Paper 2.

5(INT)
Financial
Reporting
(International Stream)

PART 2

THURSDAY 8 JUNE 2006

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A This ONE question is compulsory and MUST be

answered

Section B THREE questions ONLY to be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination

hall

The Association of Chartered Certified Accountants

Section A – This ONE question is compulsory and MUST be attempted

1 On 1 October 2005 Hydan, a publicly listed company, acquired a 60% controlling interest in Systan paying $9 per
share in cash. Prior to the acquisition Hydan had been experiencing difficulties with the supply of components that it
used in its manufacturing process. Systan is one of Hydan’s main suppliers and the acquisition was motivated by the
need to secure supplies. In order to finance an increase in the production capacity of Systan, Hydan made a
non-dated loan at the date of acquisition of $4 million to Systan that carried an actual and effective interest rate of
10% per annum. The interest to 31 March 2006 on this loan has been paid by Systan and accounted for by both
companies. The summarised draft financial statements of the companies are:
Income statements for the year ended 31 March 2006
Hydan Systan
pre-acquisition post-acquisition
$’000 $’000 $’000
Revenue 98,000 24,000 35,200
Cost of sales (76,000) (18,000) (31,000)
––––––– ––––––– –––––––
Gross profit 22,000 6,000 4,200
Operating expenses (11,800) (1,200) (8,000)
Interest income 350 nil nil
Finance costs (420) nil (200)
––––––– ––––––– –––––––
Profit/(loss) before tax 10,130 4,800 (4,000)
Income tax (expense)/relief (4,200) (1,200) 1,000
––––––– ––––––– –––––––
Profit/(loss) for the period 5,930 3,600 (3,000)
––––––– ––––––– –––––––
Balance sheets as at 31 March 2006
Hydan Systan
$’000 $’000
Non-current assets
Property, plant and equipment 18,400 9,500
Investments (including loan to Systan) 16,000 nil
––––––– –––––––
34,400 9,500
Current assets 18,000 7,200
––––––– –––––––
Total assets 52,400 16,700
––––––– –––––––
Equity and liabilities
Ordinary shares of $1 each 10,000 2,000
Share premium 5,000 500
Retained earnings 20,000 6,300
––––––– –––––––
35,000 8,800
Non-current liabilities
7% Bank loan 6,000 nil
10% loan from Hydan nil 4,000
Current liabilities 11,400 3,900
––––––– –––––––
Total equity and liabilities 52,400 16,700
––––––– –––––––
The following information is relevant:
(i) At the date of acquisition, the fair values of Systan’s property, plant and equipment were $1·2 million in excess
of their carrying amounts. This will have the effect of creating an additional depreciation charge (to cost of sales)
of $300,000 in the consolidated financial statements for the year ended 31 March 2006. Systan has not
adjusted its assets to fair value.

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(ii) In the post acquisition period Systan’s sales to Hydan were $30 million on which Systan had made a consistent
profit of 5% of the selling price. Of these goods, $4 million (at selling price to Hydan) were still in the inventory
of Hydan at 31 March 2006. Prior to its acquisition Systan made all its sales at a uniform gross profit margin.
(iii) Included in Hydan’s current liabilities is $1 million owing to Systan. This agreed with Systan’s receivables ledger
balance for Hydan at the year end.
(iv) An impairment review of the consolidated goodwill at 31 March 2006 revealed that its current value was 12·5%
less than its carrying amount.
(v) Neither company paid a dividend in the year to 31 March 2006.

Required:
(a) Prepare the consolidated income statement for the year ended 31 March 2006 and the consolidated balance
sheet at that date. (20 marks)

(b) Discuss the effect that the acquisition of Systan appears to have had on Systan’s operating performance.
(5 marks)

(25 marks)

3 [P.T.O.
Section B – THREE questions ONLY to be attempted

2 The following trial balance relates to Darius at 31 March 2006:

$’000 $’000
Revenue 213,800
Cost of sales 143,800
Closing inventories – 31 March 2006 (note (i)) 10,500
Operating expenses 22,400
Rental income from investment property 1,200
Finance costs (note (ii)) 5,000
Land and building – at valuation (note (iii)) 63,000
Plant and equipment – cost (note (iii)) 36,000
Investment property – valuation 1 April 2005 (note (iii)) 16,000
Accumulated depreciation 1 April 2005 – plant and equipment 16,800
Joint venture (note (iv)) 8,000
Trade receivables 13,500
Bank 900
Trade payables 11,800
Ordinary shares of 25c each 20,000
10% Redeemable preference shares of $1 each 10,000
Deferred tax (note (v)) 5,200
Revaluation reserve (note (iii)) 21,000
Retained earnings – 1 April 2005 17,500
–––––––– ––––––––
318,200 318,200
–––––––– ––––––––
The following notes are relevant:
(i) An inventory count at 31 March 2006 listed goods with a cost of $10·5 million. This includes some damaged
goods that had cost $800,000. These would require remedial work costing $450,000 before they could be sold
for an estimated $950,000.
(ii) Finance costs include overdraft charges, the full year’s preference dividend and an ordinary dividend of 4c per
share that was paid in September 2005.
(iii) Non-current assets:
Land and building
The land and building were revalued at $15 million and $48 million respectively on 1 April 2005 creating a
$21 million revaluation reserve. At this date the building had a remaining life of 15 years.
Depreciation is on a straight-line basis. Darius does not make a transfer to realised profits in respect of excess
depreciation.
Plant
All plant, including that of the joint venture (note (iv)), is depreciated at 12·5% on the reducing balance basis.
Depreciation on both the building and the plant should be charged to cost of sales.
Investment property
On 31 March 2006 a qualified surveyor valued the investment property at $13·5 million. Darius uses the fair
value model in IAS 40 Investment property to value its investment property.

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(iv) On 1 April 2005 Darius entered into a joint venture with two other entities. Each venturer contributes their own
assets and is responsible for their own expenses including depreciation on joint venture assets. Darius is entitled
to 40% of the joint venture’s total revenues. The joint venture is not a separate entity.
Details of Darius’s joint venture transactions are:
$’000
Plant and equipment at cost 12,000
Share of joint venture revenue (40% of total sales revenue) (8,000)
Related joint venture cost of sales excluding depreciation 5,000
Trade receivables 1,500
Trade payables (2,500)
––––––
Net balance included in the above list of balances 8,000
––––––
(v) The directors have estimated the provision for income tax for the year ended 31 March 2006 at $8 million. The
deferred tax provision at 31 March 2006 is to be adjusted (through the income statement) to reflect that the tax
base of the company’s net assets is $12 million less than their carrying amounts. The rate of income tax is 30%.

Required:
(a) Prepare the income statement for Darius for the year ended 31 March 2006. (10 marks)

(b) Prepare the statement of recognised income and expense for Darius for the year ended 31 March 2006.
(2 marks)

(c) Prepare the balance sheet for Darius as at 31 March 2006. (13 marks)
Notes to the financial statements are not required.

(25 marks)

5 [P.T.O.
 This is a blank page.
Question 3 begins on page 7.

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3 (a) The IASB’s Framework for the preparation and presentation of financial statements (Framework) sets out the
concepts that underlie the preparation and presentation of financial statements that external users are likely to
rely on when making economic decisions about an enterprise.

Required:
Explain the purpose and authoritative status of the Framework. (5 marks)

(b) Of particular importance within the Framework are the definitions and recognition criteria for assets and liabilities.

Required:
Define assets and liabilities and explain the important aspects of their definitions. Explain why these
definitions are of particular importance to the preparation of an entity’s balance sheet and income statement.
(8 marks)

(c) Peterlee is preparing its financial statements for the year ended 31 March 2006. The following items have been
brought to your attention:
(i) Peterlee acquired the entire share capital of Trantor during the year. The acquisition was achieved through
a share exchange. The terms of the exchange were based on the relative values of the two companies
obtained by capitalising the companies’ estimated future cash flows. When the fair value of Trantor’s
identifiable net assets was deducted from the value of the company as a whole, its goodwill was calculated
at $2·5 million. A similar exercise valued the goodwill of Peterlee at $4 million. The directors wish to
incorporate both the goodwill values in the companies’ consolidated financial statements. (4 marks)
(ii) During the year Peterlee acquired an iron ore mine at a cost of $6 million. In addition, when all the ore has
been extracted (estimated in 10 years time) the company will face estimated costs for landscaping the area
affected by the mining that have a present value of $2 million. These costs would still have to be incurred
even if no further ore was extracted. The directors have proposed that an accrual of $200,000 per year for
the next ten years should be made for the landscaping. (4 marks)
(iii) On 1 April 2005 Peterlee issued an 8% $5 million convertible loan at par. The loan is convertible in three
years time to ordinary shares or redeemable at par in cash. The directors decided to issue a convertible loan
because a non-convertible loan would have required an interest rate of 10%. The directors intend to show
the loan at $5 million under non-current liabilities. The following discount rates are available:
8% 10%
Year 1 0·93 0·91
Year 2 0·86 0·83
Year 3 0·79 0·75 (4 marks)

Required:
Describe (and quantify where possible) how Peterlee should treat the items in (i) to (iii) in its financial
statements for the year ended 31 March 2006 commenting on the directors’ views where appropriate.
The mark allocation is shown against each of the three items above.
(25 marks)

7 [P.T.O.
4 Shown below are the summarised financial statements for Boston, a publicly listed company, for the years ended
31 March 2005 and 2006, together with some segment information analysed by class of business for the year ended
31 March 2006 only:
Income statements: Total Total
Carpeting Hotels House building 31 March 2006 31 March 2005
$m $m $m $m $m
Revenue 90 130 280 500 450
Cost of sales (note (i)) (30) (95) (168) (293) (260)
––– ––– –––– –––– ––––
Gross profit 60 35 112 207 190
Operating expenses (25) (15) (32) (72) (60)
––– ––– –––– –––– ––––
Segment result 35 20 80 135 130
––– ––– ––––
Unallocated corporate expenses (60) (50)
–––– ––––
Profit from operations 75 80
Finance costs (10) (5)
–––– ––––
Profit before tax 65 75
Income tax expense (25) (30)
–––– ––––
Profit for the period 40 45
–––– ––––
Balance sheets: Total Total
Carpeting Hotels House building 31 March 2006 31 March 2005
$m $m $m $m $m
Tangible non-current assets 40 140 200 380 332
Current assets 40 40 75 155 130
––– –––– –––– –––– ––––
Segment assets 80 180 275 535 462
Unallocated bank balance 15 nil
–––– ––––
Consolidated total assets 550 462
–––– ––––
Ordinary share capital 100 80
Share premium 20 nil
Retained earnings 232 192
–––– ––––
352 272
Segment current liabilities – tax 4 9 12 25 30
– other 4 51 53 108 115
Unallocated loans 65 40
Unallocated bank overdraft nil 5
–––– ––––
Consolidated equity and total liabilities 550 462
–––– ––––
The following notes are relevant
(i) Depreciation for the year to 31 March 2006 was $35 million. During the year a hotel with a carrying amount of
$40 million was sold at a loss of $12 million. Depreciation and the loss on the sale of non-current assets are
charged to cost of sales. There were no other non-current asset disposals. As part of the company’s overall
acquisition of new non-current assets, the hotel segment acquired $104 million of new hotels during the year.
(ii) The above figures are based on historical cost values. The fair values of the segment net assets are:
Carpeting Hotels House building
$m $m $m
at 31 March 2005 80 150 250
at 31 March 2006 97 240 265

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(iii) The following ratios (which can be taken to be correct) have been calculated based on the overall group results:
Year ended: 31 March 2006 31 March 2005
Return on capital employed 18·0% 25·6%
Gross profit margin 41·4% 42·2%
Operating profit margin 15% 17·8%
Net assets turnover 1·2 times 1·4 times
Current ratio 1·3:1 0·9:1
Gearing 15·6% 12·8%
(iv) The following segment ratios (which can be taken to be correct) have been calculated for the year ended
31 March 2006 only:
Carpeting Hotels House building
Segment return on net assets 48·6% 16·7% 38·1%
Segment asset turnover (times) 1·3 1·1 1·3
Gross profit margin 66·7% 26·9% 40%
Net profit margin 38·9% 15·4% 28·6%
Current ratio (excluding bank) 5:1 0·7:1 1·2:1

Required:
(a) Prepare a cash flow statement for Boston for the year ended 31 March 2006. (10 marks)
Note: you are not required to show separate segmental cash flows or any disclosure notes.

(b) Using the ratios provided, write a report to the Board of Boston analysing the company’s financial
performance and position for the year ended 31 March 2006. (15 marks)
Your answer should make reference to your cash flow statement and the segmental information and consider
the implication of the fair value information.

(25 marks)

9 [P.T.O.
5 (a) Torrent is a large publicly listed company whose main activity involves construction contracts. Details of three of
its contracts for the year ended 31 March 2006 are:
Contract Alfa Beta Ceta
Date commenced 1 April 2004 1 October 2005 1 October 2005
Estimated duration 3 years 18 months 2 years
$m $m $m
Fixed contract price 20 6 12
Estimated costs at start of contract 15 7·5 (note (iii)) 10
Cost to date:
at 31 March 2005 5 nil nil
at 31 March 2006 12·5 (note (ii)) 2 4
Estimated costs at 31 March 2006 to complete 3·5 5·5 (note (iii)) 6
Progress payments received at 31 March 2005
(note (i)) 5·4 nil nil
Progress payments received at 31 March 2006
(note (i)) 12·6 1·8 nil
Notes
(i) The company’s normal policy for determining the percentage completion of contracts is based on the value
of work invoiced to date compared to the contract price. Progress payments received represent 90% of the
work invoiced. However, no progress payments will be invoiced or received from contract Ceta until it is
completed, so the percentage completion of this contract is to be based on the cost to date compared to the
estimated total contract costs.
(ii) The cost to date of $12·5 million at 31 March 2006 for contract Alfa includes $1 million relating to
unplanned rectification costs incurred during the current year (ended 31 March 2006) due to subsidence
occurring on site.
(iii) Since negotiating the price of contract Beta, Torrent has discovered the land that it purchased for the project
is contaminated by toxic pollutants. The estimated cost at the start of the contract and the estimated costs
to complete the contract include the unexpected costs of decontaminating the site before construction could
commence.
Required:
Prepare extracts of the income statement and balance sheet for Torrent in respect of the above construction
contracts for the year ended 31 March 2006 (12 marks)

(b) (i) The issued share capital of Savoir, a publicly listed company, at 31 March 2003 was $10 million. Its shares
are denominated at 25 cents each. Savoir’s earnings attributable to its ordinary shareholders for the year
ended 31 March 2003 were also $10 million, giving an earnings per share of 25 cents.
Year ended 31 March 2004
On 1 July 2003 Savoir issued eight million ordinary shares at full market value. On 1 January 2004 a bonus
issue of one new ordinary share for every four ordinary shares held was made. Earnings attributable to
ordinary shareholders for the year ended 31 March 2004 were $13,800,000.
Year ended 31 March 2005
On 1 October 2004 Savoir made a rights issue of shares of two new ordinary shares at a price of $1·00
each for every five ordinary shares held. The offer was fully subscribed. The market price of Savoir’s ordinary
shares immediately prior to the offer was $2·40 each. Earnings attributable to ordinary shareholders for the
year ended 31 March 2005 were $19,500,000.
Required:
Calculate Savoir’s earnings per share for the years ended 31 March 2004 and 2005 including
comparative figures. (9 marks)

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(ii) On 1 April 2005 Savoir issued $20 million 8% convertible loan stock at par. The terms of conversion (on
1 April 2008) are that for every $100 of loan stock, 50 ordinary shares will be issued at the option of loan
stockholders. Alternatively the loan stock will be redeemed at par for cash. Also on 1 April 2005 the directors
of Savoir were awarded share options on 12 million ordinary shares exercisable from 1 April 2008 at $1·50
per share. The average market value of Savoir’s ordinary shares for the year ended 31 March 2006 was
$2·50 each. The income tax rate is 25%. Earnings attributable to ordinary shareholders for the year ended
31 March 2006 were $25,200,000. The share options have been correctly recorded in the income
statement.

Required:
Calculate Savoir’s basic and diluted earnings per share for the year ended 31 March 2006 (comparative
figures are not required).
You may assume that both the convertible loan stock and the directors’ options are dilutive. (4 marks)

(25 marks)

End of Question Paper

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