periods are not restated.

4.2 (a)

(b)

If there is no applicable international standard or IFRIC Interpretation, management should use its judgement in selecting an accounting policy that results in information which is relevant and reliable. Reference should be made to any standards which deal with similar issues and to the IASB Conceptual Framework.

An accounting policy may be changed if this is required by an international standard or by an IFRIC Interpretation or if the change improves the reliability and relevance of the financial statements.

4.3 If a change in accounting policy is caused by the initial application of an international standard or IFRIC Interpretation, the entity should disclose the title of that standard or interpretation. If a change in accounting policy is voluntary, the entity should disclose its reasons for making the change. In all cases, the entity should disclose the nature of the change and the amount of the adjustment made to each affected item in the financial statements.

4.4 (a)

(b)

A material prior period error is a material omission or mis-statement occurring in an entity's financial statements for a prior period. Material prior period errors should be corrected retrospectively. This generally involves restating the comparative figures for the prior period in which the error occurred.

The entity should disclose the nature of the prior period error. For each prior period presented, the entity should disclose the amount of the correction to each affected line item in the financial statements. The amount of the correction at the beginning of the earliest prior period presented should also be disclosed.

459

PART 6: Answers

4.5 (a)

Profit before operating expenses Operating expenses Profit before taxation Taxation expense Profit after taxation (b) Balance b/f as previously reported Change in accounting policy Restated balance Profit for the year to 31 December 2022 Balance c/f

2022 £000 1,510 190 ––––– 1,320 264 ––––– 1,056 –––––

(restated) 2021 £000 1,450 230 ––––– 1,220 244 ––––– 976 –––––

Retained earnings £000 2,371 (112) ––––– 2,259 1,056 ––––– 3,315 –––––

Note: The change in accounting policy results in additional operating expenses of £140,000 for years 2019, 2020 and 2021 combined. Tax saved at 20% is £28,000. Therefore retained earnings at 31 December 2021 fall by £112,000.

4.6 (a)

Sales Cost of goods sold Gross profit Operating expenses Profit before taxation Taxation expense Profit after taxation (b) Balance b/f as previously reported Correction of prior period error (440 – 360) Restated balance Profit for the year to 30 June 2023 Balance c/f

460

2023 £000 1,660 670 ––––– 990 590 ––––– 400 80 ––––– 320 ––––– Retained earnings £000 1,220 80 ––––– 1,300 320 ––––– 1,620 –––––

(restated) 2022 £000 1,840 730 ––––– 1,110 560 ––––– 550 110 ––––– 440 –––––

Answers to Exercises

Chapter 5 5.1 (a)

(b)

(c)

Property, plant and equipment consists of tangible items that are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes and which are expected to be used during more than one period.

An item of property, plant and equipment should be recognised as an asset when its cost can be measured reliably and it is probable that future economic benefits associated with the item will flow to the entity. The item should be derecognised when it is disposed of or no future economic benefits are expected from either its use or its disposal.

The purchase price, plus import duties, delivery charges and non-refundable purchase taxes should be included in the asset's cost. The small spares should be treated as inventory and the cost of maintenance should be treated as an expense of the period covered by the contract.

5.2 (a)

(b)

(c)

Under the cost model, items of property, plant and equipment are carried at cost less any accumulated depreciation and less any accumulated impairment losses. Under the revaluation model, an item of property, plant and equipment is carried at a revalued amount, consisting of the item's fair value at the date of revaluation, less any subsequent accumulated depreciation and less any subsequent accumulated impairment losses.

A revaluation increase is generally credited to a revaluation reserve and accounted for as other comprehensive income. But a revaluation increase is recognised as income when calculating the entity's profit or loss to the extent that it reverses any revaluation decrease in respect of the same item that was previously recognised as an expense.

A revaluation decrease is generally recognised as an expense when calculating the entity's profit or loss. But a revaluation decrease is debited to the revaluation reserve and accounted for (as a negative figure) in other comprehensive income to the extent of any credit balance previously existing in the revaluation reserve in respect of that same item.

On 31 December 2022, a revaluation increase of £0.2m is credited to revaluation reserve and accounted for as other comprehensive income. On 31 December 2023, £0.2m is debited to the revaluation reserve and accounted for as (negative) other comprehensive income. An expense of £0.3m is recognised when calculating the company's profit or loss for the year.

If the valuations on 31 December 2022 and 2023 are reversed, then an expense of £0.3m is recognised when calculating profit or loss for the year to 31 December 2022. In the financial statements for the year to 31 December 2023, income of £0.3m is recognised when calculating the company's profit and £0.2m is credited to revaluation reserve (and accounted for as other comprehensive income).

5.3 (a)

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Depreciable amount is the cost of the asset (or other amount substituted for cost) less its residual value. Useful life is generally the period over which the asset is expected to be used by the entity. Residual value is the estimated disposal value of the asset, after deducting the estimated costs of disposal.

461

PART 6: Answers

(b)

Depreciable amount is £49,500 and useful life is 5 years. Therefore straight-line depreciation is £9,900 per annum. Diminishing balance depreciation is calculated as follows: Year

Carrying amount b/f £ 59,500 41,650 29,155 20,409 14,286

Depreciation Carrying amount at 30% c/f £ £ 2023 17,850 41,650 2024 12,495 29,155 2025 8,746 20,409 2026 6,123 14,286 2027 4,286 10,000 –––––– 49,500 –––––– The company should choose the method which most closely matches the usage pattern of the asset concerned.

5.4 (a)

(b)

Borrowing costs consist of interest and other costs incurred by an entity in connection with the borrowing of funds. IAS23 requires that borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. Other borrowing costs should be recognised as an expense in the period in which they are incurred.

Loans A, B and C total £23m and interest for the year totals £2.3m so the capitalisation rate for the year is 10%. Capitalised borrowing costs are £227,500, as follows: £ £1,500,000 ´ 10% ´ 9/12 112,500 £2,400,000 ´ 10% ´ 5/12 100,000 £1,800,000 ´ 10% ´ 1/12 15,000 ––––––– 227,500 –––––––

5.5 (a)

(b)

462

An investment property is land or a building or a part of a building held to earn rentals or for capital appreciation or both, rather than for use. Investment property may be measured using either the fair value model or the cost model. Under the fair value model, the property is measured at its fair value and any gain or loss arising from a change in fair value is recognised as income or as an expense when calculating the entity's profit or loss. The cost model is the same as for property, plant and equipment.

As stated above, gains arising in connection with investment property measured at fair value are recognised as income when calculating the entity's profit or loss. Revaluation gains arising in connection with property, plant and equipment measured under the revaluation model are generally excluded from profit or loss and are recognised as other comprehensive income.

Answers to Exercises

5.6 This ship is a complex asset and should be treated as three separate assets. The carrying amount of these assets at 30 September 2022 (eight years after purchase) is as follows: £m Ship's fabric (£300m ´ 17/25) 204 Cabins etc. (£150m ´ 4/12) 50 Propulsion system (£100m ´ 10,000/40,000) 25 ––– 279 ––– Ship's fabric Depreciation of £12m (£300m ´ 1/25) should be charged in the year to 30 September 2023. The repainting costs do not meet the recognition criteria for an asset and should be treated as repairs and maintenance.

Cabins and entertainment area fittings The upgrade (at a cost of £60m) has extended the remaining useful life of the cabins etc. by one year and therefore the costs of the upgrade meet the recognition criteria for an asset. The cost of £60m should be added to the cost of the fittings. Any of the old fittings which have been replaced should be derecognised. Assuming that none of the old fittings are to be derecognised, the revised carrying amount is £110m and this should be depreciated over the remaining useful life of five years. So depreciation of £22m is charged in the year to 30 September 2023.

Propulsion system The carrying amount of the old system (£25m) should be written off. This assumes that the system has a scrap value of zero. Depreciation of the new system for the year to 30 September 2023 is £14m (£140m ´ 5,000/50,000).

Entries in financial statements Expenses for the year to 30 September 2023 will include the following: £m Depreciation of ship's fabric 12 Depreciation of cabins etc.

22 Depreciation of propulsion system 14 Loss on disposal of propulsion system 25 Repairs and maintenance 20 The statement of financial position at 30 September 2023 will show the cruise ship as a non-current asset at a carrying amount of £406m. This is calculated as follows: £m Ship's fabric (£204m – £12m) 192 Cabins etc. (£110m – £22m) 88 Propulsion system (£140m – £14m) 126 ––– 406 –––

463

PART 6: Answers

Chapter 6 6.1 (a)

(b) (c)

An intangible asset is an identifiable, non-monetary asset without physical substance.

An asset is identifiable when it arises from contractual or other legal rights or when it is "separable". An asset is separable if it can be separated from the entity and sold, transferred, licensed, rented or exchanged. Goodwill is not separable and is therefore excluded from the IAS38 definition of intangible assets.

Monetary assets are money held and assets to be received in fixed or determinable amounts of money. Intangible assets are non-monetary and therefore items such as cash, bank deposits and trade receivables are excluded from the definition.

Intangible assets are distinguished from property, plant and equipment by the fact that they are without physical substance.

An intangible asset acquired in a separate transaction should be measured initially at its cost.

An intangible asset acquired in a business combination should be measured initially at its fair value on the date of the acquisition.

6.2 (a)

(b)

(c)

Research expenditure is expenditure on original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.

Development expenditure is expenditure on the application of research to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services.

All research expenditure must be written off as an expense when it is incurred. Development expenditure must be recognised as an intangible asset if certain conditions are satisfied. If any of these conditions are not satisfied, the development expenditure must be written off as an expense (see Chapter 6 for more details).

The £370,000 is research expenditure and must be written off as an expense. The £460,000 is development expenditure and must be capitalised as an intangible asset if all of the conditions specified in IAS38 are satisfied (see Chapter 6). Otherwise, this amount must also be written off as an expense.

6.3 (a)

Useful life is six years. The asset should be recognised initially at cost and then amortised over these six years. The asset's depreciable amount is its cost less its residual value. (b) Useful life is 30 years. The asset should be recognised initially at cost and then amortised over these 30 years. The asset's depreciable amount is equal to its cost. (c) Useful life is three years. The asset should be recognised initially at cost and then amortised over these three years. The residual value of the asset will depend upon whether the company intends to sell the trademark at the end of its useful life and whether or not a customer is likely to be found.

In each case, the chosen amortisation method should match the usage pattern of the asset.

464

Answers to Exercises

6.4 Under the cost model, intangible assets are carried at cost less any accumulated amortisation and accumulated impairment losses. Under the revaluation model, intangible assets are carried at their fair value at the date of revaluation, less any subsequent accumulated amortisation and accumulated impairment losses. If the revaluation model is applied to an intangible asset, then it must be applied to the entire class of assets to which the asset belongs. But the revaluation model cannot be applied to an intangible asset for which there is no active market.

6.5 (a)

(b)

(c)

IFRS3 defines goodwill as "an asset representing the future economic benefits arising from ... assets acquired in a business combination that are not individually identified and separately recognised". A business combination occurs when one entity acquires another. Goodwill which has been developed by an entity rather than purchased from another entity is known as internally generated goodwill and is excluded from the IFRS3 definition.

Goodwill is not separable or identifiable. Internally generated goodwill has no reliable cost figure. In general terms, goodwill is subject to unpredictable fluctuations in value and may easily be damaged or destroyed.

Goodwill has an unpredictable useful life and does not amortise at a steady rate. It is more logical to conduct regular impairment reviews than to amortise purchased goodwill.

6.6 (a) (b)

The fair value of the assets less liabilities of B Ltd is £450,000. The price paid by A Ltd is £500,000. So the amount paid for goodwill is £50,000.

The statement of financial position of A Ltd just after the purchase is as follows: £000 £000 Assets Non-current assets Goodwill 50 Property, plant and equipment (4,320 + 390) 4,710 ––––– 4,760 Current assets Inventories (1,210 + 160) 1,370 Trade receivables (940 + 80) 1,020 Cash at bank (1,650 – 500) 1,150 3,540 ––––– ––––– 8,300 ––––– Equity Ordinary share capital 1,000 Retained earnings 3,650 ––––– 4,650 Liabilities Non-current liabilities 2,500 Current liabilities (970 + 180) 1,150 ––––– 8,300 ––––– 465

PART 6: Answers

6.7 (a) (b)

The research costs of £29,200 should be written off as an expense.

The development costs of £67,900 do not seem to meet all the criteria that must be met for an asset to be recognised. There is some doubt as to whether the project will be completed or yield economic benefits. The expenditure should probably be written off as an expense. (c) The development costs of £115,900 meet the criteria for an asset to be recognised. The £115,900 should be included in intangible assets in the statement of financial position. Amortisation over a four-year period should begin as from 2024.

IAS38 requires that staff training costs should be treated as an expense. The company does not control its staff (who may leave) and so staff training costs do not qualify as an asset. It is also impossible to obtain a reliable estimate of the economic benefits that might be derived from the training.

Chapter 7 7.1 (a) (b) (c)

(d)

IAS36 defines an impairment loss as "the amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount".

IAS36 lists a number of possible indications of impairment. Some of these are derived from external sources of information and some from internal sources. See Chapter 7 for details.

The two types of asset which must always be tested for impairment are intangible assets which have an indefinite useful life (or which are not yet available for use) and goodwill acquired in a business combination.

Recoverable amount is the higher of fair value less costs of disposal and value in use.

Fair value less costs of disposal is defined as the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date, less the estimated costs of disposal.

Value in use is the present value of the future cash flows expected from the asset.

7.2 Recoverable amount £ 27,500 4,800 17,500 13,400

Impairment loss £

Asset 1 Asset 2 Asset 3 Asset 4

Carrying amount £ 25,000 6,500 18,250 11,400

Discount factor

Year 1 Year 2 Year 3

Cash inflows £ 20,000 20,000 30,000

Present value £ 18,180 16,520 22,530 –––––– 57,230 ––––––

1,700 750

7.3 (a)

Value in use

466

1/1.1 = 0.909 1/(1.1)2 = 0.826 1/(1.1)3 = 0.751

Answers to Exercises

(b)

(c)

The asset's recoverable amount is the higher of £48,000 (£50,000 – £2,000) and £57,230 which is £57,230. Therefore the impairment loss is £42,770 (£100,000 – £57,230). The asset's carrying amount should be reduced to £57,230 and an impairment loss of £42,770 should be recognised as an expense.

Assuming that residual value remains at £10,000, the asset's depreciable amount is £47,230.

Annual depreciation is approximately £15,743 (£47,230 ÷ 3).

7.4 (a)

(b)

IAS36 defines a cash-generating unit as "the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets".

A CGU should be tested for impairment is there are indications that an asset which belongs to the CGU is impaired or that the CGU as a whole is impaired. A CGU to which goodwill has been allocated should be tested for impairment every year, regardless of whether or not there are any indications of impairment.

7.5 The impairment loss is £80m (£275m – £195m). Goodwill is reduced from £25m to zero, leaving £55m of the loss remaining. This is initially allocated in the ratio 50:200 between the patents and the property, plant and equipment (PPE), so that patents are reduced by £11m to £39m and PPE is reduced by £44m to £156m. However, £156m is £4m less than the fair value less costs of disposal of the PPE. Therefore PPE is set to £160m and an extra £4m is subtracted from the patents. The assets are now patents £35m and PPE £160m, giving a total of £195m.

7.6 (a)

An impairment loss occurs when the carrying amount of an asset is higher than its recoverable amount. The recoverable amount of an asset is the higher of its fair value less costs of disposal and its value in use.

Fair value less costs of disposal The fair value of an asset for this purpose is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date. If the asset is of a type that is traded in an active market involving identical assets, then the quoted price in that market will be used. Otherwise, the fair value of the asset will have to be determined by using one of the other valuation techniques listed in IFRS13. Estimated costs of disposal are deducted when calculating an asset's fair value less costs of disposal.

Value in use The value in use of an asset is the present value of the future net cash flows expected to be derived from use of the asset. Many assets do not produce independent cash flows, so it may be necessary to consider the value in use (and the fair value less costs of disposal) of the cash generating unit (CGU) to which the asset belongs.

Frequency of testing for impairment Goodwill and any intangible asset that has an indefinite useful life must be tested for impairment every year. This is also the case for any intangible asset that has not yet been brought into use.

Other assets are tested for impairment only if there is an indication that impairment may have occurred. IAS36 provides a list of such indications.

467

PART 6: Answers

(b)

(c)

An impairment loss is subtracted from the carrying amount of the asset concerned. Future depreciation charges will be based upon the reduced carrying amount. An impairment loss is usually accounted for as an expense. But if the asset has previously been revalued upwards, the loss should first be deducted from the revaluation surplus.

An impairment loss relating to a CGU is used to eliminate any goodwill in the CGU and is then allocated to the other assets in proportion to their carrying amounts. However, an asset other than goodwill should not be reduced to less than the higher of its fair value less costs of disposal and its value in use.

The plant's carrying amount was £240,000 on 1 October 2022. Depreciation from 1 October 2022 to 1 April 2023 is £40,000 (£640,000 ´ 12.5% ´ 6/12) giving a carrying amount of £200,000 at the date of impairment.

Recoverable amount is the higher of the plant's value in use (£150,000) and fair value less costs of disposal. If Wilderness trades in the plant it will receive £180,000 but Wilderness is reluctant to do this. A better estimate of fair value less costs of disposal is £20,000. Therefore recoverable amount is £150,000 and the impairment loss is £50,000.

Since the remaining useful life of the plant is only two years (from the date of impairment) the depreciation charge for the last six months of the year is £37,500 (£150,000/2 ´ 6/12). The financial statements for the year to 30 September 2023 will show: Statement of financial position Plant (£150,000 – £37,500) = £112,500 Statement of comprehensive income Plant depreciation (£40,000 + £37,500) = £77,500 Plant impairment loss £50,000

Chapter 8 8.1 (a)

(b)

(c)

468

A non-current asset is classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. For this to be the case, the asset must be available for immediate sale in its present condition (subject only to terms that are usual and customary for sales of such assets) and the sale must be highly probable. IFRS5 lists the conditions under which a sale is regarded as highly probable (see Chapter 8).

If a non-current asset is held for sale rather than use, the notion of "useful life" is inapplicable and therefore it is no longer appropriate to make depreciation charges or to carry the asset at its cost (or revalued amount) less depreciation to date.

IFRS5 requires that a non-current asset which is held for sale should be measured at the lower of its carrying amount when it was initially classified as held for sale and its fair value less costs to sell. Fair value is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date. Costs to sell are costs directly attributable to the disposal of the asset, excluding finance costs and tax.

Answers to Exercises

8.2 (a) (b) (c) (d)

There is an impairment loss of £600 on 1 March 2023 and a further impairment loss of £200 on 30 June 2023. There is a loss on disposal of £60 in the year to 30 June 2024.

There is no impairment loss on either 1 March 2023 or 30 June 2023. There is a gain on disposal of £630 in the year to 30 June 2024.

There is an impairment loss of £100 on 1 March 2023 and a gain of £50 on 30 June 2023. There is a loss on disposal of £30 in the year to 30 June 2024.

There is an impairment loss of £100 on 1 March 2023 and a gain of £100 (not £150) on 30 June 2023. This gain is capped at £100 to ensure that the asset is not measured at more than its carrying amount when it was originally classified as held for sale. There is a gain on disposal of £80 in the year to 30 June 2024.

8.3 (a)

(b)

A discontinued operation is a component of an entity that either has been disposed of or is classified as held for sale. For this purpose, a component comprises operations and cash flows that can be clearly distinguished from the rest of the entity.

IFRS5 requires that entities should present and disclose information that enables users of the financial statements to evaluate the effects of discontinued operations. This information will help users to make more accurate assessments of an entity's likely financial performance in future years.

8.4 On 31 December 2022, the assets of the operation cannot be classified as held for sale since they are not available for immediate sale. These assets should be presented and measured in the same way as in previous years. However, the decision to close down the operation might suggest that the assets are impaired and so an impairment review should be carried out. The operation does not count as a discontinued operation at 31 December 2022, therefore its results should be included in continuing operations in the financial statements.

Assuming that the operation is closed down and the assets sold by 31 December 2023, the results of the operation should be shown under discontinued operations in the statement of comprehensive income for 2023. There should be a single figure comprising the after-tax profit or loss of the operation and the gain or loss on disposal of its assets. This figure will then be analysed, either in the statement of comprehensive income or in the notes.

8.5 (a)

(b)

The total carrying amount of the disposal group at 25 January 2023 is £3.06m, so there is an impairment loss of £60,000. This is deducted from goodwill, leaving £140,000.

The measurement requirements of IFRS5 exclude the investment properties, inventories and liabilities. So on 31 May 2023, the carrying amount of these items must be remeasured in accordance with the applicable standards. The carrying amount of the disposal group becomes £3.02m (£140,000 + £2,100,000 + £760,000 + £380,000 – £360,000) and the remeasurement gain is £20,000. There is a further impairment loss of £170,000 (£3.02m – £2.85m) on 31 May 2023. Goodwill is reduced to zero and £30,000 is deducted from the property, plant and equipment, leaving this at £2,070,000.

When the disposal group is sold for £2.8m, there is a loss on disposal of £50,000.

469

PART 6: Answers

8.6 The revised extract from the statement of comprehensive income is as follows: £000 £000 Continuing operations Sales revenue (558 – 103) 455 Cost of sales (184 – 38) 146 ––– Gross profit 309 Other operating income 12 ––– 321 Distribution costs (59 – 2) 57 Administrative expenses (148 – 20 – 17) 111 168 ––– ––– Profit before tax 153 Taxation expense (35 – 9 + 3) 29 ––– Profit for the year from continuing operations 124 Discontinued operations Profit for the year from discontinued operations 20 ––– Profit for the year 144 ––– There would be a note showing that the profit from discontinued operations is as follows: £000 £000 Sales revenue 103 Cost of sales 38 ––– Gross profit 65 Distribution costs 2 Administrative expenses 20 22 ––– ––– Profit before tax 43 Taxation expense 9 ––– Profit after tax 34 Loss on disposal of assets (17) Tax relief 3 (14) ––– ––– Profit from discontinued operations 20 ––– (This note could be less detailed if some of the figures concerned are thought not to be material).

Chapter 9 9.1 (a)

470

IFRS16 defines a lease as "a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration". The inception date of a lease is the earlier of the date of the lease agreement and the date that the parties to the lease become committed to its principal terms and conditions. The commencement date of a lease is the date on which the underlying asset is made available for use by the lessee.

Answers to Exercises

(b)

(c)

(d)

A lessor is an entity which supplies an underlying asset for use by another entity and receives lease payments in return. A lessee is an entity which acquires the right to use an underlying asset (supplied by a lessor) in exchange for making lease payments.

IFRS16 defines a right-of-use asset as "an asset that represents a lessee's right to use an underlying asset for the lease term". At the commencement of a lease, a right-of-use asset is initially measured as the sum of: - the initial amount of the lease liability - any lease payments made on or before the commencement date - any initial direct costs incurred by the lessee - estimated dismantling, removing or restoration costs to be incurred at the end of the lease.

A lease liability is initially measured as the present value of the lease payments which fall due after the commencement date.

A lessee is not required to recognise a right-of-use asset or a lease liability for short-term leases (12 months or less in duration) or for leases of low-value assets.

9.2 (a)

(b)

The initial lease liability is £45,303 ´ (1/1.14 + 1/1.142 + 1/1.143 + 1/1.144) = £132,000. The finance charge for each year and the liability at the end of the year are calculated as follows: Year to Liability Finance Lease Liability 30 June b/f charge 14% payment c/f £ £ £ £ 2023 132,000 18,480 45,303 105,177 2024 105,177 14,725 45,303 74,599 2025 74,599 10,444 45,303 39,740 2026 39,740 5,563 45,303 0 The total liability at 30 June 2023 is £105,177. Of this, £30,578 (£45,303 – £14,725) is a current liability and the remaining £74,599 is a non-current liability.

The right-of-use asset is measured at £132,000 on 1 July 2022. This asset is then depreciated over the next four years (or over a shorter period if the useful life of the right-of-use asset is less than four years).

9.3 The company should recognise a lease liability equal to the present value of the three payments that fall due after the commencement date. With a discount rate of 9%, discount factors for one, two and three years are 0.917 (1/1.09), 0.842 (1/1.092) and 0.772 (1/1.093). The sum of these factors is 2.531.

This gives an initial lease liability of (£30,000 ´ 2.531) = £75,930. The interest expense for each year and the outstanding liability at the end of each year are calculated as follows: Year

Liability Lease Balance Interest Liability Current Nonb/f payment expense 9% c/f current £ £ £ £ £ £ £ 2023 75,930 0 75,930 6,834 82,764 30,000 52,764 2024 82,764 30,000 52,764 4,749 57,513 30,000 27,513 2025 57,513 30,000 27,513 2,487 30,000 30,000 0 2026 30,000 30,000 0 0 0 0 0 (Interest expense for 2025 has been rounded up to ensure that the lease liability reduces to zero).

471

PART 6: Answers

On 1 January 2023, the company should also recognise a right-of-use asset of £105,930. This is equal to the initial lease liability of £75,930 plus the £30,000 paid on commencement. If the lease transfers ownership of the office machinery to Crimmock Ltd at the end of the lease term, the right-of-use asset should be depreciated over the useful life of this machinery. Otherwise, the right-of-use asset should be depreciated over the lease term (or over the useful life of the right-of-use asset if this is shorter than the lease term).

9.4 The initial lease liability is £7,674 ´ (1/1.06 + 1/1.062 + 1/1.063 + 1/1.064 + 1/1.065) = £32,326. The finance charge for each year and the liability at the end of the year are calculated as follows: 6 months Liability Lease Balance Finance Liability to b/f payment charge 6% c/f £ £ £ £ £ 30/9/2023 32,326 0 32,326 1,940 34,266 31/3/2024 34,266 7,674 26,592 1,595 28,187 30/9/2024 28,187 7,674 20,513 1,231 21,744 31/3/2025 21,744 7,674 14,070 844 14,914 30/9/2025 14,914 7,674 7,240 434 7,674 31/3/2026 7,674 7,674 0 0 0 The finance charge for the year to 31 March 2024 is £3,535 (£1,940 + £1,595). Similarly, the finance charges for the years to 31 March 2025 and 2026 are £2,075 and £434 respectively.

The right-of-use asset is initially measured at £32,326 + £7,674 = £40,000.

9.5 The initial lease liability is £6,595 ´ (1/1.1 + 1/1.12 + 1/1.13 + 1/1.14) = £20,905. The finance charge for each year and the liability at the end of the year are calculated as follows: Year Liability Lease Balance Finance Liability Current Nonb/f payment charge 10% c/f current £ £ £ £ £ £ £ 2023 20,905 0 20,905 2,091 22,996 6,595 16,401 2024 22,996 6,595 16,401 1,640 18,041 6,595 11,446 2025 18,041 6,595 11,446 1,145 12,591 6,595 5,996 2026 12,591 6,595 5,996 599 6,595 6,595 0 2027 6,595 6,595 0 0 0 0 0 Note that the current liability element of the liability at the end of each year is equal to the amount of the payment made at the start of the following year (since this payment is made before the following year's finance charge starts to accrue).

The right-of-use asset is initially measured at £20,905 + £6,595 + £500 = £28,000. The depreciable amount is £25,000, so the depreciation charge is approximately £3,571 per annum over the useful life of seven years.

9.6 (a)

472

The present value of the lease payments amounts to substantially less than the fair value of the underlying asset. The lease term is not for the major part if the asset's useful life. Legal title appears not to be transferred. Therefore this is an operating lease.

Answers to Exercises

(b)

The machine will continue to be shown as an asset in Lessor's statement of financial position and should be depreciated as usual. Lease payments of £6,000, £12,000, £12,000 and £6,000 should be shown respectively as income in Lessor's statements of comprehensive income for the years to 30 June 2023, 2024, 2025 and 2026. Any accruals or prepayments will be shown in the statements of financial position in the usual way.

Chapter 10 10.1 See Chapter 10 for the IAS2 definition of inventories, detailed information on costs which should be included when measuring the cost of inventories and the IAS2 definition of net realisable value.

10.2 (a)

A cost formula may be used for interchangeable items that cannot be distinguished from one another.

(b)

FIFO Issued June 2023 Issued Sept. 2023 Issued Oct. 2023 Issued Feb. 2024 Inventory April 2024

No of kg 25,000 12,000 5,000 4,000 11,000

25,000 @ £7.50 7,000 @ £7.50 5,000 @ £8.75 5,000 @ £8.75 4,000 @ £8.75 1,000 @ £8.75 10,000 @ £9.50

Cost (£) 187,500 52,500 43,750 ––––––

96,250 43,750 35,000

8,750 95,000 ––––––

103,750

AVCO No of kg Opening inventory Issued June 2023 Bought Aug. 2023 Issued Sept. 2023 Issued Oct. 2023 Bought Jan. 2024 Issued Feb. 2024 Inventory April 2024

32,000 @ £7.50 25,000 @ £7.50 –––––– 7,000 15,000 @ £8.75 –––––– 22,000 12,000 @ £8.35 –––––– 10,000 5,000 @ £8.35 –––––– 5,000 10,000 @ £9.50 –––––– 15,000 4,000 @ £9.12 –––––– 11,000 ––––––

Total cost (£) 240,000 187,500 –––––– 52,500 131,250 –––––– 183,750 100,200 –––––– 83,550 41,750 –––––– 41,800 95,000 –––––– 136,800 36,480 –––––– 100,320 ––––––

Weighted average £7.50

Cost (£)

187,500

£8.35 100,200 41,750

£9.12 36,480

473

PART 6: Answers

10.3 (a)

The cost and NRV of inventories should (if possible) be compared item by item. Therefore it is not permissible to measure inventories at the lower of total cost and total NRV.

(b)

Cost

Machine W Machine X Machine Y Machine Z

£ 10,950 16,600 18,950 8,300

NRV £ (12,500 ´ 96%) – 0 = 12,000 (17,500 ´ 96%) – 400 = 16,400 (23,000 ´ 96%) – 2,100 = 19,980 (9,500 ´ 96%) – 900 = 8,220

Lower of cost and NRV £ 10,950 16,400 18,950 8,220 –––––– 54,520 ––––––

10.4 (a) (b)

£240,000 divided by 80,000 = £3 per unit. £240,000 divided by 100,000 = £2.40 per unit.

(c)

The allocation should be £3 per unit (based on normal production capacity). This absorbs £150,000 of the fixed production overheads. The remaining £90,000 should be written off as an expense in the year to 31 March 2024.

Chapter 11 11.1 (a)

A financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. (ii) A financial asset is an asset which is either cash, an equity instrument of another entity or a contractual right to receive cash (or another financial asset) from another entity. (iii) A financial liability is a contractual obligation to deliver cash or another financial asset to another entity. (iv) An equity instrument is a contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

(b)

IAS32 takes a substance over form approach to the classification of financial instruments. An instrument is classified as an equity instrument only if it includes no contractual obligation to deliver cash or another financial asset to another entity.

Redeemable preference shares are classified as liabilities and dividends relating to such shares are treated as an expense.

(c)

474

(i)

Answers to Exercises

11.2 (a)

(b)

A compound financial instrument is one that contains both a liability component and an equity component (e.g. convertible loan stock). A compound instrument is separated into its two components by first evaluating the liability component and then subtracting this from the fair value of the whole instrument to give the equity component.

Payment Discount Present due factor value £ £ 31/3/2023 20,000 1/1.065 18,779 31/3/2024 20,000 1/(1.065)2 17,633 31/3/2025 20,000 1/(1.065)3 16,557 31/3/2026 20,000 1/(1.065)4 15,546 31/3/2027 520,000 1/(1.065)5 379,538 –––––– Liability component 448,053 –––––– The equity component is £51,947 (£500,000 – £448,053).

11.3 (a)

The three categories of financial assets which are identified by IFRS9 are "financial assets at amortised cost", "financial assets at fair value through other comprehensive income" and "financial assets at fair value through profit or loss".

Subsequent to initial recognition, "financial assets at amortised cost" are measured at amortised cost using the effective interest method. "Financial assets at fair value through comprehensive income" are measured at fair value and any changes in fair value are generally recognised in other comprehensive income. "Financial assets at fair value through profit or loss" are measured at fair value and any changes in fair value are taken into account when calculating the entity's profit or loss.

See Chapter 11 for a more detailed description of each type of financial asset.

(b) Date

b/f

Interest Received c/f at 3.5% £ £ £ £ 30/6/2023 411,225 14,393 10,000 415,618 31/12/2023 415,618 14,547 10,000 420,165 30/6/2024 420,165 14,706 10,000 424,871 31/12/2024 424,871 14,870 10,000 429,741 30/6/2025 429,741 15,041 10,000 434,782 31/12/2025 434,782 15,218 450,000 0 The amount received on 31 December 2025 consists of interest of £10,000, repayment of the £400,000 and a premium of £40,000.

Interest income for the year to 30 June 2023 is £14,393. Interest income for the year to 30 June 2024 is £29,253 (£14,547 + £14,706). Similarly, interest income for the years to 30 June 2025 and 2026 is £29,911 and £15,218 respectively.

The statements of financial position as at 30 June 2023, 2024, 2025 and 2026 should show an asset of £415,618, £424,871, £434,782 and zero respectively.

475

PART 6: Answers

11.4 (a)

(b)

(i)

Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation (e.g. a bad debt). (ii) Liquidity risk is the risk that an entity will encounter difficulty in meeting its obligations associated with financial liabilities. (iii) Market risk is the risk that the fair value or the future cash flows of a financial instrument will fluctuate because of changes in market prices. Such changes may occur because of changes in exchange rates ("currency risk"), or changes in market interest rates ("interest rate risk") or for other reasons ("other price risk").

See Chapter 11 for an outline of disclosures required in relation to these three types of risk.

11.5 (a)

The amount received is £712,500 (95% of £750,000). Issue costs of £13,175 reduce this to £699,325. This is the amount at which the loan stock should be measured on 1 May 2023.

(b) Year to 30 April

b/f

Interest Paid c/f at 7.25% £ £ £ £ 2024 699,325 50,701 22,500 727,526 2025 727,526 52,746 22,500 757,772 2026 757,772 54,938 22,500 790,210 2027 790,210 57,290 847,500 0 ––––––– 215,675 ––––––– The figures that will appear in the statement of financial position are shown in the rightmost column of this table. The amount paid on 30 April 2027 consists of interest of £22,500, repayment of the original £750,000 and a premium of £75,000.

The total cost of the loan is £215,675. This consists of interest of £90,000, the discount on issue of £37,500, the premium on repayment of £75,000 and the issue costs of £13,175. The effective interest method spreads all these costs fairly over the duration of the loan.

Chapter 12 12.1 (a) (b) (c)

(d)

476

There is a constructive obligation at the end of the reporting period. A provision of £375,000 should be made.

There is no obligation (legal or constructive) at the end of the reporting period. The decision could be reversed. No provision should be made.

A provision equal to the present value of £5m is required in relation to the rectification costs in the first country (for which there is a legal obligation). Although there is no legal obligation in relation to the other country, a provision equal to the present value of £10m should be recognised if the company's behaviour has created a constructive obligation.

There is no present obligation and therefore no provision should be made. Provisions for future operating costs are not allowed by IAS37.

Answers to Exercises

12.2 (a)

(b)

The amount of a provision should be the best estimate of the expenditure required to settle the obligation concerned. If the effect of the time value of money is material, the amount of the provision should be the present value of the expenditure required to settle the obligation.

The most likely outcome is that the repair will cost £100,000. However, both of the other possible outcomes involve higher expenditure and so a higher provision is required. IAS37 does not explain how this higher amount should be calculated but one possibility might be to calculate the expected value of the obligation. This is 60% of £100,000 plus 30% of £150,000 plus 10% of £200,000, i.e. £125,000. However, this is not definite and management should exercise its judgement in estimating the amount of the provision.

12.3 (a) (b) (c) (d)

Recognise a provision.

Disclose a contingent liability unless the possibility of an outflow of economic benefits is only remote (in which case do nothing).

Disclose a contingent liability unless the possibility of an outflow of economic benefits is only remote (in which case do nothing).

Recognise a provision.

12.4 The past event is the sale of goods to the customer. But did this give rise to a present obligation? (a) There is probably an obligation and a provision should be made, assuming that a reliable estimate can be made of the amount of the obligation. (b) There is probably no obligation and so there is no provision. A contingent liability should be disclosed unless the customer has only a remote chance of winning the case.

12.5 (a) (b)

A contingent asset should be disclosed.

A provision is required equal to the present value of £3m.

12.6 (a)

This is an adjusting event which helps the company to assess the net realisable value of its inventories. This may affect the value at which inventories are shown in the statement of financial position at 31 December 2022.

(b) (c) (d)

This is a non-adjusting event. Disclose in the notes to the financial statements.

This is a non-adjusting event. Disclose in the notes to the financial statements.

This is probably an adjusting event. The customer was probably already in financial trouble at 31 December 2022. The company should either write off a bad debt or make an allowance for a doubtful debt, depending upon the likelihood of receiving any part of the amount owed.

This is a non-adjusting event. Disclose in the notes to the financial statements.

This is an adjusting event. The cash figure in the statement of financial position as at 31 December 2022 should be reduced. If the theft is not covered by insurance, an expense should be recognised in the statement of comprehensive income for the year to 31 December 2022.

(e) (f)

477

PART 6: Answers

(g) (h)

This is a non-adjusting event. Disclose in the notes to the financial statements.

IAS10 states that this is a non-adjusting event. It should therefore be disclosed in the notes to the financial statements (see Chapter 15).

12.7 (i)

IAS37 Provisions, Contingent Liabilities and Contingent Assets requires that the costs of decontamination should be provided for in full, since the contamination has already occurred.

It is correct to discount the amount of the provision to its present value. Therefore the amount of the provision should be £5m, not £500,000.

IAS16 Property, Plant and Equipment states that the initial cost of an item of property, plant and equipment includes any estimated costs of dismantling and restoration, as long as the obligation to meet those costs is incurred when the item is acquired (as in this case). So the £5m decontamination costs should be added to the cost of the plant, bringing this to £20m.

The statement of comprehensive income for the year to 31 March 2023 will be charged with depreciation of £2m (£20m/10 years). Furthermore, the date on which the decontamination costs are payable is now a year closer than it was when the provision was raised, so its present value increases by 8% and there will be a finance charge of £400,000 (8% of £5m) to reflect one year's "unwinding" of the discount.

The statement of financial position at 31 March 2023 will show a non-current asset of £18m and a non-current liability of £5.4m. (ii) IAS10 Events after the Reporting Period requires that the fraud of £210,000 should be treated as an adjusting event and that the financial statements for the year to 31 March 2023 should be adjusted accordingly. £210,000 should be deducted from cost of sales and shown as an expense in the statement of comprehensive income. This may require separate disclosure if the amount is considered to be material.

The remaining £30,000 of the fraud should be treated as a non-adjusting event and should be disclosed in the notes (if material). (iii) The possible insurance claim is a contingent asset. Since it is only possible (not probable) that the claim will be successful, it should be ignored when preparing the financial statements for the year to 31 March 2023.

Chapter 13 13.1 Revenue is defined by international standard IFRS15 as "income arising in the course of an entity's ordinary activities". Revenue excludes borrowings, amounts contributed by shareholders and gains.

Revenue also excludes rental income, interest and dividends. The five-step model set out in IFRS15 for the recognition and measurement of revenue is as follows: Step 1: Identify a contract with a customer Step 2: Identify the performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the performance obligations in the contract Step 5: Recognise revenue when or as the entity satisfies a performance obligation.

Detailed information relating to each of these steps in given in Chapter 13.

478

Answers to Exercises

13.2 Assuming that the expected value method provides the best prediction of the amount of the consideration to which the company will be entitled, the transaction price is £5.2m ((25% ´ £6m) + (70% ´ £5m) + (5% ´ £4m)).

13.3 Revenue recognised on the date of delivery is £2,500 + £7,938 (£10,000 ´ 1/(1.08)3) = £10,438. The remaining £2,062 is treated as a finance charge. Assuming for the sake of simplicity that the sale occurs at the start of an accounting year, interest income is £635 in the first year, £686 in the second year and £741 in the third year. The calculations are as follows: Receivable Interest Received Receivable b/f at 8% c/f £ £ £ £ Year 1 7,938 635 8,573 Year 2 8,573 686 9,259 Year 3 9,259 741 10,000 0

13.4 The total of the stand-alone selling prices is £40, so the customer is receiving a discount of £10 for purchasing all three DVDs as a bundle. The amount of the transaction price allocated to each DVD is £8.25 (£11 ´ (£30 ÷ £40)), £10.50 (£14 ´ (£30 ÷ £40)) and £11.25 (£15 ´ (£30 ÷ £40)).

13.5 When the goods are delivered to the customers, the company should not recognise revenue in relation to the products that are expected to be returned (see IFRS15 application guidance). Assuming that the returned products can be resold by the company and are not impaired in any way, the company should recognise the following items in its financial statements: (a)

revenue of £288,000 (10,000 ´ £30 ´ 96%)

(b) a refund liability of £12,000 (10,000 ´ £30 ´ 4%) (c) an asset (inventory) equal to the cost of the products that are expected to be returned.

If the refunds paid to customers during the 60-day period are not exactly £12,000, the difference should be accounted for prospectively as a change in an accounting estimate (see Chapter 4).

If the refund liability has been overestimated, this change of estimate will involve reducing that liability, increasing revenue and reducing the inventory of returned products.

Conversely, if the refund liability has been underestimated, this change of estimate will involve increasing that liability, reducing revenue and increasing the inventory of returned products.

13.6 The customer does not receive or consume benefits whilst the building work is proceeding and does not control the partly-completed property. Although the entity may retain the deposit if the customer defaults on the contract, it does not have an enforceable right to payment for the work completed to date. It appears that none of the required criteria are met for this performance obligation to be satisfied over time. Therefore the obligation is satisfied at a point in time.

479

PART 6: Answers

Chapter 14 14.1 The four categories of employee benefits are: (i) Short-term employee benefits. "employee benefits (other than termination benefits) that are expected to be settled wholly before twelve months after the end of the annual reporting period in which the employees render the related service" (e.g. wages and salaries). (ii) Post-employment benefits. "employee benefits (other than termination benefits and short-term employee benefits) that are payable after the completion of employment" (e.g. pensions). (iii) Other long-term employee benefits. "all employee benefits other than short-term employee benefits, post-employment benefits and termination benefits" (e.g. long-service leave). (iv) Termination benefits. "employee benefits provided in exchange for the termination of an employee's employment ..." (e.g. redundancy pay).

14.2 The liability is £261,000 (870 ´ 2 ´ £150).

14.3 (a)

(b)

(c)

480

Defined contribution pension plans are those where an employer pays fixed contributions into the pension fund each year and is not obliged to make any further contributions, even if the fund's assets are insufficient to pay adequate benefits to employees. The risk that benefits will be less than expected falls upon the employees, not the employer.

Defined benefit plans are those where the employer is obliged to provide an agreed level of pensions to employees. The employer's contributions are not limited to any fixed amount and these contributions may need to be increased if the pension fund has insufficient assets to pay the agreed level of pensions. The risk of having to make further contributions is borne by the employer, not the employee.

The statement of comprehensive income should show an expense of £350,000. The statement of financial position should show an accrued expense of £30,000. The employer has no further liability since this is a defined contribution scheme.

Accounting for defined benefit plans is difficult because the expense recognised in each accounting period should be the cost to the employer of the pensions that will eventually be paid to employees as a result of the services which they have provided during that period. The cost of these pensions is difficult to determine in advance because of the unpredictability of factors such as employee mortality rates and future returns on investments.

Answers to Exercises

14.4 (a)

(i)

The defined benefit obligation is the amount of the accumulated benefits which past and present employees have earned in return for their services to date and which will be payable to them in the future. (ii) The current service cost is the extra amount of benefits that employees have earned in return for their services during the current period. (iii) The interest cost for an accounting period is equal to the increase (during that period) in the present value of the defined benefit obligation which was calculated at the end of the previous period. (iv) Actuarial gains and losses include adjustments arising from differences between previous actuarial assumptions and actual events. Actuarial gains and losses also include the effects of changes in actuarial assumptions.

(b)

The main components of the defined benefit expense for an accounting period are: (i) the present value of the current service cost for the period, plus interest cost, less interest income and less any employee contributions (ii) the aggregate of actuarial gains or losses and the return on plan assets (excluding interest income).

Item (i) is taken into account when calculating the profit or loss for the period. Item (ii) is shown in other comprehensive income.

(c)

The defined benefit liability is equal to the present value of the defined benefit obligation at the end of the period, less the fair value of the plan assets at that date.

14.5 In summary, the defined benefit obligation and plan assets are as follows: £m Present value of DB obligation at 31 December 2022 22.5 Interest cost 1.8 Present value of current service cost for the year 3.7 Benefits paid during the year (1.9) –––– 26.1 Actuarial loss (balancing figure) 1.3 –––– Present value of DB obligation at 31 December 2023 27.4 –––– Fair value of plan assets at 31 December 2022 Interest income Return on plan assets (after deducting interest income) Employer contributions Employee contributions Benefits paid during the year Fair value of plan assets at 31 December 2023

£m 21.9 2.1 0.8 3.8 1.5 (1.9) –––– 28.2 ––––

481

PART 6: Answers

The defined benefit expense is £2.4m, calculated as follows: Present value of current service cost for the year Less: employee contributions Interest cost Interest income Expense recognised in profit or loss Actuarial losses Return on plan assets Expense recognised in other comprehensive income Total defined benefit expense

£m 3.7 (1.5) –––– 2.2 1.8 (2.1) –––– 1.9 –––– 1.3 (0.8) –––– 0.5 –––– 2.4 ––––

The defined benefit asset is £0.8m, calculated as follows: Fair value of plan assets at 31 December 2023 Present value of DB obligation at 31 December 2023

£m 28.2 27.4 –––– 0.8 ––––

There was an opening defined benefit liability of £0.6m (£22.5m – £21.9m). This has now become an asset of £0.8m, an improvement of £1.4m. This arises because the employer has contributed £3.8m during the year, which is £1.4m greater than the expense for the year of £2.4m.

Chapter 15 15.1 Current Tax 1 May 2023 Bank

£000 127

1 Aug 2022 31 Jul 2023

Balance b/d SoCI

31 Jul 2023

SoCI

1 Aug 2023

Balance b/d

127 31 Jul 2023

Balance c/d

140 140

£000 120 7 127 140 140 140

Notes: (i) The current tax expense for the year comprises £140,000 plus the £7,000 underestimate for the previous year. The total of £147.000 is the tax expense which is shown in the statement of comprehensive income (SoCI). (ii) The current tax liability at the end of the year is £140,000.

482

Answers to Exercises

15.2 (a)

(b)

(c)

Current tax is the amount of tax payable (or recoverable) in respect of the taxable profit or loss for an accounting period. Deferred tax is the tax payable (or recoverable) in future periods in respect of taxable (or deductible) temporary differences.

Permanent differences arise because some of the income shown in financial statements may not be chargeable to tax and some of the expenses shown may not be deductible for tax purposes.

Permanent differences cause no accounting problems and can be ignored.

Temporary differences arise when some of the income or expenses shown in the financial statements in one accounting period are dealt with for tax purposes in a different period. Such differences are accounted for by making transfers to or from a deferred tax account.

Unless deferred tax is taken into account, temporary differences can lead to a significant distortion of reported figures for profit after tax. This could give a misleading impression of an entity's financial performance. This point is illustrated in Examples 2 and 3 in Chapter 15.

15.3 (a)

2021 £

2022 £

2023 £

Taxable profit

75,000 140,000 175,000 –––––– –––––– –––––– Profit before tax 125,000 130,000 135,000 Tax expense (20% on taxable profit) 15,000 28,000 35,000 –––––– –––––– –––––– Profit after tax 110,000 102,000 100,000 –––––– –––––– –––––– The impression given by these figures is that the company's profit after tax is on a downward trend. (b) Profit before tax Tax expense: Current tax Deferred tax Profit after tax

15,000 10,000 ––––––

2021 £ 125,000

2022 £ 130,000

2023 £ 135,000

25,000 –––––– 100,000 ––––––

28,000 (2,000) 26,000 –––––– –––––– 104,000 ––––––

35,000 (8,000) 27,000 –––––– –––––– 108,000 ––––––

The transfer to the deferred tax account in 2021 is £10,000 (20% of £50,000). Of this, £2,000 is transferred back in 2022 and the remaining £8,000 is transferred back in 2023. The result is that the total tax expense is a level 20% of accounting profit and profit after tax is seen to be rising.

15.4 The tax base of an asset or liability is the amount which is attributed to that asset or liability for tax purposes. The IAS12 definitions of the tax base of an asset and the tax base of a liability are given in Chapter 15.

If the tax base of an asset or liability differs from its carrying amount, this is an indication that a temporary difference exists. Therefore, determining the tax base of each asset and liability helps to identify the situations in which deferred tax adjustments are required.

483

PART 6: Answers

15.5 (a) (b) (c)

(d)

The tax base of the lorry is £30,000. There is a deductible temporary difference of £10,000 which gives rise to a deferred tax asset.

The tax base of the loan is £60,000 (£60,000 – £nil). This is the same as its carrying amount so there is no temporary difference and there are no deferred tax implications.

The amount receivable of £45,000 can be considered as two separate receivables, of £25,000 and £20,000 respectively. When the £25,000 is received it will not be taxable, so its tax base is also £25,000 and there is no temporary difference. When the £20,000 is received it will be taxable and nothing will be deductible from this amount for tax purposes. So its tax base is £nil and there is a taxable difference of £20,000 which gives rise to a deferred tax liability.

The tax base of the amount payable is £nil (£3,000 – £3,000). There is a deductible temporary difference of £3,000 and this gives rise to a deferred tax asset.

15.6 There is a taxable temporary difference of £1.4m between the carrying amount and the tax base of the company's assets. This gives rise to a deferred tax liability of £1.4m ´ 25% = £350,000. So the deferred tax figure shown in non-current liabilities should be £350,000. The statement of financial position should also show a current liability of £260,000 in relation to current tax.

The deferred tax liability has risen by £70,000. Therefore the tax expense shown in the statement of comprehensive income should be £385,000 (£55,000 + £260,000 + £70,000).

Chapter 16 16.1 (a) (b)

(c) (d)

(e)

484

Cash comprises cash on hand and demand deposits. Bank overdrafts are also included. This means that the total cash figure could be negative.

Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to insignificant risk of changes in value. Cash equivalents are regarded by IAS7 as being virtually indistinguishable from cash itself and are treated as cash rather than as investments.

Operating activities are the principal revenue-producing activities of the entity (e.g. the sale of goods and services).

Investing activities comprise the acquisition and disposal of long-term assets and other investments. The acquisition and disposal of property, plant and equipment are included under this heading.

Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. This heading includes share issues, share redemption, borrowings and repayments of borrowings.

Answers to Exercises

16.2 (a)

If the direct method is used, major classes of receipts and payments arising from operating activities are disclosed individually and are then aggregated to give the total amount of cash generated from operations.

The indirect method takes the profit or loss for the period (before tax) as its starting point and then makes a number of adjustments to this profit or loss so as to calculate the total amount of cash generated from operations.

(b)

If the indirect method is used, profit before tax is adjusted as follows: (i) Non-cash expenses (e.g. depreciation) are added back. (ii) Interest expense is added back. (iii) Non-cash income (e.g. a decrease in allowance for doubtful receivables) is subtracted. (iv) Losses on the disposal of non-current assets are added back. Profits on the disposal of non-current assets are subtracted. (v) Items of income or expense which are included in the profit calculation but are derived from investing or financing activities are subtracted (income) or added (expenses). (vi) Increases in inventories, trade receivables and prepayments are subtracted. Decreases in these items are added. (vii) Increases in trade payables and accrued expenses are added. Decreases in these items are subtracted.

Interest paid and taxes paid are then deducted to give the final figure for the entity's net cash flow from operating activities.

16.3 (a)

(b) (c) (d) (e) (f)

The purchase of the equipment has no effect on profit or loss but gives rise to a cash outflow when payment is made. The depreciation charges reduce profits (or increase losses) but have no cash flow implications.

The payment of a supplier's invoice has no effect on profit or loss but gives rise to a cash outflow in the accounting period in which the payment is made.

Accounting for an accrued expense reduces profit (or increases a loss) but has no cash flow effect.

The payment of a dividend has no effect on profit or loss but causes an outflow of cash.

The purchase of inventory for cash causes an outflow of cash but has no immediate impact on profit or loss. The impact on profit or loss is delayed until the inventory is used or sold.

This is a transfer from cash to a cash equivalent and is not a cash flow. Nor is there any effect on profit or loss.

485

PART 6: Answers

16.4 (a) Statement of cash flows for the year to 30 June 2024 £ Cash flows from operating activities Profit before taxation Depreciation (£151,650 – £107,340) Interest expense Investment income Decrease in inventories (£86,220 – £97,430) Increase in trade receivables (£82,610 – £58,100) Increase in prepaid expenses (£7,200 – £7,000) Decrease in trade payables (£40,920 – £44,310) Increase in accrued expenses (£9,130 – £8,250) Cash generated from operations Interest paid Taxation paid

171,180 44,310 6,120 (7,100) 11,210 (24,510) (200) (3,390) 880 –––––– 198,500 (6,120) (32,300) ––––––

Net cash inflow from operating activities Cash flows from investing activities Acquisition of property, plant and equipment (£369,300 – £210,000) Investment income

Net cash outflow from financing activities

(38,420) –––––– 160,080

(159,300) 7,100 ––––––

Net cash outflow from investing activities Cash flows from financing activities Proceeds from issue of share capital Proceeds from long-term borrowings Dividends paid

£

(152,200) 20,000 25,000 (85,000) ––––––

(40,000) –––––– Net decrease in cash and cash equivalents (32,120) Cash and cash equivalents at 1 July 2023 (2,790) –––––– Cash and cash equivalents at 30 June 2024 (34,910) –––––– (b) The direct method could not be used because only an extract from the company's statement of comprehensive income is provided. In particular, the sales revenue figure is not available and this makes it impossible to calculate the cash received from customers. (c) The statement of cash flows explains why the company's bank overdraft increased by £32,120 in the year. The main problem is that nearly all of the cash generated by the company's operating activities, after the payment of tax, was needed to fund the large investment in property, plant and equipment. This problem was compounded by a material increase in trade receivables but was partly alleviated by a reduction in inventories. Payment of an £85,000 dividend absorbed all of the £45,000 raised in extra financing. As a result, the company's cash position at the end of June 2024 is worse than a year previously.

486

Answers to Exercises

16.5 Statement of cash flows for the year to 31 October 2023 £000 Cash flows from operating activities Profit before taxation Depreciation Profit on disposal of property, plant and equipment Interest expense Increase in inventories (3,696 – 2,464) Increase in trade receivables (3,360 – 2,464) Decrease in trade payables (1,232 – 1,848) Cash generated from operations Interest paid Taxation paid

3,269 3,545 (224) 91 (1,232) (896) (616) –––––– 3,937 (91) (944) ––––––

Net cash inflow from operating activities Cash flows from investing activities Acquisition of property, plant and equipment (W1) Disposal of property, plant and equipment (W2)

Net cash inflow from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

(1,035) –––––– 2,902

(5,237) 845 ––––––

Net cash outflow from investing activities Cash flows from financing activities Bank loans raised Proceeds of share issue

£000

(4,392) 500 500 –––––– 1,000 –––––– (490) 129 –––––– (361) ––––––

Workings: W1. Opening balance of property plant and equipment Disposal (976 – 355) Depreciation charge for the year

24,100 (621) (3,545) –––––– 19,934 Acquisitions (balancing figure) 5,237 –––––– Closing balance of property, plant and equipment 25,171 –––––– W2. The carrying amount of the sold property plant and equipment was £621,000 (W1) and the profit on sale was £224,000, so the sale proceeds must have been £845,000.

487

PART 6: Answers

16.6 (a) Retained earnings have decreased by £55,000 but a dividend of £100,000 has been paid, so profit after tax must have been £45,000. The tax expense for the year is £9,000, so profit before tax must have been £54,000. (b) The cost of PPE has increased by £40,000, but PPE with a cost of £30,000 has been disposed of during the year. Therefore PPE must have been acquired at a cost of £70,000. Of this, £20,000 is still owing at the end of the year, so only £50,000 has been spent during the year.

Accumulated depreciation has increased by £40,000, but accumulated depreciation on equipment sold during the year was £18,000 (60% of £30,000) so the depreciation charge for the year must have been £58,000. The loss on disposal of equipment was £2,000 (£30,000 – £18,000 – £10,000).

The statement of cash flows can now be prepared.

Statement of cash flows for the year to 31 July 2024 £000 Cash flows from operating activities Profit before taxation Depreciation Loss on disposal of equipment Loss on disposal of investments Increase in allowance for doubtful debts Interest expense Dividends received Increase in inventories (£289,000 – £176,000) Increase in trade receivables (£231,000 – £106,000) Increase in prepayments (£13,000 – £12,000) Increase in trade payables (£60,000 – £55,000) Increase in accruals (£9,000 – £8,000) Cash generated from operations Interest paid Taxation paid

54 58 2 4 22 8 (5) (113) (125) (1) 5 1 –––– (90) (8) (47) ––––

Net cash outflow from operating activities Cash flows from investing activities Acquisition of property, plant and equipment Disposal of property, plant and equipment Disposal of long-term investments Dividends received Net cash outflow from investing activities

488

£000

(55) –––– (145)

(50) 10 21 5 –––– (14) –––– c/f (159)

Answers to Exercises

b/f (159) Cash flows from financing activities Proceeds of share issue Proceeds of loan stock issue Dividends paid

80 30 (100) ––––

Net cash inflow from financing activities

10 –––– (149) 109 –––– (40) ––––

Net decrease in cash and cash equivalents Cash and cash equivalents at 1 August 2023 Cash and cash equivalents at 31 July 2024 (c)

Cash at bank and in hand Cash equivalents Bank overdraft

1 August 2023 £000 59 50 –––– 109 ––––

Change in year £000 (59) (50) (40) –––– (149) ––––

31 July 2024 £000 (40) –––– (40) ––––

(d) The company's cash position has deteriorated during the year, despite selling investments and raising £110,000 of new finance. The main problem seems to be that operating activities generated a cash outflow rather than a cash inflow, and this made it difficult for the company to find the cash required to pay dividends and to replace non-current assets.

The cash outflow from operating activities was caused principally by large increases in inventories and trade receivables. It may be that the company has been trying to make itself more attractive to customers by holding greater inventories and offering longer credit, but this policy has had the inevitable effect on the company's cash position. The large proportionate increase in the allowance for doubtful debts suggests that less rigorous credit control might not be entirely advisable.

Without access to recent financial statements, it is difficult to be sure whether the company has become more or less profitable in the year to 31 July 2024, but the massive reduction in the taxation liability may indicate that profits have fallen.

In summary, the company seems to have had a bad year, from both the cash and profits point of view.

However, further information would be needed before a full analysis of the situation could be carried out.

489

PART 6: Answers

16.7 (a)

Indirect method: £000 Cash flows from operating activities Profit before taxation Depreciation Deficit on sale of non-current assets Interest expense Decrease in inventories (620 – 790) Decrease in trade receivables (3,290 – 4,700) Decrease in trade payables (1,040 – 1,099) Cash generated from operations Interest paid Taxation paid (W3)

6,136 750 72 380 170 1,410 (59) ––––– 8,859 (380) (720) –––––

Net cash inflow from operating activities (b)

£000

(1,100) ––––– 7,759 –––––

Direct method: £000 Cash flows from operating activities Cash receipts from customers (W1) Cash paid to suppliers and employees (W2) Cash generated from operations Interest paid Taxation paid (W3) Net cash inflow from operating activities

£000 34,163 (25,304) ––––– 8,859

(380) (720) –––––

(1,100) ––––– 7,759 –––––

Workings: W1. Trade receivables b/f Sales Discounts allowed Cash receipts from customers (balancing figure)

4,700 32,900 (147) (34,163) –––––– Trade receivables c/f 3,290 –––––– W2. Trade payables b/f 1,099 Purchases 14,290 Discounts received (55) Cash paid to suppliers (balancing figure) (14,294) –––––– Trade payables c/f 1,040 –––––– The total amount paid to suppliers and employees is (14,294 + 4,490 + 6,520) = 25,304.

W3. Current tax paid in the year is (1,140 – 420) = 720. The tax expense shown in the statement of comprehensive income must have been (860 – 420) = 440, which is the difference between the profit before tax (6,136) and the profit after tax (5,696).

490

Answers to Exercises

Chapter 17 17.1 (a)

Nominal financial capital maintenance measures capital in money terms with no regard to changes in the purchasing power of money. Profit is defined as the amount by which nominal financial capital has increased during the period.

General purchasing power maintenance measures capital in terms of general purchasing power (with reference to a general prices index) and defines profit as the amount by which general purchasing power has increased during the period.

Physical capital maintenance measures capital in terms of purchasing power with regard to the specific items which the entity needs to buy. Profit is defined as the increase in specific purchasing power during the period.

(b)

Assets at the end of the month: Cash Inventory Assets required to be as well off as at the beginning of the month: (i) nominal monetary units (ii) general purchasing power (£400,000 ´ 105/100) (iii) physical operating capability (£400,000 ´ 107/100) Profit for the month

Nominal financial capital maintenance £000

General purchasing power maintenance £000

Physical capital maintenance £000

475 100 –––– 575

475 105 –––– 580

475 107 –––– 582

400 420 –––– 175 ––––

–––– 160 ––––

428 –––– 154 ––––

Notes: In order to maintain its operating capability, the company needs to be able to replace the inventory which was sold during the month. This inventory cost £300,000 originally but its replacement cost is now £321,000 (£300,000 ´ 107/100). (i) In nominal monetary terms, the company has made a profit of £175,000. However, if all of this profit is paid out as a dividend, the remaining cash of £300,000 will be insufficient to replenish the company's inventory. In effect, part of the dividend will be paid out of capital. (ii) In terms of general purchasing power, the company has made a profit of £160,000. If all of this profit is paid out as a dividend, the remaining cash of £315,000 will have the same general purchasing power as £300,000 at the start of the month. However, this will still be insufficient to replenish the company's inventory. (iii) In terms of physical capital maintenance, the company has made a profit of £154,000. If all of this is paid out as a dividend, the remaining cash of £321,000 will be sufficient to replace the company's inventory and so maintain its operating capability.

491

PART 6: Answers

17.2 On 31 December 2023, C Ltd needs £224,000 (£200,000 ´ 112/100) to maintain the same general purchasing power as it had on 1 January 2022. The amount received on 31 December 2023 is £232,000, so the overall gain is £8,000. This comprises interest of £32,000, less a loss of £24,000 on the capital amount of the loan (a monetary item).

17.3 (a) (b)

Inventories held by an entity during a period of inflation will increase in monetary value. This is known as a holding gain.

In nominal financial terms, sales are £55,000 and cost of sales is £40,000, giving a gross profit of £15,000. The holding gain on the goods which have been sold is £3,200 (8% of £40,000) so it could be argued that the true gross profit is only £11,800.

There is also a holding gain of £1,600 in relation to the goods which are still held. This will not be recognised until those goods are sold.

17.4 (a)

(b)

(c)

492

Historical cost accounting (HCA) is an accounting method whereby each transaction is recorded at its monetary amount at the time of the transaction and no attempt is made to adjust recorded amounts to take account of inflation.

Strengths of HCA include simplicity and objectivity. Perceived weaknesses of HCA in a time of inflation include overstated profits, inadequate depreciation charges, failure to disclose gains and losses on monetary items, failure to identify holding gains, unrealistic non-current asset values etc. (See Chapter 17 for more details).

The two main alternatives to HCA are current purchasing power (CPP) accounting and current cost accounting (CCA). These accounting methods adopt the concepts of general purchasing power maintenance and physical capital maintenance respectively. Neither has gained wide acceptance, but IAS29 uses a CPP approach when dealing with financial reporting in a hyperinflationary economy. (See Chapter 17 for more details).

Answers to Exercises

Chapter 18 18.1 (a)

(b)

The consolidated statement of financial position is as follows: £000 Assets Non-current assets (510 + 150) 660 Goodwill (W1) 40 Current assets (325 – 225 + 75) 175 –––– 875 –––– Equity Ordinary share capital 500 Retained earnings 185 –––– 685 Liabilities Current liabilities (150 + 40) 190 –––– 875 –––– Workings: W1. Goodwill £000 Price paid by parent Subsidiary's share capital at 1 January 2024 100 Subsidiary's retained earnings at 1 January 2024 60 Fair value adjustment (150 – 125) 25 –––– Goodwill at 1 January 2024

£000 225

185 –––– 40 ––––

The only difference between this situation and the previous one is that A1 Ltd has increased its issued share capital by £150,000 and established a £75,000 share premium account, rather than spending cash of £225,000. The consolidated statement of financial position is: £000 Assets Non-current assets (510 + 150) 660 Goodwill (W1) 40 Current assets (325 + 75) 400 –––– 1,100 –––– Equity Ordinary share capital 650 Share premium account 75 Retained earnings 185 –––– 910 Liabilities Current liabilities (150 + 40) 190 –––– 1,100 –––– 493

PART 6: Answers

18.2 The consolidated statement of financial position is as follows: £000 Assets Non-current assets Property, plant and equipment (3,700 + 440) Goodwill (W1)

4,140 150 ––––– 4,290 3,000 ––––– 7,290 –––––

Current assets (2,750 + 250)

Equity Ordinary share capital Retained earnings

2,000 3,550 ––––– 5,550 100 ––––– 5,650

Non-controlling interest (W2) Liabilities Current liabilities (1,450 + 190)

1,640 ––––– 7,290 –––––

Workings: W1. Goodwill £000 Price paid by parent Subsidiary's share capital at 31 December 2023 Subsidiary's retained earnings at 31 December 2023 Fair value adjustment (440 – 320)

100 280 120 ––– 80% ´ 500 –––

Goodwill at 31 December 2023

£000 550

400 ––– 150 –––

W2. Non-controlling interest £000 100 280 120 ––– 20% ´ 500 –––

£000

Subsidiary's share capital at 31 December 2023 Subsidiary's retained earnings at 31 December 2023 Fair value adjustment (440 – 320)

Non-controlling interest at 31 December 2023

494

100 ––– 100 –––

Answers to Exercises

18.3 (a)

The consolidated statement of financial position is as follows: £000 Assets Non-current assets Property, plant and equipment (2,265 + 345 + 180) Current assets (2,124 + 466)

Equity Ordinary share capital Retained earnings (W2) Liabilities Current liabilities (1,160 + 238)

2,790 2,590 ––––– 5,380 ––––– 3,000 982 ––––– 3,982 1,398 ––––– 5,380 –––––

Workings: W1. Goodwill £000 Price paid by parent Subsidiary's share capital at 30 April 2020 Subsidiary's retained earnings at 30 April 2020 Fair value adjustment (500 – 320)

350 195 180 –––

Goodwill at 30 April 2020 Less: Impairment (100%) Goodwill at 30 April 2024

£000 800

725 ––– 75 75 ––– 0 –––

W2. Group retained earnings £000 Parent's retained earnings at 30 April 2024 Subsidiary's retained earnings at 30 April 2024 Subsidiary's retained earnings at 30 April 2020

(b)

£000 1,029

223 195 –––

28 –––– 1,057 Less: Goodwill impairment 75 –––– Group retained earnings at 30 April 2024 982 –––– The additional depreciation of £40,000 reduces the carrying amount of group property, plant and equipment to £2,750,000 and reduces group retained earnings to £942,000. Apart from making the necessary changes to totals and sub-totals, these are the only changes required.

495

PART 6: Answers

18.4 (a)

The consolidated statement of financial position is as follows: £000 Assets Non-current assets Property, plant and equipment (6,910 + 1,640 + 150) Goodwill (W1) Current assets (3,110 + 1,120)

Equity Ordinary share capital Retained earnings (W2) Non-controlling interest (W3) Liabilities Current liabilities (2,040 + 710)

8,700 350 –––––– 9,050 4,230 –––––– 13,280 –––––– 4,000 5,870 –––––– 9,870 660 –––––– 10,530 2,750 –––––– 13,280 ––––––

Workings: W1. Goodwill £000 Price paid by parent Subsidiary's share capital at 31 May 2015 Subsidiary's retained earnings at 31 May 2015 Fair value adjustment

500 850 150 –––– 70% ´ 1,500 ––––

Goodwill at 31 May 2015 (and 31 May 2023)

£000 1,400

1,050 –––– 350 ––––

W2. Group retained earnings £000 Parent's retained earnings at 31 May 2023 Subsidiary's retained earnings at 31 May 2023 Subsidiary's retained earnings at 31 May 2015

Group retained earnings at 31 May 2023

496

1,550 850 –––– 70% ´ 700 ––––

£000 5,380

490 –––– 5,870 ––––

Answers to Exercises

W3. Non-controlling interest Subsidiary's equity at 31 May 2023 Fair value adjustment Non-controlling interest at 31 May 2023 (b)

£000 2,050 150 –––– 30% ´ 2,200 ––––

£000

660 ––––

The non-controlling interest in the identifiable net assets of UU Ltd on the date of acquisition was £450,000 (30% ´ £1,500,000). So the goodwill attributable to the non-controlling interest must have been £80,000 (£530,000 – £450,000). Since there has been no impairment, this goodwill is still measured at £80,000. So goodwill at 31 May 2023 rises by £80,000 to £430,000 and the non-controlling interest at that date rises to £740,000.

18.5 (a)

Non-controlling interest Subsidiary's share capital at 30 September 2023 Subsidiary's share premium at 30 September 2023 Subsidiary's retained earnings at 30 September 2023 Fair value adjustment (37,000 – 33,000) Non-controlling interest at 30 September 2023

(b)

£000 5,000 2,000 28,370 4,000 ––––– 40% ´ 39,370 –––––

15,748 –––––

Goodwill £000 Price paid by parent Subsidiary's share capital at 1 October 2022 Subsidiary's share premium at 1 October 2022 Subsidiary's retained earnings at 1 October 2022 Fair value adjustment

5,000 2,000 24,700 4,000 ––––– 60% ´ 35,700 –––––

Goodwill at 1 October 2022 Less: Impairment (20%) Goodwill at 30 September 2023 (c)

£000

£000 29,000

21,420 ––––– 7,580 1,516 ––––– 6,064 –––––

Group retained earnings £000 Parent's retained earnings at 30 September 2023 Subsidiary's retained earnings at 30 September 2023 Subsidiary's retained earnings at 1 October 2022

Less: Goodwill impairment Group retained earnings at 30 September 2023

28,370 24,700 ––––– 60% ´ 3,670 –––––

£000 34,225

2,202 ––––– 36,427 1,516 ––––– 34,911 –––––

497

PART 6: Answers

Chapter 19 19.1 Sales revenue (£345,450 + £186,350) Cost of sales (£125,700 + £71,990) Gross profit Operating expenses (£56,330 + £37,800) Profit before tax Taxation expense (£32,000 + £14,660) Profit for the year Attributable to the non-controlling interest (35% of £61,900) Attributable to the group

£ 531,800 197,690 ––––––– 334,110 94,130 ––––––– 239,980 46,660 ––––––– 193,320 21,665 ––––––– 171,655 –––––––

19.2 (a)

The consolidated statement of comprehensive income is as follows: Sales revenue (£359,800 + £154,600 – £10,000) Cost of sales (£102,600 + £55,550 – £10,000 + £1,000) Gross profit Operating expenses (£118,480 + £19,300) Profit before tax Taxation expense (£32,000 + £16,000) Profit for the year Attributable to the non-controlling interest (20% of £63,750) Attributable to the group

£ 504,400 149,150 ––––––– 355,250 137,780 ––––––– 217,470 48,000 ––––––– 169,470 12,750 ––––––– 156,720 –––––––

Notes: (i) Intra-group sales of £10,000 are cancelled out. Inventories include an unrealised profit of £1,000 (1/4 ´ £4,000). When this is eliminated, the cost of sales rises by £1,000. (ii) Intra-group dividends of £28,000 (80% of £35,000) are cancelled out. (b)

Movements in group retained earnings for the year may be summarised as follows: Balance at 31 March 2023 (W1) Profit for the year Dividends paid Balance at 31 March 2024 (W2)

498

£ 84,370 156,720 (90,000) ––––––– 151,090 –––––––

Answers to Exercises

Workings: W1. Group retained earnings at 31 March 2023 £ Parent's retained earnings at 31 March 2023 Subsidiary's retained earnings at 31 March 2023 Subsidiary's retained earnings at 1 April 2020

41,110 18,260 ––––– 80% ´ 22,850 –––––

Group retained earnings at 31 March 2023†

£ 66,090

18,280 –––––– 84,370 ––––––

†It is assumed that there were no unrealised profits at 31 March 2023

W2. Group retained earnings at 31 March 2024 £ Parent's retained earnings at 31 March 2024 Subsidiary's retained earnings at 31 March 2024 Subsidiary's retained earnings at 1 April 2020

Less: Unrealised profit Group retained earnings at 31 March 2024

69,860 18,260 ––––– 80% ´ 51,600 –––––

£ 110,810

41,280 –––––– 152,090 1,000 –––––– 151,090 ––––––

19.3 YY Ltd acquired its holding in ZZ Ltd after four months of the accounting year, so the consolidated statement of comprehensive income should include 8/12ths of the ZZ Ltd figures for the year. Intragroup sales of £7,000 should be subtracted from group sales and group cost of sales but the sale on 8th January 2023 can be ignored since it took place before YY Ltd acquired its holding in ZZ Ltd. There is an unrealised profit of £3,000 (£7,000 – £4,000) which must be eliminated. This causes an increase of £3,000 in cost of sales. Also, goodwill impairment of £10,000 must be included in the group expenses. The consolidated statement of comprehensive income is as follows: £ Sales revenue (£150,000 + (8/12 ´ £84,000) – £7,000) 199,000 Cost of sales (£60,000 + (8/12 ´ £27,000) – £7,000 + £3,000) 74,000 ––––––– Gross profit 125,000 Operating expenses (£25,800 + (8/12 ´ £18,600) + £10,000) 48,200 ––––––– Profit before tax 76,800 Taxation expense (£12,000 + (8/12 ´ £7,200)) 16,800 ––––––– Profit for the year 60,000 Attributable to the non-controlling interest (15% of (8/12 ´ £31,200)) 3,120 ––––––– Attributable to the group 56,880 –––––––

499

PART 6: Answers

19.4 Consolidated statement of comprehensive income for the year to 31 March 2024 Sales revenue (38,462 + 12,544 – 1,600) Cost of sales (22,693 + 5,268 – 1,600) Gross profit Distribution costs (6,403 + 2,851) Administrative expenses (3,987 + 2,466) Profit from operations Finance costs (562 + 180) Profit before tax Taxation expense (1,511 + 623) Profit for the year Attributable to the non-controlling interest (25% of 1,156) Attributable to the group

£000 49,406 (26,361) –––––– 23,045 (9,254) (6,453) –––––– 7,338 (742) –––––– 6,596 (2,134) –––––– 4,462 (289) –––––– 4,173 ––––––

Chapter 20 20.1 (a)

(b)

An associate is an entity over which the investor has significant influence. Significant influence is the power to participate in the financial and operating policy decisions of the investee, without having control or joint control over those policies. Significant influence is normally assumed to exist if the investor owns at least 20% of the investee's ordinary shares.

Under the equity method of accounting, the investment made in the associate is recorded initially at cost. In each subsequent year, the investor's share of the associate's profit is added to the carrying amount of the investment and recognised as income in the investor's financial statements. Dividends received from the associate are subtracted from the carrying amount of the investment.

Only the investor's share of the associate's profit is shown in the investor's statement of comprehensive income and only the investor's share of the associate's net assets is shown in the investor's statement of financial position. These items are each shown as a single line item and there is no need to account for a non-controlling interest. This differs from the acquisition method used for subsidiaries, whereby all of a subsidiary's assets, liabilities, income and expenses are incorporated line by line into the consolidated financial statements and then the non-controlling interest (if any) is accounted for.

20.2 (a)

500

A joint arrangement is an arrangement whereby two or more parties exercise joint control over a business enterprise. Joint control exists only when decisions relating to the arrangement require the unanimous consent of the parties sharing control.

Answers to Exercises

(b)

A joint operation does not involve setting up a new entity that is separate from the parties to the arrangement. Instead, the joint operators use their own assets and incur their own liabilities for the purposes of the operation. Each joint operator recognises the assets and liabilities that relate to the joint operation in its own financial statements, along with its share of the revenue and expenses arising. Financial statements are not prepared for the joint operation itself.

A joint venture usually involves the establishment of a business entity which operates in the same way as any other entity, except that the venturers have joint control over its activities.

Such an entity presents its own financial statements. Joint ventures are accounted for in the financial statements of the joint venturers by using the equity method.

20.3 Notes: 1. P Ltd is a 90% subsidiary of M Ltd, so it is necessary to calculate figures for goodwill, group retained earnings and the non-controlling interest (see workings below).

2. Q Ltd is presumably an associate of M Ltd. On 31 July 2022, the company's total equity was £320,000 (£80,000 + £240,000) so the price paid for goodwill was £20,000 (£100,000 – 25% of £320,000). This is not negative and so is not recognised separately.

3. The retained earnings of Q Ltd have increased by £40,000 since 31 July 2022. The group's 25% share of this is £10,000. So the investment should be carried at £110,000 (£100,000 + £10,000) and £10,000 should be added to group retained earnings.

The consolidated statement of financial position is as follows: £000 Assets Non-current assets Property, plant and equipment (2,570 + 370 + 80) 3,020 Goodwill (W1) 50 Investment in associate (100 + 10) 110 ––––– 3,180 Current assets (1,150 + 220) 1,370 ––––– 4,550 ––––– Equity Ordinary share capital 1,000 Retained earnings (W2) 2,574 ––––– 3,574 Non-controlling interest (W3) 56 ––––– 3,630 Liabilities Current liabilities (810 + 110) 920 ––––– 4,550 ––––– Note: Workings W1 to W3 are given below.

501

PART 6: Answers

Workings: W1. Goodwill £000 Price paid by parent Subsidiary's share capital at 31 July 2020 Subsidiary's retained earnings at 31 July 2020 Fair value adjustment

100 220 80 ––– 90% ´ 400 –––

Goodwill at 31 July 2020 (and 31 July 2023)

£000 410

360 –––– 50 ––––

W2. Group retained earnings £000 Parent's retained earnings at 31 July 2023 Subsidiary's retained earnings at 31 July 2023 Subsidiary's retained earnings at 31 July 2020

Associate's retained earnings (25% ´ 40)

380 220 ––– 90% ´ 160 –––

£000 2,420

144 10 –––– 2,574 ––––

Group retained earnings at 31 July 2023 W3. Non-controlling interest Subsidiary's share capital at 31 July 2023 Subsidiary's retained earnings at 31 July 2023 Fair value adjustment

Non-controlling interest at 31 July 2023

£000 100 380 80 ––– 10% ´ 560 –––

£000

56 –––– 56 ––––

20.4 Notes: 1. On 30 September 2019, the total equity of L Ltd was £300,000 (£200,000 + £100,000). Therefore the price paid for goodwill was £20,000 (£140,000 – 40% of £300,000). This is not negative and so is not recognised separately.

2. The retained earnings of L Ltd have increased by £220,000 since K Ltd acquired its holding. A 40% share of this increase is £88,000, so the investment in L Ltd should be carried at £228,000 (£140,000 + £88,000). However, unrealised profit of £1,000 (one-quarter of 40% of £10,000) reduces the carrying amount of the investment to £227,000.

3. The profit after tax of L Ltd for the year to 30 September 2023 is £110,000, of which a 40% share is £44,000. The unrealised profit reduces this to £43,000.

4. On 30 September 2022, the retained earnings of L Ltd had increased by £160,000 since K Ltd acquired its holding. So the carrying amount of the investment on that date would have been £204,000 (£140,000 + (40% ´ £160,000)). The carrying amount at 30 September 2023 is therefore (£204,000 + £43,000 – dividend £20,000) = £227,000, as stated above.

502

Answers to Exercises

Statement of comprehensive income for the year to 30 September 2023 Operating profit Share of profit of associate ((40% ´ 110) – 1) Profit before tax Taxation expense Profit for the year

£000 600 43 –––– 643 120 –––– 523 ––––

Statement of financial position as at 30 September 2023 £000 Assets Non-current assets Property, plant and equipment Investment in associate (204 + 43 – 20) Current assets

Equity Ordinary share capital Retained earnings (W2) Liabilities Current liabilities

1,600 227 ––––– 1,827 780 ––––– 2,607 ––––– 1,000 1,297 ––––– 2,297 310 ––––– 2,607 –––––

Statement of changes in equity (retained earnings only) for the year to 30 September 2023 Balance at 30 September 2022 (W1) Profit for the year Balance at 30 September 2023 (W2)

£000 774 523 –––––– 1,297 ––––––

Workings: W1. Retained earnings at 30 September 2022 £000 K Ltd retained earnings at 30 September 2022 L Ltd retained earnings at 30 September 2022 L Ltd retained earnings at 30 September 2019

Retained earnings at 30 September 2022

260 100 ––– 40% ´ 160 –––

£000 710

64 –––– 774 –––– 503

PART 6: Answers

W2. Retained earnings at 30 September 2023 £000 K Ltd retained earnings at 30 September 2023 L Ltd retained earnings at 30 September 2023 L Ltd retained earnings at 30 September 2019

Less: Unrealised profit Retained earnings at 30 September 2023

320 100 ––– 40% ´ 220 –––

£000 1,210

88 –––– 1,298 1 –––– 1,297 ––––

Chapter 21 21.1 (a) (b) (c) (d)

(e) (f)

504

Alan is a related party unless it can be demonstrated that his shareholding does not give him significant influence over the company. If he is a related party, Elaine is also a related party.

Y plc is controlled by Z plc, so Y plc is a related party.

Z plc does not control X plc and (presumably) does not exert significant influence over the company or jointly control it. Therefore X plc is not a related party.

Barbara is a member of the key management personnel of Z plc and is a related party.

David is a close family member of Barbara and is therefore also a related party of Z plc.

Barbara controls W Ltd, so W Ltd is a related party of Z plc.

David does not control V Ltd and there is no indication of joint control. Therefore V Ltd is not a related party of Z plc.

Colin may or may not be a related party. It depends upon whether he is a member of the key management personnel of Z plc. If he is a related party, then so is Fiona.

The pension scheme is a related party.

Answers to Exercises

21.2 (a) 1 January 2024 £115,000 (€143,750 ÷ 1.25) is debited to equipment and credited to X. 1 February 2024 £40,000 (€48,000 ÷ 1.20) is debited to purchases and credited to Y. 28 February 2024 £115,000 is debited to X and £125,000 (€143,750 ÷ 1.15) is credited to bank.

The difference of £10,000 is debited to exchange differences.

15 March 2024 £11,000 (€13,200 ÷ 1.20) is debited to Y. £12,000 (€13,200 ÷ 1.10) is credited to bank.

The difference of £1,000 is debited to exchange differences.

15 March 2024 £70,000 (€77,000 ÷ 1.10) is debited to Z and credited to sales. (b) On 31 March 2024, there is no adjustment to equipment or inventory, since both of these are carried at historical cost. The amount owed to Y (€34,800) is translated to £34,800 (using an exchange rate of £1 = €1.00). This debt was previously carried at £29,000 (€34,800 ÷ 1.20) so there is an adverse exchange difference of £5,800. The amount owed by Z (€77,000) is translated to £77,000, giving rise to a favourable exchange difference of £7,000.

The total exchange difference for the period is £9,800 (£10,000 + £1,000 + £5,800 – £7,000). This is an adverse difference and is recognised as an expense in the statement of comprehensive income.

21.3 Statement of comprehensive income for the year to 30 June 2023 Fn Rate Sales revenue 67,200 5 Expenses 40,320 5 ––––– Profit for the year 26,880 Other comprehensive income ––––– 26,880 ––––– Statement of financial position as at 30 June 2023 Assets Share capital (issued 1 July 2022) Retained earnings Foreign exchange reserve Liabilities

Fn 112,400 ––––– 60,000 26,880 ––––– 86,880 25,520 ––––– 112,400 –––––

Rate 4 6 bal. fig.

4

£ 13,440 8,064 ––––– 5,376 6,344 ––––– 11,720 ––––– £ 28,100 ––––– 10,000 5,376 6,344 ––––– 21,720 6,380 ––––– 28,100 –––––

505

PART 6: Answers

Statement of comprehensive income for the year to 30 June 2024 Fn 71,820 41,580 ––––– Profit for the year 30,240 Other comprehensive income ––––– 30,240 ––––– Statement of financial position as at 30 June 2024

Rate 4.5 4.5

£ 15,960 9,240 ––––– 6,720 (4,040) ––––– 2,680 –––––

Fn 145,920 ––––– 60,000 57,120 ––––– 117,120 28,800 ––––– 145,920 –––––

Rate 4.8

£ 30,400 ––––– 10,000 12,096 2,304 ––––– 24,400 6,000 ––––– 30,400 –––––

Sales revenue Expenses

Assets Share capital (issued 1 July 2022) Retained earnings Foreign exchange reserve Liabilities

6 bal. fig.

4.8

Notes: (i) Retained earnings (in £) at 30 June 2024 are (£5,376 + £6,720) = £12,096. (ii) The reduction of £4,040 in the foreign exchange reserve (from £6,344 as at 30 June 2023 to £2,304 as at 30 June 2024) is shown as negative other comprehensive income in the statement of comprehensive income for the year to 30 June 2024.

506

Answers to Exercises

Chapter 22 22.1 The main assumptions made when calculating the ratios for R Ltd are: (i) The figures shown in the statement of financial position are representative of the year as a whole and so can be used instead of average figures (which are not available in this case). (ii) All sales and purchases are made on credit terms. (iii) Cost of sales can be used as a reasonable approximation to purchases. (iv) The preference shares are correctly classified as equity in accordance with the requirements of IAS32 (see Chapter 11).

The ratios are as follows: (a)

ROCE = 60/279 ´ 100% = 21.5%

(b)

ROE = (35 – 1)/119 ´ 100% = 28.6%

(c)

Gross profit margin = 175/410 ´ 100% = 42.7%

(d) (e) (f)

Operating profit margin = 60/410 ´ 100% = 14.6% Current ratio = 147/76 = 1.9 Quick ratio = (147 – 82)/76 = 0.9

(g)

Inventory holding period = 82/235 ´ 365 = 127 days

(h)

Trade receivables collection period = 58/410 ´ 365 = 52 days

(i)

Trade payables payment period = 45/235 ´ 365 = 70 days

(j) (k) (l)

Capital gearing ratio = (150 + 10)/279 ´ 100% = 57.3% Interest cover = 60/15 = 4 Dividend cover = (35 – 1)/20 = 1.7

(m) Earnings per share = (35 – 1)/100 ´ 100p = 34p.

22.2 Company X will have a high gross profit margin but much of the gross profit will be absorbed by overhead expenses so that the operating profit margin might be disappointingly low. The inventory holding period and the trade receivables collection period will both be comparatively long. The company will often have to pay for supplies of clothing well before the clothing is sold to customers and this may cause some liquidity problems. As a consequence, the company may have needed to obtain a source of long-term finance. This would be reflected in the capital gearing ratio and might depress the return obtained on equity.

Company Y will have a low gross profit margin but the lack of overhead costs may result in a surprisingly high operating profit margin. The inventory holding period and the trade receivables collection period will both be short. The company may be able to sell goods and receive payment for them before having to pay its own suppliers, so that liquidity should not be a major problem.

507

PART 6: Answers

22.3 (a) (b)

Earnings per share = (90,000 – 15,000)/1,000,000 ´ 100p = 7.5p Dividend cover = (90,000 – 15,000)/55,000 = 1.4

(c) (d)

Dividend yield = 5.5/70 ´ 100% = 7.9% Price earnings ratio = 70/7.5 = 9.3

22.4 Profitability ratios

2023

2022

(a)

ROCE

820/6,508 ´ 100% = 12.6%

745/5,583 ´ 100% = 13.3%

(b)

ROE

555/5,508 ´ 100% = 10.1%

580/5,433 ´ 100% = 10.7%

(c)

Gross profit margin

907/5,327 ´ 100% = 17.0%

820/3,725 ´ 100% = 22.0%

(d) Operating profit margin 820/5,327 ´ 100% = 15.4% 745/3,725 ´ 100% = 20.0% These ratios all show a deterioration in the year 2023. The reduction in the gross profit margin was deliberate and was presumably responsible (in part) for the 43% increase in sales, but overall the company was substantially less profitable in the year 2023 than in 2022. In absolute terms, the company's profit actually fell in the year 2023. It appears that the company's attempts to stimulate sales have been successful but the objective of increasing profits has not been achieved.

Liquidity ratios 2023 2022 (e) Current ratio 2,623/1,235 = 2.12 1,726/843 = 2.05 (f) Quick ratio (2,623 – 1,334)/1,235 = 1.04 (1,726 – 730)/843 = 1.18 The current ratio has improved slightly in 2023 but this is mainly due to the large (and deliberate) increase in the company's inventories. The quick ratio fell in 2023. It is important to realise that the company had virtually no cash left at the end of 2023, despite raising an extra £850,000 during the year from long-term loans. Given that the company is now giving longer credit to its customers, the liquidity position looks poor.

Efficiency ratios 2023 2022 (g)

Inv. holding period

1,334/4,420 ´ 365 = 110 days

730/2,905 ´ 365 = 92 days

(h) Rec. collection period 1,278/5,327 ´ 365 = 88 days 596/3,725 ´ 365 = 58 days The increases in these ratios are expected, given the company's policy of holding larger inventories and offering longer credit to customers.

Gearing ratio

2023

2022

(i) Capital gearing ratio 1,000/6,508 ´ 100% = 15.4% 150/5,583 ´ 100% = 2.7% The company has moved from being a very low-geared company in 2022 to being a moderately lowgeared company in 2023. Interest cover is still adequate but the ordinary dividend is barely covered by the profit for the year. If the company is forced by its liquidity position to increase borrowings still further and become more high-geared, it may be that the dividend paid to the ordinary shareholders will have to be reduced.

508

Answers to Exercises

Chapter 23 23.1 (a) (b)

Basic EPS is (£390,000 – £80,000)/4,000,000 ´ 100p = 7.75p.

If the company's profit after tax includes £50,000 from a discontinued operation, a second basic EPS figure must be calculated and presented, based on the profit from continuing operations.

This is (£390,000 – £50,000 – £80,000)/4,000,000 ´ 100p = 6.5p.

23.2 (a)

£188,000/100,000 = £1.88.

(b)

The weighted average number of ordinary shares outstanding during the year is (100,000 ´ 5/12) + (115,000 ´ 7/12) = 108,750. Therefore basic EPS is £217,500/108,750 = £2.00.

23.3 (a)

The bonus issue is treated as if it was made at the start of the year to 31 October 2022. Basic EPS for the year to 31 October 2023 is £341,000/550,000 ´ 100p = 62p.

(b)

Restated basic EPS for the year to 31 October 2022 is £330,000/550,000 ´ 100p = 60p. This would have been originally stated as £330,000/500,000 ´ 100p = 66p but is restated so as to be comparable with the figure for 2023.

23.4 (a)

Before the rights issue, the total market value of the company's shares (and so the worth of the company) was £120,000 (150,000 ´ 80p). The rights issue consisted of 30,000 shares and it raised £15,000 (30,000 ´ 50p). Therefore the number of issued shares rose to 180,000 and the company's worth increased to £135,000. This gives a theoretical market price after the rights issue of 75p per share (£135,000/180,000).

If the share price had fallen to 75p as the result of a bonus issue, the number of shares outstanding after this issue would have been 160,000 (since 160,000 ´ 75p = £120,000). So the size of bonus issue that would have caused a fall in market price to 75p per share is an issue of 10,000 shares (a 1 for 15 bonus issue). Therefore the rights issue is treated as a bonus issue of 10,000 shares followed by an issue of 20,000 shares at full price.

Alternatively, the bonus element is 150,000 ´ ((80p/75p) – 1) = 10,000 shares.

The weighted average number of ordinary shares outstanding during the year to 30 September 2023 is (160,000 ´ 9/12) + (180,000 ´ 3/12) = 165,000. Therefore basic EPS for the year is £52,800/165,000 ´ 100p = 32p.

(b)

Restated basic EPS for the year to 30 September 2022 is £50,000/160,000 ´ 100p = 31.25p.

509

PART 6: Answers

23.5 (a) (b)

(c)

Basic EPS is £640,000/800,000 ´ 100p = 80p.

If the loan stock had been converted into ordinary shares, profit before tax would have risen by £100,000 and profit after tax would have risen by £80,000 to £720,000. The number of extra shares would be 200,000, so the total number of shares outstanding would become one million.

Therefore diluted EPS is £720,000/1,000,000 ´ 100p = 72p.

Basic EPS is still 80p. The extra 200,000 shares that would arise if the loan stock is converted are treated as if issued on 1 October 2023. The weighted average number of ordinary shares outstanding during the year to 31 March 2024 would become (800,000 ´ 6/12) + (1,000,000 ´ 6/12) = 900,000. Only half a year's interest would be saved so profit after tax would rise by £40,000 to £680,000. Therefore diluted EPS is £680,000/900,000 ´ 100p = 75.6p.

Chapter 24 24.1 (a)

(b)

Many entities (especially large companies) engage in a wide range of business activities and operate in several economic environments. Each business activity and each environment may be subject to differing risks and returns. Therefore an analysis of an entity's results by business activity or by economic environment will help users to understand the entity's past performance, assess the entity's risks and returns and make more informed judgements. Such an analysis is required by international standard IFRS8.

IFRS8 applies to entities whose shares or securities are publicly traded.

24.2 (a)

(b)

510

An operating segment (as defined by IFRS8) is a component of an entity that meets all of the following criteria: – it is engaged in business activities from which it may earn revenues and incur expenses – its operating results are regularly reviewed by the chief operating decision maker to assess its performance and to make resource allocation decisions – separate financial information is available for it.

IFRS8 states that an operating segment is a reportable segment if it satisfies at least one of a number of quantitative thresholds. In broad terms, the segment's sales must be at least 10% of total sales or its profit must be at least 10% of total profit or its assets must be at least 10% of total assets. (See Chapter 24 for more details).

If the external revenue of reportable segments is less than 75% of the entity's total external revenue, additional operating segments must be identified as reportable (even though they fail the 10% tests) until at least 75% of total external revenue is included in reportable segments.

Answers to Exercises

24.3 The four main classes of information are: (a) general information (b) information about each reportable segment (c) reconciliations (d) entity-wide information.

See Chapter 24 for a list of the disclosures required for each class.

24.4 External revenue is £77.4m and internal revenue is £4.6m, so total revenue is £82m. An operating segment will satisfy the 10% test with respect to revenue if it has total revenue of at least £8.2m.

Combined profits are £5.6m and combined losses are £780,000. An operating segment will satisfy the 10% test with respect to segment result if it has a profit or a loss of at least £560,000.

Total assets are £38m. An operating segment will satisfy the 10% test with respect to assets if it has total assets of at least £3.8m. The results of the three 10% tests for each segment are as follows: Total revenue at Profit or loss at Assets at Reportable least £8.2m least £560,000 least £3.8m segment Segment P Y Y Y Y Segment Q Y Y Y Y Segment R N N N N Segment S N N Y Y Segment R fails all of the 10% tests and is not a reportable segment. The remaining three segments have external revenue totalling £71.2m. This exceeds 75% of £77.4m so the 75% test is satisfied. The reportable segments are segments P, Q and S.

511

PART 6: Answers

24.5 All four segments satisfy the 10% test with regard to revenue and therefore all four segments are reportable segments. The required information might be presented as follows:

Segment revenue External sales revenue Inter-segment sales Total revenue Segment profit Unallocated expenses Profit before tax Tax expense Profit after tax Segment assets Unallocated assets Total assets Segment liabilities Unallocated liabilities Total liabilities Other segment information Interest income Interest expense Depreciation Other non-cash expenses Capital expenditure

512

Total £m

Segment A £m

Segment B £m

Segment C £m

Segment D £m

3,025 781 ––––– 3,806 ––––– 620 120 ––––– 500 95 ––––– 405 –––––

652 127 –––– 779 –––– 159 ––––

764 234 –––– 998 –––– 165 ––––

389 87 –––– 476 –––– 63 ––––

1,220 333 –––– 1,553 –––– 233 ––––

2,475 457 ––––– 2,932 –––––

530 ––––

653 ––––

310 ––––

982 ––––

1,038 658 ––––– 1,696 –––––

245 ––––

276 ––––

119 ––––

398 ––––

85 192 551 65 289

17 34 101 17 99

12 51 132 12 68

20 65 7 -

56 87 253 29 122