CUALIFICACIÓN PROFESIONAL: CORTINAJE Y COMPLEMENTOS DE DECORACIÓN
GLOSARIO DE TÉRMINOS UTILIZADOS EN CORTINAJE Y COMPLEMENTOS DE DECORACIÓN
The Allowed Alternative treatment in IAS 22 requires the full fair value adjustment to be recorded with the minority being allocated their share.
Fair value adjustment: Total group share (80%) minority (20%)
Property, plant and equipment 5,000 4,000 1,000
Investments 1,500 1,200 300
——— ——— ———
6,500 5,200 1,300
——— ——— ———
The fair value adjustment of $5 million to plant will be realised evenly over the next four years in the form of additional depreciation at $1·25 million per annum. In the year to 31 March 2004 the effect of this is $1·25 million charged to Sundial’s profits (as additional depreciation); and a net of $3·75 million added to the carrying value of the plant.
Goodwill on acquisition of Aspen:
Purchase consideration (6 million ×$2·50) 15,000
Share capital 20,000
Profits up to acquisition (8,000 – (6,000 ×6/12)) 5,000
———–
Net assets at date of acquisition 25,000×30% (7,500)
———
Difference – goodwill 7,500
———
Goodwill of $7·5 million depreciated over a five-year life would give a charge of $750,000 (i.e. six months only) for the year to 31 March 2004.
(ii) Accumulated profits
Hapsburg Sundial Hapsburg Sundial
Additional depreciation (w (i)) 1,250 Per question 10,600 8,500
URP in inventory (w (v)) 300 Post acq profit 2,600
Unwinding of interest (w (vi)) 1,800 Share of Aspen’s profit
Minority interest ((8,500 – 1,250) ×20%) 1,450 (6,000 ×6/12×30%) 900
Ordinary shares (30,000 ×20%) 6,000
Share premium (2,000 ×20%) 400
Accumulated profits (w (ii)) 1,450
Balance c/f 9,150 Fair value adjustments (w (i)) 1,300
——— ———
9,150 9,150
——— ———
(iv) Investment in associate:
Investment at cost 15,000
Share of post acquisition profit (w (ii)) 900
Less goodwill amortisation (w (i)) (750)
———–
15,150
———–
Alternative calculation:
Share of net assets at 31 March 2004 (28,000 ×30%) 8,400
Goodwill (7,500 – 750) 6,750
————
15,150
———–
4J–INTAA Paper 2.5INT
(v) Unrealised profit in inventory
As the transaction is with an associate, only the group share of unrealised profits must be eliminated:
$1·6 million ×2·5 million/4 million ×30% = $300,000
(vi) The deferred consideration of $24 million has been discounted to $18 million. The discounted amount will be
‘unwound’ at 10% per annum. In the year to 31 March 2004 this will give an accrued finance cost of 10% (added to the carrying value of the deferred consideration).
(b) In recent years many companies have increasingly conducted large parts of their business by acquiring substantial minority interests in other companies. There are broadly three levels of investment. Below 20% of the equity shares of an investee would normally be classed as an ordinary investment and shown at cost (it is permissible to revalue them to market value) with only the dividends paid by the investee being included in the income of the investor. A holding of above 50% normally gives control and would create subsidiary company status and consolidation is required. Between these two, in the range of over 20% up to 50%, the investment would normally be deemed to be an associate (note, the level of shareholding is not the only determining criterion). The relevance of this level of shareholding is that it is presumed to give significant influence over the operating and financial policies of the investee (but this presumption can be rebutted). If such an investment were treated as an ordinary investment, the investing company would have the opportunity to manipulate its profit. The most obvious example of this would be by exercising influence over the size of the dividend the associated company paid. This would directly affect the reported profit of the investing company. Also, as companies tend not to distribute all of their earnings as dividends, over time the cost of the investment in the balance sheet may give very little indication of its underlying value.
Equity accounting for associated companies is an attempt to remedy these problems. In the income statement any dividends received from an associate are replaced by the investor’s share of the associate’s results. In the balance sheet the investment is initially recorded at cost and subsequently increased by the investor’s share of the retained profits of the associate (any other gains such as the revaluation of the associate’s assets would also be included in this process). This treatment means that the investor would show the same profit irrespective of the size of the dividend paid by the associate and the balance sheet more closely reflects the worth of the investment.
The problem of off balance sheet finance relates to the fact that it is the net assets that are shown in the investor’s balance sheet. Any share of the associate’s liabilities is effectively hidden because they have been offset against the associate’s assets.
As a simple example, say a holding company owned 100% of another company that had assets of $100 million and debt of $80 million, both the assets and the debt would appear on the consolidated balance sheet. Whereas if this single investment was replaced by owning 50% each of two companies that had the same balance sheets (i.e. $100 million assets and $80 million debt), then under equity accounting only $20 million ((100 – 80) ×50% ×2) of net assets would appear on the balance sheet thus hiding the $80 million of debt. Because of this problem, it has been suggested that proportionate consolidation is a better method of accounting for associated companies, as both assets and debts would be included in the investor’s balance sheet. IAS 28 ‘Accounting for Investments in Associates’ does not permit the use of proportionate consolidation of associates, however IAS 31 ‘Financial Reporting of Interests in Joint Ventures’ sets as its benchmark proportionate consolidation for jointly controlled entities (equity accounting is the allowed alternative).
2 (a) Tintagel: $000 $000
Accumulated profits at 1 April 2003 52,500
Reversal of provision plant overhaul (w (iv)) 6,000
———–
58,500
Profit for the year to 31 March 2004 47,500
Lease rental charge added back (w (i)) 3,200
Lease interest (w (i)) (800)
Depreciation (w (ii)) – building 2,600
Depreciation (w (ii))– owned plant 22,000 Depreciation (w (ii))– leased plant 2,800
———– (27,400)
Loss on investment property (15,000 – 12,400) (2,600)
Write down of inventory (w (iii)) (2,400)
Unrecorded trade payable (500)
Reversal of provision for plant overhaul (w (iv)) 6,000
Increase in deferred tax (22·5 – 18·7) (3,800)
Loan note interest (0·6 + 0·3 (w (v))) (900) 18,300
———– ———–
Accumulated profits at 31 March 2004 76,800
———–
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4J–INTAA Paper 2.5INT
4J–INTBA Paper 2.5INT
(b) Tintagel – Balance sheet as at 31 March 2004:
Tangible Non-current assets $000 $000
Freehold property (126,000 – 2,600 (w (ii))) 123,400
Plant – owned (110,000 – 22,000 (w (ii))) 88,000
– leased (11,200 – 2,800 (w (ii)) 8,400
Investment property 12,400
————
232,200 Current Assets
Inventory (60,400 – 2,400 (w (iii))) 58,000
Trade receivables and prepayments 31,200
Bank 13,800 103,000
Ordinary shares of 25c each 150,000
Reserves:
Share premium 10,000
Accumulated profits – 31 March 2004 (part (a)) 76,800 86,800
––––––– ————
236,800 Non-current liabilities
Deferred tax 22,500
Finance lease obligations (w (i)) 5,600
8% Loan note (14,100 + 300 (w (v))) 14,400
———– 42,500
Current liabilities
Trade payables (47,400 + 500) 47,900
Accrued lease finance interest (w (i)) 800
Accrued loan interest (w (v)) 600
Finance lease obligation (w (i)) 2,400
Taxation 4,200 55,900
The lease has been incorrectly treated as an operating lease. Treating it as a finance lease gives the following figures:
$000
Cash price/recorded cost 11,200
First instalment (reversed in income statement) (3,200)
———–
Capital outstanding at 1 April 2003 8,000
Interest at 10% p.a. to 31 March 2004 (current liability) 800
The capital outstanding of $8 million must be split between current and non-current liabilities. The second instalment payable on 1 April 2004 will contain $800,000 of interest (8,000 × 10%), therefore the capital element in this payment will be
$2·4 million and this is a current liability. This leaves $5·6 million (8,000 – 2,400) as a non-current liability.
(ii) Non-current assets depreciation: $000
Buildings (130 ×2%) 2,600
Non-leased plant (110 ×20%) 22,000
Leased plant (11,200 ×25%) 2,800
(iii) The damaged and slow moving inventory should be written down to its estimated realisable value. This is $3·6 million ($4 million less sales commission at 10%). Therefore the required write down is $2·4 million ($6 million – $3·6 million).
(iv) A provision for a future major overhaul does not meet the definition of a liability in IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ and must be reversed; this will increase the current year’s profit and the previous year’s profit by
$6 million each.
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4J–INTBA Paper 2.5INT
(v) International accounting standards require issue costs, discounts on issue and premiums on redemptions of loan instruments
to be included as part of the finance costs: $000 $000
Issue proceeds (15,000 ×95%) 14,250
Issue costs (150)
———–
Initial carrying value (as per suspense account) 14,100
Less
Payable on redemption (15,000 ×110%) 16,500
Total interest payments (15,000 ×8% ×4 years) 4,800 (21,300)
———– ————
Total finance costs (7,200)
————
The question says these may be apportioned on a straight-line basis at $1·8 million pa. The loan stock was issued on 1 October 2003 therefore an interest charge of $900,000 is required for the current year. Of this $600,000 is represented by the accrual to be paid on 1 April 2004 and the remainder is also accrued, but added to the carrying value of the loan stock on the balance sheet.
3 (a) Goodwill:
International Accounting Standards state that goodwill is the difference between the purchase consideration and the fair value of the acquired business’s identifiable (separable) net assets. Identifiable assets and liabilities are those that are capable of being sold or settled separately, i.e. without selling the business as a whole. Purchased goodwill should be recognised on the balance sheet at this value and amortised over its estimated useful economic life. The useful economic life is the period of time over which an asset is expected to be used by the enterprise. There is a rebuttable presumption that the life should not exceed 20 years. However, in the rare cases where there is persuasive evidence where it can be demonstrated that the life is more than 20 years, then it should be amortised over the best estimate of its useful life. Where this occurs the estimated recoverable amount must be estimated at least annually and written down if it is impaired. IAS 38 specifically states that internally generated goodwill (but not necessarily other intangibles) cannot be capitalised.
Other intangibles:
Where an intangible asset other than goodwill is acquired as a separate transaction, the treatment is relatively straightforward.
It should be capitalised at cost and amortised over its estimated useful economic life (similar rules apply to the lives of other intangible assets as apply to goodwill as referred to above). The fair value of the purchase consideration paid to acquire an intangible is deemed to be its cost.
Intangibles purchased as part of the acquisition of a business should be recognised separately to goodwill if they can be measured reliably. Reliable measurement does not have to be at market value, techniques such as valuations based on multiples of turnover or notional royalties are acceptable. This test is not meant to be overly restrictive and is likely to be met in valuing intangibles such as brands, publishing titles, patents etc. The amount of intangibles that may be recognised is restricted such that their recognition cannot create negative goodwill (as a balancing figure). Any intangible not capable of reliable measurement will be subsumed within goodwill.
Recognition of internally developed intangibles is much more restrictive. IAS 38 states that internally generated brands, mastheads, publishing titles, customer lists and similar items should not be recognised as intangible assets as these items cannot be distinguished from the cost of developing the business as a whole. The Standard does require development costs to be capitalised if they meet detailed recognition criteria.
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4J–INTBB Paper 2.5INT
(b) (i) The purchase consideration of $35 million should be allocated as: $m
The difficulty here is the potential value of the patent if the trials are successful. In effect this is a contingent asset and on an acquisition contingencies have to be valued at their fair value. There is insufficient information to make a judgment of the fair value of the contingent asset and in these circumstances it would be prudent to value the patent at $10 million. The additional $5 million is an example of where an intangible cannot be measured reliably and thus it should be subsumed within goodwill. The other issue is that although research cannot normally be treated as an asset, in this case the research is being done for another company and is in fact work in progress and should be recognised as such.
(ii) This is an example of an internally developed intangible asset and although the circumstances of its valuation are similar to the patent acquired above it cannot be recognised at Leadbrand’s valuation. Internally generated intangibles can only be recognised if they meet the definition of development costs in IAS 38. Internally generated intangibles are permitted to be carried at a revalued amount (under the allowed alternative treatment) but only where there is an active market of homogeneous assets with prices that are available to the public. By their very nature drug patents are unique (even for similar types of drugs) therefore they cannot be part of a homogeneous population. Therefore the drug would be recorded at its development cost of $12 million.
(iii) This is an example of a ‘granted’ asset. It is neither an internally developed asset nor a purchased asset. In one sense it is recognition of the standing of the company that is part of the company’s goodwill. IAS 38’s general requirement requires intangible assets to be initially recorded at cost and specifically mentions granted assets. IAS 38 also refers to IAS 20 ‘Accounting for Government Grants and Disclosure of Government Assistance’ in this situation. This standard says that both the asset and the grant can be recognised at fair value initially (in this case they would be at the same amount). If fair values are not used for the asset it should be valued at the amount of any directly attributable expenditure (in this case this is zero). It is unclear whether IAS 38’s general restrictive requirements on the revaluation of intangibles as referred to in (a) above (i.e. the allowed alternative treatment) are intended to cover granted assets under IAS 20.
(iv) There is no doubt that a skilled workforce is of great benefit to a company. In this case there is an enhancement of revenues and a reduction in costs and if resources had been spent on a tangible non-current asset that resulted in similar benefits they would be eligible for capitalisation. However the Standard specifically excludes this type of expenditure from being recognised as an intangible asset and it describes highly trained staff as ‘pseudo-assets’. The main reason is the issue of control (through custody or legal rights). Part of the definition of any asset is the ability to control it. In the case of employees (or, as in this case, training costs of employees) the company cannot claim to control them, as it is quite possible that employees may leave the company and work elsewhere.
(v) The benefits of effective advertising are often given as an example of goodwill (or an enhancement of it). If this view is accepted then such expenditures are really internally generated goodwill which cannot be recognised. In this particular case it would be reasonable to treat the unexpired element of the expenditure as a prepayment (in current assets) this would amount to 3/6of $5 million i.e. $2·5 million. This represents the cost of the advertising that has been paid for, but not yet taken place. In the past some companies have treated anticipated continued benefits as deferred revenue expenditure, but this is no longer permitted as it does not meet the Standard’s recognition criteria for an asset.
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4 Cash Flows From Operating Activities – Planter for the Year to 31 March 2004:
Reconciliation of operating profit to net cash inflow from operating activities
$ $
Net profit before interest and tax (per question) 17,900
Adjustments for:
depreciation – buildings (w (i)) 1,800
depreciation– plant (w (i)) 26,600
———– 28,400
loss on sale of plant (w (i)) 4,200
profit on sale of investments (11,000 – 8,700) (2,300)
decrease in inventory (57,400 – 43,300) 14,100
increase in receivables (50,400 – 28,600) (21,800)
decrease in payables (31,400 – 26,700) (4,700)
———–
Cash generated from operations 35,800
Interest paid (1,700 – 300 accrued) (1,400)
Income tax paid (8,900 + 1,100) (10,000)
———–
Net cash flow from operating activities 24,400
Cash Flows from Investing Activities
Purchase of plant (w (i)) (38,100)
Purchase of land and buildings (w (i)) (7,100)
Investment income 400
Sale of plant (w (i)) 7,800
Sale of investments 11,000
———— (26,000)
Cash flows from financing activities
Issue of ordinary shares (w (ii)) 28,000
Redemption of 8% loan notes (3,400)
Ordinary dividend paid (26,100) (1,500)
———— ———–
Net decrease in cash and cash equivalents (3,100)
Cash and cash equivalents at 1 April 2003 1,200
———–
Cash and cash equivalents at 31 March 2004 (1,900)
———–
4J–INTBC Paper 2.5INT
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Workings(i) Non-current assets:
Land and buildings
Valuation b/f 49,200
Revaluation surplus (18,000 – 12,000) 6,000
Acquisitions – balancing figure 7,100
———–
Valuation c/f 62,300
———–
Depreciation b/f 5,000
Charge for year – balancing figure 1,800
———–
Charge for year – balancing figure 26,600
———–
(ii) Share capital and share premium:
Ordinary shares b/f 25,000
Bonus issue 1 for 10 (from share premium) 2,500
Ordinary shares c/f (50,000)
Increase is premium on cash issue 5,500
———–
Total proceeds of issue is (22,500 + 5,500) 28,000
———–
(iii) Reconciliation of revaluation reserve
Balance b/f 12,000
5 (a) (i) Long-term construction contracts span more than one accounting year-end. This leads to the problem of determining how the uncompleted transactions should be dealt with over the life of the contract. Normal sales are not recognised until the production and sales cycle is complete. Prudence is the most obvious concept that is being applied in these circumstances, and this is the principle that underlies the completed contract basis. Where the outcome of a long-term contract cannot be reasonably foreseen due to inherent uncertainty, the completed contracts basis should be applied.
The effect of this is that sales revenue earned to date is matched to the cost of sales and no profit is taken.
The problem with the above is that for say a three year contract it can lead to a situation where no profits are recognised, possibly for two years, and in the year of completion the whole of the profit is recognised (assuming the contract is profitable). This seems consistent with the principle that only realised profits should be recognised in the income statement. The problem is that the overriding requirement is for financial statements to show a true and fair view which implies that financial statements should reflect economic reality. In the above case it can be argued that the company has been involved in a profitable contract for a three-year period, but its financial statements over the three years show a profit in only one period. This also leads to volatility of profits which many companies feel is undesirable and not favoured by analysts. An alternative approach is to apply the matching/accruals concept which underlies the percentage of completion method. This approach requires the percentage of completion of a contract to be assessed (there are several methods of doing this) and then recognising in the income statement that percentage of the total estimated profit on the contract. This method has the advantage of more stable profit recognition and can be argued shows a more true and fair view than the completed contract method. A contrary view is that this method can be criticised as being a form of profit smoothing which, in other circumstances, is considered to be an (undesirable) example of creative accounting.
Accounting standards require the use of the percentage of completion method where the outcome of the contract is reasonably foreseeable. It should also be noted that where a contract is expected to produce a loss, the whole of the loss must be recognised as soon as it is anticipated.
(ii) Linnet – income statement extract – year to 31 March 2004 (see working below):
$ million
Linnet – balance sheet extracts – as at 31 March 2004 Current assets
Gross amounts due from customers for contract work (w (iii)) 59 Workings:
cumulative 1 April 2003 cumulative 31 March 2004 amounts for year
$ million $ million $ million
Sales 150 (w (i)) 220 70
(i) progress payments received are $180 million. This is 90% of the work certified (at 29 February 2004), therefore the work certified at that date was $200 million. The value of the further work completed in March 2004 is given as
$20 million, giving a total value of contract sales at 31 March 2004 of $220 million.
(ii) the total estimated profit (excluding rectification costs) is $60 million:
$ million
The degree of completion (by the method given in the question) is 220/300
Therefore the profit to date (before rectification costs) is $44 million ($60 million ×220/300). Rectification costs must be charged to the period they were incurred and not spread over the remainder of the contract life. Therefore after rectification costs of $17 million the total reported contract profit to 31 March 2004 would be $27 million.
With contract revenue of $220 million and profit to date of $44 million, this means contract costs (excluding rectification costs) would be $176 million. The difference between this figure and total cost incurred of $195 million is part of the
$59 million of the amount due from customers shown in the balance sheet.
(iii) The gross amounts due from customers is cost to date ($195 million + $17 million) plus cumulative profit ($27 million) less progress billings ($180 million) = $59 million.
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(b) (i) The financial statements of large diversified companies are an aggregation of all their separate activities. Their results are a composite of their individual segments. Each of the separate segments may have different results. The segments may have wide ranges of profitability, cash flows, growth, future prospects and risks. Without information on these separate segments, these differences would be concealed and it would be impossible for users of financial statements to properly assess past performance and future prospects. IAS 14 ‘Segment Reporting’ requires primary and secondary reporting formats which are based on business and geographical segments. Providing information on sales revenues,
(b) (i) The financial statements of large diversified companies are an aggregation of all their separate activities. Their results are a composite of their individual segments. Each of the separate segments may have different results. The segments may have wide ranges of profitability, cash flows, growth, future prospects and risks. Without information on these separate segments, these differences would be concealed and it would be impossible for users of financial statements to properly assess past performance and future prospects. IAS 14 ‘Segment Reporting’ requires primary and secondary reporting formats which are based on business and geographical segments. Providing information on sales revenues,