Financial Accounting III

Mid-Year Mock Exam 2023

Question 1 (60 marks; 90 minutes)

McDreamy Inc are the newly appointed auditors of the Med1 Ltd (Med1) group of
companies. Med1 manages a number of hospitals throughout South Africa. Med1 Ltd is
listed on the Johannesburg Stock Exchange (JSE) and all the companies within the Med1
group have a 31 December reporting date and comply with the requirements of
International Financial Reporting Standards (IFRS).

The following Trial Balances of the companies within the group were obtained as at
31 December 2023:
Med1 GreySloan NightShift NewHolland
R Dr/(Cr) R Dr/(Cr) R Dr/(Cr) R Dr/(Cr)
Ordinary Share Capital (500 000) (600 000) (200 000) (100 000)
Preference Share Capital - (200 000) - -
Retained Earnings (3 245 000) (40 000) (220 000) (180 000)
(01/01/2023)
Revaluation Surplus - - (350 000) -
Trade Payables (84 000) (92 000) (32 000) (18 000)
Bank Overdraft - (322 403) - -
Land 850 000 100 000 - -
Buildings – Carrying Amount 1 880 000 900 833 - -
Equipment – Cost 860 000 480 000 1 460 500 532 000
Equipment – Accumulated (215 000) (288 000) (547 688) (354 667)
Depreciation
Investment in GreySloan ? - - -
Investment in NightShift ? - - -
Investment in NewHolland - - 120 000 -
Inventory 320 000 188 000 82 600 147 633
Trade Receivables 455 800 27 050 143 000 16 870
Bank 172 910 - 87 138 4 164
Profit before Tax (2 665 900) (530 000) (776 000) (90 000)
Tax expense 756 690 136 520 232 450 32 000
Ordinary Dividends Paid 560 000 222 000 - 10 000
(31 December 2023)
Preference dividends paid - 18 000 - -
(31 December 2023)

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Investment in GreySloan

Med1 acquired 90 000 of the issued ordinary shares and 20 000 of the issued preference
shares of GreySloan Ltd (GS) on 1 March 2021 (and obtained control on this date). GS is
an importer of highly specialised medical equipment and sells medical machinery and
equipment to various hospitals and medical facilities throughout South Africa. The following
equity balances appeared in the financial statements of GS on 1 March 2021:

Notes Dr Cr
R R
Ordinary Share Capital (120 000 shares) 600 000
Preference Share Capital (50 000 9% 1 200 000
Cumulative Non-redeemable Preference
Shares)
Retained Loss 2 300 000

Notes:

1. No preferences dividends were in arrears and all preference dividends were paid in
full.
2. GS had an assessed loss of R720 000 on 1 March 2021. GS did not foresee any
future taxable profits and correctly did not recognise a related deferred tax asset.
There were no other deferred tax liabilities in GS. At acquisition date, 1 March 2021,
Med1 was unsure of future taxable profits in GS and did not recognise the deferred
tax asset at that date. On 30 January 2022 it became clear that, due to the business
combination, synergies arose between Med1 and GS resulting in future taxable
profits being probable in the near future. GS returned to profitability in the financial
year ended 31 December 2022 and utilised the assessed loss against taxable
income in the financial years ending 31 December 2022 and 2023.

Med1 paid R80 000 cash for the preference shares. Med1 paid R158 000 cash for the
ordinary shares, as well as issued 15 000 of its own (Med1) shares to the previous owners
of GS in exchange for the ordinary shares. The shares were issued on 15 March 2021 due

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to a delay by the legal teams. The shares of Med1 are listed on the JSE and were trading
at the following prices:

31 December 2020 R8,80 per share

1 March 2021 R9,50 per share
15 March 2022 R9,10 per share

All the assets and liabilities of GS were considered to be fairly valued at the acquisition
date, except for the following:

1. Administration buildings: The owner-occupied buildings had a fair value of

R1 200 000, a cost of R1 150 000 and a carrying amount of R966 000 on 1 March
2021. GS estimated the buildings had a total useful life of 50 years when it was
acquired on 1 March 2013, and no expected residual value. Med1 agreed with the
remaining useful life. SARS does not allow any wear and tear deductions for
administration buildings.
2. Contingent liability: GS sold five incubator machines to Scrubbs, a birthing clinic, on
5 October 2020. The incubator machines are used for new-born babies. On 1 March
2021, GS was involved in a legal dispute with Scrubbs. Scrubbs claimed that one of
the incubators had malfunctioned and could have resulted in physical harm to one of
the babies born at the clinic on 15 October 2020. Scrubbs had thus instituted a legal
claim of R500 000 against GS. GS argued that it was not a malfunction but rather an
error made by the Scrubbs operator, who operated the incubator before training was
provided to Scrubbs’ employees on 20 October 2020. The legal dispute was disclosed
as a contingent liability in the financial statements of GS as at 31 December 2020.
The fair value of the contingent liability was determined to be R120 000 on the date
of acquisition. The receiver of revenue (SARS) will allow the expense as a deduction
when paid. The case was withdrawn by Scrubbs on 30 June 2021, after
disagreements with their legal team, with no amounts payable.

The group accountant (Ms. Mcebu) provided you with the following at acquisition
consolidation pro-forma journal entry for GS for the year ended 31 December 2023:

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Dr R CrR

Share Capital 600 000

Preference Share Capital 200 000

Retained Earnings 300 000

Buildings (R1 200 000 – R966 000) 234 000

Deferred Tax on Buildings (R234 000 x 28%) 65 520

Deferred Tax Asset (on Assessed Loss) 65 520

(Limited to Deferred Tax Liability on Building)
Provision (for contingency) 120 000

Investment in GreySloan (R88 400 + R150 000 + 15 374 900

000 x R9.10)
Non-Controlling Interest (R674 000 x 25%) 168 500

Bargain Purchase gain (P/L) 190 600

Investment in NightShift

Med1 acquired an 80% controlling interest in NightShift (Pty) Ltd (NS) on 1 January 2022
for R500 000 cash. Med1 agreed to pay an additional R50 000 on 28 February 2024, if NS
reached a profit before tax of R500 000 or more for the year ended 31 December 2023.
The fair value of this additional amount payable was R34 000 on 1 January 2022. On 31
December 2022, the fair value was determined to be R43 000. NS is a private ambulance
service that operates in the greater Johannesburg area. The following correct equity
balances appeared in the financial statements of NS on 1 January 2022:
Notes Dr Cr
Ordinary Share Capital 200 000
Retained Earnings 150 000
Revaluation Surplus 1 250 000

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Notes:

1. The revaluation surplus relates to land only. NS measures Land on the revaluation
model and the revaluation performed on 31 December 2021 was considered recent
enough that the land was still considered to be at its fair value on acquisition date.

All other assets and liabilities were considered to be at their fair value at acquisition date.

On 1 June 2022, NS acquired a computer server (classified as equipment) from GS for

R22 000. GS recognised a profit on disposal of equipment of R4 400. NS estimated that
the computer server had a remaining useful life of 6 years and no residual value.

Investment in NewHolland

NS acquired a 30% interest in New Holland (Pty) Ltd (NH), for R120 000 cash, on 1 January
2023. From this day NS exercised significant influence over NH. NH manufactures and
supplies disposable medical supplies to medical facilities throughout South Africa.
Additional information:

1. Med1 Ltd Group measures all property (land and buildings), plant and equipment
according to the cost model in terms of IAS16.
2. Med1 elected to measure the non-controlling interest in all subsidiaries at the
proportionate share of the identifiable net assets of the acquiree, in terms of IFRS
3.
3. The normal tax rate was 27% for all relevant periods and a capital gains inclusion
rate of 80% was applicable.
4. Profits are earned evenly unless indicated otherwise.
5. The consolidated profit before tax and tax expense have been correctly calculated
as R3 806 725 and R1 117 865 respectively in accordance with IFRS, after correctly
taking into account ALL of the above information.
6. Investments in associates are accounted for using the equity method in terms of
IAS28 in the consolidated financial statements of Med1.
7. Investments in subsidiaries and associates are measured at cost in the separate
financial statements.

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Question 2 (40 marks; 60 minutes)

This question consists of two parts. You are required to answer BOTH parts. Part 1

and Part 2 are unrelated.

Part 1 Ignore VAT

Kelsier Ltd (Kelsier) is a subsidiary company of Final Empire Limited. Kelsier owns and
operates certain electronic communications and transmission towers, and related information
technology hardware and broadcasting equipment. The towers are used to provide data
transmission services to clients. In addition, Kelsier occasionally retails information
technology hardware and broadcasting equipment. Kelsier has reliable accounting systems
and internal controls to account for all transactions.

The company owns buildings as well as a fleet of motor vehicles that are used primarily for
maintenance and related services of the company’s towers. Towers are erected on land that
is rented from independent third parties. The company has a 31 December 2023 reporting
date and has been audited by GMPK, a firm of registered auditors, for the past three years.

Buildings
Kelsier owns two identical warehouse buildings (Buildings 1 and 2) which it purchased on 1
January 2007 for R20 000 000 each. The buildings each had an estimated useful life of 25
years and a residual value of R10 000 000. The warehouse buildings have always qualified
for capital allowances of 5% p.a. in terms of the Income Tax Act.

Kelsier has leased both buildings out to tenants in terms of operating leases since 1 January
2007. However, on 31 December 2021 when the lease for building 1 concluded, Kelsier
decided to move its own operations into the building. At this stage building 2 continued to be
rented out. On 31 December 2021 Kelsier re-estimated the residual values of the buildings
to be R25 000 000 each and agreed that the total estimated useful lives had not changed.

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During 2023 the board of Kelsier resolved to sell building 2. The tenant was given appropriate
notice and agreed to vacate the building on 30 November 2023. The building was sold on 31
December for its fair value. The company has negotiated agent’s selling commission costs of
6% for the successful sale of the building.

The identical buildings were estimated to each have the following fair values:
31 December 2021 31 December 2022 31 December 2023

Buildings 1 and 2 R38 000 000 R40 000 000 R42 000 000

No further changes were made to the estimated residual values of the buildings established
on 31 December 2021.

Kelsier measures investment property at fair value allowed in accordance to IAS 40

Investment Property. Kelsier measures property, plant and equipment using the cost model
in accordance to IAS 16 Property, Plant and Equipment.

The applicable tax rates for companies are a 27% standard tax rate with an inclusion rate of
80% for capital gains.

Part 2
Losealot.com (Losealot), a website owned by Losealot (Pty) Ltd, was officially launched in
June 2011, following the successful acquisition of an existing ecommerce business called
TakeSome. Customers purchase items online which are then delivered to them by Losealot.
When customers register on the website they must first agree to the terms and conditions
before registration, and then every time they purchase a product.

Losealot (Pty) Ltd is South Africa’s largest, most innovative ecommerce retailer, with over
2000 employees. It has rapidly grown since inception, opening and expanding warehouses
in Johannesburg, Durban and Cape Town, while increasing its selection to over 21 divisions
across Electronics, Lifestyle, Media & Gaming and Fashion.

Losealot has a current reporting date of 31 October 2024.

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 Financial Accounting III
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The financial manager (Hammond Breeze) requires your assistance on two issues which
have been outlined below.

“Support the Bokke” Promotion

During the 2024 reporting period, Losealot launched a promotion with the aim of encouraging
the country to show their support of the ‘Bokke’ in the 2024 Rugby World Cup Tournament.
The promotion was applicable to sales in the period 1 October 2024 – 31 October 2024, and
included:

• Buy any flat-screen television; and

• If the South African rugby team wins the World Cup, each customer will receive a
refund of 50% of the purchase price.

Televisions with a total sales price of R4 000 000 were sold to customers in terms of this
promotion during the month of October 2024. The agreements were legally binding as all the
terms and conditions were outlined on Losealot’s website.

The CEO of Losealot (Dockson Cladent), a man who grew up in New Zealand, was convinced
that South Africa would not win the World Cup when he pitched this promotion idea to the
Board of Directors. Just in case the ‘Bokke’ won, the Board of Directors decided to inflate the
purchase price of the televisions by 20% to minimise the potential losses.

To Losealot’s shock, and the country’s ecstatic joy, the South African rugby team beat England
in the World Cup final on 2 November 2024.

Mr. Breeze would like to know how the transactions for the televisions should be accounted
for in the 2024 reporting period.

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Gaming division
During a review of the divisional reports Mr. Breeze noticed the following revenue figures for
the gaming division:
2024 (R) 2023 (R)

PC Games 2 750 000 2 500 000

Console Games 3 300 000 3 450 000
Gaming accessories 510 000 500 000

Mr. Breeze was concerned with the decrease in Console Games sales and the increase in
PC Games. His experts informed him that more gamers were moving from computer gaming
to console gaming. However, these year on year changes indicated otherwise.

After some investigating of the figures ONLY relating to Console Games, Mr. Breeze
discovered that one of the bookkeepers had included value-added tax in the above sales
amounts for the 2023 reporting period, but not for the 2024 reporting period, in respect of
Console Games. The correct amount of VAT was paid to SARS in both years.

Assume that a constant VAT rate of 15% applied throughout all periods presented.

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