acca_p2

KAPLAN PUBLISHING of 10

ACCA REVISION MOCK

Time allowed

Reading time: 15 minutes

Writing time: 3 hours

This paper is divided into two sections

Section A ONE compulsory question

Section B TWO questions ONLY to be attempted

Do NOT open this paper until instructed by the supervisor.

This question paper must not be removed from the examination hall.

Kaplan Publishing/Kaplan Financial

Pape

r P2

(IN

T)

Corporate Reporting (INT)

June 2010

Question paper

ACCA P2 (INT) Corporate Reporting

of 10 KAPLAN PUBLISHING

© Kaplan Financial Limited, 2010

The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials.

All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

Revision Mock Questions


SECTION A

This question is compulsory and MUST be answered

QUESTION 1: HASTINGS

The draft financial statements for Hastings, Stirling, Blarney and Warwick for the year ended 30 April 2010 were as follows:

Draft statements of financial position at 30 April 2010 Hastings Stirling Blarney Warwick $000 $000 Dinar000 $000 Non-current assets Investments in group companies 18,000 Investment in Warwick 1,400 Brands 960 4,000 AFS financial asset 500 Property, plant & equipt 6,000 11,100 1,410 2,126 Current assets: Inventory 9,010 5,000 300 592 Receivables 4,730 3,600 1,220 248 Bank 1,650 2,600 1,200 _____ _____ _____ _____

42,250 26,300 4,130 2,966 _____ _____ _____ _____

$000 $000 Dinar000 $000 Equity shares of $1 each 6,000 10,000 500 2,800 Retained earnings 24,644 10,000 1,800 80 _____ _____ _____ _____

30,644 20,000 2,300 2,880 Non-current liabilities: Bank loans 2,600 4,000 200 Convertible loan stock 2,000 Current liabilities Trade payables 3,676 1,900 1,530 36 Bank overdraft 38 Taxation 730 400 100 12 Proceeds of share disposal 2,600 _____ _____ _____ _____

42,250 26,300 4,130 2,966 _____ _____ _____ _____



Draft statements of changes in equity at 30 April 2010 Hastings Stirling Blarney Warwick $000 $000 Dinar000 $000 Brought forward 26,960 17,300 1,800 Incorporated in year 2,800 Profit for the year 3,684 2,700 500 80 _____ _____ _____

_____

Carried forward 30,644 20,000 2,300 2,880 _____ _____ _____

_____

Draft statements of comprehensive Income

For the year ended 30 April 2010 Hastings Stirling Blarney Warwick $000 $000 Dinar000 $000 Revenue 18,630 10,030 1,673 264 Cost of sales (7,824) (3,030) (478) (94) _____ _____ _____

_____

Gross profit 10,806 7,000 1,195 170 Distribution costs (2,414) (1,600) (275) (36) Admin expenses (1,184) (700) (120) (14) _____ _____ _____

_____

Operating profit before tax 7,208 4,700 800 120 Tax (3,524) (2,000) (300) (40) _____ _____ _____ _____

Profit after tax for the year 3,684 2,700 500 80 _____ _____ _____

_____

Hastings has investments in other companies as follows:

(a) Investment in Stirling

On 1 May 2006, Hastings acquired 7 million $1 equity shares in Stirling at a cost of $14 million. At the date of acquisition Stirling had a balance on retained earnings of $3.5 million and the fair value of plant and equipment was $1 million in excess of its book value. At that date, it was estimated that the remaining useful life of the plant and equipment was five years. At the date of acquisition, the fair value of an equity share in Stirling was $1.75 and $1.90 at the reporting date.

(b) Investment in Blarney

On 1 February 2010 Hastings acquired 80% of the equity share capital of Blarney for Dinar 4.8 million. The fair value of the net assets was approximately equal to their book values, with the exception of freehold land, which had a fair value of Dinar 600,000 in excess of book value. The fair value of the non-controlling interest at the date of acquisition was estimated to be Dinar 480,000. Hastings wants to make provision for reorganisation costs to assimilate Blarney into the group. At the date of acquisition, these costs were estimated at $1.25 million. Shortly after the acquisition, the directors announced their plans to the workforce and circulated details of the reorganisation to customers and suppliers. They also reassessed the reorganisation costs to be only $1 million.



(c) Loan to Blarney

On 1 February 2010 Hastings made a short-term interest-free loan to Blarney of $1 million. The loan is included within Blarney’s financial statements at the rate ruling on the date of receipt. The loan was still outstanding at the reporting date, and was repaid in full on 16 May 2010.

(d) Relevant rates of exchange during the period were as follows:

Date Dinar to $1

1 February 2010 1.2

30 April 2010 1.0

16 May 2010 1.1

Average for the period 1 February 2010 to 30 April 2010 1.1

(e) Investment in Warwick

On 1 November 2009 Hastings entered into a joint venture with one other company and subscribed for a 50% interest in the $1 equity shares in Warwick, a jointly controlled entity, upon incorporation. Hastings wants to apply proportional consolidation to account for this joint venture interest as it is the preferred method of accounting as specified in IAS 31.

The following information is also relevant:

1 Goodwill is accounted for on a fair value basis for all subsidiary companies in the group. At 30 April 2010, goodwill of each subsidiary was tested for impairment and was found to be impaired to the extent of 20% in respect of Stirling only.

2 Having accounted for the impairment of goodwill relating to Stirling, Hastings disposed of a one seventh of its interest in Stirling at $2.60 per share on 30 April 2004.

3 Continuing the practice of earlier years, Hastings made sales to Stirling, which were priced to include a profit margin of 25%. During the year to 30 April 2010, goods priced at $3 million, had been sold on this basis. At 30 April 2010, Stirling still held $500,000 of these goods (at cost to Stirling) within inventory. At 30 April 2009, Stirling held $400,000 of such goods within inventory.

4 Hastings purchased an available for sale financial asset during the year at a cost of $500,000. By 30 April 2010, its fair value was $510,000.

5 On 1 May 2009, Hastings raised $2 million from the issue of 10% convertible loan stock, redeemable on 30 April 2013 for equity shares in Hastings. In raising the funds, Hastings incurred brokers and associated legal costs issue costs of $100,000 which were charged as an administration expenses. The effective rate for a similar financial instrument without conversion rights is 12%. The annual cash return paid to the stock holders during the year has been accounted for as an administration expense.

6 On 1 November 2009, Hastings commenced share-based payment scheme on behalf of its employees for the vesting period ending 31 October 2014. Employees would receive a cash payment on 30 November 2014, provided they were still employed by Hastings at the vesting date, based upon the increase in the company share price over the vesting period. For each $1 increase in the share price, eligible employees would receive a cash payment of $0.50.



7 Of the 100,000 employees who were eligible to benefit from the scheme at inception, it was estimated that 3% would leave each year. At 30 April 2010, 2% had left since the scheme started, and it was estimated that, in each subsequent year to 30 April, 3% of those employed at the start of the scheme would leave each year, with none leaving in the final six months of the scheme. The increase in the share price to 30 April 2010 was $5.

8 Stirling acquired brands from a competitor company and regards the brands as a permanent non-current asset. During the year to 30 April 2010, Hastings capitalised what it regarded as costs of brand development and has also treated these costs as a permanent non-current asset.

9 Extracts from present value tables are as follows:

10% Discount factor

Discount factor

Cumulative discount

factor

12% Discount factor

Discount factor

Cumulative discount

factor

Year 1 0.909 0.909 Year 1 0.893 0.893

Year 2 0.826 1.736 Year 2 0.797 1.690

Year 3 0.751 2.478 Year 3 0.712 2.402

Year 4 0.683 3.170 Year 4 0.635 3.037

Year 5 0.621 3.791 Year 5 0.567 3.604

Required:

(a) Prepare a consolidated statement of comprehensive income for the year ended 30 April 2010, together with a consolidated statement of financial position at that date for the Hastings group. (35 marks)

During the year, Hastings entered into a number of transactions with another entity, Repo. The transactions have been accounted for by Hastings as a sale and subsequent repurchase of various items of inventory, and has accounted for each sale and repurchase transaction separately. In each situation, the repurchase was made within one month of the original sale. Further investigation has revealed that the repurchase price was based upon the original sale price, plus 0.5% of that sale price, and that the inventory never leaves the premises of Hastings. To date, the overall value of these transactions is not considered to be material or significant, and there are no such transactions outstanding at the reporting date. However, it is likely that Hastings will continue to enter into such transactions more frequently and for larger monetary values in the future.

Required:

(b) Critically evaluate the nature of the sale and repurchase transactions, commenting on related financial reporting, ethical and professional issues based upon the way the directors have accounted for these transactions. (15 marks)

Your answer should make reference to financial reporting, ethical and professional issues.

(Total: 50 marks)



SECTION B

TWO questions ONLY to be attempted

QUESTION 2: TAXOMIDE

Taxomide is currently preparing annual financial statements for the year ended 31 March 2010. The draft statement of comprehensive income currently identifies profit before tax of $22,543,000. The deferred tax provision brought forward from 31 March 2009 was $435,000 and the rate of income tax is 30%. There are several matters outstanding as follows:

(a) During the year to 31 March 2010, the company revalued some land which is accounted for under IAS 16 Property, Plant and Equipment. The land had a carrying value, stated at historical cost, of $800,000 and has been revalued to $875,000. No entries have been made to reflect this revaluation. In addition, at 31 March 2010 Taxomide had plant and equipment with a carrying value of $3 million and a tax base of $1,200,000. Depreciation for the year on these assets has already been charged in the financial statements. (4 marks)

(b) The company operates a defined contribution retirement benefit scheme on behalf of its employees. The contributions payable are 8% of the total payroll costs. The company pays a regular monthly contribution of $60,000, and pays any balance due in the first month of the following year. For the year ended 31 March 2010, the total payroll costs were $9,600,000. The opening accrual and monthly payments on account have been accounted for correctly. The tax authorities provide tax relief for pension contributions on a cash basis. (5 marks)

(c) The company leases certain assets, rather than purchase them outright. One asset subject to a leasing agreement was leased on the 1 April 2009 on a five-year lease. The asset has an estimated useful life of eight years. Under the terms of the lease the first year payment was $20,000; thereafter it will be $8,000 for the remaining years. The company has charged income with $20,000. The tax authorities provide tax relief on such lease agreements on a cash basis. (5 marks)

(d) Taxomide made a four-year loan to a customer on 1 April 2007. The loan was for $20,000 with 8% interest being payable annually in arrears; the effective rate of interest was also 8%. Interest for the year ended 31 March 2010 has been received but Taxomide now expects to receive only $15,000 in full settlement of all amounts due in one year. No entries have been made to reflect any impairment. Impairment losses are not allowable for tax purposes in the current year, only upon confirmation of non-receipt of amounts due at the agreed loan maturity date. (5 marks)

(e) In an attempt to reduce staff turnover and increase employee commitment, Taxomide introduced a share-option scheme on 1 April 2008. At that date, the fair value of each option was $4 and Taxomide had 6,000 employees; the company expected that 400 employees would leave each year. The share option scheme has a three-year vesting period and each employee was provisionally allocated 50 share options. At the vesting date, those employees still eligible to receive the share options would be able to exercise them at a price of $6.50 each.



Reporting date Fair value of option

Fair value of share

Estimated leavers during

the year

Actual leavers during the

year

31 March 2009 $5.0 $7.50 200 170

31 March 2010 $5.5 $9.50 350 320

31 March 2011 $7 (estimated) 100

The accounting for the first year of the scheme was correctly done but no accounting entries have been made in respect of the year to 31 March 2010. The tax authorities provide tax relief based upon the intrinsic value of the shares. (4 marks)

Required:

For each of the issues noted above:

(i) calculate and explain any accounting adjustments required, summarising any changes to the draft profit before tax of $22,543,000,

and

(ii) calculate and explain the deferred tax provision at 31 March 2010.

Professional marks for appropriate quality of presentation. (2 marks)

(Total: 25 marks)

QUESTION 3: TECHNICALITY

Technicality is in the process of finalising its annual financial statements for the year ended 30 April 2010. There are several matters on which they have requested guidance from you in your capacity as a consultant on IFRS issues. You should prepare a report which explains, with supporting computations as appropriate, the accounting and reporting issues associated with each of the matters summarised below. A specific answer requirement and mark allocation is indicated against each part of the question.

(a) On 1 May 2009, Technicality granted 50 staff 100 share options exercisable in three years time to subscribe to a $1 nominal value share at the exercise price $4. The options are valued at the grant date at $1.5 each. At 30 April 2010, share price was $6 giving an intrinsic value to each option of $2. The expectation is that five staff will leave the company each year and at 30 April 2010, 45 staff remain with the company. The tax rate is 30%.

Required:

Explain and calculate the impact on the financial statements of the granting of the options, making particular reference to the impact on earnings per share, deferred tax and cash flow. (5 marks)

(b) At the start of the current accounting period Technicality entered into a four-year operating and self-repairing lease for premises. The annual rentals are $100,000 and payable in advance. At the outset the company makes certain modifications to the building, which will need to be reversed when the lease expires and the property is vacated. The costs of the modifications are $200,000 and it is estimated that in four years time the same sum will be spent restoring the premises to its original condition. The directors wish to account for the series of transactions by recognising an asset of



$800,000, which is then subject to an annual depreciation charge of $200,000 to income over the period of the lease.

Required:

Explain whether the directors accounting treatment is correct. (5 marks)

(c) Technicality issued 10,000 redeemable preference shares on 1 May 2009. The shares have a nominal value of $1 and were issued at a premium of $1. Issue costs were $2,000 were incurred as part of the share issue. Annual cash dividends are paid in arrears paid at 5% on the nominal value of the shares. The redeemable preference shares will be redeemed for $20,730 two years after issue.

Required:

Explain and illustrate how this financial instrument will be accounted for. (4 marks)

(d) Technicality is concerned that the price of raw materials that it needs to purchase as part of its production process will rise in the coming years. As a result the company is proactive in managing that risk and during the year to 30 April 2010, entered into a series of futures contracts (derivatives) to buy the raw materials over the next two to five year period at a fixed price. The transaction costs of entering into this derivative are immaterial and can be ignored. The futures contracts are correctly designated as a hedging instrument. At the reporting date, when preparing the statement of financial position, the current price raw material had risen giving the futures contracts (derivatives) a value of $300,000.

Required:

Explain how the derivatives should be accounted for. (5 marks)

(NB: you are not asked for the conditions for the use of hedge accounting)

(e) When assets are classified as held-for-sale it changes their presentation and may also change their measurement.

Required:

Explain the circumstances that would lead to an asset being classified as held for sale and the accounting treatment that results. How does this benefit the user of the financial statements? (4 marks)

Required:

Prepare a report which explains, with supporting computations where appropriate, the accounting and reporting issues associated with each of the matters summarised above. Where appropriate, you should use a 10% discount rate, unless otherwise indicated. A specific answer requirement and mark allocation is indicated against each part of the question.

Professional marks will be awarded for appropriate format and quality of presentation (2 marks)

(Total: 25 marks)



QUESTION 4: LEASES/DEFERRED TAX/FRAMEWORK

(a) When accounting for a lease in accordance with IAS 17 Leases the fundamental issue is whether to classify a lease as an operating lease or a finance lease. When the standard was first introduced it was celebrated as an application of the substance over form principle that would improve the reliability and comparability of the financial statements of lessees. It is important that a standard in this area should allow users to understand the economic substance of transactions and preparers to properly apply generally accepted accounting principles. However in recent years IAS 17 has attracted criticism in the way that it has been applied by some preparers and for its apparent inconsistencies with the Framework for Financial Reporting.

Required:

Discuss how the classification of leases under IAS 17 Leases can create confusion and complexity for preparers and users of financial statements. (10 marks)

(b) A company owns an asset with a carrying value of $5,000 and a fair value of $7,750. The company has cash flow problems and wishes to sell the asset and then to lease it back. It is considering two potential transactions. The first possibility is to sell the asset for $7,750 and then lease it back for one year at $3,000 per annum with payments in arrears. The second possibility is to sell the asset for the same amount and also to lease it back for the same annual rental over the asset’s remaining useful life of three years.

Required:

Discuss the accounting treatments of both potential transactions under current accounting standards. (5 marks)

(c) IAS 12 Income Taxes requires that deferred tax be accounted for in full on year-end temporary differences except goodwill, where temporary differences are the differences between the carrying value of assets and liabilities and their respective tax base. Accordingly the majority of companies report a provision for a deferred tax liability although some companies do report a deferred tax asset in their statement of financial position. It has been argued by some commentators that the valuation approach taken to deferred tax by IAS 12 results in an overstatement of a company’s liabilities and is arguably inconsistent with the definition of a liability as set out in the Framework for Financial Reporting.

Required:

Discuss the accounting treatment of deferred tax in accordance with IAS 12 Income taxes, specifically commenting whether it provides useful information to the users of financial statements. (10 marks)

(Total: 25 marks)

KAPLAN PUBLISHING Page 1 of 22

ACCA

Paper P2 (INT)

Corporate Reporting

June 2010

Revision Mock – Answers

To gain maximum benefit, do not refer to these answers until you have completed the revision mock questions and submitted them for marking.


Page 2 of 22 KAPLAN PUBLISHING

© Kaplan Financial Limited, 2010

The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials.

All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

Revision Mock Answers


ANSWER 1: HASTINGS

(a) (1) Blarney SOFP has been translated at the closing rate Dinar 1 = $1

(2) Blarney SOCI has been translated at the average rate since acquisition = Dinar 1.1 = $1

(3) Warwick as a joint venture entity has been accounted for on a proportional consolidation basis.

Statement of financial position at 30 April 2010

Assets $000 Marks

Goodwill (W3) 3,800 + 2,505 6,305 4.0

Brand (W11) 4,000 0.5

PP&E 6,000 + 11,100 + (1,410/1) + 1,063 + 200(W2) + (600/1)(W2)

20,373 1.5

AFS Financial asset (W12) 510 1.0

Inventory 9,010 + 5,000 + (300/1) + 296 – 125(W8) 14,481 1.0

Receivables 4,730 + 3,600 + (1,220/1) + 124 - 1,000(W6)

8,674 1.5

Bank 1,650 + 2,600 + (1,200/1) 5,450 0.5

–––––

59,793

–––––

$000

Share capital @ $1: 6,000 0.5

Equity reserve 23(W9) + 10(W12) 33 2.0

Retained earnings (W6)

27,238 3.0

–––––

30,271

NCI (W4) 9,620 2.0

–––––

Total equity of the group

39,891

Bank loans 2,600 + 4,000 + (200/1) 6,800 0.5

Convertible stock 1,902 1.0

SARS liability 21 1.0

Current liabilities

Payables 3,676 + 1,900 + (1530/1) +18 – 200(W6) – 1,000(W6)

5,924 1.0

Reorganisation prov’n 1,000 1.0

Tax 730 + 400 + (100/1) + 6 1,236 0.5

Overdraft 19 0.5

––––– –––––

59,793 23.0

––––– –––––



Group statement of comprehensive income

for the year ended 30 April 2010

Hastings Stirling Blarney 3/12

Warwick Adjusts Total Marks

FX Rate = 1.1

50% JV

$000 $000 $000 $000 $000 $000

Revenue 18,630 10,030 380 132 (3,000) 26,172 0.5

Cost of sales (7,824) (3,030) (109) (47) 3000 0.5

FVA dep’n (200) 0.5

URP adj inventory (25) 0.5

Goodwill impaired (950) (11,116.5)

SARS expense (21.5) 0.5

Brand dev w/off (960) 0.5

Reorg prov’n (W13) (1,000) 0.5

–––––

Gross profit 15,005.5

Distribution costs (2,414) (1,600) (63) (18) (4,095) 0.5

Admin expenses (1,184) (700) (27) (7) 0.5

Extra finance cost (W9)

(25) (1,661) 0.5

Issue costs removed (W9)

100 0.5

Exchange gain on FX loan (W6)

182 1.5

–––––

Profit before tax 9,249.5

Tax (3,524) (2,000) (68) (20) (5,612) 0.5

––––– ––––– ––––– –––––

Profit for the year 1,732 113 3,637.5

NCI %age 30% 20%

NCI profit 519 23 542 1.5

Group profit 3,095.5

–––––

3,637.5

–––––

Other comp income:

AFS fin asset (W12) 10 1.0

FX gain on net investment (W14)

911 2.0

––––– –––––

Total comprehensive income for the year

4,558.5

––––– 12.0

NCI

–––––



W1 Group structure Hastings

Warwick 50% JV

70% Stirling

Blarney 3/12 of year 80%

W2 Net assets

Stirling Acquisition $000

Reporting date $000

Equity capital 10,000 10,000 Retained earnings 3,500 10,000 FVA - PPE 1,000 1,000 Dep’n adjust 4/5 (800) ––––– ––––– 14,500 20,200 ––––– –––––

Blarney Acquisition Dinar000

Reporting date Dinar000

Equity capital 500 500 Retained earnings b/f 1,300 1,800 R E year 9/12 x 500 375 FVA - Land 600 600 FX gain on loan (W6) 200 ––––– ––––– 2,775 3,100 ––––– –––––

W3 Goodwill

Stirling $000 Cost to group 14,000 FV of NCI 3,000 @ $1.75 5,250 ––––– 19,250 FV of NA at acquisition (14,500) ––––– Full goodwill at FV at acquisition 4,750 NCI share of impairment (30%) (285) Group share of impairment (70%) (665) (950) 20% ––––– ––––– Unimpaired goodwill to SOFP 3,800 –––––



Blarney goodwill in Dinars Dinar000 Cost to group $4,000 @ 1.2 4,800 FV of NCI at acquisition 480 ––––– 5,280 FV of NA at acquisition (2,775) ––––– FV goodwill at acq’n unimpaired 2,505 ––––– Translate at CR @ 1 $2,505 –––––

Exchange gain or loss on retranslation of cost of investment

Cost of inv $000 Exchange rate Dinar000 1 Feb 10 4,000 @ 1.2D 4,800 30 April 10 4,800 @ 1.0D 4,800 ––––– Exchange gain 800 –––––

W4 Non-controlling interests

30/04/10 30/04/09 $000 $000 Stirling FV @$1.75 x 3000 5,250 5,250 30% x ($20,200 - $14,500) (W2) 1,710 30% x ($17,700 - $14,500) 960 Goodwill impaired (W3) (285) Equity transfer (W7) 2,400 Blarney FV at acq’n 480Dinar/1 480 20% x (3,100 – 2,775)(W2) 65 ––––– ––––– 9,620 6,210 ––––– –––––



W5 Retained earnings at 30 April 2010 $000 Hastings 24,644 Stirling 70% x ($20,200 – $14,500) (W2) **3,990 Goodwill impaired (W3) (665) Blarney 80% x ($3,100 – 2,775) (W2) 260 Warwick 50% x 80 40 Gain on retranslation of cost of investment (W3) 800 Reorganisation provision (W13) (1,000) Equity transfer on sale of shares (W7) 200 URPS in inventory (W8) (125) Convertible stock extra finance charge (W9) (25) Convertible stock expenses written back (W9) 100 SARS liability (W10) (21) Brand development written off (W11) (960) ––––– 27,238 ––––– **Alternatively: Stirling 60% x (20,200 – 14,500) 3,420 Group share of goodwill impaired (W3) 665 Adjustment on disposal of shares 1/7 x 665 (95) ––––– 3,990 –––––

W6 Exchange gain or loss on monetary item (loan from Hastings) in Blarney FS

Dinar000 1 Feb 10 $1,000 @ 1.2D 1,200 30 April 10 $1,000 @ 1.0D 1,000 (SOFP) ––––– Exchange gain as liability reduced 200 –––––

W7 Equity transfer re Stirling

This sale of sales does not result in a loss of control – Stirling remains a subsidiary of Hastings. Where this is the case, IFRS 3 Revised requires the sale of shares to be accounted for as a transaction between equity holders (i.e. between the controlling group and NCI). In effect, there has been a sale of shares in exchange for an increase in NCI, with the transaction accounted for within equity as follows:

$000 CV of subsidiary at date of share sale: Net assets 20,200 Unimpaired goodwill (W3) 3,800 ––––– 24,000 ––––– Dr Cash 2,600 Cr NCI Disposal of 1/7 of holding (i.e. 10% of total share capital) (W4) 2,400 Cr Equity (W5) 200



W8 URPS in inventory

%age 30 April 2010 30 April 2009 $000 $000 Cost 75 Profit 25 125 100 ––––– ––––– ––––– Transfer price 100 500 400 ––––– ––––– ––––– Net increase in cost of sales (125 – 100) 25 –––––

W9 Convertible loan stock

30 April 2010 Factor PV $000 Proceeds raised 2,000 Less: issue costs removed from admin expenses

(100)

––––– Net proceeds raised 1,900 PV of obligation at effective rate: Years 1-4 interest paid $200 3.037 607 Year 4 – loan cleared $2,000 0.635 1,270 1,877 Liability ––––– ––––– Equity reserve 23 –––––

Accounting for liability

Bal b/fwd Finance cost @12%

Cash paid Bal c/fwd

$000 $000 $000 $000 30 April 2010 1,877 225 (200) 1,902

There must be an increase in the finance cost for the year – so far Hastings has recognised only the cash paid as an expense – this must be increased up to $225,000 – i.e an increase of $25,000.

W10 Share appreciation rights – liability at 30 April 2010:

This should be based upon information known at 30 April 2010, together with a reliable estimate of the number of employees expected to be eligible to benefit from the scheme at the vesting date. Note that at the reporting date, the scheme has been in operation for only 6 months.

SOFP liability

SOCI expense

$000 $000 Expected eligible employees (100,000 – 2,000 – (3,000 x 4) = 860 86,000 x $5 x $0.5 x 0.5/5 21 21 ––––– –––––



W11 Intangible non-current asset – brand

The brands purchased by Stirling from a competitor can be recognised in the group SOFP. The brand development costs incurred by Hasting would not appear to meet the definition of an intangible asset per IAS 38 and therefore have been written off.

W12 Available for sale financial asset

Available for sale financial assets are measured at fair value at each reporting date, with any change in carrying value taken to equity – an increase of $10,000.

W13 Reorganisation provision

At the date of acquisition, a reorganisation provision cannot be recognised in relation to assimilation of Blarney into the Hastings group as there is no obligation per IAS 37 at that date. However, by 30 April 2010, there was a public announcement of the reorganisation which would give rise to a future obligation, especially as it can be reliably estimated at $1,000,000.

W14 Exchange gain or loss on net investment in foreign subsidiary

Group 80% NCI 20% Net assets at acquisition (W2) Dinar000 Ex rate $000 $000 $000 At acquisition date 2,775 1.2 2,312 At reporting date 2,775 1.0 2,775 ––––– Exchange gain 463 370 93 ––––– Adjusted profit for year (W2) In SOCI 325 1.1 295 At re date 325 1.0 325 ––––– 30 24 6 ––––– Goodwill (W3) At acquisition date 2,505 1.2 2,087 At reporting date 2,505 1.0 2,505 ––––– 418 334 84 ––––– ––––– ––––– Total exchange gains 911 728 183 ––––– ––––– ––––– (SOCI)

(b) Sale and repurchase transactions

The nature of the sale and repurchase transactions should be examined to ascertain both their legal nature, together with the commercial substance or reality of the arrangements to determine how they should be accounted for in the financial statements.

Relevant issues to consider may include, for example:

• Is there a commitment for Hastings to repurchase the good sold to Repo?

• Why have the goods sold apparently not been delivered to Repo?



• Who bears the risks and rewards attached to the inventory apparently sold to Repo, should they, for example, become lost or damaged in any way during the period between their sale and repurchase?

• How was the repurchase price determined?

IAS 18 Revenue deals with revenue recognition, unless specific situations are dealt with by other reporting standards. For example, rental and lease agreements are covered by IAS 17.

A useful starting point is to define what is meant by revenue, then to evaluate whether the circumstances in the question meet the definition. Revenue may be defined as the gross inflow of economic benefits during the period under review. It could be argued that there are receipts received from the apparent sale of inventory, and therefore that the inventory should be derecognised and the revenue recognised in the financial statements.

However, upon closer examination of the circumstances it would appear that the sale and repurchase transactions are linked – each sale will be followed within one month by a repurchase of those goods at a pre-determined price. In addition, the goods are not despatched to Repo, rather they remain in the possession of Hastings. Although there is insufficient information to be definitive on the issue, it would appear that Hastings still retains control of the goods as there is no reference to them being separated from other items of inventory etc. Consequently, it would appear that Hastings has retained the risks and rewards associated with the inventory – it should therefore continue to be recognised as an asset on the statement of financial position.

If this point of view is accepted, then the receipt of cash from Repo cannot be regarded as sales revenue. Instead, it should be regarded as receipt of a short-term loan and classified as a current liability. When the goods are subsequently repurchases, this is, in fact, repayment of the loan, plus a finance cost of 0.5% of the initial proceeds received.

Although it is stated that the transactions are not material or significant in value, they have not been correctly accounted for. Potentially, the impact on the statement of financial position is that there will be an understatement of inventory, together with an understatement of the loan liability during the period between the initial receipt of the cash and its subsequent repayment. The impact upon the statement of comprehensive income is that, there will be an overstatement of revenue and purchase cost, with omission or understatement of finance costs.

If Hastings continues to enter into such transactions more frequently and for greater amounts, the degree of distortion to the financial statements will increase. This may be particularly marked where there are repurchase transactions still outstanding at the reporting date so that users of financial statements will not have reliable information upon which to base their decisions.

In terms of ethical and professional issues, the directors of Hasting have a responsibility to prepare financial statements which show a true and fair view. This means that they should exercise due care and skill in the performance of this responsibility – they should not be negligent in the preparation of the financial statements.



Directors therefore need the underlying competence to discharge their responsibility effectively. This could come from appropriate qualifications and/or training. Typically, if there is one or more qualified accountants on the board of directors of Hastings, they should possess the required technical competence to accounts for these transactions correctly. Alternatively, if they have a knowledge gap, they should seek appropriate professional guidance from a reputable third party.

If the directors are deliberately accounting for the sale and repurchase transactions in an inappropriate manner, perhaps to disguise their true nature, or to manipulate the view presented by the financial statement (e.g. to understate short-term borrowings), then their integrity can be questioned.

Information should be prepared and presented in an objective manner. This means that it should be a balanced and unbiased presentation of that information. If directors are not objective when they prepare information for use by others, they risk losing their professional reputation, together with incurring potential liability for losses suffered by those who have relied upon information which is found to be unreliable.

Finally, such circumstances could bring the accountancy profession into disrepute, with the perception that their behaviour or conduct has been less than would be expected from a reputable profession.

ACCA marking scheme Marks (a) Group SOFP per schedule 23 Group SOCI per schedule 12 (b) FR, ethical and professional issues 15 ––– Total 50 –––



ANSWER 2: TAXOMIDE

(a) Non-current assets:

Per IAS 16 revaluation of land is taken to revaluation reserve. As land is not a depreciable non-current asset, it will not be subject to depreciation, and will have no impact on profit before tax. In accordance with IAS GAAP, the revaluation will create a temporary difference which will give rise to a deferred tax liability on the increase from carrying value to the new revalued amount amounting to $75,000 ($800,000 to $875,000). There has been an increase in the carrying value of an asset, but without any change in the tax base of that asset.

For the items of plant and equipment, there is no adjustment to the draft profit before tax as the assets have already been subject to depreciation for the year. However, there is a temporary difference, giving rise to a deferred tax liability, as the assets have attracted more tax relief than the cumulative write-off of depreciation to date. This means that there will be increased tax liabilities in future years. The amount of the temporary difference is $1.8 million ($3.0 million - $1.2 million).

(b) Defined contribution scheme:

Per IAS 19 account for contributions on an accruals basis in the financial statements as follows:

Expense to recognise: 8% × $9,600,000 = $768,000

Expense already recognised due to monthly payments made

12 × $60,000 $720,000

Additional charge required $48,000

For deferred tax purposes, tax relief is granted when pension contributions are paid. There is a temporary difference on the year-end accrual of $48,000 which will create a deferred tax asset as tax relief will only be received on this amount when paid after the year-end.

(c) Lease payments

The lease would appear to be an operating lease per IAS 17 as it accounts for only five years of the expected asset life of eight years. The cost of the lease should be charged in the statement of comprehensive income on a straight-line basis as follows:

Total payments/Lease term

$20,000 + (4 × $8,000)/5years = $10,400

Therefore, adjust the draft profit for the year by adding back the current charge included by the company of $20,000 and deduct the correct charge of $10.400. There is a net reduction in the lease rental charge of $9,600.

As the lease payments are allowed for tax when they are paid, there will be tax relief on the payment of $20,000, but a charge of only $10,400 in the accounts, thus creating a deferred tax liability on the $9,600 temporary difference.



(d) Financial asset

If the company is acknowledging that it will not get full recovery on the financial asset, it is an indication of impairment, which should therefore be reviewed as follows:

Impairment review:

Carrying value $20,000

Less: Recoverable amount in one year$15,000/1.08 $13,889

Impairment $6,111

The impairment loss creates a temporary difference as the tax base remains unchanged. The impairment loss will not be eligible for tax relief until after the due date of the loan – i.e. after 31 March 2011 – there is a deferred tax asset to the extent that there is an expected tax benefit at a later date.

(e) Share option scheme

Per IFRS 2 the accounting treatment is to determine the year-end equity reserve required. Any change in the equity reserve from one reporting date to the next is charged against income. The share options are valued using the fair value of the options at the grant date, together with the number of options expected to be eligible to be exercised at the vesting date. The total expected cost is then spread over the vesting period.

Year 1 Equity reserve at 31 March 2009:

(6,000 – 170 – 350 - 100) = 5,380 × 50 × $4 × 1/ 3 years = $358,667 = also IS charge for the year

Year 2 Equity reserve at 31 March 2010:

(6,000 – 170 – 320 – 100) = 5,410 x 50 x $4 x 2/3 years $721,333

Charge for the year = increase in equity reserve = $362,666

The charge against profit is not allowed for tax purposes until exercise of the share options. This will create a deferred tax asset as an expense is recognised each year but tax relief will be obtained at a later date if and when the options are exercised. The intrinsic value of the option is the difference between the fair value (market price) of a share and the exercise price of the option.

The position at 31 March 2010 is:

Cumulative expense charged against income: $721,333

Deferred tax asset based upon intrinsic value of options expected to be eligible for exercise at the vesting date:

(6,000 – 170 – 320 – 100) = 5,410 x 50 x ($9.50 - $6.50) x 2/3 years $541,000



Finally, as the total remuneration expense to date is greater than eligible tax deduction, none of the deferred tax income relates to equity.

$ Draft profit before tax 22,543,000 (a) Non-current assets - no impact upon profit before tax (b) Defined contribution scheme – additional charge required (48,000) (c) Operating lease rental – reduction in amount charged 9,600 (d) Impairment of financial asset (6,111) (e) Share option scheme – remuneration expense for the year (362,666) ––––––––– Revised profit before tax 22,135,823 –––––––––

Deferred tax – IFRS

DT Asset DT Liability $ $ (a) Non-current assets – temporary difference re plant & equipment - deferred tax liability

– temporary difference – re revaluation deferred tax liability

75,000

(b) Defined contribution scheme 1,800,000 – temporary difference – deferred tax asset 48,000 (c) Operating lease payments – temporary difference - deferred tax liability 9,600 (d) Impaired financial asset – temporary difference - deferred tax asset 6,111 (e) Employee share option scheme –temporary difference - deferred tax asset 541,000 ––––––– ––––––– 595,111 1,884,600 (595,111) ––––––– Net temporary difference at 31 March 2010 1,289,489 ––––––– Deferred tax liability balance c’fwd 31 March 2010 @ 30% 386,847 Deferred tax liability balance b’fwd 31 March 2009 435,000 ––––––– Released to income as part of income tax charge for year 5,947 –––––––

This presumes that there are no other deferred tax issues to be dealt with. It also assumes that any deferred tax assets are regarded as recoverable and can therefore be offset against deferred tax liabilities for the net position to be included in the statement of financial position at 31 March 2010.



ACCA marking scheme Marks a) Revaluation of land 4 b) Defined contribution scheme 5 c) Leased assets 5 d) Financial asset 5 e) Share option scheme 4 Professional marks 2 ––– Total 25 –––

ANSWER 3: TECHNICALITY

Subject: Accounting and financial reporting issues

To: Report to the Directors of Technicality

From: IFRS Consultant

Date: May 2010

The following report summarises the key accounting and financial reporting issues regarding five separate issues identified by the Directors of Technicality during a recent briefing.

(a) Share option scheme

The granting of share options to staff creates an additional remuneration expense and a corresponding credit to an equity reserve. The expense is based on the value of the options at the grant date, the current estimate of the numbers expected to qualify at the vesting date and spread over the qualifying period.

Based upon information provided, for the year ended 30 April 2010, the following would be the required equity reserve. As this is the first period of the scheme, there will be a charge to income for the same amount. In subsequent years, there will be a similar calculation for the equity reserve required, with the remuneration charge being the movement in the equity reserve.

Year 1 $ 100 × $1.5 × 35 × 1/3 = 1,750 Options Fair Value at

grant date Expected take up rate (45-10)

Proportion of qualifying period

B/f Nil ––––– Equity reserve & charge 1,750 –––––

The granting of options creates a deductible temporary difference. The charge to income is disallowed (it is, after all, a non cash expense) and so the corresponding credit to equity has a nil tax base. Tax relief will be in the future when the options are exercised and this creates a deferred tax asset. The deferred tax asset on options is measured by reference to the intrinsic value of the option, and has to reflect the qualifying period and the tax rate as follows.

35 staff x 100 options each x $2 intrinsic value x 1/3 qualifying period x 30% tax rate = $700.



In the year of issue there is no impact on the cash flow of the company. If the options do vest at the end of the qualifying period and are exercised then at that time the company will receive a cash inflow.

Earnings per share will be reduced. As the options are part of the remuneration package of the staff there will be an additional expense charged and thus earnings will be reduced, although there will be a CR to the tax charge in respect of the deferred tax asset arising. Because of the existence of the options these represent additional potential shares so it will be necessary to calculate and disclose diluted EPS.

(b) Property lease

The director’s treatment is of course incorrect.

The annual rentals of $100,000 under the operating lease are to be expensed to income. They do constitute neither an asset nor a liability under IAS17 Leases and should not be capitalised.

On the other hand the cost of the improvements to the premises of $200,000 does constitute capital expenditure and creates a non-current asset to be accounted for under IAS16 Property Plant and Equipment. This will be subject to annual depreciation over the expected useful life of the asset to the business.

The restoration costs do represent a present obligation that will have to be provided for under IAS37 Provisions. A provision is defined in the standard as ‘a liability of uncertain timing or amount’.

A liability is then defined as ‘obligations of an entity to transfer economic benefits as a result of past transactions or events’.

The standard requires that a provision should be recognised when and only when,

• an entity has a present obligation (legal or constructive) as a result of a past event AND

• it is probable that a transfer of economic benefits will be required to settle the obligation, AND

• a reliable estimate can be made of the amount of the obligation

All the above conditions are met. The relevant past event is the initial modification of the property as, under the self-repairing lease contract, this creates a legal obligation. Such expenditure is capitalised. This must be capitalised as a non-current asset and recognised as a provision which will be stated at the present value of the future obligation of the modifications to restore the property to its original condition.

The provision is measured at present value to reflect the time value of money, as it will not be spent for four years. This discounted value is then unwound each year to identify a finance cost up to the expected date of incurring the expenditure.

The asset and obligation to recognise in respect of the future property modification costs will be as follows:

$200,000 x 0.8722 = $174,458 i.e the present value of a cash flow in four years, discounted at the rate of 10%

Consequently, the total amount recognised as a non-current asset will be the $200,000 cost of modifications incurred now, together with the present value of the future costs of restoring the premises in four years time.

In the statement of comprehensive income for the year to 30 April 2010, there will be a finance cost in the first year of 10% x $174,458 = $17,446, together with a depreciation charge in the first year of ¼ x ($200,000 + $174,458) = $93,615



(c) Financial liability

The issue of redeemable preference shares represent an issue of debt rather than equity. There is a clear obligation to repay or redeem the shares. This reflects substance over form.

Thus we have a non-current liability that will attract a finance charge to be recognised in income statement using the effective rate of interest. The liability is therefore accounted for at amortised cost.

The liability is initially recognised at the fair value of consideration received, having deducted external issue costs. i.e. $18,000. At 30 April 2010, the liability will be stated at $19,300. The finance cost to recognise in the financial statements for the year to 30 April 2010 is $1,800.

Opening balance $

Finance cost @ 10%

Cash paid $

Closing balance $

30 April 2010 18,000 1,800 (500) 19,300

30 April 2011 19,300 1,930 (500) + (20,730)

Nil

(d) Derivatives

A futures contract is a special form of financial instrument – it is a derivative. Companies enter into derivatives either for speculation purposes or to manage their risks ie to hedge. With hedge accounting the principle is to match the loss (or gain) on the risk with the gain (or loss) on the hedging instrument so that loss and gain are paired i.e. off set together. This reflects substance and purpose of the hedging instrument.

There are two types of risks that derivatives can be used to cover – fair value and cash flow. The distinction is important, as the accounting treatment is different.

The risk being covered here concerns a future (cash) transaction i.e. the purchase of raw materials rather than the fluctuation in the price (fair value) of an existing asset (or liability) Consequently, this situation should be accounted for as a cash flow hedge.

All derivatives must be recognised on the statement of financial position at their fair value (this is sometimes referred to being marked to market). In this case we have a non-current financial asset of $300,000. This treatment enables the user to “see” the derivative as if it had been accounted for at cost, rather than not visible given that its cost was nil!

The gain of $300,000 on this cash flow hedge cannot be taken to income, as there is no loss to match it against in the current year. The loss will be in the future when the cash flow actually occurs. The gain on the derivative is taken directly to equity i.e. reserves, and so is also reported in the other comprehensive section of the comprehensive income statement. When the loss does occur in the future the gain can be recycled out of equity and back to income.

(e) Assets held for sale

A non-current asset or disposal group is “held for sale” if its carrying amount will not be recovered principally by continuing use. The following list of requirements must be satisfied at the reporting date for classification as held for sale:

• Management commits itself to a plan to sell



• The asset or disposal group is available for immediate sale in its present condition

• There is an active plan to sell the asset

• The sale is highly probable and is expected to be completed within a year of being held for sale

• The asset or disposal group if being offered for sale at a reasonable price in relation to its current fair value

• There are no indications of changes to the plan to sell

Note that a decision made after the year-end but before the accounts are approved that a fixed asset or disposal group is held for sale is a non-adjusting event in accordance with IAS 10.

There are three consequences of classifying a non-current asset or a disposal group as held for sale:

1 Disclosure as a current asset

2 Measurement at the lower of the carrying value and the fair value less costs to sell. This effectively recognises any impairment at the point when the decision is made for the asset(s) to be classified as held for sale.

3 If the asset is a depreciable asset, depreciation is no longer charged as the principal source of financial recovery on the asset(s) is through a sale transaction.

Users of the accounts want the financial statements to contain information that is useful to their decision making process. One characteristic of useful information is that it should be "relevant". The presentation of what would normally be considered a non-current asset as a current asset gives the statement of financial position a predictive quality which is beneficial to users wishing to use the accounts to extrapolate.

Another characteristic of useful information is that it is reliable. The writing down of an asset about to be sold anticipates a loss and this is prudent. If the accounts are prepared without regard to prudence then they would not be reliable.

Conclusion:

By following the advice and comments within this report, Technicality should be able to finalise the financial statements for the year to 30 April 2010 in compliance with IFRS GAAP.

ACCA marking scheme Marks a) Share option scheme 5 b) Property lease 5 c) Redeemable preference shares 4 d) Derivative 5 e) Held for sale assets 4 Professional marks 2 ––– Total 25 –––



ANSWER 4: LEASES/DEFERRED TAX/FRAMEWORK

(a) LEASES

The classification of a lease as either finance or operating determines the accounting treatment adopted in financial statements.

Per IAS 17 a finance lease is defined as one that 'transfers substantially all of the risks and rewards of ownership of an asset to the lessee', whilst an operating lease 'is a lease other than a finance lease'. A finance lease should be recognised as both an asset and an obligation in the financial statements of a lessee based upon the present value of the minimum lease payments utilising the lease term and the interest rate implicit in the lease contract. The capitalised asset is then depreciated on a basis similar to owned assets. For finance leases the depreciation should be calculated over the lease term if this is shorter than its useful life. The obligation is then divided between current and non-current elements for classification on the statement of financial position. Finance charges on the obligation must produce a constant periodic rate of charge. In substance the lessee is accounting for a loan to purchase an asset and that is then reflected in the financial statements.

Lessors with a finance lease are in substance a lender. Whilst they retain legal title to the asset subject to the lease they have no control over that asset. Rather they recognise a financial asset (loan and receivables) on which finance income is reported based upon amortised cost.

Lessees with operating lease rentals are charged to income on a straight-line basis over the lease term irrespective of when payments are due. This reflects the pattern of benefits derived from the leased asset.

Lessors with operating leases are acting as a rental company. They will recognise the rental receivable as revenue.

The classification of leases is subjective rather than objective and this does also arguably cause some problems for the preparer of the accounts, as they have to exercise their judgement.

The standard does give some guidance as to the circumstances that would indicate that a lease is a finance lease – for example if legal title passes under the terms of the lease, or if the asset is unduly adapted to the needs of the lessee such that the lessee will be the only beneficiary, or if the asset is leased out for substantially the whole of the asset’s useful life. However as it guidance it is always going to be subject to interpretation (even manipulation) as, for example, the expected useful life of an asset is always an estimate.

The classification of leases can therefore have significant financial reporting consequences. Unfortunately the current accounting standards do not deal adequately with leases. They do not require the rights and obligations arising under operating leases to be recognised in the lessee's financial statements. Long-term financing leases can be packaged as operating leases to secure the benefits of “off balance sheet finance”. The problem that arises is that the same leasing arrangement in substance could be accounted for in a significantly different way, depending upon the satisfaction of the quantitative criteria and the perception of the relevant risks and rewards criteria.



One consideration is that, based upon IAS 17, the lease of land is always regarded as an operating lease, irrespective of the lease term. The thinking behind this is that land does not waste way or get used up over a period of time; therefore substantially most of the economic useful life of the land will not be covered by the lease term. Thought may need to be given regarding whether this is always the best accounting treatment for the lease of land as an obligation is incurred once the lease is signed for what may be a significant number of years, which could be omitted from the statement of financial position.

The users of the accounts expect to be given relevant information. Information that is relevant should be understandable, reliable and comparable. For a lessee to be able to account for a long-term lease as an operating lease and still comply with IAS 17 creates confusion and complexity for the users. The company will technically have a present obligation under the lease to make payments in the future that in all other circumstances would be recognised and measured at the present value of the future cash flow. The statement of financial position is not therefore going to be a complete record of the company’s liabilities and so not wholly reliable.

The various methods employed to avoid the standard can be seen as a shortcoming of the current rules. The arbitrary criteria used to determine 'de facto' ownership are easily circumvented and the difficulty of establishing the substance of leases raises serious questions about the adequacy of the arbitrary separation of leases into finance and operating leases. A major deficiency of the current accounting standards is the non-recognition in lessee's statement of financial positions of material assets and liabilities arising from operating leases.

Perhaps such confusion and complexity will remain until IAS 17 is replaced with a new standard that is simpler and more consistent. Such a standard could be built on the premise that all leases should be treated in the same way and that the classification process cease. In the financial statements of the lessee the first question that could in future be asked is not “is this a finance or operating lease?” rather “what are the minimum lease payments that we have to make under this lease?”. In this way lessees would bring onto their statement of financial positions all lease obligations.

If this was to happen, the result would be completeness of financial information which, in turn, would result in increased reliability and comparability of that information.

(b) SALE & LEASEBACK

The accounting for a sale and lease back transaction depends as to the nature of the leaseback arrangement.

It appears the asset in question has an estimated useful life of three years so where the asset is leased back just for one year then the seller/lessee is not obtaining substantially all the risks and rewards of ownership. Even though there is limited information it is safe to conclude that this is an operating lease as the lease term covers only one year of the three-year remaining useful life of the asset.

Accordingly the asset is derecognised and the monies received regarded as sale proceeds generating a gain to be reported in income of the difference between the fair value and the carrying value i.e. $2,250. The payment of $3,000 will be expensed to income as an operating lease rental expense.



However if the asset is leased back for three years, assuming that the lease had no effective break clause, then the seller/lessee is getting substantially all the risks and rewards of ownership. In substance therefore the asset has not really been sold. Legal title may have passed but not the beneficial ownership.

In these circumstances of a sale and finance leaseback, the monies received are simply receipt of a loan and, as such, a finance cost will arise in the first period. This reflects the substance of a finance lease i.e. that finance is involved!

The asset continues to be recognised in the financial statements, but is re-measured to match the proceeds of $7,750. Depreciation will therefore be one third of this in the first accounting period. The difference of $2,750 is not a gain rather is accounted for as deferred income that will be released to the income statement over the three-year lease term to compensate for the deprecation now being based on a higher figure. The lease payments will be accounted for as repayment of the loan that will accrue interest. The interest will be charged to income as a finance cost. The total interest is $1,250 being the difference between the monies to be repaid $9,000 and the proceeds received of $7,750.

(c) DEFERRED TAX

If information is to be useful to the users of the accounts then it needs to be understandable. It can be argued that the concepts and application of deferred tax on temporary differences may well be beyond the average user.

Nevertheless, accounting for deferred tax is essential if the accounts are to be reliable and regarded as true and fair. It is possible for a company to report large pre tax profits but not be called upon to pay any tax in the current year because of, for example accelerated capital allowances i.e. the company may be able to defer the payment of tax to a future accounting period. A simple application of the accruals concept calls for the tax that relates to the events and the transactions of the period to be charged in the same period that the income is recognised. Further, prudence also suggests it is appropriate to recognise the tax liability that has been deferred as it is expected to become payable at a later date.

IAS 12 requires that deferred tax indeed be provided for all year-end temporary differences. Deferred tax is a valuation adjustment. Temporary differences, which can be taxable or deductible, are the difference between the carrying value of assets (and liabilities) and the tax base of those assets (and liabilities). The carrying value is the value or amount as acknowledged for financial reporting purposes (i.e. NBV). The tax base is the amount as acknowledged for taxation purposes.

For example the carrying value of plant and equipment will be reduced by the accumulated depreciation charged in income. Depreciation is a disallowed expense for tax purposes so the tax base of the asset is unaffected by deprecation; instead tax relief for capital expenditure is given in the form of capital allowances which reduces the tax base of the asset (but not the accounts carrying value).

Taxable temporary differences arise when, for example, the tax base of an asset is smaller than the carrying value (NBV) of the asset. This may be caused by a revaluation gain being recognised in the financial statements. Such unrealised paper gains do not generally trigger an obligation to pay current tax so the tax base is unaffected by the revaluation. Under IAS 12 a revaluation gain does create a taxable temporary difference and consequently a so deferred tax liability must be recognised.



Some users are confused by the recognition of such a deferred tax liability, as they believe that IAS 12 overstates the liabilities of a company. Strictly, there is no obligation to pay such a tax until the asset is actually sold. Furthermore, the tax liability has been deferred to the future but IAS12 prohibits the deferred tax liability from being discounted. Even if it was to be discounted, there would need to be a reliable estimate of when such asset(s) may be sold so that they can be discounted on an appropriate basis. This makes accounting for a deferred tax liability inconsistent with other provisions, usually recognised in accordance with IAS 37. Users wanting relevant and reliable information normally look for consistency of accounting treatment which, arguably, is not the case at present.

ACCA marking scheme Marks a) IAS 17 Leases 10 b) Sale and leaseback transactions 5 c) Deferred tax 10 ––– Total 25 –––

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