GRADUATE ACHIEVERS

GA INTENSIVE REVISION COURSE (IRC) 2016

APPLIED FINANCIAL ACCOUNTING 1
(FAC4861 & FAC4863)
Q1 to Q12 of this QUESTION BANK are basic questions covering the broad aspect of the
syllabus and should be reviewed if necessary.

Q13 to Q40 of this QUESTION BANK are typical exam questions and ideally all of these
questions should be done under exam conditions.

However because of time constraints we recommend the following:

Quick Review: Q1 to Q12

Review: Q13, Q14, Q15, Q16, Q17, Q18, Q21, Q23, Q24, Q25,
Q27, Q28, Q30, Q31, Q32, Q37, Q38, Q39, Q40

Do: Q19, Q20, Q22, Q26, Q29, Q33, Q34, Q35, Q36, Q41

Reference
to yearly
QUESTION LEVEL
QUESTION BANK BANK 2 ONLY

Q1. A question dealing with various issues relating to inventory Q8

(IAS2)
Q2. Journal entries including revaluations and impairment Q15
(IAS36 & IAS16) and various issues on impairment (IAS36) Q18 P2, P3,
P4
Q3. Various basic issues on investment properties (IAS40) Q20 P4, P5, L2
P6
Q4. Various basic issues on fair value measurement (IFRS13) Q22 P4, P5 L2
Q5. Various basic revenue (IFRS15) Q28
Q6. Discussion of measurement and recognition of Q32
decommissioning costs (IFIRC1 & IFRIC5)
Q7. Journals i.r.o. revaluation, impairment and disposal (IAS16, Q38 L2
IAS36 and IFRS5)
Q8. Journals illustrating share based payments (IFRS2) Q39 P3, P4, L2
P5, P7, P8
Q9. Part 1: Discuss the principles of IFRIC19 Q41 L2
Part 2: Journals i.r.o IFRIC17 Q41 L2
Q10. Basic journals illustrating various issues on leases Q44 P5, P6,
(IAS17 and IFRIC4) P7, P8
 Reference
to yearly
QUESTION LEVEL
QUESTION BANK BANK 2 ONLY

Q11. Basic journals illustrating various issues i.r.o. financial Q53, Q55,
instruments (IFRS9, IAS33) Q56
Q12. Journals illustrating hedging of financial instruments (IFRS9) Q60
Q13. An integrated question of deferred tax incorporating prior Q6
period error and change in accounting policy (IAS2, IAS8)
Q14. An integrated question incorporating inventory, taxation, Q7
employee benefits and prior period error
(IAS2, IAS8, IAS12 and IAS19)
Q15. An integrated question covering journals i.r.o. COS, sale and Q9
leaseback and calculation of deferred tax
Q16. An integrated question incorporating employee benefits and Q11
journals i.r.o. defined benefit plan (IAS19)
Q17. A discussion question on initial recognition of transactions Q1 P1, P3
according to the framework and discussion on recognition and & Q17
measurement of customer acquisition costs
Q18. An integrated question incorporating PPE, revaluation, transfer Q24
from investment property and impairment
Q19. An integrated question incorporating PPE, revaluations, Q25
impairments of cash generating unit and deferred tax
Q20. Integrated question incorporating IFRS13, IAS36, IAS16 & Q26 L2
IAS2
Q21. An integrated question incorporating PPE, revaluations, Q27
impairments, deferred taxation and discussion on intangible
assets
Q22. An integrated question incorporating IFRS2, journals i.r.o. Q35 L2
deferred benefit plan and leave pay and disclosure in terms of
IFRS13 and calculation of remuneration expense i.t.o. share
based payment
Q23. An integrated question incorporating discontinued operation, Q43 L2
PPE, investment property and non-current assets held for sale
Q24. A discussion question to classify a long-term agreement and Q46
disclosure of a sale and leaseback transaction
Q25. A question illustrating various issues on EPS including diluted Q48, Q49,
EPS, rights issue, HEPS and the impact of share based Q50, Q51
payment on EPS
Q26. A financial instrument question incorporating investment in Q54
equity, convertible debentures and impairments of bonds
Q27. An integrated question on financial instruments including Q62
coverage of financial assets and financial liabilities and journals
including sale, capitalization issue and impairment
Q28. Discussion question on various issues on financial instruments Q65
including journal entries, capitalization issues, change of
investment until maturity and impairments of debentures
Q29. An integrated question including preparing the statement of - L2
profit or loss and other comprehensive income incorporating
IAS16, IAS33, IAS28, IFRS9, IAS12, IFRS2,
IAS23, IAS1
Q30. An integrated question incorporating discussions of provisions, TEST 14
revenue, employee benefits and borrowing costs.
 Reference
to yearly
QUESTION LEVEL
QUESTION BANK BANK 2 ONLY

Q31. Calculation of charge to profit or loss for machine including - L2

depreciation, foreign exchange, capitalization of borrowing
costs
Q32. An integrated question that includes discussion of revenue, SIM T3 Q1
provisions, borrowing costs, non-current assets held for sale
and share based payments
Q33. Part 1: Calculation of profit before tax incorporating various -
issues of revenue
Part 2: Calculate amounts that should be recognised as
revenue
Part 3: Calculation of employee benefits
Part 4: Discussion of provisions
Q34. A comprehensive question on deferred tax incorporating -
leases, PPE, investment property and installment credit
receivables.
Q35. An integrated question incorporating IFRS9, statement of -
changes in equity and EPS
Q36. An integrated question incorporating classification in - L2
accordance of IAS32, EPS notes and prepare statement of
changes in equity including share buyback, shares to directors,
preference shares, cash flow hedge, compound financial
instrument, revaluation surplus and mark-to-market reserve
Q37. An integrated question incorporating fair value measurement, - L2
calculate net cash flows from operating activities, NPV
calculation and factors to consider to acquire the proposed
residential property
Q38. Part 1: A question on share-based payments incorporating - L2
appreciation rights and tax implications
Part 2: Discussion of events after reporting date
Q39. An integrated question incorporating PPE, leases, non-current - L2
held for sale and capitalization of borrowing cost, reconciliation
and deferred taxation consequences
Q40. An integrated discussion question incorporating employee -
benefits, recognition and measurements of reduced electricity
charge and journals i.r.o. impairment.
Q41. An integrated question incorporating leases and deferred tax, -
discussion of various financial instruments and calculation of
EPS
FINANCIAL ACCOUNTING I

QUESTIONS FROM UNISA TUTORIAL LETTERS

FAC4861 LEVEL 1

These are all past CTA Questions and you should DO all of these. However, if time is a problem,
the following are recommended REVIEW questions and DO questions:

TL106: CASE STUDY 1 page 5 – 21 Q1 (R), Q2 (R)

CASE STUDY 2 page 22 – 37 Q1 (R), Q2 (R)

CASE STUDY 3 page 38 – 54 Q1 (Do), Q2 (Do)

CASE STUDY 4 page 55 – 75 Q1 (R), Q2 (R), Q3 (Do)

CASE STUDY 5 page 76 – 93 Q1 (R), Q2 (R)

CASE STUDY 6 page 94 – 112 Q1 (Do), Q2 (R)

CASE STUDY 7 page 113 – 135 Q1 (R), Q2 (R), Q3 (R), Q5 (Do)

CASE STUDY 8 page 136 – 153 Q1 (Do), Q2 (Do), Q3 (Do)

CASE STUDY 9 page 154 – 167 Q1 (R), Q2 (R)

CASE STUDY 10 page 168 – 183 Q1 (R), Q2 (Do), Q3 (Do)

Questions from these UNISA tutorials may be re-reviewed:

TL102: Framework, IAS1, IAS2, IAS12, IAS8

TL103: IAS16, IAS36, IAS38, IAS20

TL104: IAS10, IAS37, IAS19

TL105: IAS32, IFRS9, IFRS7, IAS17, IAS33, IFRIC4, circular 12/06, SIC15, Circular 02/13

UNISA TUE TEST

Re-review all the relevant in UNISA TEST 1, 2, 3 & 4

Make a detailed study of the model solution against your marked solution. Pay special
attention to those areas in the model solution that was not in your solution.
FINANCIAL ACCOUNTING 1

QUESTIONS FROM UNISA TUTORIAL LETTERS

FAC4863 LEVEL 2

TL107: These are all past CTA Questions and you should DO all of these. However, if time is a
problem the following are recommended REIVEW and DO questions:

CASE STUDY 1 page 6 – 24 Q1 (R), Q2 (R)

CASE STUDY 2 page 25 – 42 Q1 (Do), Q2 (R)

CASE STUDY 3 page 43 – 62 Q1 (Do), Q2 (R)

CASE STUDY 4 page 63 – 82 Q1 (R), Q2 (R), Q3 (R)

CASE STUDY 5 page 83 – 102 Q1 (R), Q2 (R), Q3 (R)

CASE STUDY 6 page 103 – 121 Q1 (Do), Q2 (R)

CASE STUDY 7 page 122 – 141 Q1 (R), Q2 (R)

CASE STUDY 8 page 142 – 154 Q1 (Do)

CASE STUDY 9 page 155 – 177 Q1 (Do); Q2 (R)

CASE STUDY 10 page 178 – 198 Q1 (Do), Q2 (R)

You may want to re-review these questions in the UNISA tutorials:

TL102: Framework, IAS1, IAS2, IAS12, IAS8, IAS19

TL103: IFRS13, IAS16, IAS38, IAS36, IAS40, IAS20, IFRIC1, SIC32

TL104: IFRS15, IFRS5, IAS23

TL105: IAS2, IAS10, IAS37, FRIC5, IFRIC1, FRG2

TL106: IAS21, IAS32, IFRS7, IFRS9, IAS17, IFRIC4, IFRIC19

Circular 12/06, SIC15, IAS33, Circular 02/13

UNISA TUE TEST

Re-review all the relevant questions in UNISA TEST 1, 2, 3 & 4

Make a detailed study of the model solution against your marked solution. Pay special
attention to those areas in the model solution that was not in your solution.
QUESTION 25 Page 1 of 9

Part 1

The following information relates to Dagmar Ltd. Dagmar Ltd is a manufacturing company listed
on the exchange operated by the JSE Limited.

1. The net profit for the financial year ended 31 December 20.12 amounted to R13 114 350
(after taking into account the income tax expense of R4 905 580). Dagmar Ltd did not have
any discontinued operations for the financial year ended 31 December 20.12.

2. Dagmar Ltd’s issued share capital consisted of the following on 1 January 20.12:

* 10 000 000 issued ordinary shares;

* 2 000 000 8% non-redeemable cumulative convertible preference shares with a total face
value of R2 000 000; and
* 5 000 000 redeemable non-cumulative preference shares with a total face value of
R5 000 000.

3. No ordinary dividends were declared for the year ended 31 December 20.12.

4. On 11 May 20.12 Dagmar Ltd had a rights issue of one ordinary share for every four ordinary
shares held. The exercise price of the rights was R6 per share and the last day to exercise
the rights was 1 June 20.12. All the rights were exercised. The rights traded separately from
the ordinary shares from 12 May 20.12 and the market price of one ordinary share at the close
of the last day on which the shares traded together with the rights was R9 per share.

5. On 31 July 20.12 a further 3 000 000 ordinary shares were issued at fair value.

6. The non-redeemable cumulative convertible preference shares are convertible into ordinary
shares at the option of Dagmar Ltd at a ratio of one ordinary share for every five preference
shares held. Preference dividends of 8% are only payable if ordinary dividends are declared
and are therefore within the discretion of Dagmar Ltd. 25% of the convertible preference
share were converted into ordinary shares on 30 September 20.12.

7. The redeemable non-cumulative preference shares are redeemable at the option of Dagmar
Ltd and preference dividends are payable at the discretion of Dagmar Ltd. A discretionary
dividend of R500 000 was declared and paid to these preference shareholders on 1 December
20.12.

8. The income tax rate is 28%

REQUIRED: Marks

Present and disclose earnings per share in the financial statements of Dagmar Ltd for
the year ended 31 December 20.12. [18]

Communication skills: Presentation and layout [2]

Please note:

* Your answer must comply with International Financial Reporting Standards (IFRS)
* Comparative are not required
* Round the adjustment to two decimals
QUESTION 25 Page 2 of 9

Part 2

The following information relates to Beta Ltd, a listed company in the manufacturing industry:

1. Profit for the year ended 31 December 20.11 amounts to R722 200, after taking it on account
tax of R202 000. This profit includes the following pre-tax items:
(Dr)/Cr
R

Operating profit of discontinued operations* 161 389

Impairment loss on disposal group (79 722)
Fair value adjustment on land classified as investment property 25 000
Fair value adjustment on building classified as investment property 8 000
Income from associate 30 000
Dividends received 10 000
Equity profit (Includes Beta Ltd's share of R6 000 related to reversal of an
impairment loss on plant) 25 000
Goodwill - Impairment loss (5 000)
Amortisation of patent (10 000)
Gain on sale of land 66 000
Impairment loss on plant (35 000)
Provision for reconstruction costs# (8 000)
Write - off of inventory to net realisable value (4 000)
Additional provident fund contributions (22 000)
Defined benefit plan expense (35 000)

* Does not include any non-taxable or non-deductible differences

# Not allowed by SARS as a deduction

2. At 1 January 20.11 Beta Ltd's issued share capital consisted of 500 000 shares of R1 each.

3. 100 000 options were issued on 1 September 20.11, which entitle the holders thereof to
purchase 100 000 shares in Beta Ltd at R5 per share at any stage from 1 February 20.12
to 31 December 20.12. The average price of Beta Ltd's shares for the year was R6 per share,
and assume the average price from 1 September 20.11 to 31 December 20.11 was R5,50 per
share and that these options are not subject to IFRS 2. Assume that these options were
accounted for correctly according to IFRS2 and are included in profit for the year.

4. Assume a tax rate of 28%

REQUIRED:

Disclose earnings per share in the financial statements of Beta Ltd for the year ended
31 December 20.11.
QUESTION 25 Page 3 of 9

Part 3

Prade Ltd (Prade) specialized in the importing of fashion from all over the world and is listed on
the exchange operated by the JSE Limited.

On 1 March 20.10, Prade issued 10 000 10% convertible bonds. The bonds mature four years
from issue and were issued at a face value of R2 500 per bond. Interest is payable annually in
arrears. The holder has the option to convert each bond into 100 shares at any time until maturity
date. If not converted into shares before maturity date, the bonds will be settled in cash at
premium of 2.5%. The market related interest rate for bonds without a conversion option was
12% per annum on 1 March 20.10.

On 1 March 20.11, Prade entered into a share-based payment transaction whereby each of its
700 managers were granted 100 share options. These share options will only vest if the
managers are still in the service of Prade at the end of three years. At the end of three years the
manager will be entitled to purchase one ordinary share for each option held at an exercise price
(strike price) of R20 per share. The fair value per share option as at 1 March 20.11, as
determined by an actuary, was R15 per share option.

On 1 January 20.12, the directors of Prade reviewed the performance of the share price and
decided to reduce the exercise price per share option from R20 to R12. On this date an actuary
determined the fair value of an original share option with an exercise price of R20 per share to be
R4 per share option and the fair value of a repriced share option with an exercise price of R12 per
share to be R13 per share option. It is expected that all 700 managers will remain in the service
of Prade for the three year period and no managers resigned in the financial year ended 28
February 20.12

The average market price of a Prade share was R32 per share for the financial year ended
28 February 20.12.

The profit for the year ended 28 February 20.12 was R36 000 000. The weighted number of
ordinary shares for basic earnings per share is 12 000 000.

Assume a tax rate of 28%.

REQUIRED: Marks

Present and disclose earnings per share in the financial statements of Prade Ltd
for the financial year ended 28 February 20.12. [16]

Please note:

~ Your answer must comply with International Financial Reporting Standards (IFRS)
~ Comparative figures are not required
~ For the convertible bonds, for earnings per share purposes, you may assume that the
option to settle in shares is more dilutive than the cash option
QUESTION 25 Page 4 of 9

Part 4

Ilayimi Ltd (‘Ilayimi’) crushes limestone at its plant in Mokpane in the Limpopo Province. Ilayimi
was incorporated on 2 January 19.90. Ilayimi is the largest supplier in South Africa of high-
calcium limestone and dolomitic limestone. High-calcium limestone is used in poultry and cattle
feedstock, while dolomitic limestone is used in the agricultural industry.

Ilayimi is listed on the AltX which is operated by the Johannesburg Stock Exchange (JSE) Limited

The following information relates to Ilayimi for the financial year ended 31 December 20.12:

Securities

At 31 December 20.11 Ilayimi had an authorized share capital of 2 300 000 ordinary shares and
1 252 000 ordinary shares in issue.

The following is an extract from the securities register of Ilayimi for 20.12. These are the only
securities that were issued from 1 January 20.12 to 31 December 20.12.

ILAYIMI LTD SECURITIES REGISTER

1 January 20.12 to 31 December 20.12
ORDINARY SHARES
Shares Date of Certificate
Name Title Address issued issue number Note
6 Lead Ave
J Stein Director Johannesburg 20 000 1 April S124 1
77 Park St
M Nthuli Director Kempton Park 30 000 1 April S125 1
Ilayimi 5 Lourens Dr
Tribal Trust Trust Mokopane 125 000 1 July S127 3

SHARE OPTIONS
Share options Vesting
Name Title Address granted start date Note
6 Lead Ave
J Stein Director Joahnnesburg 80 000 1 April 1
77 Park St
M Nthuli Director Kempton Park 60 000 1 April 1

DEBENTURES
Date
Debentures of Conversion
Name Title Address issued issue Type date Note
54 Lion
STAR St Compulsorily
Investments Cape convertible 30 Nov
Limited Company Town 300 000 1 Dec unsecured 20.16 2
QUESTION 25 Page 5 of 9

Notes

1. On 1 April 20.12 Ilayimi appointed two new executive directors. The directors’ remuneration
packages were structured as follows:

J Stein
Basic remuneration R1 020 000 per annum
Ordinary shares issued as joining bonus 20 000
Share options with vesting conditions 80 000

M Nthuli
Basic remuneration R1 015 000 per annum
Ordinary shares issued as joining bonus 30 000
Share options with vesting conditions 60 000

Vesting conditions

Share options with an exercise price of R50 per share were granted to the directors on
1 April 20.12 that will vest on 31 March 20.16 if the directors are still in the service of Ilayimi
and the share price of Ilayimi shares exceeds R121 per share on 31 March 20.16.

Both Mr Stein and Mr Nthuli were still in the service of Ilayimi on 31 December 20.12 and it
is expected at year end that both of them will still be in the service of Ilayimi on the vesting
date.

The fair value per share option on 1 April 20.12, as calculated by an actuary, amounted
to R46 per share option. The fair value of R46 per share option takes into account the
probability of the Ilayimi share price exceeding R121 per share on 31 March 20.16 (which
is the market condition in terms of the share option agreement).

Conditions at year end

On 1 December 20.12 the executive directors announced that Ilayimi had entered into a
supply contract with a limestone quarry in the Gope area in Botswana. This limestone quarry
will supply Ilayimi with both high-calcium limestone and dolomitic limestone. This
announcement had a positive impact on the share price of Ilayimi.

The share price on 31 December 20.12 was R124 per share and the average share price
from 1 April to 31 December 20.12 was R112 per share.

2. To fund the construction of a new crushing plant at the limestone quarry in Gope, Botwsana,
Ilayimi issued 300 000 6% debentures with a nominal value of R100 each to Star
Investments Limited on 1 December 20.12. Each debenture is mandatorily convertible into
one ordinary share and the initial conversion price was set at R100 per share. There is no
option for cash settlement. Interest of R108 000 (after tax) was correctly expensed in profit
or loss.
QUESTION 25 Page 6 of 9

3. On 30 June 20.12 Ilayimi issued 125 000 ordinary shares for a cash consideration of
R12 500 to the Ilayimi Tribal Trust, a community trust that benefits the Selwane and Majeje
tribes.

The Ilayimi Tribal Trust is part of Ilayimi’s corporate social responsibility programme and is
aimed at helping local communities in the Mokopane are to become self-reliant through
sustainable development programmes. An IFRS2 expense was correctly recognised in the
financial records of Ilayimi for this transaction. In terms of the trust deed, Ilayimi Ltd controls
100% of the trust. In terms of IFRS10 Consolidated Financial Statements, the trust qualified
for consolidation into the Ilayimi Ltd Group and has been correctly accounted for in the group
accounting records.

4. The consolidated profit attributable to the owners of the Ilayimi Ltd Group (after taking into
account the above transactions) was R12 656 775 for the year ended 31 December 20.12
and includes profit after tax from discontinued operations of R33 275.

REQUIRED: Marks

Prepare the earnings per share information to be presented and disclosed in the
consolidated financial statements of the Ilayimi Ltd Group for the year ended
31 December 20.12 [18]

Communication skills: Presentation and layout [1]

Please note:

~ Comparatives are not required.

~ Ignore any normal income tax implications
~ Ignore any Value Added Taxation (VAT) implications
~ Your answer must comply with International Financial Reporting Standards (IFRS)

SAICA ITC Exam - January 2011 (adapted)

EXAM TECHIQUE

Please ensure that you understand the difference between presentation and disclosure
of earnings per share. In this question both the presentation and disclosure are required.
Please do not waste time in a test or exam by preparing information that is not required
QUESTION 25 Page 7 of 9

Part 5

Ignore Value-Added Tax (VAT)

You have recently been appointed as the assistant financial manager of Glasgow Ltd (‘Glasgow).
In this role you have been allocated the responsibility for the preparation of the consolidated
annual financial statements for the financial year ended 30 September 2014 (‘FY2014’). Glasgow
was incorporated in South Africa in 1963 and it listed on the Johannesburg Stock Exchange in
2002. Glasgow has established itself as the leading manufacturer, distributor and recycler of
glass products in and around sub-Saharan Africa and supplies a wide range of customers.

The chairman of Glasgow’s remuneration committee, Mr Severus Brickett, has drafted a revised
group remuneration policy in the hope of motivating, attracting and retaining talent throughout the
Glasgow group. In order to implement the revised remuneration policy, Glasgow entered in
several transactions during the course of the financial year. These transactions have been
summarized below to assist you in finalising the consolidated annual financial statements for
FY2014.

The following is an extract from the preliminary consolidated statement of comprehensive income
of the Glasgow group for FY2014:

R’000
Profit before tax 252 000
Income tax expense (70 560)
Profit for the period 181 440

Attributable to
Equity holders of the parent 132 480
Non-controlling interest 48 960
181 440

1. An overview of Glasgow’s share register on 30 September 2013 revealed that its issued
share capital consisted of 20 million ordinary shares with no par value.

2. The impact of the transactions in notes 3 and 4 below are not reflected in the preliminary
consolidated statement of comprehensive figures provided above.

3. Group share incentive scheme

The following emerged from an overview of the minutes of Glasgow’s annual general
meeting of shareholders held on 15 January 2014:

3.1 The shareholders approved the establishment of an employee share option scheme for the
15 executive directors of Glasgow. On 1 February 2014, 1000 000 ordinary share options,
with a strike price of R30 per option, were granted to each of the executive directors. This
was conditional upon them remaining in the employ of Glasgow until 31 January 2017. On
grant date, Glasgow determined the fair value per share option to be R15. The terms of the
options do not create an entitlement to a strike price adjustment in the event of a rights
issue by Glasgow.

3.2 Glasgow purchased 1 500 000 of its own ordinary shares on 15 March 2014. Glasgow will
use these shares to settle the share option upon exercise.
QUESTION 25 Page 8 of 9

3.3 The weighted average market price of Glasgow’s ordinary shares form grant date to year
end was R42 per share. On 30 September 2014 the remuneration committee approved a
reduction in the strike price per option from R30 to R25 to compensate the executive
directors for their non-participation in the rights issue (see par 5). The service condition
remained unchanged. No further approval was required for these changes. Glasgow
estimated the fair value per share option at 30 September 2014 to be as follows:

Fair value (original terms) Fair value (revised terms)

R9 R12

3.4 One executive director resigned during July 2014. No further resignations are expected for
the foreseeable future.

4. Investment in Greentech

On 1 October 2013 Glasgow obtained an 80% shareholding (comprising 1 200 000 shares)
in and control over Green Technologies (Pty) Ltd (‘Greentech’). The purchase
consideration was agreed as follows:

4.1 R5 million paid in cash on 1 October 2013.

4.2 The purchase agreement stipulates that should the profit after tax of Greentech increase by
at least 5% per annum for each of the three years following the acquisition, the seller would
receive 200 000 ordinary shares in Greentech in three years’ time.

4.3 Greentech’s profit after tax was as follows:

Profit after tax

Year-ended 30 September R
2011 605 000
2012 650 000
2013 710 000
2014 750 000

5. Rights issue

On 1 August 2014 Glasgow issued 4 625 000 ordinary shares as a result of a one for four
rights issue at R32 per share. Glasgow did not exercise its rights with regard to the
purchased treasury shares. The fair value per share on the date of the rights issue (and
immediately prior to the rights issue) was R37.75.

6. Other information

The closing market price of Glasgow’s ordinary shares as at 30 September 2014 was
R35 per share.
QUESTION 25 Page 9 of 9

REQUIRED: Marks

With regard to the Glasgow group’s consolidated annual financial statements for
FY2014 –

~ calculate the basic earnings per share;

~ calculate the diluted earnings per share; and
~ provide the required reconciliations in terms of par 70(a) and 70(b)
of IAS33 Earnings per Share [38]

Communication skills – presentation [2]

Total [40]
QUESTION 25 (Suggested Solution) Page 1 of 14

Part 1

DAGMAR LTD

STATEMENT OF PROFIT AND LOSSES AND OTHER COMPREHENSIVE INCOME FOR

THE YEAR ENDED 31 DECEMBER 20.12
Note 20.12

Basic earnings per share 5

a
- Profit attributable to ordinary equity holders 0,96 1

Diluted earnings per share 5

b
- Profit attributable to ordinary equity holders 0,94 1

a R12 464 350 / 13 024 999 = R0,96

b R12 614 350 / 13 399 999 = R0,94

DAGMAR LTD
NOTES FOR THE YEAR ENED 31 DECEMBER 20.12

5. Earnings per share

Reconciliation of numerators used for basic and diluted earnings per share
R

Profit attributable to the parent entity for the period 13 114 350 0,5
c
Preference dividends (R150 000 + R500 000 (given)) (650 000) 3,5
Numerator for basic earnings for the period 12 464 350
c
Preference dividends saving on convertible preference shares 150 000 1
Numerator for diluted earnings per share 12 614 350

Reconciliation of denominators used for basic and diluted earnings

per share Shares

Weighted average number of shares used for basic earnings per share [C1] 13 024 999 9,5
Convertible preference shares [C3] 375 000 2,5
Weighted average number of shares used for diluted earnings per share 13 3999 999

c (R2 000 000 x 8% x 9 / 12) + (R2 000 000 x 75% x 8% x 3 / 12) = R150 000
(The 8% dividend is cumulative, therefore included even though not declared)
Total 18
Communication skills: Presentation and layout 2

CLASSIFICATION OF PREFERENCE SHARES

8% non-redeemable cumulative convertible shares:

Classified as equity because the principle amount is not redeemable and preference dividends
are payable at the discretion of Dagmar Ltd, even though it is cumulative.

5 000 000 redeemable cumulative preference shares:

Classified as equity because the preference shares are redeemable at the option of Dagmar Ltd
and the preference dividends are payable at the discretion of Dagmar Ltd
QUESTION 25 (Suggested Solution) Page 2 of 14

CALCULATIONS

C1. Weighted average number of shares for basic earnings per share (denominator)

Rights issues Rights EXERCISED Issue for cash Prefs converted YEAR-END
1/01/20.12 11/05/20.12 1/06/20.12 30/07/20.12 30/09/2012 31/12/2012

Shares 10 000 000

Adjustment factor
1,07
Total 10 700 000 Shares 10 000 000
Rights issue 2 500 000
Total 12 500 000 Balance 12 500 000
Issue 3 000 000
Total 15 500 000 Balance 15 500 000
Converted 100 000
Total 15 600 000

5 months 2 months 2 months 3 months

Shares Adjustment Fraction Weighted

Outstanding t factor of year average
shares

1 Jan – 1 Jun 20.12 10 000 000 [C2]1.07 5 / 12 4 458 333 1

d
Rights exercised on 1 June 20.12 2 500 000
From 1 June – 31 Jul 20.12 12 500 000 - 2 / 12 2 083 333 1
Issue for cash on 31 Jul 20.12 3 000 000
From 31 Jul – 30 Sep 20.12 15 500 000 - 2 / 12 2 583 333 1
e
25% of PS converted on 30 Sep 20.12 100 000
From 30 Sep – 31 Dec 20.12 15 600 000 - 3 / 12 3 900 000 1
13 024 999

d 10 000 000 / 4 = 2 500 000 ordinary shares

e 2 000 000 / 5 = 400 000.
400 000 x 25% = 100 000 ordinary shares
4

C2. Rights issue

Calculation of theoretical ex-right value per share

[Fair value of all outstanding shares before the exercise of rights + total received from exercise of rights] /
[Numbers of shares outstanding before exercise + number issues in the exercise]

= [(10 000 000 x R9 = R90 000 000) + (10 000 000 shares / 4 = 2 500 000 x R6 = R15 000 000)] / 2,5
[10 000 000 + 2 500 000] 1

= R105 000 000 / 12 500 000 shares

= 8,40 Theoretical ex-right value per share

Calculation of adjustment factor 1

R9 / 8,40 = 1,07 (rounded to decimals)
QUESTION 25 (Suggested Solution) Page 3 of 14

RIGHTS ISSUE

For companies listed on the exchange operated by the JSE Limited, rights trade separately from
the shares from shortly after the rights issue has been announced. Shareholders will then have a
period of three weeks to decide whether to exercise their rights or not. The fair value of the share
at the close of the last day that the shares trade together with the rights must be used to calculate
the bonus element.

3. Test for dilution

Increase Increase in Earnings per
earnings number of incremental
ordinary share
shares

8% convertible preference
c f
shares(IAS33.58) 150 000 375 000 0,40 2,5
Dilutive as
less than
R0,96

f (2 000 000 / 5 x 9 / 12) + ((2 000 000 x 75%) / 5 x 3 / 12) = 375 000 shares
QUESTION 25 (Suggested Solution) Page 4 of 14

Part 2

BETA LTD

STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.5

Note R

Profit for the year 722 200

Basic earnings per share 6

Profit from continued operations attributable to ordinary equity holders [W1] R1,33
Profit from discontinued operations [(161 389 - 79 722) x 72%] / 500 000 R0,11
Profit attributable to ordinary equity holders [W1] R1,44

Diluted earnings per share 6

Profit from continuing operations attributable to ordinary equity holder [W2] R1,32
Profit from discontinued operations [(161 389 - 79 722) x 72%] / 503 030 R0,12
Profit attributable to ordinary equity holders [W2] R1,44

BETA LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.5

6. Earnings per share

Reconciliation of numerators used for basic and diluted earnings per share
R

Profit attributable to the parent entity 722 200

Preference dividends -
Numerator for basic and diluted earnings for profit for the period 722 200
Profit from discontinued operations (161 389 - 79 722) x 72% (58 800)
Numerator for basic and diluted earnings for profit from continuing operations 663 400

Reconciliation of denominators used for basic and diluted earnings per share Shares

Number of shares for diluted earnings per share 500 000

Options 3 030
Number of shares for diluted earnings per share 503 030

7. Headline earnings per share

Headline earnings excludes all items of a capital nature and represents an after-tax amount.

Headline earnings per share [W3] R1,47

Diluted headline earnings per share [W3] R1,46
QUESTION 25 (Suggested Solution) Page 5 of 14

Reconciliation and headline earnings

Gross Net
R R

Earnings attributable to the owners of parent entity 924 200 722 200
Plus: Impairment loss on disposal group 79 722 57 400
Less: Fair value adjustment on investment properties:
- Land (25 000) (18 000)
- Building (8 000) (5 760)
Plus: Impairment loss on goodwill 5 000 3 600
Less: Remeasurement included in equity accounted earnings (6 000) (4 320)
Less: Gain on sale of land (66 000) (47 520)
Plus: Impairment loss on plant 35 000 25 200
Headline earnings 732 800

WORKINGS

W1. Basic earnings per share

Profit from continuing operations:

Profit for the year 722 200
Operating profit of discontinued operation (161 389 x 72%) (116 200)
Loss on discontinuance of operation (79 722 x 72%) 57 400
663 400

Basic earnings per share:

Profit from continuing operations (663 400 / 500 000) R1,33

Profit for the period (722 200 / 500 000) R1,44

W2. Diluted earnings per share

Number of shares 1 January 20.11 (given) 500 000

Options [100 000 x (5,5 - 5)] / 5,5 x 4 / 12 3 030
503 030

Diluted earnings per share:

Profit from continuing operations (663 400[W1] / 503 030) R1,32

Profit for the year (722 200 / 503 030) R1,44

W3. Headline earnings per share

Headline earnings (732 800 / 500 000) R1,47

Diluted headline earnings (732 800 / 503 030[W2]) R1,46
QUESTION 25 (Suggested Solution) Page 6 of 14

Part 3

PRADE LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE

YEAR ENDED 28 FEBRUARY 20.12

20.12
Note R
Basic earnings per share 5
a
- Profit attributable to ordinary equity holders R3.00 1

Diluted earnings per share 5

b
- Profit attributable to ordinary equity holders R2.93 1

a R36 000 000 (given) / 12 000 000 (given) = R3.00

b R36 094 677 (note 5) / 13 003 702 (note 5) = R2.93

PRADE LTD

NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.12

5. Earnings per share

Reconciliation of numerators used for basic and diluted earnings per share

R
Profit attributable to the ordinary equity holders (given) 36 000 000 0.5
Preference dividends -
Numerator for basic earnings for the period 36 000 000
After tax interest saving on 10% convertible bonds [C5] 2 094 677 3.5
Numerator for diluted earnings per share 38 094 677

Reconciliation of denominators used for basic and diluted earnings per share

Shares
Weighted average number of shares used for basic earnings per share
(given) 12 000 000 0.5
Share option [C5] 3 702 8
10% convertible bonds [C5] 1 000 000 1.5
Weighted average number of shares used for diluted earnings per share 13 003 702
Total 16
CALCULATIONS

C1. Debt and equity components of the convertible bonds on 1 March 20.10
C
Liability component 23 878 524
Equity component (balancing figure) 1 121 476
Total proceeds on issue 25 000 000

c N = 4 years
I = 12% (market related interest rate)
PMT = R2 500 000 (10 000 bonds x R2 500 x 10%)
FV = R25 625 000 (10 000 bonds x 2 500 x 102.5%)
PV = R23 878 524
QUESTION 25 (Suggested Solution) Page 7 of 14

C2. Interest expense recognized in P/L for the convertible bonds for the year ended
28 February 20.12

After tax interest (2 Amort (interest)) [C1] (R2 909 274 x 72%) 2 094 677 1.5
Alternative calculation of interest:
Capital balance on 1 March 20.11:
R23 878 524 [C1] + (R23 878 524 x 12%) – R2 500 000
= R24 243 947
Interest expense R2 909 274 (R24 243 946 x 12%)

C3. Share options issued to managers

SHARE BASED PAYMENT TRANSACTION WITH SERVICE CONDITION

The vesting condition is a service condition of three years and in terms of IAS33.47A the
issue price (for the purpose of calculating diluted earnings per share) must include services
to be supplied by the managers to Prade before the share options vest (calculated below in
[C3.1]).

IAS33.48 states that share options with fixed terms (a service condition is a fixed term) are
treated as options in the calculation of diluted earnings per share. Refer to IAS33 illustrative
example 5A.

C3.1 Value of services yet to be rendered by the managers (unrecognized IFRS2 expense)

Value of original share options issued:

R15 per share option (fair value on issue) x 100 options per manager
x 700 managers x 2 / 3 years remaining 700 000 2
Incremental value of modification:
d
R9 per share option x 100 options per manager x 700 managers
e
x 24 / 26 months remaining 581 538 2
Total value of services yet to be rendered 1 281 538

d R13 per share option (after the option was repriced) – R4 per share option
(before repricing) = R9 per option
e 10 months of the three year term (36 months) have lapsed by 1 January 20.12. The
modification must be recognised over the 26 remaining months. As at 28 February
20.12, two months of the remaining 26 months have lapsed and only 24 months remain.

C3.2 Assume total proceeds from share options

Total exercise price to be paid by the managers

(R12 x 100 options x 700) 840 000 1
Total value of services yet to be rendered [C3.1] 1 281 538
2 121 538 0.5

C3.3 Number of ordinary shares to be used in diluted earnings per share

Number of shares under option (100 x 700 managers) 70 000 1

Number of shares that would have been issued at the average market
price for the year (R2 121 538 [C3.2] / R32) 66 298 1
Share options issued for no consideration (given) 3 702
7.5
QUESTION 25 (Suggested Solution) Page 8 of 14

The alternative calculate of “share options issued for no consideration” is shown below
(refer IAS33 IE5A).

Exercise price to be paid by managers 12 0000

Fair value of service yet to be rendered 18,3077

- original transaction (R15 x 24 / 36) 10,0000
- repriced transaction (R9 x 24 / 26) 8,3077
Total exercise price 30,3077

Average market price per for the financial year R32,00

Number of options (100 x 700) 70,000
Number of options issued for no consideration
[70 000 x ((32,00 – 30,3077) / 32)] 3,702

C4. Test for dilution and sequence of dilution

Increase in
number of Earnings Order in
Increase in ordinary per which to
earnings shares incremental include
share*
[C2] f
10% convertible bonds 2 094 677 1 000 000 2.09 Dilutive 2 1
[C3.3]
Share options Rnil 3 702 Rnil Dilutive 1

* The incremental earnings per share is dilutive if it is less than R3.00

f 10 000 bonds x 100 shares = 1 000 000

10% CONVERTIBLE BONDS

The convertible bonds may be settled in cash or shares at the option of the holder.
IAS33.60 states that the more dilutive of cash or shares settlement must be used in dilutive
earnings per share. The required of this question states that you must assume that the
shares option is more dilutive and therefore the share option is used in the calculation of
diluted earnings per share.

It is highly unlikely that the option to convert the bonds into cash will ever be dilutive. In
addition, the cash option will never be more dilutive than the shares option, because the
number of shares are not increased when the cash option is selected.

If you are advised in a question that the share option is more dilutive than the cash option
(if the holder has the option to elect cash or shares), it is not necessary to perform a
calculation to prove that the shares option is more dilutive.

C5. Diluted earnings per share

Profit from
continuing
operation (control Ordinary Per
number) shares share
Basic earnings per share 36 000 000 12 000 000 3.000
[C4] [C4]
Share options (1) - 3 702
36 000 000 12 003 702 2.999 Dilutive 0.5
[C4] [C4]
10% convertible bonds (2) 2 094 677 1 000 000
38 094 677 13 003 702 2.93 Dilutive 0.5
QUESTION 25 (Suggested Solution) Page 9 of 14

Part 4

ILAYIMI LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

FOR THE YEAR ENDED 31 DECEMBER 20.12

20.12
Note R
Basic earnings per share 6
a
- Profit from continuing operations attributable to ordinary equity holders 9.60 1
b
- Profit from discontinued operations 0.03 1
c
- Profit attributable to ordinary equity holders 9.63 1

Diluted earnings per share 6

d
- Profit from continuing operations attributable to equity holders 9.44 1
e
- Profit from discontinued operations 0.02 1
f
- Profit attributable to ordinary equity holders 9.46 1

a R12 623 500 (note 6) / 1 314 500 (note 6) = R9.60

b R33 275 (note 6) / 1 314 500 (note 6) = R0.03
c R12 656 775 (note 6) / 1 314 500 (note 6) = R9.63
d R12 623 500 (note 6) / 1 337 586 (note 6) = R9.44
e R33 275 (note 6) / R1 337 586 (note 6) = R0.02
f R12 656 775 (note 6) / 1 337 586 (note 6) = R9.46

ILAYIMI LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12

6. Earnings per share

Reconciliation of numerators used for basic and diluted earnings per share

20.12
R
Profit attributable to the parent entity for the period (given) 12 656 775
Preference dividends -
Numerator for basic earnings for the period 12 656 775 1
Deduct profit from discontinued operations (given) (33 275) 0.5
Numerator for basic earnings from continuing operations 12 623 500
Share options granted to directors [C3] -
Numerator for diluted earnings from continuing operations 12 623 500
Profit from discontinued operations 33 275 0.5
Numerator for diluted earnings for the year 12 656 775

Reconciliation of denominators used for basic and diluted earnings per share

Shares
Weighted average number of shares used for basic earnings
per share [C1] 1 314 500 6
Share options granted to directors [C3] 23 086 6
Weighted average number of shares used for diluted earnings per share 1 337 586
Total 18
Communication skills: Presentation and layout 1
QUESTION 25 (Suggested Solution) Page 10 of 14

CALCULATIONS

C1. Weighted average number of ordinary shares for basic earnings (denominator)

The weighted average number of ordinary shares is illustrated on the time line below:

Issue to directors Issue to trust Compulsorily deb

1 Jan 20.12 1 Apr 20.12 30 Jun 20.12 1 Dec 20.12 31 Dec 20.12

Shares 1 252 000 Shares 1 252 000

Issue 50 000
Total 1 302 000 Balance 1 302 000
Issue 125 000
Treasury (125 000)
Total 1 302 000 Balance 1 302 000
Comp deb 300 000
Total 1 602 000

3 months 3 months 5 months 1 month

Weighted
Shares Fraction average
Dates outstanding of year shares
1 Jan 20.12 – 1 Apr 20.12 (given) 1 252 000 3 / 12 313 000 1
Share issued to directors 50 000
1 April 20.12 – 30 Jun 20.12 1 302 000 3 / 12 325 500 1
Issue share to trust on 30 Jun 20.12 125 000
Shares to trust treated as treasury shares (125 000)
1 Jun 20.12 – 1 Dec 20.12 1 302 000 5 / 12 542 500 1
Issue compulsorily convertible debentures
on 1 Dec 20.12 300 000
1 Dec 20.12 – 31 Dec 20.12 1 602 000 1 / 12 133 500 1
1 314 500
4

SHARES ISSUED TO ILAYIMI TRIBAL TRUST

The trust holds shares in Ilayimi Ltd which is the parent company of the trust. The trust is
consolidated into the Ilayimi Ltd Group. Upon consolidation, the shares held by the trust in the
parent company must be deducted from equity as treasury shares (IAS32.33). Treasury shares
are not regarded as outstanding shares of the Ilayimi Ltd Group and must be excluded from the
calculation of the consolidated earnings per share.
QUESTION 25 (Suggested Solution) Page 11 of 14

Alternative method

Weighted
Shares Fraction average
Dates outstanding of year shares
1 Jan 20.12 Opening balance (given) 1 252 000 1 252 000
1 April 20.12 Shares issued to directors 50 000 9 / 12 37 500
30 Jun 20.12 Issue share to trust 125 000 6 / 12 62 500
Shares to trust treated as
treasury shares (125 000) 6 / 12 (62 500)
1 Nov 20.12 Issue compulsorily convertible
debentures 300 000 1 / 12 25 000
1 602 000 1 314 500

IAS33.20 The time-weighting factor is the number of days that the shares are
outstanding as a proportion of the total number of days in the period

C2. Share options granted to directors

SHARE BASED PAYMENT WITH MARKET (PERFORMANCE) CONDITION

In terms of IAS33.48, share options with a performance condition must be treated as contingently
issuable shares for diluted earnings per share because their issue is contingent upon satisfying a
specified condition in addition to the passage of time. At year end the share price is R124 per
share which is more than R121 of the share price target that need to be met. The potential
ordinary shares are therefore included in diluted earnings per share because the performance
condition has been satisfied at 31 December 20.12 (IAS33.52)

C2.1 Value of service yet to be rendered by directors (IAS33.47A)

(unrecognized IFRS2 expense)

R
Total value of share options granted on 1 April 20.12
((60 000 + 80 000) x R46) 6 440 000 1.5
Recognised as an IFRS2 expense on 31 Dec 20.12
(6 440 000 / 4 years x 9 / 12) (1 207 500) 1.5
5 232 500

C2.2 Assumed total proceeds from share options

R
Total exercise price to be paid by the directors
((60 000 + 80 000) x R50) 7 000 000 1
Total value of future services yet to be rendered [C2.1] 5 232 500 1
12 232 500
QUESTION 25 (Suggested Solution) Page 12 of 14

C2.3 Number of ordinary shares to be used in diluted earnings per share

Number of shares under option (80 000 + 60 000) 140 000

Number of shares that would have been issued at the average market
price for the year (R12 232 500 [C2.2] / R112) (109 219) 1
Share options issued for no consideration (no value) 30 781

Weighted for 9 / 12 23 086

6

Alternative calculation

Exercise price paid by the directors 50

Fair value of service yet to be rendered (R46 x 39 / 48) 37.3750
Total exercise price 87.3750

Average mark price per share for the financial year R112
Number of options (80 000 + 60 000) 140 000
Number of options issued for no consideration
(140 000 x (112 – 87.3750) / 112) x 9 / 12 23 086

C3. Test for dilution

Increase Increase in Earnings per

in number of incremental
earnings ordinary shares share
[C2.3]
Share options to directors Rnil 23 086 0 Dilutive
QUESTION 25 (Suggested Solution) Page 13 of 14

Part 5

With regard to the Glasgow group’s consolidated annual financial statements for FY2014 –

~ calculate the basic earnings per share;

~ calculate the diluted earnings per share; and
~ provide the required reconciliations in terms of par 70(a) and 70(b)
of IAS33 Earnings per Share

1. Profit or loss attributable to the parent entity – EPS (C1) 128 413 333 1
Dilutive items
Contingent Shares: Decreased profit after tax from Greentech (C2) (70 575) 1
Profit or loss attributable to the parent entity – DEPS 128 342 758

2. Weighted average number of ordinary shares (C3) 20 545 312 1

Dilutive items
Share-based payment options (C4) 51 778 or 1
7 333
Total diluted WANOS 20 545 312 + 51 778 = 20 597 090 or
20 545 312 + 7 333 = 20 552 645

Earnings per share 128 413 333 ÷ 20 545 312 = 6.25 1

Profit or loss attributable to the parent entity – EPS 128 413 333
Total WANOS 20 545 312

Diluted Earnings per share 128 342 758 ÷ 20 597 090 R6.23 or 1
128 342 758 ÷ 20 552 645 R6.24
Profit or loss attributable to the parent entity – DEPS 128 342 758
Total diluted WANOS 20 597 090 or
20 552 645

Calculation 1: Profit or loss attributable to the parent entity – EPS

Profit attributable to ordinary shareholders of the parent 132 480 000 1

Share-based payment expense
Original grant: 100 000 (1) Options x 14 (15 – 1) (1) x 8 / 36 (1) x R15 (1) (4 666 667) 4
Modification: No impact in current reporting period (applied Prospectively) -
Tax on share-based payment expense -
Consolidation of profits after tax from Greentech (750 000 x 0.80) 600 000 1
Profit or loss attributable to the parent entity – EPS 128 413 333

Calculation 2: Greentech DEPS impact

Profit after tax has grown by more than 5% per annum in the past and is
expected to be sustained for the foreseeable future. Therefore it is
expected that 200 000 shares in Greentech will be issued 1
Total shares after issue in Greentech (1 200 000 / 80%) (1) + 200 000 (1) 1 700 000 2
Effective holding after issue (1 200 000 / 1 700 000) 70.59% 1
Decrease in Profit after Tax (600 000 – (600 000 / 80% x 70.59%)) or 70 595 1
(750 000 x (80% - 70.59%)
QUESTION 25 (Suggested Solution) Page 14 of 14

Calculation 3: WANOS and rights issue

Theoretical ex-price per share (18 500 000 (20 000 000 – 1 500 000) (1) x
37.75 (1) + (4 625 000 (1) x 32 (1) / 23 125 000 (1) 36.6 5
Adjustment factor (37.75 / 36.64) 1.03 1
Ordinary shares before rights issue 20 000 000 1
Treasury shares before rights issue (1 500 00 x 4.5 / 12 (1)) (562 500) 1
Ordinary shares outstanding before rights issue 19 312 500

Adjusted ordinary shares before rights issue

(19 312 500 x 1.03 (1P)x 10 / 12 (1)) 16 576 562 1

Ordinary shares after rights issue 24 625 000 1

Treasury shares after rights issue (1 500 000 x 6.5 / 12) (812 500) 1
Ordinary shares outstanding after rights issue 23 812 500
Time weighted (23 812 500 x 2 / 12 (1)) 3 968 750 1

Total WANOS (16 576 562 + 3 968 750) 20 545 312 1

Calculation 4A: Share-based payment options – view 1

(Ignore the modification as the time weighting is effectively 0 / 12 given that

the scheme was altered at year end)
Weighted average market price of ordinary shares from grant date
to year end 42.00 1
Original strike price (30.00) 1
Future IFRS2 charges:
Original grant: R15 x 28 / 36 (1) (11.67) 1
Intrinsic value 0.33 1

Total shares (R0.33 x 100 000 Options (1) x 14 (15 – 1) / R42) (1) 11 000 2
Time weighted (11 000 x 8 / 12 (1)) 7 333 1

Calculation 4B: Share-based payment options – view 2

(Ignore the modification and impact on DEBS)

Weighted average market price of ordinary shares from grant date
to year end 42.00 1
Modified strike price (25.00) 1
Future IFRS2 charges:
Original grant: R15 x 28 / 36 (1) (11.67) 1
Modification: R3 (R12 – R9) (1) x 28 / 28 (1) (3.00) 2
Intrinsic value 2.33 1

Total shares (R2.33 x 100 000 Options (1) x 14 (15 – 1) / R42) (1) 77 667 2
Time weighted (77 667 x 8 / 12 (1)) 51 778 1
Available 40
Max 38
Communication skills: presentation and layout 2
Total 40
QUESTION 29 Page 1 of 5

Unisoccer Ltd is a company listed on the exchange operated by the JSE Limited. The company
performs promotional and advertising work for major soccer events. The financial manager has
prepared the following summarised draft trial balance for the year ended 30 June 20.11. The
notes indicate how various items have been processed in the summarised draft trial balance.

SUMMARISED DRAFT TRIAL BALANCE AS AT 30 JUNE 2009

Dr Cr
Notes R R
Land (Carrying amount 01/07/20.10) 2 1 200 000
Commercial buildings (Carrying amount 01/07/20.10) 2 3 377 778
Plant at cost 1 1 100 00
Furniture, fittings and vehicles
(Carrying amount 30/06/20.11) 3 1 728 500
Investment in associate 4 490 000
Inventories 556 500
Trade and other receivables 3 250 000
Cash and cash equivalents 5 15 414 722
Share capital (01/07/20.10) 5 12 000 000
Non-cumulative non-redeemable preference shares 11 1 500 000
Retained earnings (01/07/20.10) 4 360 800
Revaluation surplus (01/07/20.10) 2 987 808
Actuarial loss on defined benefit plan 8 98 000
Short-term borrowings 1 1 100 000
FEC asset / liability 6 - -
Compulsory convertible debentures 7 3 000 000
Defined benefit liability 8 34 000
Deferred tax liability (30/06/20.11) 10 824 497
Trade creditors 290 600
Other creditors: SARS (current tax) 548 500
Income tax expense (current and deferred tax) 9 1 097 055
Profit before tax 4 172 600
Dividends paid 11 506 250 ________
28 818 805 28 818 805

Notes:

1. Unisoccer Ltd decided on 1 November 20.10 to erect a new plant to be used to manufacture
memorabilia for major soccer events. The contract for the construction of the plant was
concluded with a third party for R1 100 000. The construction of the plant was completed
and available for use on 1 May 20.11. A specific loan of R1 100 000 was raised on
1 November 20.10 from the government for the construction of the plant at an pre-tax interest
rate of 10%per annum, which is calculated on an annual basis. Assume that a pre-tax
interest rate of 12% per annum is regarded as a market-related interest rate on 1 November
20.10. The loan capital and the interest accrued were repaid on 31 October 20.11. Surplus
funds were invested on a temporary basis and interest of R49 200 was earned until 1 May
20.11. The loan form government is treated the same for accounting and tax purposes.

The only journal entry processed in respect of this first revaluation was as follows:

Dr Cr
1 November 20.10 R R
Bank (SFP) 1 100 000
Specific loan from government (SFP) 1 100 000
Specific loan raised for construction of plant
QUESTION 29 Page 2 of 5

It is the policy of Unisoccer Ltd to account for any government grants as a deduction from the
related asset. Any difference between amounts received from government and the fair value
of the loan is taxable by the SARS when the loan is obtained.

Depreciation on the newly erected plant is calculated at 20% per annum on the straight-line
method and is allocated pro rata for a portion of a year. The SARS granted a section 12C
deduction of 40% per annum on the plant for the first year and 20% per annum on the
subsequent three year without any apportionment for part of a year. The residual value of the
new plant is Rnil. The financial manager has not yet accounted for the depreciation on the
new plant

2. It is Unisoccer Ltd's policy to revalue their land and commercial buildings according to the
revaluation model. The first revaluation was done on 1 July 20.8 and it was determined on
this date that the useful life of the building was unchanged. Assume that the residual values
are immaterial. The company realizes the revaluation surplus only when the assets are sold or
derecognised.

The journal entry processed in respect of this first revaluation was as follows:

Dr Cr
1 July 20.8 R R

Commercial buildings at revaluation model (SFP) 3 800 000

Accumulated depreciation of commercial buildings (SFP) 320 000
Commercial buildings at cost (SFP) (Purchase date 1 July 20.6) 3 200 000
Revaluation surplus (OCI) 920 000
Revaluation of commercial buildings

Revaluation surplus (OCI) 257 600

Deferred tax (SFP) (R920 000 x 28%) 257 600
Deferred tax on revaluation surplus on commercial buildings

Land at revaluation (SFP) 1 200 000

Land at cost (SFP) (purchase date 1 July 20.6 and base cost) 800 000
Revaluation surplus (OCI) 400 000
Revaluation of land

Revaluation surplus (OCI) 74 592

Deferred tax (SFP) (R400 000 x 66.6% x 28%) 74 592
Deferred tax on revaluation surplus on land

On 1 July 20.9 the revaluation was performed by Valuers Inc and the fair value of the land
and commercial buildings were similar to their carrying amounts on1 July 20.9. As a result no
revaluation journals were passed. The useful life of the buildings remained the same and the
residual values remained immaterial.

The valuation on 1 July 20.10 was also performed by Valuers Inc, on which date the useful
life of the building remained unchanged and the residual values remained immaterial.
Valuers Inc determined the market value of the land and commercial buildings as R900 000
and R3 100 000 respectively. The SARS allows a section 13 deduction of 5% per annum on
the commercial buildings, without any apportionment for part of a year. The financial
manager has not processed any journal entries relating to the revaluation and depreciation of
the land and commercial buildings for the year ended 30 June 20.11.
QUESTION 29 Page 3 of 5

3. Unisoccer Ltd subsequently measures furniture, fittings and vehicles using the cost model.
The depreciation expense for the year ended 31 June 20.11 for furniture, fittings and vehicles
is the same as the wear-and-tear allowance granted by the SARS and the depreciation
expense is correctly included in profit before tax.

4. Unisoccer Ltd acquired a 25% interest in Creative Shirts Ltd on 1 July 20.10, at a cost of
R490 000 ($70 0000). Unisoccer Ltd has the power to participate in the financial and
operating policy decision in terms of Creative Shirts Ltd and Creative Shirts Ltd is an
associate of Unisoccer Ltd in terms of IAS28 Investments in Associates and Joint Ventures.
Creative Shirts Ltd’s business is to design and print shirts as requested by clients. Creative
Shirts Ltd has a functional currency of US$. The statement of financial position of Creative
Shirts Ltd reflected net assets with a carrying amount of $175 000 at acquisition date. All
assets and liabilities were fairly valued, except for land that was undervalued by $2 500.
It is the policy of Unisoccer to account for investments in associates at cost in its separate
financial statements. The profit (earned evenly throughout the year) after local income taxes
of Creative Shirts Ltd for the year ended 30 June 20.11 was $45 000. No dividends were
declared by Creative Shirts Ltd for the year ended 30 June 20.11. Assume that the tax base
of the investment in associate for deferred tax purposes is R490 000 and that the entire
temporary difference is subject to normal income tax.

5. On 1 July 20.10 Unisoccer Ltd had 5 000 000 ordinary shares in issue. Unisoccer Ltd bought
back 500 000 ordinary share at the 30-day average market price of R7 per share on 1 April
20.11. In 1 June 20.11 a capitalisation issue took place at a ratio of one ordinary share for
every four ordinary share held at that date. The financial manager has not processed any
journals in respect of the share buy-back and the capitalisation issue.

6. Unisoccer Ltd placed a cancellable order to purchase mini soccer balls (inventory) to the
value of $120 000 on 1 May 20.11. On the same date Unisoccer Ltd entered into a nine-
month forward exchange contract (FEC) for the same amount in order to hedge itself against
fluctuations in the exchange rates. The hedge meets all the qualifying hedge criteria for
hedge accounting in terms of IFRS9.6.4.1. Assume that the hedge is 100% effective for the
entire duration of the hedge.

Unisoccer Ltd designated the hedge relationship as the changes in the entire fair value of the
FEC to offset the changes in the future cash flow of the highly probably forecast transaction,
and the changes in the fair value of the resulting payable due to changes in the forward
exchange rates.

The inventory was shipped free on board on 1 September 20.11 and the foreign creditor is
payable on 31 January 20.12.

The following exchange rates are applicable:

Spot rate Forward rate

$1=R $1=R
1 May 20.11 7.85 7.95 (9 months FEC)
30 June 20.11 7.90 7.99 (7 months FEC)
30 June 20.11 7.90 8.05 (9 months FEC)
1 September 20.11 7.95 8.01 (5 months FEC)
1 September 20.11 7.95 8.07 (9 months FEC)
Average (1 July 20.10 – 30 June 20.11) 7.70

Any fair value adjustments on the FEC before transaction date will only be taxable or
deductible for tax purposes when the FEC expires. The financial manager has not
processed any journals relating to the FEC.
QUESTION 29 Page 4 of 5

7. Unisoccer Ltd issued 1 500 000 14% compulsory convertible debentures with a face value
of R2 each on 1 January 20.11. Interest is payable on 31 December each year until
31 December 20.13. The debentures will be converted into Unisoccer Ltd ordinary shares
after three years at a conversion rate of one ordinary share for every debenture held. This
conversion ratio will not be adjusted for any future changes in the issued ordinary share
capital of Unisoccer Ltd. The market interest rate for similar debentures without conversion
rights was 15% on 1 January 20.11. The tax base of the compulsorily convertible debentures
for deferred tax purposes is the total proceeds received on the date of issue. The only
journal passed in relation to the debentures was at initial recognition at the amount shown in
the trial balance

8. Unisoccer Ltd provides post-retirement medical benefits to certain employees. The actuarial
valuation of the company's obligation and plan asset as at 30 June 20.11 revealed that the
present value of the obligation amounted to R3 075 000, while the fair value of the plan
assets amounted to R3 041 000. The remeasurement recognized during the current year on
the defined benefit obligation and plan assets amounted to a loss of R98 000 and arose due
to changes in actuarial assumptions. This loss has been correctly accounted for in the trial
balance.

9. The tax department of Unisoccer Ltd’s audit firm has calculated the income tax expense for
the year and has provided the financial manager with the journal entries for the year to
account for current and deferred tax. You may assume that all the information in this
question was taken into account correctly and that the tax amounts were also calculated
correctly.

10. The tax department did not provide the financial manager with a copy of their deferred tax
calculation. Unisoccer Ltd has no temporary difference other than those apparent from the
information provided in this question. The Minister of Finance announced during his budget
speech in February 20.11 that the normal income tax rate applicable to companies will
decrease from 28% to 27% for financial years starting on or after 1 April 20.11.

11. The 1 500 000 non-cumulative non-redeemable preference shares were correctly classified
as an equity instrument. The directors, at their discretion, resolved to declare preference
dividends of R225 000. The preference dividend were paid on 30 June 20.11 The dividends
paid per the trial balance include dividends paid to both the preference and ordinary
shareholders.

12. 1 500 share options were granted to each of Unisoccer Ltd’s top 100 performing employees
on 1 May 20.11. These options will vest on 30 April 20.14 and are conditional upon
employees still working for the company on that date. During the year ended 30 June 20.11,
17 of the top 100 employees resigned from Unisoccer Ltd. It was estimated that only five
employees will resign in the 20.12 financial year and no other resignations are expects for the
years thereafter. Each share option grants the employee a right to purchase one ordinary
share at R4.40 per share. The average market price of ordinary shares form grant date until
30 June 20.11 was R6.50 per share. Using a pricing model, the fair value of the options was
determined at R1.20 per option on 1 May 20.11 and at R1.60 per option at 30 June 20.11.
The expense relating to the share option scheme is deductible for tax purposes, but only on
vesting date and the tax base as at 30 June 20.11 should be calculated in the same way as
the IFRS2 expense is calculated but using the fair value of the options as at 30 June 20.11.
The financial manager has not processed any journal entries relating to the share option
scheme.
QUESTION 29 Page 5 of 5

REQUIRED: Marks

(a) (i) Process the adjusting journal that will result in the specific loan from
government to be recorded correctly on 1 November 20.10 (refer note 1).
Journal narrations are not required [4]

(ii) Calculate the borrowings cost that will be capitalized to the plant for the year
ended 30 June 20.11. Show all calculations [3]

(b) Provide the journal entries to account for the FEC (refer note 6) for the year ended
30 June 20.11. Tax journals and journal narrations are not required. [3]

(c) Prepare the statement of profit or loss and other comprehensive income of
Unisoccer Ltd Group for the year ended 30 June 20.11 starting with the “profit
before tax” line, using the single statement format. [29]

Communication skills :Presentation and layout [1]

~ The presentation of basic and diluted earnings per share is not required
~ The gross amounts, tax effects and reclassification amounts of each component
of other comprehensive income must be presented separately in the statement
of profit or loss and other comprehensive income
~ Comparative figures are not required

(d) Disclose the deferred taxation note to the annual financial statements of
Unisoccer Ltd Group for the year ended 30 June 20.11. [16]

Communication skills: Presentation and layout [1]

~ Deferred tax must be calculated using the statement of financial position method
~ Accounting policy information and comparative figures are not required

(e) Disclose the earnings per share information in the notes to the annual financial
statements of Unisoccer Ltd Group for the year ended 30 June 20.11. [12]

Communication skills : Presentation and layout

~ Accounting policy information and comparative figures are not required [1]

Please note:

~ Your answers must comply with International Financial Reporting Standards (IFRS)
~ Ignore Value Added Tax (VAT) and Dividend Tax
~ All amounts must be rounded to the nearest Rand
QUESTION 29 (Suggested Solution) Page 1 of 10

Part a (i)
Dr Cr
R R
1 November 20.10
Specific loan from government (SFP) 1 100 000 1
a
Specific loan from government (SFP) 1 080 357 2
Plant at cost (SFP) 19 643 1
Recognize loan at fair value and deduct
government grant from Plant 4

OR
Specific loan form government (SFP) (1 100 000 – 1 080 357) 19 643 3
Plant at cost (SFP) 19 643 1
Recognize loan at fair value and deduct
government grant from Plant
4

a Fair value of the loan from government on

1 November 20.10
N = 1 year 0.5
I = 12% per annum 0.5
PMT = Rnil
FV = R1 210 000 (R1 100 000 + 10% interest) 0.5
PV = R1 080 357
1.5
(ii) Borrowing costs capitalized

1 November 20.10 – 1 May 20.11 (6 months): 64 821 2

Effective interest (R1 080 357 x 12% x 6 / 12) (49 200) 1
Interest received 15 621

Part b – Journal entries for FEC

Dr Cr
R R
1 May 20.11
No entry as the FEC was entered into at fair value

30 June 20.11
J1 FEC asset (SFP) 4 800 1.5
Cash flow hedge reserve (OCI) ($120 000 x (7.99 – 7.95) 4 800 1.5
Recognise FEC at fair value at year end
3
QUESTION 29 (Suggested Solution) Page 2 of 10

Part c

UNISOCCER LTD

CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 30 JUNE 20.11

20.11
R
Profit before tax [C1] 3 927 613 15
Income tax expense (given) (1 097 055) 0.5
PROFIT FOR THE YEAR 2 830 558
Other comprehensive income
Items that will not be reclassified to profit or loss:
Revaluation surplus [C5] (436 968)
Loss on property devaluation [C5] (577 778) 2
Tax expense [C5] 128 946 1.5
Change in tax rate [C5] 11 864 4.5

Actuarial losses on defined benefit plan (71 540)

Actuarial losses arising during the year (given) (98 000) 1
Tax expense (98 000 x 27%) 26 461 0.5
(508 508)
Items that my be reclassified to profit or loss:
Cash flow hedge 3 504
Gains arising during the year (see part 9b)) 4 800 0.5
Tax expense (R4 800 x 27%) (1 296) 0.5

Exchange difference on translating foreign associate 47 632

Gains arising during the year [C7] 65 250 3
Tax expense (65 250 x 27%) (17 618)
51 136
Other comprehensive income for the year, net of tax (457 372)
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 2 373 186
Total 29
Communication skills: Presentation and layout 1
QUESTION 29 (Suggested Solution) Page 3 of 10

Part d

UNISOCCER LTD

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR TH YEAR ENDED

31 JUNE 20.11

16. Deferred taxation

20.11
R
Analysis of temporary differences:
Property, plant and equipment 262 520
- Accelerated deductions for tax purposes [C10] 107 850 2
- Revaluation, net of related depreciation [C10] (136 688 + 17 982) 154 670 6
Investment in associate [10] 41 006 1
FEC asset [C10] 1 296 1
Compulsorily convertible debentures [C10] 531 663 2
Defined benefit liability [C10] (9 180) 2
IFRS2 expense on share options [C10] (2 808) 2
Net deferred tax liability 824 497
Total 16
Communication skills: Presentation and layout 1
Part e

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED

30 JUNE 20.11

6. Earnings per share

20.11
R
Reconciliation of numerators used for basic and diluted earnings
per share
Profit attributable to parent entity for the period (see part (c)) 2 830 559 0.5
Preference dividends (given) (225 000) 0.5
Numerator for basic earnings for the period 2 605 559
Share options (no effect) [C14] -
Numerator for diluted earnings 2 605 559 0.5

Reconciliation of denominators used for basic and diluted earnings

per share
Weighted average number of ordinary shares used for basic earnings
per share [C11] 6 843 750 5
Share options granted to employees [C14] 2 900 5
Weighted average number of ordinary shares used for diluted earnings
per share 6 846 650 0.5

DISCLOSURE OF CAPITALISATION ISSUE

If comparative figures are required, it should be disclosed in terms of IAS33.64 that the
comparative weighted average number of ordinary shares were also adjusted for the
capitalization issue that took place on 1 June 20.11
QUESTION 29 (Suggested Solution) Page 4 of 10

CALCULATIONS

C1. Profit before tax

Profit before tax (given) 4 172 600 0.5

Interest expense on specific loan from government [C2] (21 607) 1.5
Depreciation on commercial buildings [C3] (193 750) 3
Depreciation on plant [C6] (36 533) 2.5
Share in profit of associate [C7] 86 625 1.5
Interest expense on compulsorily convertible debentures [C8] (71 922) 3
IFRS2 expense on share options [C9] (7 800) 3
3 927 613

C2. Interest accrual on specific loan from government

Interest accrual from 1 May 20.11 – 30 June 20.11

(R1 080 357 x 12% x 2 / 12) 21 607 1.5

C3. Depreciation on commercial buildings

Cost (purchased on 1 July 20.6) 3 200 000 0.5

Accumulated depreciation on 1 July 20.8 (2 years) (given) 320 000
Depreciation per year (320 000 / 2 years) 160 000 1
Useful life (3 200 000 / 160 000) 20 years
Market value on 1 July 20.10 (given) 3 100 000 0.5
Remaining useful life on 1 July 20.10 16 years 1
Depreciation for the year ended 30 June 20.11 (3 100 000 / 16 years) 193 750 1
3

C4. Revaluation surplus on commercial buildings

Gross revaluation amount on 1 July 20.8 (see journals given) 920 000 0.5
Tax effect (28%) (see journals given) (257 600) 0.5
662 400
Change in tax rate ((257 600 / 28 x 27) = 248 400 – 257 600) or
(920 000 x 1%) 9 200 1
Balance on 1 July 20.8 (net of tax at 27%) 671 600
Devaluation on 1 July 20.10 (3 377 778 (given) – 3 100 000) (277 778) 1
Tax effect (27%) 75 000 0.5
468 822 3.5

C5. Revaluation surplus on land

Gross revaluation amount on 1 July 20.8 (see journals given) 400 000 0.5
Tax effect (see journals given) (74 592) 0.5
352 408
Change in tax rate ((400 000 x 66.6% x 27%) – 74 592) 2 664 1.5
Balance on 1 July 20.8 (net of tax) 328 072
Devaluation on 1 July 20.10 (1 200 000 (given) – 900 000) (300 000) 1
Tax effect (66.6% inclusion rate) 53 946 1
82 018
QUESTION 29 (Suggested Solution) Page 5 of 10

Totals for land and buildings combined:

Total change in tax rate (9 200 [C4] + 2 664) 11 864
Total devaluation (277 778 [C4] + 300 000) (577 778)
Total tax effect of devaluation (75 000 [C4] + 53 946) 128 946
Movement for the year on revaluation surplus (436 968) 4.5

C6. Depreciation on plant

Plant at cost (given) 1 100 000

Borrowing costs capitalized (calculated in part (a)(ii)) 15 621 0.5
Government grant deducted from plant (calculated in part (a(i)) (19 643) 0.5
Total cost of plant 1 095 978

Depreciation for the year (1 095 978 x 20% x 2 / 12) 36 533 1.5
2.5
C7. Investment in Creative Shirts Ltd (associate)

Share in profit of associate ($45 000 x 25%) = $11 250 x 7.70) 86 625 1.5

Carrying amount of investment in Creative Shirts Ltd: R $

Cost 490 000 70 000 0.5
Share of profit of associate 86 625 11 250 0.5
576 625 81 250 1
Translation at closing rate on 30 June 20.11 ($81 250 x 7.90) 641 875 1
Foreign currency translation reserve (exchange gain) 65 250 4.5

C8. Compulsorily convertible debentures

Liability component on 1 January 20.11:

N = 3 years 0.5
I = 15% per annum 0.5
PMT = R420 000 (1 500 000 x R2 x 14%) 0.5
FV = Rnil 0.5
PV = R958 955

Interest expense from 1 January 20.11 – 30 June 20.11

1Amort (interest) R143 843 x 6 / 12 or (R958 955 x 15% x 6 / 12) 71 922 1
3

C9. IFRS2 expense on share options

Expected number of employees as at 30 June 20.11 (100 – 17 – 5) 78 1

Total shares expected to vest (78 employees x 1 500) 117 000 0.5
IFRS2 expense (117 000 share options x R1.20 x 1 / 3 years x 2 / 12) R7 800 1.5
3
QUESTION 29 (Suggested Solution) Page 6 of 10

C10. Deferred tax

Carrying Tax Temporary Deferred
amount base difference tax asset /
at 100% or (liability)
66.6% at 27%
30 June 20.11
a b
Commercial buildings 2 906 250 2 400 000 506 250 (136 688) 3
c d
Land (66.6%) 900 000 800 000 66 600 (17 982) 3
Furniture, fittings and vehicles 1 728 500 1 728 500 - -
e f
Plant 1 059 445 660 000 399 445 (107 850) 2
g
Investment in associate 641 875 490 000 151 875 (41 006) 1
h
FEC asset 4 800 - 4 800 (1 296) 1
i j
Loan from government (1 166 786) (1 166 786) - -
k
Convertible debentures (1 030 877) (3 000 000) 1 969 123 (531 663) 2
Initial recognition (958 955)
Subsequent (71 922)
l m
Defined benefit liability (34 000) - (34 000) 9 180 2
n
IFRS2 share options expense - 10 400 (10 400) 2 808 2
3 053 693 (824 497)

a 3 377 778 – 193 750 [C3] – 277 778 [C4] = 2 906 250
b 3 200 000 / 20 x 15 years = 2 400 000
c 1 200 000 – 300 000 [C5] = 900 000
d The tax base is the capital gains tax base cost
e 1 095 978 [C6] – 36 533 [C6] = 1 059 445
f 1 100 000 – (1 100 000 x 40%) = 660 000
g 490 000 + 86 625 + 65 250 = 641 875 [C7]
h Tax base is the amount deductible in future. No amount is deductible in future.
However, the gain will be taxable when the FEC expires
i 1 080 357 [C1] + 64 821 (part (a)(ii) + 21 607 [C3] = 1 166 786
j 1 166 786 (carrying amount) minus Rnil (deductible in future) = 1 166 786
k Sum of liability and equity component is the total proceeds (IAS12.23)
l 3 075 000 – 3 041 000 = (34 000)
m 34 000 (carrying amount) – 34 000 (amount deductible in future) = 0
n 117 000 options x R1.60 at year end x 1 / 3 years x 2 / 12 = 10 400

DEFERRED TAX ON INVESTMENT IN ASSOCIATE

The question requires you to assume that the tax base is R490 00 and that the temporary
difference is subject to normal income tax. This information was given as deferred tax on
investments in associates per IAS12.38 – 45 is not examinable per the SAICA Examinable
Accounting Pronouncements.

DEFERRED TAX ON IFRS2 SHARE OPTION EXPENSE

IAS12.68A – C is only examinable at level one per the SAICA Examinable Accounting
Pronouncements

The share option expense is treated in a similar manner than research expenditure. The question
states that the company will receive a tax deduction for the share option expense, but only when
the share options are exercised (based on the share price on exercise date). The question also
states that the tax base must be calculated in the same way as the IFRS2 expense, except that
the fair value of the share options as at year end should be used (and not the grant date fair value
of the share options)
QUESTION 29 (Suggested Solution) Page 7 of 10

C11. Weighted average number of shares

Compulsorily deb Share buy back Cap issue 1 Jun 20.11

1 Jul 20.10 1 Jan 20.11 1 April 20.11 1 June 20.11

Shares 5 000 000 Shares 5 000 000 Shares 5 000 000

Comp deb 1 500 000 Comp deb 1 500 000
Total 6 500 000 Total 6 500 000
Buy back (500 000)
Total 6 000 000
Cap issue 1 250 000
Cap issue (31 250)
Total cap issue 1 218 750

6 months 3 months 3 months

Weighted
Shares Fraction average
Dates outstanding of year shares
1 July 20.10 – 1 January 20.11 5 000 000 6/12 2 500 000 1
Issue compulsorily convertible debentures on
1 January 20.11 1 500 000
1 January 20.11 – 1 April 20.11 6 500 000 3/12 1 625 000 1
Share buy-back on 1 April 20.11 (500 000)
1 April 20.11 – 1 June 20.11 6 000 000 3/12 1 500 000 1
g
Capitalization issue on 1 June 20.11 1 218 750 12/12 1 218 750 2
6 843 750

g (5 000 00 x 9 /12) + (4 500 000 x 3 / 12) = 4 875 000 shares / 4 = 1 218 750
The capitalization convertible debentures are ignored as they do not take part in the
capitalization issue

CAPITALISATION ISSUE AND SHARE BUY BACK

A capitalization issue is the issue of ordinary shares to existing shareholders for no consideration.
In terms of IAS33.28 the number of share outstanding before the capitalization issue is adjusted
for the proportionate change in the number of outstanding shares as if the capitalization issue had
occurred at the beginning of the earliest period presented, in this question in its 1 January 20.11

If shares were issued or bought back for value before the capitalization date, the effect thereof,
which has been weighted for the earnings per share calculation, should be taken into account
when calculating the effect of the capitalization issue. Even though 1 125 500 actual shares have
been issued (4 500 000 / 4), the weighted shares issued in terms of the capitalization issue is
1 218 750.
QUESTION 29 (Suggested Solution) Page 8 of 10

The alternative calculation of weighted average number of ordinary shares is shown below

Weighted
Shares Fraction average
Dates outstanding of year shares
1 July 20.10 – 30 Jan 20.11) 5 000 000 6/12 2 500 000 1
Issue compulsorily convertible debentures on
1 Jan 20.11 1 500 000
1 Jan 20.11 – 1 Apr 20.11 6 500 000 3/12 1 625 000 1
Share buyback on 1 April 20.11 (500 000)
1 Apr 20.11 – 10 Jun 20.11 6 000 000 3/12 1 500 000 1
g
Capitalisation issue on 1 Jun 20.11 1 218 750 12/12 1 218 750 2
6 843 750 5

g (5 000 000 x 9 / 12) + (4 500 000 x 3 / 12) = 4 875 000 shares / 4 = 1 218 750
The compulsorily convertible debentures are ignored as they do not take part in the
capitalization issue.

CAPITALISATION ISSUE AND SHARE BUY BACK

A capitalization issue is the issue of ordinary shares to existing shareholders for no consideration.
In terms of IAS33.28 the number of share outstanding before the capitalization issue is adjusted
for the proportionate change in the number of outstanding shares as if the capitalization issue had
occurred at the beginning of the earliest period presented, in this question it is 1 January 20.11.

If shares were issued or bought back for value before the capitalization date, the effect thereof,
which has been weighted for the earnings per share calculation, should be taken into account
when calculating the effect of the capitalization issue. Even though 1 125 000 actual shares have
been issued (4 500 000 / 4), the weighted shares issued in terms of the capitalization issue is
1 218 750.

The alternative calculation of weighted average number of ordinary shares is shown below:

Weighted
Shares Fraction average
Dates outstanding of year shares
Shares outstanding beginning of year
(1 Jul 20.10 – 30 June 20.11) 5 000 000 12/12 5 000 000 1
Issue compulsorily convertible debentures
(1 Jan 20.11 – 30 Jun 20.11) 1 500 000 6/12 750 000 1
Share buy back (1 Apr 20.11 – 30 Jun 20.11) (500 000) 3/12 (125 000) 1
Capitalization issue (5 000 000 – 125 000) / 4 1 218 750 12/12 1 218 750 2
6 843 750 5
QUESTION 29 (Suggested Solution) Page 9 of 10

MANDATORILY CONVERTIBLE INSTRUMENTS

In terms of IAS33.23 the compulsorily convertible debentures must be included in basic earning
per share from the date the contract was entered into. The cash received on the issue of the
compulsorily convertible debentures was available from 1 January 20.11 to generate earnings
and therefore the debentures are treated as ordinary shares from 1 January 20.11 for purposes of
calculating basic earnings per share only. The interest expense on the debentures is not added
back for basic earnings per share because only preference dividends must be adjusted for
(IAS33.12).

Please note that the compulsorily convertible debentures do not take part in the capitalization
issue as they are not issued ordinary shares. The question also states that the conversion ratio
for the debentures of one for one is not adjusted as a result of the capitalization issue which
confirms that the compulsorily convertible debentures do not take part in the capitalization issue.

C12. Share options granted for no value

SHARE BASED PAYMENT TRANSACTION WITH SERVICE CONDITION

The vesting condition is a service condition of three years and in terms of IAS33.47A the issue
price (for purposes of calculating diluted earnings per share) must include service to be supplied
by the managers before the share options vest (calculated below in [C12.1]).

IAS33.48 states that share options with fixed terms (a service condition is a fixed term) are
treated as options in the calculation of diluted earnings per share. Refer to IAS33 Illustrative
example 5A

C12.1 Value of services yet to be rendered by the managers (unrecognized IFRS2 expense)

Total IFRS2 expense relating to the share options

(117 000 options [C9] x R1.20) 140 400 1
IFRS2 expense recognized on 30 June 20.11 [C9] (7 800) 0.5
Total value of services yet to be rendered 132 600

C12.2 Assumed total proceeds form share options

Total exercise price to be paid by the employees (R4.40 x 117 000) 514 800 1
Total value of services yet to be rendered [C3.1] 132 600
647 400
QUESTION 29 (Suggested Solution) Page 10 of 10

C12.3 Number of ordinary shares to be used in diluted earnings per share

Number of shares under option (1 500 x 78 employees) 117 000 0.5

Number of shares that would have been issued at the average market price for
the year (R647 400 [C3.2] / R6.50) (99 600) 1
Share options issued for no consideration (no value) 17 400

Weighted for 2 months (17 400 x 2 / 12) 2 900 1

5

C13. Test for dilution

Increase in earnings Increase in number Earnings per

of ordinary shares incremental share*
Share options Rnil [C12.3] 2 900 Rnil Dilutive

* The incremental earnings per share is dilutive if it is less than R0.41

C14. Diluted earnings per share calculation

Profit form Ordinary shares Per share

continuing
operations (control
number)
Basic earnings per share 2 830 558 6 843 750 R0.3807
Share options [C13] - [C13] 2 900
2 830 558 6 846 650 R0.3806 Dilutive
0.5
QUESTION 31 Page 1 of 3

Gateway Ltd (‘Gateway’) is a South African company listed on the JSE Limited. The functional
currency of Gateway is Rand (R).

The company develops, manufactures and markets a range of navigation, communication and
information devices and applications, which are operated with global positioning system (GPS)
technology.

The company’s mission is ‘innovation and stability through diversity’ and it has continued to
generate healthy margins despite the recent financial crisis and the impact it has had on the
discretionary spending of its customer base.

The company operates in two markets:

* Fitness products: The two main products are touch-screen outdoor handsets with integrated
digital cameras, wireless workout courses and fitness watches designed for casual runners to
elite tri-athletes; and

* Marine products: High definition radar and transceiver systems for boats of all sizes.

You are completing your training contract as a trainee accountant with Gateway. You are
assisting Gateway’s chief financial officer, a qualified CA(SA), with the finalization of the annual
financial statements of Gateway for the year ended 31 December 20.11 and was provided with
the following:

1. Decision to construct a new machine

During September 20.10 it became apparent that Gateway would have to invest in a new
manufacturing machine in order to manufacture the new range of handsets according to the
latest technological specifications. On 20 December 20.10 the directors of Gateway
approved the decision to construct the new manufacturing machine (machine Z). As
Gateway does not have the expertise to construct machine Z, Channel Plc, (“Channel”), the
world leader in the construction of specialized equipment of this nature, was appointed to
construct machine Z at Gateway’s premises. As only the construction of machine Z is
outsourced to Channel, ownership of machine Z will vest n Gateway throughout the
construction, assembly and testing periods.

Channel is a company based in the United Kingdom (UK) and therefore has a functional
currency of pounds sterling (£).

Channel uses computer-aided design software which means that Channel is able to
construct a virtual prototype of machine Z. Gateway is able to view the prototype of machine
Z and the specification of raw materials (machine components) available from Channel.
Components other than those available from Channel, can also be accommodated into the
design. The design of the virtual prototype is delivered to Gateway through a free web
service.

The directors of Gateway are also aware of environmentally friendly components that are
produced by Green Technologies Plc (‘Green Tech’) that is also based in the UK. Gateway
decided to use the environmentally friendly components in its construction of machine Z as
these components would help to reduce Gateway’s carbon footprint in future. Channel
confirmed that they would be able to use these components in the construction of machine Z.

On 1 January 20.11 Gateway entered into a contract with Channel for the construction of
machine Z and on 1 January 20.11 Gateway placed a non-cancellable order with Green Tech
to purchase the environmentally friendly components to be used in the construction of
machine Z. Green Tech also has a functional currency of pounds sterling (£).
QUESTION 31 Page 2 of 3

2. Outsourcing contract with Channel for the construction of machine Z

On 1 January 20.11 Gateway entered into the contract with Channel, in terms of which
Channel would:

* construct, install and test the machine on Gateway’s premises for a fixed price of
£3 600 000, to be paid in two instalments:
- an advance payment of £2 500 000 on 1 February 20.11; and
- the balance of £1 100 000 on the date that the machine is ready for use;

* commence construction once the environmentally friendly components have been received
from Green Tech;
* as part of constructing the machine, be responsible for transporting the environmentally
friendly components ordered from Green Tech from their port of departure to Gateway’s
premises in South Africa; and
* have completed the testing of the machine in order for it to be ready for use by for use by
31 October 201.11.

3. Loan from Royal Bank

A loan from Royal Bank in the UK of £3 600 000 was drawn down fully on 1 February 20.11
to fund the two payments to Channel. The loan (together with any interest owning) was
repaid in full on 31 December 20.11 and bore interest at a market-related rate of 5.8% per
annum.

Gateway was able to place the surplus funds on a fixed nine month investment at Queen
Bank in the UK (from 1 February 20.11) at a rate of 2.5% per annum. Capital and interest on
the fixed nine month investment was receivable on maturity date.

4. Components imported from Green Tech

On 1 February 20.11 the environmentally friendly components were shipped and risks
and rewards transferred to Gateway. The components arrived at Gateway’s premises on
15 February 20.11. The cost of the components, amounting to £450 000, was paid on
1 February 20.11 by Gateway, as per the order agreement.

5. Cost schedule received from Channel

Channel provided Gateway with the following cost schedule:

Cost Profit Total

incurred margin amount
Costs £ £ £ Notes
Raw materials (excluding
the components purchased Incurred on
from Green Tech) 2 300 000 200 000 2 500 000 1 February 20.11
Transportation costs of
components purchased Incurred on
from Green Tech 20 000 20 000 15 February 20.11
Labour costs and Incurred evenly
overheads to construct, over the period
assemble and test 15 February 20.11
machine Z 980 000 100 000 1 080 000 to 31 October 20.11
3 300 000 300 000 3 600 000
QUESTION 31 Page 3 of 3

6. Additional information

* If Channel had obtained the loan in South Africa, it would have incurred net finance costs
(interest expense less interest income on surplus funds) of R2 612 980.
* Gateway applied the cost model to manufacturing equipment in terms of IAS16 Property,
plant and equipment
* Machine Z is a qualifying asset in terms of IAS23 Borrowing Costs. For purposes of IAS23,
it is the accounting policy of Gateway to include the foreign exchange gains or losses on the
following items in net finance costs:
- foreign loan,
- interest expense on foreign loan,
- interest expense accrual (if any),
- reinvestment of foreign loan, and
- interest income on reinvestment
* The construction was completed on schedule and machine Z was ready to use on
31 October 20.11 on which date it was expected that machine Z would have a useful life
of ten years, with a residual value of R8 million.
* Gateway started using machine Z in its manufacturing processes on 1 November 20.11.
* Gateway does not discount creditors as the time value of money is regarded as immaterial
* The following exchange rates were applicable:

Date Sport rate 1£ : R

1 January 20.11 11.950
1 February 20.11 12.280
15 February 20.11 12.164
31 October 20.11 and 1 November 20.11 11.960
31 December 20.11 11.000
Average:
1 February 20.11 to 31 October 20.11 12.120
15 February 20.11 to 31 October 20.11 12.062
1 November 20.11 to 31 December 20.11 11.480

REQUIRED: Marks

Calculate the amounts to be included in the statement of profit or loss and other
comprehensive income of Gateway for the financial year ended 31 December 20.11 [30]
for machine Z and its related function.

Please note:

~ Amounts affecting profit or loss and amounts affecting other comprehensive income
(if any) must be calculated
~ Clearly differentiate between items affecting profit or loss and those affecting other
comprehensive income (if any)
~ Comparative figures are not required
~ Round off all amounts to the nearest Rand
~ Ignore any normal income tax implications
~ Ignore any Value Added Taxation (VAT) implications
~ Your answer must comply with International Financial Reporting Standards (IFRS)
QUESTION 31 (Suggested Solution) Page 1 of 5

EXAM TECHNIQUE

The required does not guide you to do specific calculations. In a question like this, it is important
that you identify the main issues in order to determine what amounts to calculate. The main
issues can be listed as follows:

1. Machine Z was constructed for Gateway in the current year (consider the amount at which
machine Z must be recognised – IAS16).
2. Machine Z was brought into use in the current year (depreciation will need to be recognised –
IAS16)
3. The construction costs of the machine has been incurred in foreign currency (consider
exchange rates to be used – IAS21)
4. Gateway obtained a foreign loan to fund the construction of the machine (the calculation of
borrowing costs and capitalization thereof must be considered – IAS23)

Amounts to be included in the statement of profit or loss and other comprehensive income
for the financial year ended 31 December 20.11

20.11
R
All three amounts listed below must be included in P/L 1.5
1. Depreciation [C1] (705 375) 18
2. Foreign exchange gains on foreign exchange transactions [C4] 3 737 280 8
3. Interest capitalized [C4] (399 504) 2.5
Interest expense 649 479
Interest income (249 975)
Total 30

CALCULATIONS

C1. Depreciation expense

Cost of machine Z R
1 Feb 20.11 Raw materials (£2 500 000 x 12.280) 30 700 000 1.5
15 Feb 20.11 Green Tech components (£450 000 x 12.280) 5 526 000 1.5
15 Feb 20.11 Transport costs (£20 000 x 12.164) 243 280 1.5
15 Feb 20.11 to
31 Oct 20.11 Labour and overheads (£1 080 000 x 12.062) 13 029 960 1.5
49 496 240
Borrowing costs capitalised [C3] 826 261 9
Total cost of machine Z on 31 October 20.11 50 322 501
Residual value (given) (8 000 000) 1
Depreciable amount 42 322 501
Depreciation expense (42 322 501 / 10 years x 2 / 12) 705 375 1.5
17.5
QUESTION 31 (Suggested Solution) Page 2 of 5

C2. Journals entries for the loan from Royal Bank, investment in Queen Bank and the
foreign creditor

Loan obtained Creditor paid

investment made investment returned Loan repaid
1 Jan 20.11 1 Feb 20.11 31 Oct 20.11 31 Dec 20.12
1 month 9 months 2 months

Capitalisation period

EXAM TECHNIQUE

The transactions relating to foreign exchange differences, interest paid and interest income are
done in the form of journal entries in C2 below for explanatory purposes. Journal entries are
not required. Do not provide entries in the exam, if it is not required, as it wastes valuable time.
Only show the relevant calculations.

Dr Cr
R R
Loan from Royal Bank
1 February 20.11
J1 Bank (SFP) (£3 600 000 x 12.280) 44 208 000
Loan from Royal Bank (SFP) 44 208 000
Recognise loan obtained

31 October 20.11
J2 Loan from Royal Bank (SFP)
(£3 600 000 x (12.280 – 11.960) 1 152 000
Foreign exchange difference (P/L) 1 152 000 1.5
Remeasure loan to spot rate on 31 Oct 20.11

31 December 20.11
J3 Loan from Royal Bank (SFP)
(£3 600 000 x (11.960 – 11.000) 3 456 000
Foreign exchange difference (P/L) 3 456 000 1.5
Remeasure loan to spot rate on 31 Dec 20.11

Interest expense on loan from Royal Bank

1 February – 31 October 20.11
J4 Interest expense (P/L)
(£3 600 000 x 5.8% x 9 / 12 x 12.120 average rate) 1 897 992 2
Interest expense accrual (SFP)
(£3 600 000 x 5.8% x 9 / 12 x 11.960 spot rate) 1 872 936
Foreign exchange difference (P/L)
(£3 600 000 x 5.8% x 9 / 12 x (12.120 – 11.960) 25 056 1
Recognize interest expense at average rate
QUESTION 31 (Suggested Solution) Page 3 of 5

1 November – 31 December 20.11

J5 Interest expense (P/L)
(£3 600 000 x 5.8% x 2 / 12 x 11.480 average rate) 399 504 2
Interest expense accrual (SFP)
(£3 600 000 x 5.8% x 2 / 12 x 11.000 spot rate) 382 800
Foreign exchange difference (P/L)
(£3 600 000 x 5.8% x 2 / 12 x (11.480 – 11.000) 16 704 1
Recognize interest expense at average rate

31 December 20.11
J6 Interest expense accrual (SFP)
(£3 600 000 x 5.8% x 11 / 12 x 11.000) = R2 105 400
(R1 872 936 [J4] + R382 800 [J5] = R2 255 736
(R2 105 400 – R2 255 736 = (R150 336)) 150 336
Foreign exchange difference (P/L) 150 336 3
Remeasure interest expense accrual to spot rate on
settlement date

Investment at Queen Bank

J7 1 February 20.11
Investment at Queen Bank (SFP) (£1 100 000 x 12.280) 13 508 000
Bank (SFP) 13 508 000
Recognise investment at spot rate

31 October 20.11
J8 Foreign exchange difference (P/L)
(£1 100 000 x (12.280 – 11.960)) 352 000 1.5
Investment at Queen Bank (SFP) 352 000
Remeasure investment to spot rate on maturity date

Interest income on investment at Queen Bank

1 February – 31 October 20.11
J9 Bank (SFP)
(£1 100 000 x 2.5% x 9 / 12 x 11.960 spot rate) 246 675
Foreign exchange difference (P/L)
(£1 100 000 x 2.5% x 9 / 12 x (12.120 - 11.960)) 3 300 1
Interest income (P/L)
(£1 100 000 x 2.5% x 9 / 12 x 12.120 average rate) 249 975 2
Recognize interest received at average rate

Foreign creditor
1 February 20.11
The raw materials of R30 700 000 [C1] and Green Tech
components of R5 526 000 [C1] was recognised and paid
on 1 February 20.11
J10 1 February – 31 October 20.11
Machine Z (R243 280 [C1] + R13 026 960 [C1] 13 270 240
Foreign creditor (Channel) (SFP) 13 270 240
Capitalise costs of construction of machine Z
QUESTION 31 (Suggested Solution) Page 4 of 5

J11 Foreign creditor (Channel) (SFP) 114 240

Foreign exchange difference (P/L)
(£1 100 000 x 11.960 = R13 156 000)
R13 156 000 – R13 270 240 = (R114 240)) 114 240 2
Remeasure creditor to spot rate on settlement date

C3. Borrowing costs capitalized

Borrowing costs are capitalized from 1 February 20.11 until 31 December 20.11 when
physical construction of the machine is complete.

Summary of the borrowing costs from the journals in [C2] above that must be
capitalized:

Gain / (loss)
J2 Foreign exchange difference on loan from Royal Bank (gain) 1 152 000 1.5
J4 Portion of interest expense on loan from Royal Bank qualifies for
capitalization (1 897 992) 2
J4 Foreign exchange difference on interest expense (gain) 25 056 1
J8 Foreign exchange difference on investment at Queen Bank (loss) (352 000) 1.5
J9 Foreign exchange difference on interest income (loss) (3 300) 1
J9 Interest income in investment at Queen Bank 249 975 2
(826 261)

Journal to capitalize borrowing costs on 31 October 20.11

J12 Machine Z (SFP) (see above) 826 261

Foreign exchange difference (P/L) (1 152 000 (J2)
+ 25 056 (J4) – 352 000 (J8) – 3 300 (J9)) 821 756
Interest expense (P/L) (J4) / (J9) (1 897 992 – 249 975) 1 648 017
capitalize borrowing costs of machine Z
QUESTION 31 (Suggested Solution) Page 5 of 5

FOREIGN EXCHANGE DIFFERENCE CAPITALISED AS BORROWING COSTS

It is the accounting policy of Gateway to include foreign exchange differences in borrowing in

costs for IAS23 Borrowing costs. In terms of IAS23.6(e), borrowing costs capitalized may include
foreign exchange differences arising from foreign currency loans to the extent that they are
regarded as adjustments to finance costs.

On the assumption that exchange rates are normally a function of the different interest rates
between countries, it can be argued that the foreign exchange differences on the capital of the
foreing loan and the foreign investment are regarded as adjustments to finance costs. However,
exchange rates are also influenced by other factors such as market sentiment which do not
qualify for capitalization. Therefore it is prudent to limit the borrowing costs capitalized to the
amount of borrowing costs that would have been incurred if the loan was obtained in South Africa
in Rand (the functional currency).

The net borrowing costs would have been R2 612 980 if the loan was obtained in South Africa
(given in the question). As the total net borrowing costs is only R826 261, it is not necessary to
apply the limit to the borrowing costs capitalized.

For taxation purposes, should the question, not have requested to ignore normal income tax
implications, the borrowing cost capitalized to machine 2 will not create deferred tax, since the
South African Revenue Service (SARS) also allows for interest to be capitalized against the cost
of inventory in terms of s22(3)(9) of the Income Tax Act (“cost price of trading stock”)

C4. Amounts (other than depreciation) affecting P/L form 1 January

until 31 December 20.11

Summary of amounts form the journals in C2 above that affects P/L:

Gain / (loss)
Foreign exchange differences
J3 Foreign exchange difference on loan from Royal Bank (gain) 3 456 000 1.5
J5 Foreign exchange difference on interest expense accrual (gain) 16 704 1
J6 Foreign exchange difference on interest expense accrual on
settlement date (gain) 150 336 3
J11 Foreign exchange difference on foreign creditor (gain) 114 240 2
Total net foreign exchange gains 3 737 280

Finance costs
J5 Interest expense on loan from Royal Bank (649 479) 2
Interest expense (J4) 1 897 992
Interest expense (J5) 399 504
Borrowing cost capitalized (1 897 992 – 249 975 (J9)) (1 648 017)
J9 Interest received 249 975
9.5
QUESTION 33 Page 1 of 5

Part 1

Gracoo Ltd entered into the following transaction during the year ended 28 February 20.14:

1. On 1 March 20.13 Gracoo Ltd sold goods to the value of R500 000 to Bunnee Ltd in a
consignment arrangement. On 28 February 20.14, Bunnee Ltd had already sold and
delivered 80% at a profit of 10% to its customers.

2. On 1 February 20.13, Graccoo Ltd received R75 000 (the selling price) for goods ordered
that were delivered on 30 March 20.13.

3. On 1 February 20.14, Gracoo received R100 000 (the selling price) from a major client for
goods that must still be manufactured and delivered on 1 April 20.14.

4. On 30 June 20.13, Gracoo Ltd entered into an exchange transaction with one of its
competitors, KindHearts Ltd in terms of which Gracoo Ltd gave KindHearts Ltd 15 prams
in exchange for 20 cots for selling in Gracoo Ltd’s shop. Gracoo Ltd usually sells prams
for R3 600 each and KindHearts Ltd sells cots for R2 750 each, which is considered a
reasonable estimate of the fair values of the prams and cots respectively. On the same
date Gracoo Ltd entered into an exchange transaction with a new online children’s boutique
TinyTots Ltd in terms of which Gracoo Ltd gave TinyTots Ltd 2 prams in exchange for
35 vintage inspired couture dresses. TinyTots Ltd sells these dresses for R220 each,
however, due to the exclusivity of this range of dresses this selling price is not considered
a reasonable estimate of the fair value of the vintage inspired couture dresses.

5. On 15 August 20.13 Gracoo Ltd entered into an agreement with Small-B Ltd in terms of
which Small-B Ltd must annually pay royalties to Graccoo Ltd, based on the number of
Graccoo prams being sold. The agreement came into effect on 1 September 20.13.
According to the agreement R100 per pram must be paid to Gracoo Ltd. At year-end
on 28 February 20.14 Small-B Ltd sold 500 Gracoo prams.

6. On 30 June 20.13, goods to the value of R3 000 were sold on a lay-away arrangement.
On this date R1 000 was received. On 22 February 20.14, another R1 000 was received.
The goods are on hand, but will only be delivered to the customer once the final payment
has been received.

Part 2

4x4View Ltd is a manufacturer and retailer of exclusive caravans and trailers. 4x4View Ltd also
sells various 4x4 accessories and products directly to the public and through a network of
distributors.

1. During the year ended 28 February 20.14, 85 caravans were sold at a selling price of
R125 400 each, inclusive of value added tax of 14%. The following information relates
to the sale of these caravans:

R
Sales received in cash 10 408 200
Sales outstanding at year end 250 800

On 25 February 20.14, two (2) caravans with a total selling price of R250 800 (including 14%
VAT) were sold to Mr Wild. Mr Wild paid for these caravans on 28 February 20.14 and the
caravans were transferred in the name of Mr Wild. Mr Wild is responsible for both the
maintenance and the insurance of the caravans from the date legal title is transferred. The
other caravans sold for cash have already been transferred in the names of the buyers at
year end on 28 February 20.14.
QUESTION 33 Page 2 of 5

2. 4x4View Ltd undertakes 4x4 adventure tours for both local and international tourists. The
duration of the guided adventure tours ranges between two and four weeks. Game park
bookings and conservation fees are paid one month before the guided adventure tour starts.
The following details relate to the guided adventure tours starting during February 20.14 and
March 20.14:

R
Tour fees received in cash for a 4 week guided tour starting 15 February 20.14 80 000
Transaction price allocated to game park bookings and conservation fees 25 000
Transaction price allocated to guided tour 55 000

Tour fees in cash for a 3 week guided tour starting 15 March 20.14 70 000
Transaction price allocated to game park bookings and conservation fees 20 000
Transaction price allocated to guided tour 50 000

3. 4x4View Ltd sells 4x4 accessories on a consignment basis through a network of various
distributors. All consignment sales are made at a gross profit of 20% on selling price.
The following details relate to these 4x4 accessories:

R
4x4 accessories at cost, delivered on consignment to various distributors
during the current year 45 000
4x4 accessories on consignment not yet sold at cost – 28 February 20.14 14 000

4. On 15 January 20.14 a customer, FarOut Ltd, placed an order for 500 t-shirts and
immediately paid an amount of R10 000 as final settlement for the order. 4x4View Ltd placed
an order for these t-shirts at their supplier on 17 January 20.14, but the supplier will deliver
the ordered t-shirts directly to FarOut Ltd on 3 March 20.14.

5. On 1 September 20.13, 4x4View Ltd sold five (5) trailers with a cash selling price of R88 500
(excluding VAT) each to Mr Mild for use in his business. Mr Mild is an entrepreneur who
recently started a rental company and negotiated the following payment terms with 4x4View
Ltd:

Deposit paid in cash on 1 September 20.13 R44 250.00

4 biannual instalments payable in arrears R117 574.60
Nominal interest rate 14%

The following is the repayment schedule, which you can assume to be correct:

Balance
Instalment Capital Interest outstanding
Date R R R R
- - - 398 250.00
28/02/20.14 117 574.60 89 697.10 27 877.50 308 552.90
31/08/20.14 117 574.60 95 975.89 21 598.70 212 577.01
28/02/20.15 117 574.60 102 694.21 14 880.39 109 882.80
31/08/20.15 117 574.60 109 882.80 7 691.80 -
72 048.39
QUESTION 33 Page 3 of 5

Part 3

Wolverine Ltd, a company listed on the JSE Ltd, has a 31 December year-end. The company
specializes in the development and supply of technologically advanced defense weapons.

The following details relate to Wolverine Ltd’s defined benefit pension fund:

Dr / (Cr)
Date R
Fair value of plan assets 01/01/20.11 9 000 000
31/12/20.11 9 750 000
Present value of plan obligation 01/01/20.11 (10 500 000)
31/12/20.11 (11 400 000)
Increase in total defined benefit obligation as a result of
increase in base calculation of pension 01/01/20.11 600 000
Contributions received by the fund 31/12/20.11 1 500 000
Benefits paid out during the year by the fund 31/12/20.11 (1 650 000)
Current service costs (accrues evenly) 2 250 000

Rate on long-term high-quality bonds 01/01/20.11 12%

31/12/20.11 13%

The following information relates to Wolverine Ltd’s year-end provisions:

Leave pay:

Leave
Gross Max leave taken in
salary per allowed Max leave current
Type pf year per per year allowed to year
employee Male Female employee (days) c/f (days) (days)

Engineers 45 30 R650 000 18 8 9

* According to company policy, all leave accumulates for one year but is non-vesting
* Experience has indicated engineers employed in 20.12 will only use 75% of the leave
due to them.
* Two engineers resigned with immediate effect from 1 January 20.12. No other employees
are expected to resign. There are 260 working days in a year.

Maternity leave:

* Maternity leave (90days) is non-accumulating and not paid out in cash if not taken.
* This leave is only applicable to female employees
QUESTION 33 Page 4 of 5

Part 4

In order to finalise the financial statements of Junglebook Ltd for the year ended 30 June 20.11,
the following transactions must be considered:

1. Junglebook Ltd is experiencing fierce competition within the industry. In an attempt to create a
new market entry, the company constructed a plant in a sensitive conservation area on the
coast of Mexico. The plant was ready for use on 1 December 20.10 and has a useful life of 20
years. There is currently no legislation that requires the company to restore the environmental
damage at the end of the period. The company however has a well-know environmental policy
of restoring all environmental damage that they cause. The company has a record of
compliance in order for the company to keep up a good corporate image.

* The directors made no provision for the cost of restoring the environment because they
believe that no legal obligation exists. Environmentalists determined that the restoration
costs would amount to R5 000 000 at the end of the useful life of the plant. A market related
discounted rate is 9% before tax (capitalized monthly).

* Due to the high level of wear and tear on the plant, the company expects that components of
the plant should b replaced every five years because of technical reasons. The directors
provided an amount of R50 000 per month to cover the estimated costs. No replacements
were required for the financial year ended 30 June 20.11, but the directors believe that he
provision should be included, as components need to be replaced in the financial year ended
30 June 20.16

2. Shortly before year-end, an explosion at the plant caused extensive damage, and a worker
was seriously injured. The employee indicated shortly after year-end that he is going to submit
a claim of R2 million against the company for medical expenses. The legal advisors of
Junglebook Ltd are of the opinion that the case against the company will not succeed. On the
date that the directors authorized the financial statements for issue, the company had not
received any legal action from the employee. The directors are not sure whether any
adjustments or disclosure of the claim are required. Assume that this claim of R2 000 000 is
material
QUESTION 33 Page 5 of 5

Part 1

REQUIRED: Marks
Calculate the profit before tax of Gracoo Ltd for the year ended 28 February 20.14,
taking into account all the above transactions. Assume that the profit before tax
amounted to R1 400 000 before taking the above transactions into account. Assume
that the cost of sales of the above transactions had already been correctly taken into
account in determining the profit before tax. [10]

Part 2

REQUIRED: Marks

For each of the points (1) to (5) above do the following:

(a) Calculate the amount that should be recognized as revenue in the statement of
profit or loss and other comprehensive income of 4x4View Ltd for the year ended
28 February 20.14; and [10]

(b) Give the reasons why this amount is included or excluded as revenue for the year
ended 28 February 20.14, according to the requirements of International Financial
Reporting Standards (IFRSs). [14]

Part 3

REQUIRED: Marks

(a) Disclose the cost related to the defined pension fund in the profit-before-tax note to
the financial statements of Wolverine Ltd for the year ended 31 December 20.11. [4]

Comparative figures are not required

(b) Calculate the maternity and leave pay provisions for the year ended 31 December
20.11. Give reasons for no provision being made. [5]

Part 4

REQUIRED Marks

Prepare a memorandum explaining the accounting treatment of each of the two issues [25]
QUESTION 33 (Suggested Solution) Page 1 of 7

Part 1

(a) Profit before tax

Comment R
Profit before tax (given) 1 400 000
1. Consignment sales (R500 000 x 80%) 1 400 000 1
2. Sale of goods already manufactured 2 75 000 1
3. Sale of goods still to be manufactured 2 - 1
4. Non cash consideration
Fair value of non-cash consideration can be reasonably
estimated 3 - 1
Transaction price measured at fair value of non-cash
consideration (20 x R2 750)
Fair value of non-cash consideration cannot be reasonably
estimated 3 55 000 2
Transaction price measured by reference to the stand-alone
selling price of the goods promised to the customer
(2 x R3 600) 7 200 1
5. Royalties received (500 x R100) 4 50 000 1
6. Lay away sales 2 - 2
Adjusted profit before tax 1 987 200

Comments

1. When Gracoo Ltd delivers a product to another party (Bunnee Ltd) for sale to end
customers (the customer of Bunnee Ltd), Gracoo Ltd shall evaluate whether Bunnee
Ltd has obtained control of the product at that point in time. A product that has been
delivered may be held in a consignment arrangement if Bunnee Ltd has not obtained
control of the product. Accordingly, an entity shall not recognize revenue upon delivery
of a product to another party if the delivered product is held on consignment (IFRS15
Appendix B, par .B77). Gracoo Ltd will therefore recognize 80% of revenue as Bunnee
Ltd has sold 80% of the goods to its end customers.

2. If a customer pays consideration, or an entity has an unconditional right to an amount of

consideration (a receivable), before the entity transfers a good or service to the customer,
the entity shall present the contract as a contract liability when the payment is made or
the payment is due (whichever is earlier). A contract liability is an entity’s obligation to
transfer goods or services to a customer for which the entity has already received
consideration (or an amount of consideration is due) from the customer
(IFRS15 par .106).

In accordance with par 106, upon receipt of a prepayment form a customer, an entity
shall recognize a contract liability in the amount of the prepayment for its performance
obligation to transfer, or to stand ready to transfer, goods or services in the future. An
entity shall derecognize that contract liability (and recognize revenue) when it transfers
goods or services and, therefore, satisfies its performance obligation (IFRS15
Appendix B, par B44).

3. To determine the transaction price for contract in which a customer promises

consideration in a form other than cash, an entity shall measure the non-cash
consideration (or promise of non-cash consideration) at fair value (IFRS15 par .66).
QUESTION 33 (Suggested Solution) Page 2 of 7

If an entity cannot reasonably estimate the fair value of the non-cash consideration, the
entity shall measure the consideration indirectly by reference to the stand-alone selling
price of the goods or services promised to the customer (or class of customer) in
exchange for the consideration (IFRS15 par .67).

4. An entity shall recognize revenue for a sales-based or usage-based royalty promised in

exchange for a licence of intellectual property only when (or as) the later of the following
events occurs:

(a) the subsequent sales or usage occurs; and

(b) the performance obligation to which some or all of the sales-based or usage-based
royalty has been allocated has been satisfied (or partially satisfied)
(IFRS15 Appendix B, par .B63)

Part 2

1. Caravan sales

1.1 R9 130 000 [R10 408 200 x 100 / 114] or [83 x (125 400 x 100 / 114)] 2
1.2 An entity shall consider the terms of the contract and its customary business practices to
determine the transaction price. The transaction price is the amount of consideration to
which an entity expects to be entitled in exchange for transferring promised goods or
services to a customer, excluding amounts collected on behalf of third parties (for
example, VAT) (IFRS15 par .47). Value added tax is an amount collected on behalf of
a third party and therefore is excluded from the transaction price. 1

When (or as) a performance obligation is satisfied, an entity shall recognize as revenue
the amount of the transaction price that is allocated to that performance obligation
(IFRS15 par .46). The transfer of the legal title and the responsibility of both
maintenance and insurance indicate that the point in time at which Mr Wild obtains
control of the promised asset and 4x4View Ltd satisfies its performance obligation on
28 March 20.14 (IFRS15 par .38(b)). Revenue should only be recognized for the 83
caravans as legal title of the 2 caravans have not been transferred to Mr Wild at year
end. These caravans were only registered in Mr Wild’s name after year-end. 2

2. Adventure tour sales

2.1 R72 500 [25 000 + (55 000 x 2 weeks / 4 weeks) + 20 000] 2
2.2 An entity shall recognize revenue when (or as) the entity satisfies a performance
obligation by transferring a promised good or services (i.e. an asset) to a customer.
An asset is transferred when (or as)the customer obtains control of that asset
(IFRS15 par .31). 1

The entity has a present right to payment for the asset – if a customer is presently
obliged to pay for an asset, then that may indicate that the customer has obtained the
ability to direct the use of, and obtain substantially all of the remaining benefits from, the
asset in exchange (IFRS15 par .38(a)). The performance obligation to make the
necessary bookings and pay the conservation fees is satisfied one month before the
date of the tour. Therefore the transaction price relating to the game park bookings and
conservation fees for both the tour starting 15 February 20.14 and 15 March 20.14
should be recognized during the current financial year ending 28 February 20.14. 2

The customer simultaneously receives and consumes the benefits provided by the
entity’s performance as the entity performs (IFRS15 par .35(a)) and therefore the
performance obligation is satisfied over time. 1
QUESTION 33 (Suggested Solution) Page 3 of 7

The performance obligation to provide a guided tour is satisfied during the course of the
tour. Therefore the transaction price relating to the guided tour for the tour starting
15 February 20.14 should be recognized for the period of the guided tour that has already
lapsed during the financial year ended 28 February 20.14. Progress toward complete
satisfaction of the performance obligation is based on the output method of time elapsed
(IFRS15 Appendix B, par .B15) 1

3. Consignment sales

3.1 R38 750 [(R45 000 – R14 000) x 100 / 80] 2

3.2 When an entity delivers a product to another party (such as a dealer or a distributor) for
sale to end customers the entity shall evaluate whether that other party has obtained
control of the product at that point in time. A product that has been delivered to another
party may be held in a consignment arrangement if that other party has not obtained
control of the product. Accordingly, an entity shall not recognize revenue upon delivery
of a product to another party if the delivered product is held on consignment. (IFRS15
Appendix B, par .B77). Revenue is therefore recognized by the seller when the goods
are sold to a third party by another party (such as the dealer or distributor) 2

4. T-shirt sales

4.1 Rnil 2
4.2 An entity shall recognize revenue when (or as) the entity satisfies a performance
obligation by transferring a promised good or service (i.e. an asset) to a customer. An
asset is transferred when (or as) the customer obtains control of that asset (IFRS15
par .31). Revenue is not recognized since the promised t-shirts have not been
transferred to the buyer. Revenue is only recognized when the t-shirts are delivered to
the buyer on 3 March 20.14. A contract liability shall be recognized for the amount of
consideration received from FarOut Ltd in the statement of financial position for the year
ended 28 February 20.14 (IFRS15 par .106) 2

5. Trailer sales

5.1 R470 337.50 [(88 500 x 5) + 27 877.50] 2

5.2 The customer has the significant risks and rewards of ownership of the asset – the
transfer of the significant risks and rewards of ownership of an asset to the customer
may indicate that the customer has obtained the ability to direct the use of, and obtain
substantially all of the remaining benefits from the asset (IFRS15 par .38). Revenue
attributable to the sales price, exclusive of interest, is recognized at the date of sale as
Mr Wild is able to use the trailers in his business and obtain substantially all of the
remaining profits. 1

An entity shall use the discount rate that would be reflected in a separate financing
transaction between the entity and its customer at contract inception. An entity may be
able to determine that rate by identifying the rate that discounts the nominal amount of
the promised consideration to the price that the customer would pay in cash for the
goods or services when (or as) they transfer to the customer. (IFRS15 par .64). An
entity shall present the effects of financing (interest revenue or interest expense)
separately from revenue from contracts with customers in the statement of profit or loss
and other comprehensive income. Interest revenue or interest expense is recognized
only to the extent that a contract asset (or receivable) or a contract liability is recognized
in accounting for a contract with a customer (IFRS15 par .65). Therefore the interest
element is recognized as revenue as it is earned, over time as Mr Wild simultaneously
receives and consumes the benefits provided by 4x4View Ltd for the extended payment
terms. 2
QUESTION 33 (Suggested Solution) Page 4 of 7

Part 3

(a) Disclosure

WOLVERINE LTD

NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.11

6. Profit before tax

20.11
Employee benefit expense R
Current service costs (given) 2 250 000 1
Net interest (10 500 000 – 9 000 000) x 12%) 180 000 2
Past service cost recognized 600 0000 1
3 030 000 4

(b) Leave provision

R
Leave pay
Engineers:
(R650 000 / 260 (45 + 30 = 75 – 2) employees x 8 days [C1] x 75%) 1 095 000 4.5

Maternity leave
Maternity leave is non-accumulating and non-vesting,
therefore no provision will be made 0.5
Should any female employee make use of the leave due to her, it will be
expensed as salaries 0.5
Total 5.5
Limited to 5
CALCULATIONS

C1. 18 – 9 = 9 – limited per company policy to 8

QUESTION 33 (Suggested Solution) Page 5 of 7

Part 4

UNISA Top Student

Muckleneuk Campus
UNISA
Financial director
Junglebook Ltd
Per e-mail

Dear Financial Director

Advice required on transactions

As requested, please see below my comments an advice on the 2 transactions. I have attached
to this letter an Appendix with calculations.

Transaction 1

(a) Provision for cost to restore the environment

IAS37.14 states that a provision shall be recognized when Junglebook Ltd:

* Has present obligation (legal or constructive) as a result of a past event;
* It is probable that an outflow of resources embodying economic benefits will be required
to settle the obligation; and
* A reliable estimate can be made of the amount 1

Junglebook Ltd has constructive present obligation (IAS37.10) because) 0.5

* Junglebook Ltd has a well-know environmental policy of restoring environmental
damage caused by them. Junglebook Ltd also has a past record of complying
with this policy 1
* By complying with their environmental policy in the past, Junglebook Ltd has created a
valid expectation that they will discharge this responsibility 0.5
* The past event is the construction of the plant in a sensitive environment which caused
damage to the environment 0.5

The outflow of resources is likely, and a reliable estimate can be made 0.5

Conclusion:
* A provision should be recognized for the best estimate of the costs to restore the
environmental damage. 0.5
* The present value of the cost is R876 743 [C1] for which a provision must be raised on
30 June 20.11 2
* The amount of the provision needs to be increased each year as the present value of the
cost to restore the environment increases. The increase in the provision is an interest
expense and the provision will continue to increase until it reaches R5 000 000 at the
end of the 233 months. 1

C1 N = 233
FV = (5 000 000)
I = 0.75% (9 / 12) or 9% p.a. (12P / YR for HP)
PV = R876 743
QUESTION 33 (Suggested Solution) Page 6 of 7

(b) Costs to restore the environment that must be capitalized to the plant

IAS16.16(c) requires that the initial estimate of the costs to restore the environment be
capitalized to the plant 0.5

The construction of the plant caused damage to the environment and not the production of
inventories; therefore the costs to restore the environment should be capitalized to the plant
in terms of IAS16. 1

The present value of the amount that had to be capitalized to the plant on 1 December
20.10 is R832 064 [C2] 1

Depreciation on the plant should be based on the cost of the plant inclusive of the costs to
restore the environment. Depreciation should be recalculated after the costs to restore the
environment were capitalized. 0.5

The journal to be passed to recognize the provision for costs to restore the environment is
as follows:

Dr Cr
R R
Property, plant and equipment 832 064
Interest expense (P/L) (876 473 – 832 064) 44 679
Provision to restore environment (SFP) 876 743 1

C2 N = 240
FV = (R5 000 000)
I = 0.75% (9 / 12) or 9% p.a. (12P / YR for HP)
PV = R832 064

(c) Maintenance Cost

According to IAS37.14, a provision should be recognized for a present obligation as a result

of a past event. There is no legal or constructive obligation to make future repairs and to
incur maintenance expenditure to the plant, and as a result, no provision should be
recognized 1

Even in the event that a legal or constructive obligation exists to keep the plant on a certain
level of performance, no provision must be recognized as no present obligation exists at
year-end to replace the components 0.5

The provision that was raised at R50 000 per month from 1 December 20.10 until 30 June
20.11 (7 months) needs to be reversed 0.5

In terms of IAS16.44, Junglebook Ltd must allocate the amount initially recognized in
respect of the plant to its significant parts (or components) and should depreciate each part
separately. Accordingly, the components with a useful life of 5 years should be depreciated
over 5 years and not 20 years. 1

The depreciation expense needs to be corrected to reflect depreciation of these

components over 5 years and not 20 years. 0.5
QUESTION 33 (Suggested Solution) Page 7 of 7

Transaction 2

In terms of IAS10.3, events after the reporting period are those events that occur between
the end of the reporting period and the date when the financial statements are authorized
for issue. The employee reported shortly after year-end but before the financial statements
for authorized for issues, that he was going to submit a claim for medical expenses of
R2 000 000 against Junglebook Ltd, which is an event after the reporting period. 1

An event that is indicative of conditions that arose after the reporting period is a “non-
adjusting event after the reporting period”. The possibility of a claim by the employee is a
“non-adjusting event after the reporting period” as the employee has only indicated after
year-end that he intend to submit a claim. 1

It should be noted that even though the explosion and injury to the employee took place
before year-end, the possible obligation to pay medical expenses does not arise form the
explosion and injury. The intention of the employee to submit a claim for medical expenses
give rise to the possible obligation 1

In terms of IAS10.21, if this “non-adjusting event after year-end” is material, Junglebook Ltd
should disclose the nature of the event and estimate of the financial effect. 0.5

On the assumption that this non-adjusting event after year-end is material, the nature of this
potential claim, together with an estimate of the financial effect should be disclosed. As the
legal advisors of Junglebook Ltd are of the opinion that the potential claim will not succeed,
the estimate of the financial effect should take into account the probability that the potential
claim will not succeed. 1
QUESTION 34 Page 1 of 5

Amounts in this question exclude VAT except where indicated

Yellowstone Ltd is a large manufacturer of industrial plant and sells these items for cash and on
installment sale agreements.

Yellowstone Ltd is listed on the JSE Limited and has a 30 June year-end.

The following abridged trail balance relates to Yellowstone Ltd for the financial year ended
30 June 20.12:

Note Dr Cr
R R
Share capital
- Ordinary shares 2 3 200 000
- Cumulative preference shares 2 800 000
Revaluation surplus at 30/06/20.11 4 315 000
Retained earnings at 30/06/20.11 593 433
Deferred taxation at 30/06/20.11 341 088
Long term liabilities 3 1 757 564
Plant and machinery 1, 4
Gross carrying amount 3 000 000
Accumulated depreciation at 30/06/20.11 375 000
Land and buildings 1, 5
Cost 1 415 000
Accumulated depreciation at 30/06/20.11 31 000
Motor vehicles 1, 6
Cost 1 400 000
Accumulated depreciation at 30/06/20.11 280 000
Bank balances and cash 2 217 808
Gross investment in installment sale agreement 7 3 150 000
Allowance for credit losses 8 205 000
Unearned finance income at 30/06/20.12 9 895 000
Inventory 1 322 870
Accounts payable 10 1 025 125
Shareholders for dividend 795 000
Provisional tax payments 1, 11 604 210
Current portion of long-term liabilities 3 536 678
Revenue 15 957 000
Finance income earned 9 355 000
Dividends received 678 000
Preference dividend paid 2 96 000
Interest paid 452 000
Cost of sales 10 500 000
Other operating expenses 12 3 982 000
________
28 139 000 28 139 888
QUESTION 34 Page 2 of 5

Notes:

1. Depreciation and taxation have not been accounted for the year ended 30 June 20.12.

2. Share capital

At 30 June 20.11 the issued share capital consisted of 3.2 million ordinary shares of R1 each.
On 1 July 20.11, the board of directors was given the option to take up 1 600 000 ordinary
shares at R1.50 each, while the average market price of ordinary shares was R2.50.

Cumulative preference shares consisted of 800 000 shares with a fixed dividend of 12c per
share. The preference shares are classified as equity in accordance with IAS32 Financial
Instrument: Presentation

3. Long term liabilities

The long term liabilities consist of the following:

R
Long term loans 1 326 562
Finance lease liability 967 680
2 294 242
Less: Current portion of long term liabilities 536 678
1 757 564

The finance lease liability is in respect of motor vehicles (delivery vans) (see note 6) and was
entered into on 1 July 20.10. The total amount of interest payable on the lease liability
amounts to R593 250. The accountant of Yellowstone Ltd provided the following repayment
schedule (which you may assume to be correct):

Capital Interest Total

R R R
Cash price (including14% VAT) 1 596 000 - 1 596 000
Installment: 1/7/20.10 (420 000) - (420 000)
1 176 000 - 1 176 000
Interest at 18% per annum - 211 680 211 680
Installment: 1/7/20.11 (208 320) (211 680) (420 000)
967 680 - 967 680
Interest at 18% per annum - 174 182 174 182
Installment: 1/7/20.12 (245 818) (174 182) (420 000)
721 862 - 721 862
Interest at 18% per annum - 129 935 129 935
Installment: 1/7/20.13 (290 065) (129 935) (420 000)
431 797 - 431 797
Interest at 18% per annum - 77 723 77 723
Installment: 1/7/20.14 (431 797) (77 723) (509 520)
- - -

Interest accrued at year end is included in accounts payable

QUESTION 34 Page 3 of 5

4. Plant and machinery

The plant and machinery was purchased on 1 July 20.8 for R3 125 000 from a dealer selling
used plant and machinery. The plant and machinery is depreciated using the straight-line
method over the total estimated useful life of 10 years. The SARS allows the 20% per annum
allowance in terms of s12C of the Income Tax Act, which is not apportioned.

Plant and machinery are revalued using the fair value at the beginning of each year. When
the plant is revalued, any accumulated depreciation at the date of the revaluation is eliminated
against the carrying amount of the asset. The revaluation surplus realizes to retained
earnings on derecognition of the asset. The accounting entries relating to the revaluation of
plant and machinery for the year ended 30 June 20.12 must still be processed.

The market value of the plant and machinery on 1 July 20.11 amounted to R3 850 000 and on
1 July 20.10 to R3 000 000.

5. Land and buildings

The land and buildings at 30 June 20.11 consisted of the following:

Accumulated Carrying
Cost depreciation amount
Factory R R R
Land 175 000 - 175 000
Factory building 1 240 000 31 000 1 209 000
1 415 000 31 000 1 384 000

The factory was constructed at a cost of R1 240 000. The factory was available for use on
31 December 20.10.

Derecognition at 5% per annum using the straight-line method is provided on all buildings.
The SARS allows the 5% annual allowances in terms of s13(1)(b of the Income Tax Act on
factory buildings, which is not apportioned. On 31 December 20.11 the company moved its
manufacturing operations back to leased premises as the factory did not meet their
requirements. It was decided to keep the building and rent it out. Tenants occupied the
building from 1 January 20.12. The market value of the property was as follows:

31/12/20.11 30/06/20.12
R R
Land 200 000 220 000
Factory building 1 300 000 1 350 000

The company decided to use the fair value model for investment properties and the cost
model for owner-occupied property. The rent received and the direct operating expenses in
respect of this property amounted to R150 000 and R60 000 respectively, for the period
1 January 20.12 to 30 June 20.12 and is included in other operating expenses. The
accounting entries relating to the revaluations and fair value adjustments on land and
buildings for the year ended 30 June 20.12 must still be processed.

Land and buildings are disclosed as two separate classes of assets

6. Motor vehicles

Depreciation is provided at 20% per annum using the straight-line method

QUESTION 34 Page 4 of 5

7. Installment credit receivables

The installment credit receivables consist of the following amounts on 30 June 20.11:

R
Gross investment in installment credit receivables 4 850 000
Unearned finance income (1 250 000)
Net investment in installment credit receivables 3 600 000

All the installment credit receivables qualify for the debtor’s allowance in terms of s24 of the
Income Tax Act. The s24 debtors’ allowance granted for the 20.11 tax year amounted to
R450 200. An allowance of R773 246 may be claimed for the 20.12 tax year.

8. Allowance for credit losses

The SARS grants an allowance in terms of s11(j) at a rate of 25% of the specific doubtful
debts provision for tax purposes. The provision for doubtful debts increased from R125 000
at 30 June 20.11 to R205 000 at 30 June 20.12.

9. Finance income earned

Finance income is accounted for by using the effective interest rate method over the period of
the installment sale agreement. The SARS accepts this method of accounting for tax
purposes.

10. Accounts payable

Accounts payable include provisions in respect of expenses of R350 000 (20.11: R285 000),
These provisions will be allowed as a tax deduction in future when the amounts are paid in
cash.

11. Provisional tax payments

Provisional tax payments include the following:

R
Under provision for the 20.11 tax assessment 64 210
Penalties on late submission of provisional tax (Not tax deductible) 27 000
Interest paid on late submission of provisional tax (Not tax deductible) 8 550

12. Other operating expenses

Other operating expenses include the following:

Donations to charity (Not tax deductible) 4 000

13. Taxation

Assume the normal taxation rate is 28% and capital gains are taxed at an inclusion rate
of 66.6%. The company is a registered vendor for VAT purposes. On 30 June 20.11 the
assessed loss for tax purposes amounted to R150 000. it is probable that future taxable
profits will be available against which unused tax losses can be utilized. The deferred tax
asset relating to the assessed loss was correctly recorded for the year ended 30 June 20.11

No other temporary differences exist, other than those which are evident from the question
QUESTION 34 Page 5 of 5

REQUIRED: Marks

(a) Calculate the profit before tax of Yellowstone Ltd for the financial year ended
30 June 20.12. Show all calculations [10]

(b) Calculate the income tax expense that should be disclosed on the fact of the
statement of profit or loss and other comprehensive income of Yellowstone Ltd
for the year ended 30 June 20.12. [39]

Please note:

~ Begin your calculation with the profit tax amount as calculated in (a)
~ Deferred tax movements must be calculated by using the statement of
financial position method

(c) Prepare the statement of changes in equity of Yellowstone Ltd for the year ended
30 June 20.12. The total column and the share capital column are not required. [4]

Communication skills: Presentation and layout [1]

(d) Provided the following notes to the annual financial statements of Yellowstone Ltd
for the year ended 30 June 20.12:

~ Income tax and deferred tax as required by IAS12.79, IAS12.81(c)(i) and (g) [22]
~ Property, plant and equipment as require by IAS16.73 (d) – (e) [12]
~ Earnings per share (ignore headline earnings per share) as required by IAS33.70 [8]

Communication skills: Presentation and layout [4]

Please note:

~ Comparative figures are not required

~ Round off all amounts to the nearest Rand
~ Your answers must comply with International Financial Reporting Standards
(IFRS)
QUESTION 34 (Suggested Solution) Page 1 of 7

Part a – Profit before tax

R
a
Revenue 15 957 000 0.5
a
Finance income 355 000 0.5
a
Dividends received 678 000 0.5
a
Interest paid (452 000) 0.5
a
Cost of sales (10 500 000) 0.5
a
Other operating expenses (3 982 000) 0.5
b
Depreciation – plant and machinery (550 000) 1
c
Depreciation – factory building (31 000) 1
d
Fair value adjustment – factory building 50 000 1
e
Fair value adjustment – land 20 000 1
f
Depreciation – motor vehicles (280 000) 1
SARS – penalties (27 000) 1
SARS – interest paid (8 500) 1
1 229 450
Total 10
a Given
b 3 850 000 / 7 = 550 000
c 1 240 000 x 5% x 6 / 12 = 31 000
d 1 350 000 – 1 300 000 = 50 000
e 220 000 – 200 000 = 20 000
f 1 400 000 x 20% = 280 000

Part b – Income tax expense

R
Profit before tax (P/L) 1 229 450
Non-taxable / non-deductible items
Dividends received (678 000) 1
Portion of fair value adjustment (land) that will never be taxable ( 6 680)
Deduct entire fair value adjustment (20 000)
Fair value adjustment that will be taxable in the future (20 000 x 66.6%) 13 320
Portion of fair value adjustment (buildings) that will never be taxable (16 700)
Deduct entire fair value adjustment (50 000)
Fair value adjustment that will be taxable in the future (50 000 x 66.6%) 33 300
Penalties and interest to SARS (27 000 + 8 550) 35 550 1
Donations 4 000 1
Taxable profit before temporary differences 567 620
Movement in taxable temporary differences (78 029 / 28 x 100) [C1] (278 889) 28
Tax profit before tax loss 288 731
Tax loss (150 000) 1
Taxable income` 138 731

Current tax expense – R138 731 @ 28% 38 845 1

Deferred tax movements [C1] 78 089 1
Tax loss utilized [C1] 42 000 1
Underprovision for prior years 64 210 1
223 144
QUESTION 34 (Suggested Solution) Page 2 of 7

Part c

YELLOWSTONE LTD

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.12

Revaluation Retained
surplus earnings
R R
Balance at 30 June 20.11 315 000 593 433 1
Total comprehensive income
a
Profit for the year - 1 006 306 1
b
Other comprehensive income 995 789 - 1
Preference dividend - (96 000) 1
Balance at 30 June 20.12 1 310 789 1 503 739
Total 4
Communication skills: Presentation and layout 1

a 1 229 450 (part a) – 223 144 (part b)

b 1 372 000 [C2] – 376 211 [C3]

Part d

YELLOWSTONE LTD

NOTES FOR THE YEAR ENDED 30 JUNE 20.12

1. Income tax expense

Major components of tax expense

R
SA normal tax
Current tax 103 055
- current year (part b) 38 845 1
- underprovision for prior years (part b) 64 210 1
Deferred 120 089
- movement in temporary differences [C1] 78 089 1
- tax loss utilized [C1] 42 000 1
223 144

Tax rate reconciliation

Accounting profit 1 229 450 0.5
Tax at 28% 344 246 0.5
Tax effect of non-deductible / non-taxable items: 0.5
- fair value adjustment – land (6 680 x 28%) (1 870) 1
- fair value adjustment – building (16 700 x 28%) (4 676) 1
- dividends received (678 000 x 28%) (189 840) 1
- donations (4 000 x 28%) 1 120 1
- penalties and interest (35 550 x 28%) 9 954 1
Under provision for current tax in prior year 64 210 0.5
Income tax expense 223 144
QUESTION 34 (Suggested Solution) Page 3 of 7

2. Deferred tax

R
Analysis of temporary differences: 0.5
Property, plant and equipment
- accelerated deductions for tax purposes
[(1 875 000 – 625 000) x 28%] + 235 200 [C1] 585 200 2
- revaluation surplus after deduction of related deprecation
(1 425 000 x 28%) [C4] 399 000 3
Investment property (8 392 + 55 233) [C1] 63 625 1.5
Finance lease liability [C1] (285 896) 1
Installment sale receivable [C1] 216 509 1
Allowance account for credit losses [C1] (43 050) 1
Provision of expenses [C1] (98 000) 1
Net deferred tax liability [C1] 837 388
Total 22
Communication skills: Presentation and layout 2

3. Property, plant and equipment

Plant and
Land Buildings Vehicles machinery
R R R R
Carrying amount beginning of
year 175 000 1 209 000 1 120 000 2 625 000 0.5
Gross carrying amount or cost 175 000 1 240 000 1 400 000 3 000 000 2
Accumulated depreciation - (31 000) (280 000) (375 000) 2
Revaluation 25 000 122 000 - 1 225 000 2
Depreciation for the year - (31 000) (280 000) (550 000) 2
Transfer to investment property (200 000) (1 300 000) - - 1.5
Carrying amount end of year - 840 000 3 300 000
Gross carrying amount or cost - - 1 400 000 3 850 000 1
Accumulated depreciation - - (560 000) (550 000) 1
Total 12
Communication skills: Presentation and layout 2
4. Earnings per share

Reconciliation of numerators used for basic and diluted earnings per share 1

R
Profit for the year to parent 1 006 306 1
Preference dividends (800 000 x 12c) (96 000) 1
910 305

Reconciliation of denominators used for basic and diluted earnings per share
Weighted average number of shares used for basic earnings per share 3 200 000 1
Options [C7] 640 000 3.5
Weighted average number of shares used for diluted earnings per share 3 840 000 0.5
QUESTION 34 (Suggested Solution) Page 4 of 7

CALCULATIONS

C1. Deferred tax

Temporary Deferred
differences tax at 28%
Carrying at 100% or (asset) /
amount Tax base 66.6% liability
Investment property
(66.6%)
a b c
- land 220 000 175 000 29 970 8 392 2
d e f
- building 1 350 000 1 116 000 197 760 55 233 4.5
g h i
Plant and machinery 3 300 000 625 000 2 675 000 749 000 3
Finance lease (301 862) (120 805) (181 057) (50 696)
j i
- vehicles 840 000 0 840 000 235 200 1.5
k l i
- finance lease liability (1 141 862) (120 805) (1 021 057) (285 896) 3.5
Installment sale
m
receivables 2 255 000 2 255 000 0 0 1.5
n i
S24 allowance 0 773 246 773 246 216 509 1
o i
Allowance for credit losses (205 000) ( 51 250) (153 750) (43 050) 2
p i
Provision i.r.o expenses (350 000) 0 (350 000) (98 000) 2
837 388
Opening balance (341 088) 0.5
Increase in deferred tax
liability 496 300
Total movement:
Movement in unused tax loss (150 000 x 28%) 42 000 1
Movement through other comprehensive income [C3] 376 211 4.5
Movement through profit or loss (balancing) 78 089 1
Increase in deferred tax liability 496 300

a Given
b Given
c 45 000 x 66.6% = 29 970
d Given
e 1 240 000 – (1 240 000 x 5% x 2) = 1 116 000
f (1 350 000 – 1 240 000) x 66.6% = 73 260
(1 240 000 – 1 116 000) = 124 000
g 3 850 000 – (3 850 000 / 7) = 3 300 000 or [C4]
h 3 125 000 – (3 125 000 x 20% x 4) = 625 000 or [C4]
i @ 28%
j 1 400 000 – (1 400 000 x 20% x 2) = 840 000
k 967 680 + 174 182 = 1 141 862
l (14 / 114 x 1 596 000) x 1 349 520 / 2 189 520 = 120 850
m 3 150 000 – 895 000 = 2 255 000
n Given
o 205 00 x 25% = 51 250
p 350 000 – 350 000 = 0
q 496 300 – 42 000 – 376 211 = 78 089
QUESTION 34 (Suggested Solution) Page 5 of 7

C2. Other comprehensive income

Plant and machinery (3 850 000 – 2 625 000) 1 225 000 1

Factory building (1 209 000 – 31 000 (part a) – 1 300 000) 122 000 1.5
Factory land (200 000 – 175 000) 25 000 1
1 372 000
3.5
C3. Tax on other comprehensive income

Plant and machinery (1 225 000 x 28%) 343 000 1.5

Factory building (122 000 x 28%) 34 160 0.5
Factory building [C5] (5 611) 2.5
Factory building (25 000 x 66.6% x 28%) 4 662 1
376 211
4.5

C4. Plant and machinery (for illustrative purposes)

Carrying amount Deferred

tax at
Temporary 28%
differences (asset) /
Total Revaluation Cost Tax base at 100% liability
Cost 3 125 000 3 125 000 3 125 000
Accumulated depreciation /
allowances (625 000) (625 000) (1 250 000)b
Carrying amount 1/7/20.10 2 500 000 2 500 000 1 875 000 625 000 175 000
Revaluation 20.11 500 000c 500 000 - - 500 000 140 000
Depreciation / allowances
20.11 (375 000)d (62 500) (312 000) (625 000)e 250 000 70 000
Carrying amount
30/06/20.11 2 625 000 437 500 2 187 500 1 250 000 1 375 000 385 000
Revaluation 20.12 1 225 000 f 1 225 000 - - 1 225 000 343 000
Depreciation / allowances
20.12 (550 000)g (237 500) (312 500) (625 000) 75 000 21 000
Carrying amount 30/6/20.12 3 300 000 1 425 000 1 875 000 625 000 2 675 000 749 000

a 3 125 000 x 20% = 625 000

b 3 125 000 x 20% x 2 = 1 250 000
c 3 000 000 – 2 500 000 = 500 000
d 3 000 000 / 8 = 375 000
e 3 125 000 x 20% = 625 000
f 3 850 000 – 2 625 000 = 1 225 000
g 3 850 000 / 7 = 550 000
QUESTION 34 (Suggested Solution) Page 6 of 7

C5. Factory building (for illustrative purposes)

Deferred tax
Temporary at 28%
Carrying differences (asset) /
amount Tax base at 100% or liability
66.6%
a
Carrying amount 30/06/20.11 1 209 000 1 178 000 31 000 8 680
b c
Depreciation / Allowances 20.12 (31 000) (62 000) 31 000 8 680
d
Revaluation 20.12 122 000 - 122 000 34 160
Carrying amount 31/12/20.11 1 300 000 1 116 000 184 000 51 520
e
Correction of deferred tax % (5 611)
e
Investment property 1 300 000 1 116 000 163 960 45 909
f g
Fair value adjustment 20.12 50 000 - 33 300 9 324
Carrying amount 30/06/20.12 1 350 000 1 116 000 197 260 55 233

a 1 240 000 – (1 240 000 x 5%)

b 1 240 000 x 5% x 6 / 12
c 1 240 000 x 5%
d 1 300 000 – (1 209 000 – 31 000)
e Above cost now at CGT rates
(1 300 000 – 1 240 000) x 66.6% x 28% = 11 189
(1 300 000 – 1 240 000) x 28% = 16 800
5 611

1 300 000 – 1 240 000 = 60 000 x 66.6% 39 960

1 240 000 – 1 116 000 124 000
163 960
f 1 350 000 – 1 300 000
g 50 000 x 66.6%

C6. Factory building – land (for illustrative purposes)

Deferred tax
Temporary at 28%
Carrying differences (asset) /
amount Tax base at 100% or liability
66.6%
Carrying amount 30/06/20.11 175 000 175 000 - -
a c
Revaluation 31/12/20.11 25 000 - 16 650 4 662
Investment property 200 000 175 000 16 650 4 662
b d
Fair value adjustment 20.12 20 000 - 13 320 3 720
Carrying amount 30/06/20.12 220 000 175 000 29 970 8 392

a 200 000 – 175 000

b 220 000 – 200 000
c 25 000 x 66.6%
d 20 000 x 66.6%
QUESTION 34 (Suggested Solution) Page 7 of 7

C7. Earnings per share

Total comprehensive income for the year 1 006 306

Dividends on preference shares (800 000 x 12c) (96 000)
Basic earnings 910 306

Number of shares 3 200 000 1

Possible exercise of option (see below) 640 000 3.5
3 840 000

Number of share options 1 600 000 0.5

Number of shares issued at fair value (1 600 000 x R1.50 / R2.50) (960 000) 3
Number of shares issued for no consideration 640 000
QUESTION 35 Page 1 of 4

Lenglen is a French chocolate-maker, founded in France in 19.22 by Felix Lenglen. Felix

Lenglen also founded a South African company, Lenglen Chocolates (Lenglen), in Cape Town
in 19.50. Their chocolate is sold in their own stores in Cape Town as well as in 12 stores
throughout South Africa. Lenglen is a premier chocolate-maker in South Africa and produces
plain milk and dark chocolates, but is more well know for their flavored chocolates.

Lenglen imports the highest qualify cocoa beans which are delivered unroasted from plantations
around the world and then crafted into tablets of chocolates. Upon arrival, the cocoa beans are
thoroughly cleaned and separated from their shells. At Lenglen’s factory the cocoa beans are
carefully roasted in accordance with in-house process. The beans are then crushed in special
mills and finely ground until a liquid cocoa mass arises. This is the most important part in the
manufacturing process of chocolate. After that the chocolate manufacturing begins with
combining the other three basic ingredients for making chocolate with the cocoa mass, namely
butter, sugar and milk. By blending all the ingredients in accordance with their secret recipe,
Lenglen produces the various types of chocolates they are renowned for.

You are the financial manager of Lenglen in South Africa. The profit before tax of Lenglen before
taking transaction 1 to 9 into account, amounted to R5 520 000 for the year ended 30 June 20.13

Transaction 1

In order to generate additional cash flow, Lenglen issued a total of 1 200 000 10% convertible
debentures with a face value of R3 each of 1 January 20.12. The maturity date of the debenture
is 1 January 20.16. Interest is payable annually on 31 December. Each debenture is convertible
at the option of the holder at any time up to maturity into four ordinary shares in Lenglen. If the
debentures are not converted into ordinary shares by the maturity date, it will be settled in cash at
face value. A market-related interest rate on 1 January 20.12 for similar debentures without
conversion rights is 12% per annum.

Transaction 2

Lenglen acquired 1 000 unlisted bonds in Lindtnoir Ltd on 1 July 20.12 when the market interest
rate was 7.5% per annum. The investment is held within a business model with the objective of
realizing fair value gains when the investment is sold. The bonds were acquired at fair value and
will be redeemed at a premium of 10% on 30 June 20.17. The bonds have a face value of R500
each and carry a coupon rate of 7% per annum which is payable annually on 30 June. The
market-interest rate on 30 June 20.13 and 1 July 20.13 was 8% per annum.

It is the policy of Lenglen to account for the interest and fair value adjustments on investments in
debt instruments (including bonds) separately.

Transaction 3

Lenglen has 200 employees, who are each entitled to 15 working days paid annual leave for each
completed year of service, which is non-vesting. Unused paid annual leave may be carried
forward for one calendar year. Paid annual leave is first taken form the previous year’s
entitlement (FIFO utilization). At 30 June 20.13, the average unused entitlement is three days per
employee. Based on past experience, Lenglen expects 150 employees will take 15 days paid
annual leave in 20.14 and that the remaining employees will each take an average of 18 days
paid leave each. Assume the average daily (work day) pay rate per employee to be used in the
calculation is R200, and that 10% of the 150 employees will resign during 20.14 before taking
their leave.
QUESTION 35 Page 2 of 4

Transaction 4

The following information relates to Lenglen’s funded defined benefit plan:

R
Information for the year ended 30 June 20.12
Present value of defined benefit obligation 3 525 000
Fair value of plan assets held in Lenglen Pension Fund 3 450 000
Cumulative remeasurements on the net defined benefit liability 2 820

Information for the year ended 30 June 20.13

Present value of defined benefit obligation 3 990 000
Fair value of plan assets held in Lenglen Pension Fund 3 900 000
Current service cost 670 500
Benefits paid 745 500
Contributions paid into the fund 790 000
Discount rate at 1 July 20.12 6%
Discount rate at 30 June 20.13 7%

During 20.13, the plan was amended to provide additional benefits to employees with effect from
1 July 20.12. The present value of the additional obligation arising form the additional benefits
amounted to R300 000 in total.

The present value of the defined benefit obligation and the fair value of the plan assets are
determined by an actuary on an annual basis. Assume that the remeasurements on the defined
benefit obligation are actuarial gains or losses due to a change in financial assumptions.

Transaction 5

You recently discovered that an amount of R508 772 received on 28 June 20.12, was incorrectly
recognized as revenue for the year ended 30 June 20.12. The amount was received from a
customer who ordered 1 500 triple deck chocolate trifle boxes that were only ready for delivery on
10 July 20.12. The SARS indicated that they will reopen the 20.12 assessment to correct the
amount that was incorrectly included in taxable profits. Assume the error is material.

Transaction 6

Lenglen acquired 400 000 ordinary shares in Quick Milk Ltd on 1 September 20.11 for R10.20 per
share. The transaction cost amounted to R24 000 on this date. Quick Milk Ltd is a manufacturer
of milk products that are used by Lenglen in their production process. This investment constitutes
an 8% investment and was acquired as a long-term investment. Lenglen did not obtain control of
Quick Milk Ltd through the acquisition. Lenglen irrevocably elected to present subsequent
changes in the fair value of the investment in the mark-to-market reserve in other comprehensive
income in terms of IFRS9 Financial Instruments paragraph 5.7.5.

The transaction cost qualify to be included in the base cost of the investment in terms of
paragraph 20 of the Eighth Schedule of the Income Tax Act,

The fair value of the ordinary shares of Quick Milk Ltd was as follows:

Date Fair value per share

30 June 20.12 R10.80
30 June 20.13 R11.00
QUESTION 35 Page 3 of 4

The balance of the mark-to-market reserve on 30 June 20.11 was Rnil.

Quick Milk Ltd declared a dividend of R1.25 per ordinary share on 31 March 20.13.

Transaction 7

On 1 July 20.12 Lenglen acquired an 80% interest in Unique Sweets Ltd for a cash amount of
R1 500 000. In addition to the R1 500 000 cash, Lenglen will issue 150 000 shares (at no cost) to
the sellers of the 80% interest if the market price of Unique Sweets Ltd shares exceeds R8.50 per
share on 30 June 20.16. The fair value of the contingent shares was estimated as R350 000 on
1 July 20.12 and R650 000 on 30 June 20.13.

The market price of Unique Sweets Ltd’s shares was as follows:

Date Market price per share

1 July 20.12 R7.80
30 June 20.13 R8.40

Transaction 8

Lenglen issued 200 000 non-redeemable preference shares on 1 November 20.12 at a fair value
of R8 each. The directors at their discretion may resolve to declare and pay preference
dividends. A preference dividend of R128 000 was declared and paid on 30 June 20.13

Transaction 9

On 1 May 20.13 Lenglen issued 350 000 ordinary shares at a fair value of R11 each.

Additional information

* A tax specialist, employed by Lenglen, calculated the income tax expense (current and
deferred) for the 20.13 financial year and provided the financial manager with the journal
entries to account for current and deferred tax for the year ended 30 June 20.13. The income
tax expense presented in the profit or loss section of the statement of profit or loss and other
comprehensive income for the year ended 30 June 20.13 amounted to R1 880 000. You may
assume that all the information in this question was correctly taken into account and that the
income tax expense was correctly calculated.

* Lenglen had issued share capital of R8 500 000 (4 200 000 ordinary shares) on
30 June 20.12

* Lenglen declared an ordinary dividend of 25 cents per ordinary share on 30 June 20.13 to
shareholders registered on 30 June 20.13

* The retained earnings of Lenglen amounted to R34 250 000 on 30 June 20.12

* The income tax rate is 28% and the inclusion rate for capital gains tax is 66.6%
QUESTION 35 Page 4 of 4

REQUIRED: Marks

(a) Discuss the classification of transaction 8 in the financial statements of Lenglen

Chocolates Ltd for the year ended 30 June 20.13 in accordance with IAS32
Financial Instruments: Presentation [5]

Communication skills: Logical flow and conclusion [1]

(b) Prepare the statement of changes in equity of Lenglen Chocolates Ltd for the
year ended 30 June 20.13 [40]

Communication skills: Presentation and layout [2]

Please note:

~ The total column in the statement of changes in equity is not required

~ Round off all amounts to the nearest Rand

(c) Assume that during the financial year ended 30 June 20.13, there was a significant
change in the business model objective for managing investments in debt
instruments including the investment in Lindtnoir Ltd bonds. The investment in
Lindtnoir Ltd bonds met all the criteria to be reclassified as a financial asset
measured at amortised cost. Discuss how Lenglen Chocolates Ltd should account
for the reclassification of the investment in Lindtnoir Ltd bonds in terms of IFRS9
Financial Instruments. [5]

Communication skills: Logical flow and conclusion [1]

(d) Disclose the earnings per share note as required by IAS33.70 in the financial
statements of Lenglen Ltd for the year ended 30 June 20.13.

Assume for this part of the question, the profit after tax of Lenglen Chocolates Ltd
(after taking into account any adjustments from (b) above) amounted to R3 184 746
for the year ended 30 June 20.13 [10]

Communication skills: Presentation and layout [1]

Please note:

~ Amounts in the test of dilution are rounded off to three decimals

~ For the convertible debentures you may assume that the option to settle in
shares is more dilutive than the cash option

Please note:

~ Comparative figures are not required

~ Ignore Dividends tax and Value Added Tax (VAT)
~ Your answer must comply with International Financial Reporting Standards (IFRS)
QUESTION 35 (Suggested Solution) Page 1 of 6

Part (a)

On initial recognition the instrument should be classified in accordance with the substance
of the contractual arrangement and the definition of a financial liability, a financial asset and
an equity instrument (IAS32.15) 1
The principle amount and the dividends are considered separately for classification as
either equity or a financial liability 1

Principle amount
Lenglen has no obligation to deliver cash or other financial assets since the preference
shares are non-redeemable 1
Then non-redeemable preference shares therefore do not represent a financial liability but
an equity instrument in the financial statements of Lenglen 0.5

Preference dividends
Lenglen has no contractual obligation to make dividend payments as the dividends
payments are within the discretion of Lenglen (the issuer) 1
The dividend payments are therefore not a financial liability but represent equity 0.5
Total 5
Communication skills: Logical flow and conclusion 1
Part (b)

LENGLEN CHOCOLATES LTD

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.13

Equity Equity
component instrument
Ordinary Preference of (Contract Mark to
share share Retained convertible to issues market
capital capital earnings debentures shares) reserve
R R R R R R
Balance at
[C1] [C4]
30/06/20.12 8 500 000 - 34 250 000 218 689 - 175 720 8
Correction of prior
period error
(508 772 x 72%) (366 316) 1
Restated
balance 33 883 684 0.5
Shares issued
(350 000 x R11) 3 850 000 1
Total
comprehensive
income for the
year
- Profit for the
[C5]
year 3 184 746 16.5
- other
comprehensive
[C3] [C4]
income 122 400 65 082 8.5
Contract to issue
shares 350 000 1
Ordinary dividend
(4 200 000 +
350 000) x 0.25 (1 137 500) 1.5
Issue of
preference share
(200 000 x 8) 1 600 000 1
Preference
dividend (given) _______ ________ (128 000) ______ ______ ______ 1
Balance at
30/06/2013 12 350 000 1 600 000 35 925 330 218 689 350 000 240 802
Total 40
Communication skills: Presentation and layout 2
QUESTION 35 (Suggested Solution) Page 2 of 6

Part (c)

Reclassification of investment in Lindtnoir bonds

The investment in Lindtnoir bond is a financial asset and qualifies for reclassification
(IFRS9.4.4.2) since there was change in business model in terms of IFRS9 Financial
Instruments. 1
The reclassification should be applied prospectively from the reclassification date
IFRS9.5.6.1 0.5
The reclassification date is the very first day of the entity’s next financial year i.e.
1 July 20.13 0.5
The change in the objective of the business model must be effected before reclassification
date IFRS9.B4.4.2 and it must be significant to the entity’s operations 0.5
The change in business model happened during the financial year 30 June 20.13 before
reclassification date of 1 July 20.13 and it is significant to the entity’s operations 1
If an entity reclassifies a financial asset to be measured at amortised cost, its fair value will
at the reclassification date becomes its new carrying amount IFRS9.5.6.3 0.5
The fair value of the investment in Lindtnoir bonds on 30 June 20.13 was calculated at an
amount of R520 191 [C2.4] 0.5
There is no need to remeasure the fair value on 1 July 20.13, since the market related
interest of 8% is the same as the market interest rate on 30 June 20.13 1
Therefore the carrying amount of the investment now measured at amortised cost would be
R520 191 0.5
The category of financial assets measured at amortised cost will increase with the carrying
amount of the investment as measured on 1 July 20.13, with a corresponding decrease in
financial assets measured at fair value 1
Total 7
Max 5
Communication skills: Logical flow and conclusion 1

Part (d)

(ii) LENGLEN CHOCOLATES LTD

NOTES FOR THE YEAR ENDED 30 JUNE 20.13

Earnings per share

Reconciliation of numerators used for basic and diluted earnings per share

R
Profit attributable to the parent entity (given) 3 184 746 0.5
Preference dividends (given) (128 000) 1
Numerator for basic earnings 3 056 746
Interest on convertible debentures [C7] 294 122 1
Numerator for diluted earnings 3 350 868
Reconciliation of denominators used for basic and diluted earnings
per share
Weighted average number of shares used for basic earnings per share [C6] 4 258 333 2
Contingent shares 150 000 1.5
Convertible debentures [C7] 4 800 000 4
Weighted average number of shares used for diluted earnings per share 9 208 333
Total 10
Communication skills – Presentation and layout 2
QUESTION 35 (Suggested Solution) Page 3 of 6

CALCULATIONS

C1. Convertible debentures

Fair value of financial liability

N 4 0.5
I 12% 0.5
PMT (1 200 000 x R3 x 10%) 360 000 0.5
FV (1 200 000 x R3) 3 600 000 0.5
PV = 3 381 311

Present value of financial liability 3 381 311

Equity component (balancing) 218 689 0.5
Proceeds on issue of convertible debentures 3 600 000 0.5
3

Interest for the year 20.12

Effective interest accrued: 1 January 20.12 – 30 June 20.12
3 381 311 x 12% x 6 / 12 or 1 Amort (INT = 405 757 x 6 / 12) 202 879 1.5
Interest for the year 20.13
Effective interest accrued: 1 July 20.12 – 31 December 20.12
3 381 311 x 12% x 6 / 12 or 1 Amort (INT = 405 757 x 6 / 12) 202 879
Coupon interest (360 000)
Amortised costs 45 758
Effective interest accrued: 1 January 20.13 – 30 June 20.13
3 381 311 + 45 758 = 3 427 069 x 12% x 6 / 12 or
2 Amort (INT = 411 248 x 6 / 12) 205 624 1.5
Total interest for 2013 (202 879 + 205 624) 408 503
3

C2. Investment in Lindtnoir bonds

C2.1. Fair value of Lindtnoir bonds on 1 July 20.12

N 5 0.5
I 7.5% 0.5
PMT (1 000 x R500 x 7%) 35 000 0.5
FV (1 000 x R500 x 110%) 550 000 0.5
PV = 524 713

C2.2 Interest for the year ended 30 June 20.13

524 713 x 7.5% or 1 Amort (INT = 39 353) 39 353 1

3

C2.3 Carrying amount of Lindtnoir bonds on 30 June 20.13

Present value on 1 July 20.12 524 713

Effective interest accrued 39 353 0.5
Coupon interest (35 000) 0.5
Amortised balance or 1 Amort BAL 529 067
QUESTION 35 (Suggested Solution) Page 4 of 6

C 2.4 Fair value of Lindtnoir bonds on 30 June 20.13

N 4 0.5
I 8 0.5
PMT (1 000 x R500 x 7%) 35 000 0.5
FV (1 000 x R500 x 110%) 550 000 0.5
PV = 520 191
C2.5 Fair value adjustment Lindtnoir bonds on 30 June 20.13

Amortised balance [C2.3] 529 067

Fair value [C2.4] 520 191
Fair value adjustment (loss) 8 876 3

C3. Remeasurements on defined benefit plan

Reconciliation of obligation
Present value of obligation at the beginning of the year 3 525 000 0.5
Current service costs 670 500 0.5
Past service costs 300 000 0.5
Benefits paid (745 500) 0.5
Interest on obligation (3 525 000 x 6%) 211 500 1
3 961 500
Remeasurement recognized in other comprehensive income 28 500
Present value of obligation at the end of the year 3 990 000 0.5
Reconciliation of plan assets
Fair value of the plan assets at the beginning of the year 3 450 000 0.5
Contributions 790 000 0.5
Benefits paid (745 500) 0.5
Interest income on plan assets (3 450 000 x 6%) 207 500 1
3 701 500
Remeasurement recognized in other comprehensive income 198 500
Fair value of the plan assets at the end of the year 3 900 000 0.5
Remeasurement recognized in other comprehensive income
(28 500 loss – 198 500 gain) x 72% 122 400 0.5
7
C4. Investment in Quick Milk

Cost (400 000 x 10.20) 4 080 000 1

Transaction cost 24 000 0.5
4 104 000
Fair value gain (OCI) 216 000
Fair value 30 June 20.12 (400 000 x 10.80) 4 320 000 0.5
Fair value gain (OCI) 80 000
Fair value 30 June 20.13 (400 000 x 11) 4 400 000 0.5

Mark to market reserve 20.12: 216 000

Tax (216 000 x 66.6% x 28%) 40 280 1
Mark-to-market reserve (net of tax) 175 720

Mark-to-market reserve 20.13 80 000

Tax (80 000 x 66.6% x 28%) (14 918) 1
Mark-to-market reserve (net of tax) 65 082
4.5
QUESTION 35 (Suggested Solution) Page 5 of 6

C5. Profit for the year

Profit for the year (given_ 5 520 000 0.5

Interest expense on liability component of convertible debentures [C1] (408 503) 3
Interest income on investment in Lindtnoir Ltd bonds [C2.2] 39 353 3
Fair value adjustment on investment in Lindtnoir Ltd bonds [C2.5] (8 876) 3
Leave pay expense ((50 + (150 x 90%) x 3 days x R200) (111 000) 2.5
Employee costs defined benefit plan:
Current service costs (given) (670 500) 0.5
Past service cost (given) (300 000) 0.5
Net interest costs (211 500 [C3] – 207 000 [C3) (4 500) 1
Revenue (correction of prior period error) 508 772 1
Dividends received (R1.25 x 400 000) 500 000 1
Adjusted profit before tax 5 064 746
Income tax expense (given) (1 880 000) 0.5
Net profit after tax 3 184 746
16.5

C6. Weighted average number of ordinary shares for basic earnings (denominator)

Weighted
Shares Fraction average
Dates outstanding of year shares
Shares in issue
1 July 20.12 – 30 April 20.13 4 200 000 10 / 12 3 500 000 1
Issue of shares on 1 May 20.13 350 000
4 550 000 2 / 12 758 333 1
4 258 333
2

The alternative calculation of weighted average number of ordinary shares is shown below:

Weighted
Shares Fraction average
Dates outstanding of year shares
Shares in issue
1 July 20.12 – 30 April 20.13 4 200 000 12 / 12 4 200 000 1
Issue of shares on 1 May 20.13 350 000 2 / 12 58 333 1
4 258 333
2
C7. Test for dilution and sequence of dilution

Increase Increase in Earnings per Order in

in number of incremental which to
earnings ordinary shares share include
Contingent share (given) - 150 000 - 1 1
a b
10% convertible debentures 294 122 4 800 000 0.061 2 2
3

a R408 503 (see part (a)) x 72% = R294 122

b 1 200 000 x 4 shares = 4 800 000
QUESTION 35 (Suggested Solution) Page 6 of 6

C8. Diluted earnings per share

Basic earnings Ordinary Per share

(control shares
number)
Basic earnings per share 3 056 746 4 258 333 0.718 1
Contingent shares (rank 1) - 150 000 0.5
3 056 746 4 408 333 0.693 Dilutive
10% convertible debentures (rank 2) 294 122 4 800 000 1
3 350 868 9 208 333 0.364 Dilutive
QUESTION 36 Page 1 of 5

Bonnat is a French chocolate-maker, founded in France in 19.22 by Felix Bonnat. Felix Bonnat
also founded a South African company, Bonnat Chocolates Ltd (Bonnat), in Cape Town in 19.50.
Their chocolate is sold in their own store in Cape Town as well as in 12 stores throughout South
Africa. Bonnat is a premier chocolate-maker in South Africa and produces plain milk and dark
chocolates, but is more well-known for their flavored chocolates.

Bonnat imports the highest quality cocoa beans which are delivered unroasted from plantations
around the world and then crafted into tablets of chocolates. Upon arrival, the cocoa beans are
thoroughly cleaned and separated from their shells. At Bonnat’s factory the cocoa beans are
carefully roasted in accordance with an in-house process. The beans are then crushed in special
mills and finely ground until a liquid cocoa mass arises. This is the most important part in the
manufacturing process of chocolate. After that the chocolate manufacturing begins with
combining the other three basic ingredients for making chocolate with the cocoa mass, namely
cocoa butter, sugar and milk. By blending all the ingredients in accordance with their special
recipe, Bonnat produces the various types of chocolates they are renowned for.

You are the financial manager of Bonnat in South Africa. The profit before tax of Bonnat
before taking transactions 1 to 8 into account, amounted to R5 520 000 for the year ended
30 June 20.13.

Transaction 1

On 1 December 20.12 Bonnat anticipated the import of cocoa beans to the value of BRL850 000
from their supplier in Brazil. On 1 January 20.13, Bonnat placed a non-cancellable order at their
Brazilian supplier for the purchase of cocoa beans amounting to BRL850 000. The official
currency of Brazil is the Brazilian Real (BRL).

The cocoa beans were shipped free-on-board on 1 February 20.13. The foreign creditor was
settled in full on 31 May 20.13. Forty percent (40%) of the imported cocoa beans were used in
the production of chocolate and included in costs of sales for the year ended 30 June 20.13. The
remainder of this batch of imported beans are unroasted and unprocessed, have a net realizable
value of R2 226 000 and is included in inventory at 30 June 20.13.

On 1 December 20.12 Bonnat decided to hedge the anticipated transaction against foreign
exchange fluctuations by entering into a six month forward exchange contract (FEC) to buy
BRL850 000. The FEC is designated as a hedging instrument for changes in the future cash
flow of the highly probable forecast purchase of the cocoa beans, the cash flow of the firm
commitment and the fair value of resulting foreign creditor.

The hedge meets all the qualifying criteria for hedge accounting of IFRS9.6.4.1. Assume that the
transaction has no deferred tax consequences.

You may ignore the effect of the time value of money for this transaction.

The following exchange rates were applicable:

Spot rate Forward rate

Date BRL1 = R BRL1 = R
1 December 20.12 4.20 4.25 (6 months)
1 January 20.13 4.35 4.36 (5 months)
1 February 20.13 4.42 4.44 (4 months)
31 May 20.13 4.47
QUESTION 36 Page 2 of 5

Transaction 2

In order to generate additional cash flow, Bonnat issued a total of 1 200 000 10% convertible
debentures with a face value of R3 each on 1 January 20.12. The maturity date of the
debentures is 1 January 20.16. Interest is payable annually on 31 December. Each debenture
is convertible at the option of the holder at any time up to maturity into four ordinary shares in
Bonnat. If the debentures are not converted into ordinary shares by the maturity date, it will
be settled in cash at face value. A market-related interest rate on 1 January 20.12 for similar
debentures without conversion rights is 12% per annum. Assume transaction 2 has no deferred
tax consequences.

Transaction 3

On 1 July 20.12 a decision was made by Bonnat not to pay any bonuses to the five directors of
the company for the financial year ended 30 June 20.13. As an alternative, Bonnat decided on
1 July 20.12 to grant each director the right to receive either a cash payment equal to 17 000
ordinary shares or alternatively 20 000 actual ordinary shares. The terms of the arrangement
provide Bonnat with the choice of settlement.

The settlement is 30 June 20.13 and the grant is conditional upon the directors still being in the
employment of Bonnat on 30 June 20.13. Bonnat has no legal or constructive obligation to settle
by means of cash. All five directors were still in the employment of Bonnat on 30 June 20.13.
At 30 June 20.13 Bonnat chose to settle in shares.

The share price of Bonnat on the various dates was as follows:

Fair value per share to be

Date Market share price issued to the directors
1 July 20.12 R10.80 R10.20
30 June 20.13. R11.10 R11.70

Assume that transaction 3 has no deferred tax consequences.

Transaction 4

Bonnat also granted 10 000 share options to each of the five directors of the company on
1 July 20.12. One share option will entitle a director to acquire one Bonnat ordinary share for
a purchase consideration of R8 per share. These directors are required to work for a period of
30 months before they can exercise their options. It is expected that all five directors will be in
the service of the company at the end of the 30 month period.

The remuneration committee of Bonnat decided on 1 January 20.13 that the directors would be
able to obtain these shares for a purchase consideration of R3 per share.

The fair values of the options, as calculated by an independent actuary, were as follows:

Option – R8 purchase Option – R3 purchase

Date consideration consideration
1 July 20.12 R4.50 -
1 January 20.13 R4.60 R9.60
30 June 20.13. R4.80 R10.20
QUESTION 36 Page 3 of 5

The average market share price of a Bonnat ordinary share was R10.86 for the period
1 July 20.12 to 30 June 20.13.

Assume that transaction 4 has no deferred tax consequences.

Transaction 5

Bonnat erected a manufacturing building in Epping, an industrial area in Cape Town, in order to
increase the production capabilities of the company to meet the increased demand for chocolate
and confectionaries. The manufacturing building was completed and brought into use on 1 July
20.11. On this date the manufacturing building had a residual value of R1 050 000. The SARS
allows a deduction of 5% per annum on the manufacturing building in terms of section 13 of the
Income Tax Act which is not apportioned for part of a year.

It is the accounting policy of Bonnat to measure the manufacturing building according to the
revaluation model. On the date of the revaluation the accumulated depreciation is eliminated
against the gross carrying amount of the asset and the net amount is restated to the revalued
amount of the asset. The revaluation surplus is realised and transferred to retained earnings
as the manufacturing building is used.

The first revaluation of the manufacturing building was performed on 1 July 20.12. The balance
of the revaluation surplus on 30 June 20.12 was Rnil.

A junior accountant prepared the following working paper in order to process the depreciation
and revaluation surplus journals in respect of the manufacturing building for the year ended
30 June 20.13.

Bonnat Ltd
30 June 20.13
Assets: Manufacturing building Working paper 22/4

R
Cost price of manufacturing building on 1 July 20.11 12 000 000
Depreciation for the year ended 30 June 20.12 547 500
Fair value on 1 July 20.12 (note 1) 11 875 000
Depreciation for the year ended 30 June 20.13 ?

Note 1

On 1 July 20.12 the valuation was performed by an independent valuer, Best Value Inc. On the
date of the revaluation there was no change to the remaining useful life of the manufacturing
building. The residual value however increased to R1 300 000.

You may assume that the amounts calculated by the junior accountant in the working paper
above are correct.

Transaction 6

On 1 March 20.13, Bonnat repurchased 350 000 ordinary shares at the fair value of R11.02 per
share as part of a voluntary share buy-back transaction. Assume that the share buy-back has no
tax consequences.
QUESTION 36 Page 4 of 5

Transaction 7

Bonnat acquired 400 000 ordinary shares in Quick Milk Ltd on 1 September 20.11 for R10.20 per
share. The transaction cost amounted to R24 000 on this date. Quick Milk Ltd is a manufacturer
of milk products that are used by Bonnat in their production process. This investment constitutes
an 8% investment and was acquired as a long-term investment. Bonnat did not obtain control of
Quick Milk through the acquisition. Bonnat irrevocably elected to present subsequent changes in
the fair value of this investment in the mark-to-market reserve in other comprehensive income in
terms of IFRS9 Financial Instruments par 5.7.5.

The transaction costs qualify to be included in the base cost of the investment in terms of
par 20 of the Eighth Schedule of the Income Tax Act.

The fair value of the ordinary shares of Quick Milk Ltd were as follows:

Fair value per share

30 June 20.12 R10.80
30 June 20.13 R11.00

The balance of the mark-to-market reserve on 30 March 20.13

Quick Milk Ltd declared a dividend of R1.25 per ordinary share on 31 March 20.13.

Transaction 8

Bonnat issued 200 000 non-redeemable cumulative preference shares on 1 November 20.12 for
R1 600 000. The dividend rate is an 8% cumulative preference dividend per annum calculated on
the issue price. The payment of a preference dividend is solely at the discretion of the directors
and any unpaid dividends accumulate for possible future declaration. A preference dividend of
R128 000 was declared and paid on 30 June 20.13.

Additional information

* A tax specialist, employed by Bonnat, calculated the income tax expense (current and
deferred) for the 20.13 financial year. The income tax expense disclosed in the profit or loss
section of the statement of profit or loss and other comprehensive income for the year ended
30 June 20.13 amounted to R880 000. You may assume that all the information in this
question was correctly taken into account and that the income tax expense was correctly
calculated.

* Bonnet had issued share capital of R8 500 000 (4 200 000 ordinary shares) on 30 June 20.12.

* The retained earnings of Bonnat amounted to R34 250 000 on 30 June 20.12.

* Bonnet declared an ordinary dividend of 25 cents per ordinary share on 30 June 20.13 to
shareholders registered on 25 June 20.13.

* The income tax rate is 28% and the inclusion rate for capital gains tax is 66.6%.
QUESTION 36 Page 5 of 5

REQUIRED: Marks

(a) Discuss the classification of transaction 8 in the financial statements of Bonnat

Chocolates Ltd for the year ended 30 June 20.13 in accordance with IAS32
Financial Instruments: Presentation [4]

(b) Prepare the statement of changes in equity of Bonnat Chocolates Ltd for the
year ended 30 June 20.13 [49]

Communication skills: Presentation and layout [2]

Please note:

~ Use a double page to present the statement of changes in equity

~ The total column in the statement of changes in equity is not required
~ Round off all amounts to the nearest Rand

(c) Present the earnings per share in the statement of profit or loss and other
comprehensive income of Bonnat Chocolates Ltd for the year ended 30 June
20.13 in accordance with IAS33 Earnings per share

Assume, for this part of the question, that the profit after tax of Bonnat Chocolates
Ltd (after taking into account any adjustments from part (b) above) amounted to
R2 795 318 for the year ended 30 June 20.13. [14]

Communication skills: Presentation and layout [1]

Please note:

~ Amounts presented in the statement of profit or loss and other comprehensive

income should be rounded off to two decimals whilst the amounts in the test of
dilution should be rounded off to three decimals.

Please note:

~ Comparative figures are not required

~ Ignore Dividend tax and Value Added Tax (VAT)
~ Your answer must comply with International Financial Reporting Standards (IFRS)
QUESTION 36 (Suggested Solution) Page 1 of 7

Part a

On initial recognition the instrument should be classified in accordance with the substance
of the contractual arrangement and the definition of a financial liability, a financial asset
and an equity instrument (IAS32.15) 0.5

The principle amount and the dividends are considered separately for classification as
either equity or a financial liability. 0.5

Principle amount

Bonnat has no obligation (an unconditional right to avoid payment) to deliver cash or
other financial assets since the preference shares are non-redeemable. 0.5

The non-redeemable preference shares therefore do not represent a financial liability but
an equity instrument in the financial statements of Bonnat. 0.5

Preference dividends

Since the non-redeemable preference shares do not contain a redemption obligation and
the payment of preference dividends are at the directors discretion, the preference shares
establish no contractual rights to a preference dividends (IAS32.AG26) 1

The dividend payments are therefore not a financial liability but represents equity 0.5

Conclusion: The entire instrument is classified as an equity instrument. 0.4

4
QUESTION 36 (Suggested Solution) Page 2 of 7

Part b
QUESTION 36 (Suggested Solution) Page 3 of 7

Part c

BONNAT CHOCOLATES LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE

YEAR ENDED 30 JUNE 20.13

20.13
Note R
Basic earnings per share
a
- Profit attributable to ordinary equity holders 0.65 4
Diluted earnings per share
b
- Profit attributable to ordinary equity holders 0.33 10
Total 14
Communication skills: Presentation and layout 1

a R2 667 318 [C10] / 4 112 500 [C11] = R0.65

b R2 961 440 [C14] / 9 032 804 [C14] = R0.33

CALCULATIONS:

C1. Cash flow hedge reserve

R
1 Dec 20.12 – 1 Jan 20.13 FEC 850 000 x (1.36 – 4.25) 93 500 Gain 1.5
1 Jan 20.13 – Feb 20.13 FEC 850 000 x (4.44 – 4.36) 68 000 Gain 1
161 500
Transfer cash flow hedge
reserve to cost of inventory (161 500) 1
Cash flow hedge reserve
balance -
Amount in included in cost of
inventory sold (161 500 x 40%) 64 600 1

C2. Fair value adjustment on FEC

R
1 Feb 20.13 – 31 May 20.13 850 000 x (4.47 – 4.44) 25 500 Gain 1

C3. Foreign exchange loss on foreign creditor

R
1 Feb 20.13 – 31 May 20.13 850 000 x (4.42 – 4.47) (42 500) Loss 1

C4. Write-down of inventory to net realizable value

1 February 20.13 R
Cost of inventory 850 000 x4.42 3 757 000 1
Closing inventory 3 757 000 x 60% 2 254 200 1
Net realizable value (given) (2 226 000) 1
Write-down to net realizable value 28 200
QUESTION 36 (Suggested Solution) Page 4 of 7

C5. Convertible debentures

Fair value of financial liability

Present value of debentures on 1 January 20.12

N 4 0.5
I 12% 0.5
PMT (1 200 000 x R3 x 10%) 360 000 0.5
FV (1 200 000 x R3) 3 600 000 0.5
PV = 3 381 311

Present value of financial liability 3 381 311

Equity component (balancing) 218 689 0.5
Proceeds on issue of bonds 3 600 000 0.5
3

Interest for the year 20.12

Effective interest accrued: 1 Jan 20.12 – 30 June 20.12
3 381 311 x 12% x 6 / 12 202 879
Interest for the year 2013
Effective interest accrued: 1 July 2012 – 31 Dec 20.12
3 381 311 x 12% 6/ 12 or 1 Amort (INT = 405 757) 202 879 1.5
Coupon interest (360 000)
Amortised costs 45 758

Effective interest accrued: 1 Jan 2013 – 30 June 20.13

3 381 311 + 45 758 = 3 427 069 x 12% x 6 / 12
or 2 Amort (INT = 411 248 x 6 / 12) 205 624 1.5
Total interest for 2013 (202 879 + 205 624) 408 503
3

C6. Share based payment

Bonus-scheme
Share based payment expense 20 000 x 5 x 10.20 1 020 000 1.5
Value of the cash alternative at 30 June 20.13 1.5
17 000 x 5 x 11.10 = 943 500
Value of the equity alternative at 30 June 20.13 1.5
20 000 x 5 x 11.70 = 1 170 000
Additional share based payment expense for highest alternative
1 170 000 – 943 500 226 500 1
Total share based payment expense 1 246 500
5.5

Share-option scheme
Original option 5 x 10 000 x 4.50 x 12 / 30 90 000 2
Modification 5 x 10 000 x (9.60 – 4.60) x 6 / 24 62 500 1
152 500
3

Total share based payment expense in P/L 1 399 000

QUESTION 36 (Suggested Solution) Page 5 of 7

C7. Manufacturing building – revaluation surplus

Carrying amount (12 000 000 – 547 500) 11 452 500 1

Fair value 1 July 20.12 (given) 11 875 000 1
Revaluation surplus 422 500
Deferred tax 422 500 x 28% 118 300 1
Revaluation surplus after tax 304 200 3

Useful life ((12 000 000 – 1 050 000) / 547 500) 20 years 1.5
Depreciation (11875 000 – 1 300 000) / 19 556 579 1.5
3
Transfer to retained earnings
(11 452 500 – 1 300 000) = 10 152 500 / 19 = 534 342
(534 342 – 556 579) = 22 237 x 72% 16 011 1.5

C8. Investment in Quick Milk

Cost (400 000 x 10.20) 4 080 000 1

Transaction cost 24 000 0.5
4 104 000
Fair value gain (OCI) 216 000
Fair value 30 June 20.12 (400 000 x 10.80) 4 320 000 0.5
Fair value gain (OCI) 80 000
Fair value 30 June 20.12 (400 000 x 11) 4 400 000 1.5

Mark to market reserve 20.12: 216 000 x 81.352% 175 720 1

Mark to market reserve 20.13: 80 000 x 81.352% 65 082 1
4.5

C9. Profit for the year

Profit for the year (given) 5 520 000 0.5

Cash flow hedge reserve reclassified to P/L [C1] 64 600 1
Fair value adjustment on FEC [C2] 25 500 1
Foreign exchange loss on foreign creditor [C3] (42 500) 1
Write down of inventory [C4] (28 200) 3
Interest on liability component of convertible debentures [C5] (408 503) 3
Share based payment expense (bonus) [C6] (1 246 500) 1
Share based payment expense (options) [C6] (152 500) 1
Depreciation [C7] (556 579) 3
Dividend received (R1.25 x 400 000) 500 000 1
Adjusted profit before tax 3 675 318
Income tax expense (given) (880 000) 1
Net profit after tax 2 795 318
16.5

C10. Basic earnings

Profit for the year (see part (a)) 2 795 318 1

Preference dividends (given) (128 000) 1
Numerator for basic earnings for the period 2 667 318
2
QUESTION 36 (Suggested Solution) Page 6 of 7

C11. Weighted average number of ordinary shares for basic earnings (denominator)

Weighted
Shares Fraction average
Dates outstanding of year shares
Shares in issue 1 Jul 20.12 – 31 Mar 20.13 4 200 000 9/12 3 150 000 1
Share buy back on 31 Mar 20.13 (350 000)
From 1 Apr 20.13 – 30 Jun 20.13 3 850 000 3/12 962 500 1
c
Shares issued to directors on 30 Jun 20.13 100 000
30 Jun 20.13 – 30 Jun 20.13 3 950 000 0/12 -
4 112 500
2
c 20 000 shares x 5 directors = 100 000

The alternative calculation of weighted average number of ordinary shares is show below:

Weighted
Shares Fraction average
Dates outstanding of year shares
Shares in issue 1 Jul 20.12 – 30 Jun 20.13 4 200 000 9/12 4 200 000 1
Share buy back on 31 Mar 20.13
1 Apr 20.13 – 30 Jun 20.13 (350 000) 3/12 (87 500) 1
Shares issued to directors on 30 Jun 20.13 100 000 0/12 -
4 112 500
2

C12. Test for dilution and sequence of dilution

Increase
in number Earnings
Increase of per Order in
in ordinary incremental which to
earnings shares share* include
d e
10% convertible debentures 294 122 4 800 000 0.061 2 1
f
Bonus scheme for directors - 100 000 - 1 1
Share options for directors - 20 304 - 1
[C13.2]
3

d R408 503 (see part (a)) x 72% = R294 122

e 1 200 000 x 4 shares = 4 800 000

f 20 000 x 5 x 12 / 12 = 100 000. The shares issued to the directors on 30 June 2013
are all issued for no value, therefore the entire 100 000 shares are included in diluted
earnings per share. As the shares were potential ordinary shares from 1 July 20.12 –
30 June 20.13 (issue date), the 100 000 potential ordinary shares are weighted fro
12 months.

* All three incremental earnings per share is less than R0.65 per share and are
therefore dilutive
QUESTION 36 (Suggested Solution) Page 7 of 7

C13. Share options issue fro no value

C13.1 Assumed total proceeds from share options

Total exercise price to be paid by the directors (no contribution) -

Unrecognized IFRS2 expense on original share options
(5 directors x 10 000 shares x R4.50 x 18 / 30) 135 000 2
Unrecognized IFRS2 expense on modified share options
(5 directors x 10 000 shares x (R9.60 – R4.60) x 18 / 24 187 500 2.5
322 500

C13.2 Number of ordinary shares to be used in diluted earnings per share

Number of shares under option scheme 50 000 0.5

Number of shares that would have been issued at the average market
price for the year (R322 500 [C13.1] / R10.86) (29 696) 1
Share options issued for no consideration (no value) 20 304
6

C14. Diluted earnings per share

Basic
earnings
(control Ordinary Per
number) shares share
Basic earnings per share [C10] [C11] 2 667 318 4 112 500 0.648
Bonus scheme for directors (rank 1)
[C12] - 100 000
2 667 318 4 212 500 0.633 Dilutive
Share options to directors (rank 1)
[C13] - 20 304
2 667 318 4 232 804 0.630 Dilutive 0.5
10% convertible debentures (rank 2) 294 122 4 800 000
2 961 440 9 032 804 0.328 Dilutive 0.5
1
QUESTION 36 (Suggested Solution) Page 2 of 7

Part b

BONNAT CHOCOLATES LTD

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.13

Equity
Cash component Share
Preference flow of based Reval- Mark to
Share share Retained hedge convertible payment uation marketed
capital capital earnings reserve debentures reserve surplus reserve
R R R R R R R R
Balance at 30 June 20.12 8 500 000 34 250 000 218 689 175 720 7
[C5] [C8]
Share based payment (share 3
options issued to directors) 152 500
[C6]
Share based payment (bonus
scheme) 1 246 500 0.5
Shares issued to directors 1 246 500 (1 246 500) 0.5
[C6]
Revaluation surplus realised –
transfer to retained earnings 16 011 (16 011) 2
[C7] [C7]
Share buy back (350 000 x R11.02) 1.5
see * below (3 857 000)
Total comprehensive income for the
year
- Profit for the year 2 795 318 16.5
[C9]
- Other comprehensive 161 500 304 200 65 082 9
income [C1] [C7] [C8]
Cash flow hedge reserve
transferred to cost of inventory (161 500)
Ordinary dividend
(4 200 000 – 350 000)
x 0.25 (962 500) 2
Issue of preference shares (given )
1 600 000 1
Preference dividend (given) ________ ________ (128 000) _____ _______ _______ _______ _______ 1
Balance at 30 June 20.13 5 889 500 1 600 000 35 970 829 - 218 689 152 500 288 189 240 802
Total 49
Communication skills: Presentation and layout 2

* Share buy back:

It is also acceptable to reduce Share Capital with R708 333 ((R8 500 000 / 4 200 000) x 350 000) and to
reduce Retained Earnings with the balance of R3 148 667 (R3 857 000 – R708 333).
QUESTION 37 Page 1 of 10

Umhlanga Holdings (Pty) Ltd (‘Umhlanga’) is an investment holding company registered in South
Africa. The Umhlanga group is a leading supplier of ocean surfing equipment and related gear.

All entities within the group apply International Financial Reporting Standards (IFRSs). The
consolidated annual financial statements for the year ended 31 December 2014 (‘FY2014’) are
currently being finalized.

The following extracts from the notes to the drafted consolidated annual financial statements are
available. The extracts provided are correct, unless indicated otherwise. Additional information
supporting the disclosures is also provided. These are referred to as notes A, B, C and D under
the additional information.

Umhlanga
Notes to the drafted consolidated annual financial statements
for the year ended 31 December 2014

3. Key sources of estimation uncertainty

3.3 Fair value measurements and valuation processes

The group measures some of its assets and liabilities at fair value. The board of directors
of the company has set up a valuation committee, chaired by the chief financial officer of
the company, to determine the appropriate valuation techniques and inputs for fair value
measurements.

When measuring the fair value of an asset or a liability, the group uses observable market
data as far as possible. Fair values are categorized in a fair value hierarchy in accordance
with IFRS13 Fair Value Measurement.

In cases where level 1 inputs are not available, the group engages third-party, qualified
valuers to perform the valuation. The valuation committee works closely with the qualified
external valuers to establish the appropriate valuation techniques for and inputs to the
model.

Information about the valuation techniques and inputs used in determining the fair value
of various assets and liabilities is disclosed in notes 15, 16 and 40.

4. Significant accounting policies

4.5 Property, plant and equipment

Property, plant and equipment are stated at revalued amounts, being the fair value at the
date of revaluation, less any subsequent accumulated depreciation and accumulated
impairment losses. Revaluations are performed with sufficient regularity to ensure that the
carrying amounts do not differ materially from their fair values…

4.7 Investment property

Investment property is measured initially at cost. Subsequent to initial recognition,

investment property is measured at fair value.

4.8 Intangible assets

Intangible assets comprise a brand which was initially measured at cost. Subsequent to
initial recognition, the brand is measured at cost less accumulated amortization and
accumulated impairment losses.
QUESTION 37 Page 2 of 10

Amortisation is recognised on a straight-line basis over the estimated useful life of ten
years. The residual value is reviewed during each reporting period and is estimated as
zero…

4.9 Financial instruments

Financial assets

Derivative financial assets are subsequently measured at fair value with changes
recognised in profit or loss.

Unlisted shares are not held for trading. The group measures unlisted shares
subsequently at fair value with changes recognised in other comprehensive income.

Trade and other receivables are subsequently measured at amortised cost using the
effective interest method.

Financial liabilities

Trade and other payables and bank loans are measured at amortised cost using the
effective interest method.

Contingent consideration in a business combination is measured at fair value with the

resultant gain or loss recognised in profit or loss.

15 Investment property

At fair value
R
Balance at 1 January 2014 1 941 000
Additions 202 000
Disposals -
Gain on property revaluation 375 000
Balance at 31 December 2014 2 518 000

15.1 Fair value measurement of the group’s investment property

The fair value measurements of the group’s investment property as at 31 December 2014
were performed by Naidoo and Associates (‘Naidoo’), independent valuers not related to
the group. Naidoo is a member of the South African Institute of Valuers and has
appropriate qualifications and recent experience in fair value measurement.

Details of the group’s investment property and information about the fair value hierarchy
as at 31 December 2014:

Investment property
Fair value at 31 December 2014 R2 518 000
Fair value hierarchy level ?
Valuation technique(s) and Discounted cash flow (current lease income
key input(s) streams) using assumptions for growth rates
and discount rates
QUESTION 37 Page 3 of 10

16 Property, plant and equipment

Total at
revalued
amount
R
Balance at 1 January 2014 16 476 200
Additions 2 147 300
Disposals (1 566 400)
Acquisitions through business combinations 2 466 200
Depreciation (1 548 500)
Revaluation increase through other comprehensive income 1 000 000
Impairment losses reversed through profit or loss 645 000
Balance at 31 December 2014 19 619 800

16.1 Fair value measurement of the group’s property, plant and equipment

The fair value measurements of the group’s property, plant and equipment as at
31 December 2014 were performed by Naidoo.

Details of the group’s property, plant and equipment and information about the fair value
hierarchy as at 31 December 2014:

Property, plant and equipment

Fair value at 31 December 2014 R19 619 800
Fair value hierarchy level ?
Valuation technique(s) and key Market approach using prices for similar assets
input(s)

18 Intangible assets

R
Balance at 1 January 2014 -
Additions -
Disposals (-)
Acquisition through business combination ?
Amortization ?
Balance at 31 December 2014 ?
QUESTION 37 Page 4 of 10

40 Financial instruments

This note provides information about how the group determines the fair values of
various financial assets and liabilities.

40.1 Fair value of the group’s financial assets and liabilities that are measured
at fair value

Foreign currency forward contracts

Fair value at 31 December 2013 Assets – R224 000
Fair value at 31 December 2014 Assets – R345 000
Fair value hierarchy level ?
Valuation technique(s) and key input(s) ~ Discounted cash flow
~ The fair value is calculated by the bank
(counterparty of the forward), using future
cash flows that are estimated based on
observable forward exchange rates and
contract forward rates, discounted at an
observable interest rate
~ Discount rates include appropriate
adjustments for credit risk
Significant unobservable input(s) None

Unlisted shares
Fair value at 31 December 2013 Assets – R590 000
Fair value at 31 December 2014 Assets – R725 000
Fair value hierarchy level ?
Valuation technique(s) and key input(s) Discounted cash flow
Significant unobservable input(s) ~ Management’s estimate of long-term
revenue growth rates
~ Management’s estimate of long-term
operating margins
~ Weighted average cost of capital, using
the capital asset pricing model.

Contingent consideration in a business combination

Fair value at 31 December 2013 -
Fair value at 31 December 2014 Liability – R850 000
Fair value hierarchy level ?
Valuation technique(s) and key input(s) Discounted cash flow
Significant unobservable input(s) ~ Pre-tax discount rate of 12% per annum
~ Probability-adjusted profits as at
31 December 2014, with a range of
R0 to R1 000 000
QUESTION 37 Page 5 of 10

40.2 Fair value of the group’s financial assets and liabilities that are not measured
at fair value

Financial assets at amortised cost – trade and other receivables

At 31 December 2013
Carrying amount R1 683 200
Fair value R1 671 300
At 31 December 2014
Carrying amount R2 250 600
Fair value R2 233 900
Fair value hierarchy level ?

Financial liabilities at amortised cost – trade and other receivables

At 31 December 2013
Carrying amount R2 042 200
Fair value R2 019 900
At 31 December 2014
Carrying amount R1 565 900
Fair value R1 550 800
Fair value hierarchy level ?

Bank loans
At 31 December 2013
Carrying amount R625 000
Fair value R650 000
At 31 December 2014
Carrying amount R1 067 400
Fair value R1 100 000
Fair value hierarchy level ?

Note A – Investment property (see note 15)

Investment property comprises a property (land and a building) situated in Tongaat, KwaZulu
Natal, next to the N2 freeway. The building is a warehouse that is leased to an unrelated third
party who uses the building as a distribution facility. Recently, residential development has taken
place in the area surrounding the property. This has led to substantial increases in the value of
residential properties in the area. The most recent development is that the town council has in
principle approved the rezoning of the Tongaat property owned by Umhlanga, for residential
development. The fee to finalise the rezoning application of the property from industrial use to
residential use would amount to R10 000.

Umhlanga is seriously considering the possibility of developing the land into a residential estate,
in which units will initially be leased out. Each unit in the residential estate will be similar in terms
of size and layout. Umhlanga has already enlisted the services of an architect who drew up plans
for the proposed development. The architect was paid for his services in December 2014.

Umhlanga has been in negotiations with a contractor to develop the residential property. The
contractor will commence work after the existing building has been demolished. The scope of the
contractor’s work will include all relevant earthworks, infrastructure development and construction
of the residential units. The development will take two years to complete, and the contractor will
require payments as follows:
QUESTION 37 Page 6 of 10

* 40% of the total development contract fee upfront;

* 35% on the completion of certain milestones after one year; and
* The balance upon completion of the development at the end of year 2

As part of the planned project, upon completion of the residential estate, Umhlanga plans to let
the units and increase occupancy up to 100% as soon as possible. Umhlanga will consider
selling the entire residential estate as a going concern at the end of three years after completion
of the development.

Umhlanga is in the process of finalising an agreement with Marula Ltd (‘Marula’), a major fashion
wholesale group in South Africa, to place Marula’ logo and advertisements on the exterior of the
highly visible property boundary fence during the two-year construction phase. Marula is very
excited about the opportunity, for these advertisements would be seen by motorists on the busy
N2 freeway, and would thus give their group enormous exposure.

In the past Marula had supplied Umhlanga with certain fashion product lines that Umhlanga
marketed under its surfing brands. However, some of these contracts were not honored in that
Umhlanga failed to include Marula’s logo on the inside of the merchandise. As a result, Marula
cancelled its supply contracts with Umhlanga. Umhlanag has informed Marula that the
advertising rates will be lower than market rates in order to compensate Marula for this
unfortunate incident. Market rates for similar advertising would amount to R2 500 000 per
annum, but Marula will pay 74% of the market rate for this advertising opportunity.

After doing extensive research into the planned residential property development, Umhlanga, with
the assistance of Naidoo, determined that the fair value of the property would be R4 million if it
were to pursue the opportunity. The valuation committee of Umhlanga questioned the R4 million
fair value of the residential development and its significant difference from the current fair value of
the investment property of R2 518 000. Naidoo prepared detailed forecasts relating to the
residential development project for presentation to the valuation committee. The board of
directors of Umhlanga asked that this information be summarized into a capital budget to assist
the board with its evaluation of the proposed project. Details of the project’s forecast revenue
and costs, together with other relevant information, are summarized in the table below:

Total development contract fee R9 500 000

Architect fee (drawing up of plant) R100 000
Cost to demolish the warehouse prior to
commencement of development R300 000
Total units in estate 28
Expected rental income per unit R16 000 per month in the first year of renting
the units, with an escalation of 6% per year
Estimated occupancy of residential units after 50% in year 1
completion 100% in year 2 and 3
Operating profit margin 45% of rental income
Earnings before interest, tax, depreciation and
amortization (EBITDA) margin 61% of rental income
Tax rate 28%
Expected selling price of the fully developed and
100% occupied residential estate at the end of
year 5 R15 300 000
Transaction costs to sell the estate (agent
commissions and legal fees) at the end of year 5 R1 560 000
QUESTION 37 Page 7 of 10

Betqa coefficient (levered) of PropcCo Ltd

(‘PropCo’), a company which owns and lets
residential property and is listed on the
Johannesburg Stock Exchange. PropCo has a
market capitalization of R500 million 1.3
Debt : Equity ratio of PropCo (based on market
values) 45%
Average ten-year government bond yield 8.3%
Market risk premium 6%
Estimated fair value of 100% of the ordinary
shares of Umhlanga R100 000 000
Weighted average cost of capital (WACC) of
Umhlanga 15%

The only permanent debt financing utlised by Umhlanga are the bank loans referred to in note
40.2 above, which bear interest at a market-related rate of 9.5% per annum. The residential
property development will be funded out of the surplus cash to be generated by the Umhlanga
group over the next three years.

Note B – Acquisition of Verulam (also see note 18)

During FY2012 Umhlanga acquired a 40% interest in Verulam (Pty) Ltd (‘Verulam’) for R980 000.
This interest gave Umhlanga significant influence over Verulam. Umhlanga considered the
carrying amount of the identifiable assets and liabilities of Verulam to be reflective of their
respective fair values when the 40% interest was acquired.

Carrying amount of identifiable assets and

liabilities of Verulam as recognised by Verulam
At acquisition of initial 40% R1 900 000
At 31 December 2013 R2 500 000

Verulam’s profit after tax for the period 1 January 2014 to 31 July 2014 amounted to R275 000.
Dividends of R51 000 were declared and paid on 31 March 2014. There have been no changes
in the share capital since the initial acquisition and there were no other changes in the reserves in
the current year.

The fair value of Umhlanga’s 40% interest in Verulam at 31 July 2014 was estimated to be
R1 500 000.

Umhlanga acquired an additional 35% of the ordinary shares in Verulam on 31 July 2014.
The purchase price was an immediate cash consideration of R1 200 000, and a further cash
consideration payable on 31 July 2016, dependent on the cumulative profit over the two years
to 31 July 2016.

The probabilities of the various amounts payable, which are dependent on the cumulative profit
target, are summarized in the table below (see also note 18 and note 40.1 above):

Profit target Amount payable Probability at acquisition date

R0 – R499 999 R500 000 35%
R500 000 – R999 999 R750 000 55%
R1 000 000 and more R1 000 000 10%

The acquisition of the additional interest on 31 July 2014 resulted in Umhlanga obtaining control
over Verulam. This is the only business combination that occurred in the group during FY2014.
QUESTION 37 Page 8 of 10

Except for the brand intangible asset noted below, the effect of the acquisition is already reflected
in the notes to the draft consolidated annual financial statements provided above.

A brand which is recognised as an intangible asset was acquired in the business combination and
is included in the identifiable assets and liabilities acquired. Umhlanga has decided not to use the
brand as its removal from the market would generate greater incremental value for Umhlanga as
a result of increased revenues from its existing internally generating brands. The valuation
committee was uncertain about the fair value of the brand and asked a brand valuation expert to
held with this. The expert estimated that discontinuing the use of the acquired brand would
generate R1 350 000 in incremental present value for the group. Should Umhlanga wish to sell
the brand, competitors would be prepared to pay R995 000 for it.

The net value of all the identifiable assets and liabilities, excluding the intangible brand acquired
on 31 July 2014, amounted to R2 461 200. No intangible assets were acquired apart from the
brand.

Note C – Financial instruments (see note 40)

The following relate to the movements in the group’s financial assets and liabilities:

Foreign currency forward These contracts are held for the settlement of foreign trade
contracts payables.
Contracts that have matured during the year resulted in a net cash
inflow of R100 000
There were no open foreign currency forward contracts relating to
Verulam on 31 July 2014.
Unlisted shares There were no acquisitions or disposals or dividends during
FY2014
Trade and other Receivables with a fair value of R495 000 were recognised on the
receivables acquisition of the additional interest in Verulam
Trade and other payables Payables with a fair value of R175 000 were recognised on the
acquisition of the additional interest in Verulam
Bank loans There were no capital or interest loan repayments during the year
No additional capital amounts were withdrawn from the bank loan
during the year
Loans with a fair value of R200 000 were recognised on the
acquisition of the additional interest in Verulam
QUESTION 37 Page 9 of 10

Note D – Additional information

* The decrease in Umhlanga group inventories for FY2014 amounted to R138 200. No
inventory was acquired with the acquisition of Verulam.

* Umhlanga chose to measure any non-controlling interest arising from the acquisition of
Verulam at the proportionate share of the identifiable net assets at acquisition.

* All items of property, plant and equipment disposed of during FY2014 were sold at their
respective carrying values.

* Umhlanga has no foreign subsidiaries

* Umhlanga did not receive any dividends during FY2014 from the unlisted investments
measured at fair value with changes recognised in other comprehensive income.

* The Hamada formula for levering and unlevering beta coefficients is as follows:

Bl = Bu x [1 + (1 – t) (D ÷ E)]

Where Bu = unlevered beta

Bl = levered beta
t = income tax rate
D = market value of debt
E = equity value
QUESTION 37 Page 10 of 10

REQUIRED: Marks

(a) Critically discuss, with reasons, whether the fair value measurement of the Tongaat
investment property included in the FY2014 draft consolidated annual financial
statements is appropriate in terms of IFRS13 Fair Value Measurement [9]

Communication skills – clarity of expression; logical argument [2]

(b) Indicate, with supporting reasons, what the appropriate level in the fair value
hierarchy would be for each item in notes 15.1, 16.1, 40.1 and 40.2 to the FY2014
draft consolidated annual financial statements, where the levels in the
fair value hierarchy have not been disclosed. [13]

Item Fair value hierarchy level Reason(s)

Communication skills – presentation and layout [1]

(c) Based on the information provided, calculate the net cash flows from operating
activities in the consolidated statement of cash flows of the Umhlanga group for
FY2014

Assume the following:

~ The consolidated profit before tax of the Umhlanga group was R22 982 000
and is correct in all respects;
~ This profit before tax was determined based on a fair value of R4 million for the
investment property (which you may assume is the appropriate fair value of the
investment property for answering this part of the required);
~ Cash taxes paid amounted to R6 200 000; and
~ Interest paid was presented as a financing cash flow and dividends received
were presented as an investing cash flow [29]

Communication skills – presentation and layout [1]

(d) Prepare a capital budget to estimate the net present value of the proposed
residential property development by Umhlanga

Assume the following:

~ The property will be taxed as a capital asset; and
~ All cash flows occur at the beginning or end of the relevant period

Provide reasons for any other assumption you make regarding –

~ the discount rate you used to present value the forecast cash flows; [30]
~ the normal income tax consequences of the project
[1]
Communications skills – presentation and layout

(e) Identify and discuss the key factors that the board of directors of Umhlanga should
consider in deciding whether or not to pursue the proposed residential property
development project. [13]

Communication skills – clarity of expression [1]

QUESTION 37 (Suggested Solution) Page 1 of 7

Part (a) Critically discuss, with reasons, whether the fair value measurement of the
Tongaat investment property included in the FY2014 draft consolidated annual
financial statements is appropriate in terms of IFRS13.

* IFRS13 Fair Value Measurement defines fair value as the price that would be received to
sell an asset in an orderly transaction between market participants at the measurement
date (IFRS13.09) 1

* IFRS13.15 requires that the price to sell the asset should be determined at measurement
date (31 December 2014). It also appears that Umhlanga has access to the principal
(or most advantageous) market for this property at the measurement date 1

* The valuation included in the FY2014 draft financial statements (R2.518) uses an income
approach (discounted cash flows based on lease income streams). This is an appropriate
valuation technique in terms of IFRS13. 1

* However, the fair value measurement should take into account a market participant’s
ability to generate economic benefits by using the asset in its highest and best use
(IFRS13.27) 1

* The highest and best use of a non-financial asset is the use by market participants that
would maximize the use of the asset (Tongaat property) within which the asset would be
used (IFRS3.App A) (definition) 1

* The highest and best use of a non-financial asset takes into account the use of the asset
that is physically possible, legally permissible and financially feasible, as follows
(IFRS13.28):

~ A use that is physically possible takes into account the physical characteristics of the
asset that market participants would take into account when pricing the asset (e.g. the
location or size of a property) – it is physically possible to use the property either as
a warehouse (current use) or to covert it into residential property (potential use) 1
~ A use that is legally permissible takes into account any legal restrictions on the use
of the asset that market participation would take into account when pricing the asset
(e.g. the zoning regulations applicable to a property) – it is legally permissible to use
the property under its current use as a warehouse or to rezone the property for
potential use as residential. 1
~ A use that is financially feasible takes into account whether a use of the asset that is
physically possible and legally permissible generates adequate income or cash flows
(taking into account the costs of converting the asset to that use) to produce an
investment return that market participants would require from an investment in that
asset put to that use – the current use as a warehouse generate cash flows from
leasing and potential use and conversion into residential property also appears
financially feasible (taken into account the costs to convert and the return that will
be earned. 1
QUESTION 37 (Suggested Solution) Page 2 of 7

* It appears as if the residential development is the highest and best use (over the leasing
alternative) based on the following:
~ Recent residential development has taken place in the area surrounding the
property
~ Substantial increases in the value of residential properties in the area indicates
that the higher and best use is the residential development
~ If the property are zoned for residential development, the costs to finalise are
marginal
~ Umhlanga is seriously considering the development which would also imply that it
has identified the opportunity to unlock value
~ Based on the valuation performed, the higher and better use value is the residential
estate of R4 000 000 rather than the R2 518 000 value based on current use of
leasing out the premises.

* Fair value measurement should take into account the characteristics of the asset that
market participants would take into account when pricing the asset or liability. 1

* IFRS13.61 requires that the valuation techniques used are appropriate in the
circumstances and for which data are available to measure fair value, maximizing the
use of observable inputs and minimizing the use of unobservable inputs. 1

* The valuation performed based on highest and best use can be evaluated on the
following considerations:
~ The NPV valuation of R4m contains a large amount of unobservable inputs (including
the entities own cash flow forecasts, risk adjustments, etc.) Although this would lead
to a lower level in the fair value hierarchy, the NPV used is nevertheless appropriate
since it makes use of the best and most appropriate data available to the entity. 1
However, this could also be criticized in accordance with IFRS13 par B14 (a) which
require present value techniques to reflect cash flows and discount rates that reflect
the assumptions that market participants would make which by definition should be or
independent. 1
~ Since residential development in the areas has expanded, it might also be argued
that prices for similar residential developments might be available, and this
observable input can be used (with appropriate adjustments) to determine the fair
value of the residential use of the property (using less entity specific data). This
valuation could be given priority as there are less unobservable inputs (IFRS13.72) 1
~ In the residential development case, multiple valuation techniques might be
appropriate. The multiple valuation techniques shall be evaluated considering the
reasonableness of the range of values indicated by those results. A fair value
measurement is the point within that range that is most representative of fair
value in the circumstances. 1
* The use of a discounted cash flow technique valuation (for the R4m valuation) is
appropriate, as IFRS13 includes reference to an ‘income approach valuation’
IFRS13.B10 as a suitable approach to calculating fair value. 1

* Fair value measurement should take into account the risk of the specific asset being
measured. Thus it is appropriate to adjust (either the cash flows or) the discount rate
to factor in the risk that market participants would consider when pricing the asset. 1

* Conclusion: it appears as if the valuation should be based on the residential development

use and it is unlikely that the fair value of R2 518 000 (based on current use) is
appropriate in the current circumstances. 1
Available 19
Max 9
Communication skills – clarity of expression; logical argument 2
Total 11
QUESTION 37 (Suggested Solution) Page 3 of 7

Part (b) Indicate, with supporting reasons, what is the appropriate level in the fair value
Hierarchy.

Item Level Reason(s)

Investment 3 The fair value measurement includes significant unobservable
property (15.1) inputs, namely the future cash flow estimates of Messrs
Naidoo and associates / entity, as well as their
assumptions for growth rates and discount rates. Note that
merely because the value is provided by an independent third
party expert does not cause the inputs to become observable. 2
Property, plant 2 The market price for a similar asset is an observable input.
and equipment It would not qualify for level 1 since it is not a quoted price for an
(16.1) identical asset in an active market. 2
Foreign currency 2 The contract rates, forward exchange rates are all
forward contracts observable inputs. Even though the valuation is provided by
(40.1) the bank, it would not qualify for level 1 since it is not a quoted
price for an identical asset in an active market. OR 2
Or 3 Dependent on the adjustment require for the unobserved
inputs, being credit risk, the contracts could result in the
instrument being classified also at level 3 2
Unlisted shares 3 Significant unobservable inputs, namely management’s
(40.1) assumptions regarding future revenue, profit margins and
WACC of the investment. 2
Contingent 3 Significant unobservable inputs, namely management’s
consideration in a assumptions regarding future profitability and discount
B/Com (40.1) rates of the contingent consideration 2
Trade and other 2 The valuation of trade and other receivables would in all
receivables (40.2) likelihood (no information to the contrary provided) take into
account contractual cash flows receivable which would
constitute observable inputs. OR 2
Or 2 Dependent on the adjustment require for the unobserved
inputs, being credit risk, the trade receivables would be
regarded as a level 3 instrument. 2
Trade and other 2 The valuation of trade and other payables would in all likelihood
payables (40.2) (no information to the contrary provided) take into account
contractual cash flows payable as well as assumptions
regarding the credit risk of Umhlanga, which would constitute
observable inputs. OR 2
Or 3 Dependent on the adjustment require for the unobserved
inputs, being entity’s own credit risk (Umhlanga is
unlisted), the trade payables would be regarded as a level 3
instrument. 2
Bank loans (40.2) 2 The bank loan bears interest at a market related rate of 9.5%,
which is an observable input. Thus the fair value would likely
equal the carrying amount of the bank loan. 2
Available 16
Max 13
Communication skills – presentation and layout 1
Total 14
QUESTION 37 (Suggested Solution) Page 4 of 7

Part (c) Based on the information provided, calculate the net cash flows from operating
activities

Profit before tax 22 982 000

Adjustments for:
Gain on investment property valuation
(R4 000 000 – (R1 941 000 + R202 000)) or (R375 000 + R1 482 000) (1 857 000) 2
Depreciation 1 548 500 1
Revaluation through other comprehensive income (1 000 000) - -1
Impairment losses reversed through profit or loss (645 000) 1
Amortization (R985 000 / 10 x 5 / 12) 41 042 2
Share of profit of associate (R275 000 x 40%) (110 000) 1
Dividends received (Umhlanga has elected to present as
part of investing activities) (51 000 x 40%) - -1
Remeasurement of associate on disposal thereof (C1) (190 400) 1
Fair value movements on FECs ((R345 000 + R100 000) – R224 000) (221 000) 1
Cash settlement of FECs 100 000 -1
Unlisted shares through other comprehensive income
(725 000 – 590 000 = 135 000) - -1
Fair value change on contingent consideration (R850 000 – R548 071*) 301 929 1
*R500 000 x 35% + R750 000 x 55% + R1 000 000 x 10% = 687 500
.
FV = R687 500; n = 2; i = 12 . . PV = R548 071 3
Interest expense (R1 067 400 – (R625 000 + R200 000)
(Umhlanga elected to present interest paid as part of financing activities) 242 400 2
OR Calculation of interest based on an interest rate of 9.5%
and apportionment of time) 2
Increase in receivables (R2 250 600 – (R1 683 200 + R495 000)) (72 400) 2
Change (decrease) in inventories 138 200 1
Decrease in payable (R1 565 900 – (R2 042 200 + R175 000) (651 300) 2
Taxation paid (6 200 000) 1
Net cash from operating activities XXX 1

C1. Re-measurement gain:

Net asset value on 31/12/2013

Cost (given) 980 000 OR (R2 500 000) x 40% 1 000 000 1
Growth (R2 500 000 – Goodwill at acquisition
R1 900 000) x 40% 240 000 (R1 900 000 x 40% - 980 000) 220 000 2
Growth current year
net of div 89 600 Growth current year net of div 89 600 2
(R275 000 – R51 000) x 40%
1 309 600 1 309 600
FV of previously
held interest 1 500 000 FV of previously held interest 1 500 000 1
Re-measurement gain 190 400 Re-measurement gain 190 400
QUESTION 37 (Suggested Solution) Page 5 of 7

C2: Determining if gain on bargain purchase arose upon obtaining control:

Consideration given (1 200 000 + R548 071) 1 748 071

Non-controlling interest (25% x 3 446 200) 861 550
Fair value of previously held interest 1 500 000
Fair value of net asset value (2 461 200 + 985 000) (3 446 200)
Goodwill 663 421
.
. . No gain on bargain purchase arises on the acquisition
and no adjustment is necessary in the cash flows
Marks awarded if gain on bargain purchase was considered 2
Available 31
Max 29
Communication skills – presentation and layout 1
Total 30
QUESTION 37 (Suggested Solution) Page 6 of 7

Part (d) Prepare a capital budget to estimate the net present value of the proposed
residential property development by Umhlanga

Assume the following:

~ The property will be taxed as a capital asset; and
~ All cash flows occur at the beginning or end of the relevant period

Provide reasons for any other assumption you make regarding –

~ the discount rate you used to present value the forecast cash flows;
~ the normal income tax consequences of the project

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Development contract fee -3 800 000 -3 325 000 -2 375 000 1
Architect cost (sunk cost) - 1
Demolition costs -300 000 1
Rezoning -10 000 1
Rental income - - - 2 688 000 1
5 698 560 6 040 474 1
Operating costs - - - -1 048 320 -2 222 438 -2 355 785 1
EBITDA 1.639.680 3.476.122 3.684.689
Advertising income - 1 875 000 1 875 000 - - - 1
Income tax -525 000 -525 000 -320 370 - 834 574 -2 023 411 1
Sale of property 15 300 000 1
Selling costs ________ ________ ________ ________ ________ -1 560 000 1
Net cash flows -4 110 000 -1 975 000 -1 025 000 1 319 310 2 641 548 15 401 278 1

NPV @ 14.16% 3 758 537 1

Section 13sex calculation

Development costs 9 500 000 1
Demolition costs 300 000
Architect fees 100 000 1
Rezoning fees 10 000
(OR 9.6 mil, allow R480k) 9 910 000
5% deduction -495 500 -495 500 -495 500 1
Rental income - - - 2 688 000 5 698 560 6 040 474
Operating costs - - - -1 048 320 -2 222 438 -2 355 785
Advertising income - 1 875 000 1 875 000 - - -
(OR alt discussion)
Recoupment 1 488 500 1
CGT inclusion (66.6%) ________ _______ ________ ________ 2 550 780 1
(Award for incl flows) 1 875 000 1 875 000 1 144 180 2 980 622 7 226 469 1
Tax @ 28% -525 000 -525 000 -320 370 -834 574 -2 023 411 1

Sale of property
Sale price 15 300 000 1
Selling costs -1 560 000 1
Cost -9 910 000 1
Capital gain 3 830 000 1
Opportunity cost (lease) 1
Consideration low
cost residential
CGT implications on
demolishing bidg.
QUESTION 37 (Suggested Solution) Page 7 of 7

Discount rate?
Property development is a different business to surfing equipment and gear,
and therefore PropCo’s beta should be used. 1
Unlevering beta
1.3 ÷ [1 + (0.72 x .45)] = 0.98 1
Relever Beta: BL = 0.9818 (1 + (1 – 0.28) (1 100 000 / 100 000 000) = 0.9896 1
Risk free + (market risk premium x beta) = 8.3% + (6% x 0.9896) 14.24% 1
Risk adjustments for listed, diversified, scale, etc. 1
WACC =
(14.24 x 100 000 000 / 101 100 000) + (9.5 x .72 x 1 100 000 / 101 100 000) 14.16% 1
Cost of equity cannot be used as the pooling of funds approach applies 1
Available 32
Max 30
Communication skills – presentation and layout 1
Total 31
Part (e)

* Residential property does not link to their existing business and strategy. 1
Does Umhlanga have the skills / capacity to manage residential property? 1

* Alternate uses for the property, opportunity costs, fair value land. 1
Why the development, letting, selling, why not just selling new? 1

* Are there sufficient cash reserves to fund the development? 1

There is debt capacity within the business, it is low geared. 1

* Any cost of canceling the existing lease agreement with tenant? 1

* Robustness of forecasts? Rental income and operating costs reasonable? 1

Sensitivity analysis re capital budget 1
Likelihood of selling property for R15.3m in year 5? 1

* Occupancy estimates seem very aggressive. Further potential competition? 1

Scenario indicates significant competition, market for another development? 1

* Developer’s reputation and credibility? 1

Financial standing? 1

* Potential labour strike action during construction? 1

Consider impact of delays, costs, and damage to reputation of entity 1

* Environmental impact studies performed? 1

Any future liabilities in this regard? 1

* Advertising contract firm? 1

Will Marula honour contract? Their financial status? 1

* Other valid insightful comment 1

Explanation of other comment 1

Available 22
Max 13
Communication skills – clarity of expression 1
Total 14
QUESTION 38 Page 1 of 3

Part 1

Ignore Value-Added Tax (VAT)

Alpha Pharmaceutical Holdings Ltd (‘Alpha’) is an investment holding company registered in

South Africa and listed on the Johannesburg Stock Exchange. The Alpha group is a leading
supplier of branded and generic pharmaceutical products in Africa, and has major investments in
three subsidiaries in the pharmaceutical industry. The subsidiaries are Alpha Pharmaceutical
Marketing Ltd (‘APM’), Omega Pharmaceuticals Plc (‘Omega’) and Delta Pharmaceuticals Africa
Ltd (‘Delta’).

1. APM

1.1 Alpha subscribed for 100% of the one million ordinary shares of APM for R1 million when
APM was incorporated in South Africa on 1 January 2004. APM manufactures
pharmaceutical products at five sites in South Africa for sales in Southern Africa and,
from the beginning of 2012, also for export to Delta

1.2 On 1 July 2010 Alpha granted 50 000 share application rights to each of the 15 members of
the executive committee of APM, on the following conditions:

~ The shares appreciation rights vested on 30 June 2013, provided that the employee is
still employed within the Alpha group at that date.
~ Each share appreciation right entitles the employee to a cash amount of the difference
between the Alpha share price on the exercise date and on 1 July 2010.
~ Vested but unexercised share appreciation rights may be exercised on or before the
earlier of 1 July 2016 or the date on which an employee resigns. If they are not exercised
by the earlier of these dates, the rights will lapse.

The following information relates to the share appreciation rights scheme:

Estimated
Actual number number of
of employees employees Fair value* Alpha share
still employed expected to be of share price
at relevant employed at appreciation (closing
date vesting date right price)
1 July 2010 15 13 R9.80 R27.80
31 December 2010 15 13 R10.20 R38.10
31 December 2011 13 13 R12.05 R40.00
31 December 2012 12 11 R10.12 R36.20
27 February 2013 12 11 R10.12 R37.00
30 June 2013 12 n/a R10.40 R38.20
31 December 2013 11 n/a R13.00 R39.80

* The fair value was determined using an options pricing model

250 000 share appreciation rights were exercised on 31 December 2013 and Alpha settled
the amounts owing to the employees on that date. APM is not required to compensate
Alpha for any payments Alpha makes to APM employees in terms of the share appreciation
rights scheme. One executive left the employ of APM towards the end of 2013 and forfeited
his right to participate in the share appreciation rights scheme.
QUESTION 38 Page 2 of 3

2. Alpha

In addition to the above, Mr Music, who is an executive of Alpha, was granted 10 000 share
appreciation rights by Alpha on the same terms as the 15-member executive committee of
APM. Mr Music was also granted 5 000 shares in Alpha at R27.80 each on 1 July 2010.
Mr Music became entitled to these shares on or after 27 February 2013 and was able to
dispose of these shares from that date. On 31 December 2013 he exercised his share
appreciation rights and disposed of the shares at that date. No other employees of Alpha,
apart from Mr Music, were offered share options or participation in the share appreciation
rights scheme. Mr Music had no other disposals of assets.

3. Other information

All entities in the Alpha group –

~ present annual financial statements in accordance with International Financial Reporting

Standards (IFRS)
~ have a 31 December financial year end; and
~ apply consistent group accounting policies

REQUIRED: Marks

(a) With reference to the Alpha share appreciation rights scheme granted to the
executive committee of APM, discuss, with supporting calculations, the amounts
that should be recognized in profit before taxation for the financial year ended
31 December 2013 of –

(i) APM; and [10]

(ii) the Alpha group [9]

Communication skills – clarity of expression [1]

(b) Discuss the tax implications of the share appreciation rights and share options
granted to Mr Music in the hands of –

(i) Mr Music; and [10]

(ii) Alpha [8]

Support your discussions with calculations and case law where applicable

Communication skills – logical argument, clarity of expression [2]

TOTAL [40]
QUESTION 38 Page 3 of 3

Part 2

Alaska Limited is a listed food preparation company with a 31 December 2012 year end. The
vast majority of Alaska Limited's business includes the preparation of meals for airline
companies. On 15 February 2013 one of the airline companies, which was responsible for 80%
of Alaska Limited's profit and 70% of Alaska Limited's sales, announced that it is not going to
renew its contract with Alaska Limited for the provision of food on its flights. The renewal date of
the contract is 30 June 2013. Alaska Limited is in the process of finalising its financial statements
for the year ended 31 December 2012. Stock Exchange regulations require that the financial
statements should be published not later than 31 March 2013.

Part 3

On 15 January 2013, Alaska declared a dividend of R120 000 to be paid on 15 February 2013
to all sharesholderes registered on 23 December 2012. Since the date of entitlement was
23 December 2012, Alaska provided for the dividend in the financial statements for the year
ended 31 December 2012.

REQUIRED: Marks

Discuss the appropriate accounting treatment in accordance with Generally Accepted

Accounting Practice of the abovementioned problems for the year ended 31 December [10]
2012.
QUESTION 38 (Suggested Solution) Page 1 of 5

Part 1

Part (a)(i) With reference to the Alpha share appreciation rights scheme granted to the
executive committee of APM, discuss, with supporting calculations, the amounts
that should be recognized in profit before taxation for the financial year ended
31 December 2013 of APM

APM is an entity within the Alpha group of companies and is receiving services from their
executive employees in exchange for cash amounts that are based on the price of equity
instruments of Alpha, another group entity. Therefore this constitutes a share-based
payment arrangement and IFRS2 is applicable. 1

As APM is receiving the services provided by the executive committee members, APM has
to account for the share-based payment expense within their separate financial statements
(IFRS2:43A) 1

As APM has no obligation to settle the share-based payment transaction, APM accounts for
the share-based payment arrangement as an equity settled share-based payment transaction
with their separate financial statements (IFRS2:43B(b)) 1

Equity-settled share-based payments are measured at the fair value of goods and services
rendered. When granted to employees, however, the fair value of services received is
measured indirectly with reference to the fair value of the equity instruments granted
(IFRS2:11) 1

Consequently, APM measures the services received at the fair value of the share
appreciation rights (SARs) on 1 July 2010 (the grant date) (IFRS2:10,12) 1

The share-based payment expense should be recognized over the vesting period of three 1
years (IFRS2:15), taking into account estimates of the number expected to vest (IFRS2:20) 1

For the current financial year, the expense shall be recognized over the 6 month period to 1
30 June 2013 and given the vesting date of 30 June 2013, shall take into account the actual
number of employees on vesting date. 1

No adjustments are made subsequent to the vesting date (30 June 2013) for SARs forfeited
or lapsed should employees resign (IFRS2:23) 1

Cumulative (balance)
30/06/2013: 50 000 x 12 employed x 3/3 x R9.80 5 880 000 2
31/12/2013: 50 000 x 11 expected x 2.5 / 3 x R9.80 (4 491 667) 2
Net impact on profit or loss (expense) 1 388 333 1
Total 16
Max 10
Total 10
QUESTION 38 (Suggested Solution) Page 2 of 5

Part (a)(ii) With reference to the Alpha share appreciation rights scheme granted to the
executive committee of APM, discuss, with supporting calculations, the
amounts that should be recognized in profit before taxation for the financial
year ended 31 December 2013 of the Alpha group

Because the group has an obligation to settle the transaction in cash, the group accounts 1
for the share-based transaction as cash settled (IFRS2:B58) 1

Consequently, the group measures the transaction at the fair value of the liability as the 1
employees render the service (over the three-year service period), remeasured until
settlement date, at the fair value of the share appreciation rights (IFRS2:30-33) 1

Relating to the remeasurement of the 250 000 rights on the settlement date, these rights are
re-measured to their intrinsic value on 31 December 2013, this being the fair value of the
rights on the settlement date 1

The consolidation journals / process will involve the following: The APM expense will flow
through to the group records and needs to be reversed at group level. Alpha may records 1
as cash-settled in their separate records and this expense flows through to the group
records but is not reversed.

Calculations:

Bank Opening balance:31/12/2012

(250 000 x (R39.80 – R27.8)) 3 000 000 50 000 x 11 x 2.5 / 3x R10.12 4 638 333 3
Closing balance: 31/12/2013
50 000 x 11 = 550 000 –
250 000 exercised
= 300 000 x 13 3 900 000 Staff costs (P/L (derived) 2 261 667 3
6 900 000 6 900 000
Available 12
Max 9
Communication skills – clarity of expression 1
QUESTION 38 (Suggested Solution) Page 3 of 5

Part (b)(i) Discuss the tax implications of the share appreciation rights and share options
granted to Mr Music in the hands of Mr Music

The share appreciation rights and shares are not s8B Broad-based employee share plan
shares, as these rights and shares were only available to a select few employees 1

Shares (5 000)

The tax implications of the shares in the hands of Mr Music must be determined in terms of
s8C, because he acquired equity instruments as defined and by reason of employment 1

The shares are a restricted equity instrument. Vesting took place on 27 February 2013
when he was free to dispose of the shares 1

The shares vested on 27 February 2013 and the gain on vesting is the market value of the
shares at this date (R37.00 per share) less the amount paid of R27.80 (x 5 000 shares
= R46 000) 1

This gain was included in his income and was subject to employee’s tax 1

On disposal (31 December 2013) a capital gain arises (proceeds of R39.80 less
base cost of R37.00 x 5 000) = R14 000 1

Appreciation rights (10 000)

The share appreciation rights are equity instruments in terms of par (c) of that definition in 1
s8C(7)

It was also a restricted instrument. These rights vested on 30 June 2013. 1

(Alternative 31 December 2013: The rights remain a restricted instrument until 31 December
2013 as the cash bonus payable in terms of the SAR is not deliverable to the taxpayer until
the happing of an event (namely the exercise of the employee’s right)).
1
The gain on vesting is (10 000 x (R38.20 minus R27.80) or 10 000 x (R10.40 minus R0.00)
= R104 000 (Alternative 31 December 2013: 10 000 x (R39.80 minus R27.80) = R120 000)
1
This constitutes “remuneration” as defined in par 1, Schedule 4 and employees’ tax must be
withheld. The amount is included in his income (s8C(2))

On exercise of his share appreciation (31 December 2013) a capital gain arises
(proceeds of R120 000 less base cost of R104 000) = R16 000 1

No capital gain amount will be included in his taxable income as the combined capital gain
equates R30 000 which equals the annual exclusion 1

In the year when the equity instruments were granted to Mr Music (the 10 000 share
appreciation rights and the 5 000 shares), it would constitute a receipt otherwise than in
cash – gross income par (c) but is exempt under s10(1)(nD) 1
Available 13
Max 10
Total 10
QUESTION 38 (Suggested Solution) Page 4 of 5

Part (b)(ii) Discuss the tax implications of the share appreciation rights and share options
granted to Mr Music in the hands of Alpha

Deduction of the payment of the share appreciation rights

There is no specific section in the Income Tax Act that provides for the deduction (s11(IA)
does not apply) and the deduction must therefore qualify in terms of s11(a) and not be
prohibited by s23(g) 1

The expense is not capital in nature and it is in the production of income (employees). It is
also for purposes of trade. 1

The issue relating to “in the production of income” related to pertaining and motivating
Mr Music as an executive (employee) of Alpha. The P.E Electric Tramway case and the
closeness of connection of the payment of the R120 000 on 31 December 2013 is relevant 1

At issue then is when the expense was actually incurred. In Edgars Stores Ltd v CIR the 1
Judge stated that the words ‘expenditure … actually incurred’ refer to only expenditure 1
(otherwise qualifying for deduction) in respect of which the taxpayer has incurred an
unconditional legal obligation during the year of assessment in question that may be 1
deducted in terms of s11(a) from income returned for that year

Conclusion: The expense was actually incurred when paid in December 2013 and can be
deducted in terms of s11(a) read with s23(g) 1

Shares

CSAR v Labat (669 / 10 [2011] ZASCA 157: ‘Expenditure … requires a diminution (even if
only temporary) or at the very least movement of assets of the person who expends.’ 1

The issue of the share does not constitute expenditure and no deduction can therefore be
made 1

Available 9
Max 8
Communication skills –clarity of expression 1
logical argument 1
QUESTION 38 (Suggested Solution) Page 5 of 5

Part 2

The loss on the contract represents an event after reporting date, as events after reporting date
are those events, both favourable and unfavourable, that occur between the reporting date and
the date when the financial statements are authorised for issue. 1

The loss on the contract represents a non-adjusting event after reporting date, because the
event is indicative of conditions that arose after the reporting date. Therefore it will not be
necessary to adjust assets and liabilities. 1

The following information regarding non-adjusting events after reporting date should be disclosed:

* nature of the event 0.5

* an estimation of its financial effect, or a statement that such an estimate cannot be made. 0.5

Consideration must be given to whether the going concern assumption is still appropriate. 1

An enterprise should not prepare its financial statements on a going concern basis, if events
after reporting date indicate that the going concern assumption is no longer appropriate. 1

Current information indicates that a fundamental part of the enterprise's profit and sales is
generated by the contract. 1

This is sufficient information to draw up the financial statements according to the expected
liquidation values. The shareholders should be informed about the current state of affairs.
The above can only be avoided if there is a possibility of new contracts that can replace the
profit and sales. 1

Part 3

The fact that shareholders right to receive dividends is on 23 December 2012 the dividend
payable is seen as an adjusting event. 1

In terms of ISA10 par 12, if an entity declares dividends to holders of equity instruments after
the reporting period the entity shall not recognise those dividends as a liability at the end of the
reporting period. 1

Since the dividends of R120 000 were declared after year-end, the provision that is made on
31 December 2012 is not in compliance of IAS10 and should therefore be reversed. 1

IAS10 par 13 states that if dividends are declared after the reporting period but before financial
statements are authorised for issue, the dividends are not recognised as a liability at the end of
the reporting period because no obligation exists at that time. Such dividends are disclosed in
the notes in accordance with IAS1. 2
Lim 3
QUESTION 39 Page 1 of 5

Lefatshe Ltd (Lefatshe) is a company that performs blasting and excavation work in the mining
sector. Lefatshe has an office in Rustenburg and a warehouse in Phokeng. The company has a
30 June financial year end.

Below is an extract of Lefatshe’s major property, plant and equipment (PPE) on 1 July 20.12:

Class of PPE Machinery Vehicles Buildings Land

Description Hydraulic Excavators Rock Phokeng Rustenburg Rustenburg
crawler drill dumper warehouse office office
trucks
Quantity 3 2 5 1 1 1
Measurement
model Revaluation model Cost model Revaluation model

1. Machinery

Lefatshe purchased three hydraulic crawler drills on 1 July 20.10 for cash from a company in
Finland. The cost of one hydraulic crawler drill was R2 400 000 (including delivery costs of
R150 000). Hydraulic crawler drills are used during the blasting of opencast mines. These
drills are depreciated on a straight-line basis over six years and are subsequently measured
according to the revaluation model. The residual values of the hydraulic crawler drills are
immaterial. The first revaluation of the hydraulic crawler drills to its fair value was performed
on 30 June 20.12 when Lefatshe determined that the fair value of the hydraulic crawler drills
was R1 800 000 each.

The hydraulic crawler drills imported from Finland suffered various breakdowns. During the
20.13 financial year, a report published in the Mining Weekly magazine indicated that the
hydraulic crawler drills manufactured in Finland were not designed for the harsh African
climate. In view of the abovementioned report, Lefatshe obtained the following information
with regard to their hydraulic crawler drills:

* The expected remaining useful life and residual values remained unchanged.
* It is expected under normal circumstances that the three hydraulic crawler drills will
generate net cash flows of R1 080 000 per annum in total for the rest of their useful life.
Included in this amount is a net cash outflow of R200 000 per annum representing
additional maintenance costs required to keep the machinery in a workable condition in
the harsh African climate.
* Lefatshe signed a contract before 30 June 20.13 with Ngwe Mining Ltd, a large mining
company with various mining operations in the Lydenburg area. The contract stipulated
that Lefatshe will be the only contractor allowed to perform blasting and excavation work
at the various mining operations of Ngwe Mining Ltd
* Lefatshe will move all their operations to the Lydenburg area due to the abovementioned
contract that they are committed to. This contract will increase the total annual cash
inflow of the three hydraulic crawler drills by R250 000 per annum. It is estimated that
the costs to move these hydraulic crawler drills to Lydenburg will amount to R120 000 in
total. The employees who operate these hydraulic crawler drills indicated they are not
willing to relocate to Lydenburg and as a result, their services will be terminated at a total
cost of R270 000. New employees will be appointed in Lydenburg which will result in total
additional salaries of R40 000 per annum. You may assume for calculation purposes that
the cash inflow / outflow will take place at the end of each year.
* Brokers indicated that they could sell these hydraulic crawler drills at a price of
R1 105 000 each on 30 June 20.13. A fee of 2% of the selling price would be charged
to conclude the transaction.
* Assume a discount rate of 8% per annum (pre-tax) as appropriate.
QUESTION 39 Page 2 of 5

Lefatshe decided to import one hydraulic crawler drill from South Korea, due to the number
of breakdowns the company experienced with the hydraulic crawler drills imported from
Finland. A recent study indicated that hydraulic crawler drills from South Korea were more
suitable for the African climate. The total cost of the hydraulic crawler drill was 360 000 000
South Korean Won (KRW) (including transport, assembly and testing costs). Lefatshe
obtained a foreign loan on 1 June 20.13 from a South Korean bank to finance the purchase
of the hydraulic crawler drill. The South Korean supplier was paid on 1 June 20.13 and the
hydraulic crawler drill parts were shipped, free on board, on the same date. Interest on the
foreign loan is payable at 4% per annum (market related) in arrears. The loan capital is
repayable after four years. An interest rate on an equivalent loan in South Africa is 7% per
annum. The exchange rates were as follow:

ZAR 1 = KRW
1 June 20.13 120
30 June 20.13 119
Average for June 20.13 121

The hydraulic crawler drill from South Korea was imported in parts and assembled and
tested on site. The South Korean supplier expects that the hydraulic crawler drill will be
available for use on 1 October 20.13. Lefatshe indicated that the period of time before the
hydraulic crawler drill will be available for use is substantial. The fair value of the South
Korean hydraulic crawler drill equals its carrying amount at year end.

2. Vehicles

Excavators

Lefatshe purchased both excavators on 1 October 20.11 at a total amount of R6 000 000.
A specific loan was raised on 1 October 20.11 to finance the purchase of the two
excavators. This loan is payable annually in arrears and has a nominal interest rate of 7%
per annum (market-related). The loan capital is repayable after eight years. The excavators
were transported to Rustenburg on 7 October 20.11 at a cost of R30 000. After the
excavators were delivered, they were tested on 8 October 20.11 at a cost of R2 000.
Management spent R5 000 on advertising the excavators in the October issue of Mining
Weekly magazine.

Rock dumper trucks

On 1 January 20.12 Lefatshe leased five rock dumper trucks from Glocke Ltd in return for
five annual payments in arrears of R4 155 000 each. The five rock dumper trucks had a
total value of R17 500 000 on 1 January 20.12. The interest rate implicit in the lease is 6%
per annum. Lefatshe incurred direct negotiating costs of R15 000 to secure the lease
arrangements and paid this amount in cash. Lefatshe will carry all the risks and rewards
incidental to ownership of the rock dumper trucks.

One of the rock dumper trucks (Truck D1) was contracted to transport waste from the
smelting process at a mine onto slag piles. On1 May 20.13 all six tyres on this rock dumper
truck caught alight and were totally destroyed. There were no damages to the truck itself.
Although the tyres form a significant part of the rock dumper truck, they were not
depreciated separately. The insurances company paid an amount of R90 000 (in cash) for
damages relating to the tyres on 1 June 20.13. The six tyres were replaced at a total cost of
R192 000. It is expected that the new tyres will be replaced after 30 000 working hours.
QUESTION 39 Page 3 of 5

Depreciation method

Lefatshe uses the units of production method to calculate the depreciation on their vehicles.

Lefatshe expects the useful life of one excavator to be 65 000 hours and that the residual
value is immaterial. On 30 June 20.13 management revised the residual value of each
excavator to R200 000 each. The total working hours of the excavators were as follows
(assume that each excavator has worked the same number of hours):

Year ended Total hours per year for 2 excavators Cumulative total
30 June 20.12 10 500 10 500
30 June 20.13 14 500 25 000

Lefatshe expects each rock dumper truck to work 55 000 hours over its useful life and that
the residual value of each rock dumper truck is immaterial. The total working hours of the
rock dumper truck were as follows (assume that each rock dumper truck has worked the
same number of hours, except for Truck D1 during 20.13 (refer below)):

Year ended Total hours per year for 5 rock dumper trucks Cumulative total
30 June 20.12 16 000 16 000
1
30 June 20.13 35 000 51 000
1
Included in the 35 000 hours are 5 000 working hours which relates to Truck D1. Truck D1
did not work any hours during May 20.13 and worked only 500 hours during June 20.13.

3. Land and buildings

Phokeng warehouse

Lefatshe owns a warehouse that is used as a workshop and also to store spare parts as well
as idle machinery and vehicles. The piece of land on which the warehouse is situated is
leased under an operating lease. The warehouse was obtained on 1 July 20.10 at a cost of
R2 200 000. The warehouse is depreciated on a straight-line basis over 20 years and is
subsequently measured according to the revaluation model. The first revaluation of the
warehouse to its fair value was performed on 30 June 20.12. Lefatshe decided to rent their
warehouse to a company in need of storage space at an annual rental of R250 000 from
1 May 20.13, since Lefatshe had to move all their operations to the Lydenburg area due to
the abovementioned contract (refer to point 1) with Ngwe Mining Ltd. The warehouse
qualified for a building allowance in accordance with the Income Tax Act. The following fair
values were determined by Lefatshe:

Entity-specific Market-based
measurement measurement
R R
30 June 20.12 2 150 000 2 160 000
1 May 20.13 2 210 000 2 220 000
30 June 20.13 2 100 000 2 180 000
QUESTION 39 Page 4 of 5

Rustenburg office

Lefatshe acquired the Rustenburg office on 1 July 20.10 at a total cost of R7 500 000 (land
R1 500 000 and buildings R6 000 000). The administration and finance departments of
Lefatshe occupy this office building. The office building is depreciated on a straight-line basis
over 20 years and the land and buildings are subsequently measured according to the
revaluation model. The residual values were determined as immaterial. Lefatshe revalued
their land and buildings to its market value for the first time on 30 June 20.12. The office
building does not qualify for a tax deduction in terms of s13 of the Income Tax Act.

The board of directors decided to acquire an office building in the Lydenburg area and
therefore decided on 31 December 20.12 to dispose of the Rustenburg office. On this date
all the classification criteria per IFRS5 Non-current assets held for sale and discontinued
operations have been complied with

The following market values were determined by Lefatshe on 30 June 20.12:

Land R1 800 000

Buildings R6 480 000

The fair values less costs to sell of the disposal group was as follows:

31 December 20.12 R7 776 000

30 June 20.13 R7 776 000

4. Accounting policies

* It is Lefatshe’s accounting policy to realise revaluation surpluses as the assets as used

except if transferred to investment property after which it will only be realised, when the
investment property is sold. It is the policy of Lefatshe to eliminate the accumulated
depreciation against the gross carrying amount of the asset on the date of revaluation.
Revaluations are performed at the end of the financial year and depreciation for the
current year is based on the most recent values determined with the revaluation at year
end.
* Lefatshe uses the fair value model for investment property
* Lefatshe applies IAS23 Borrowing Costs to qualifying assets measured at fair value. It is
the accounting policy of Lefatshe for purposes of IAS23 Borrowing Costs, to include the
foreign exchange gains or losses on the principle amount of the loan and the interest
expense accrual (if any) in the cost of the qualifying assets. Lefatshe limits the borrowing
costs capitalized to the amount of borrowing costs that would have been incurred if the
loan was obtained in their functional currency of South African Rand.
* Land and buildings are disclosed as two separate classes of assets.

5. Taxation

* The normal income tax rate is 28% and the capital gains tax inclusion rate is 66.6%
* Ignore VAT
* Assume that future taxable profits and capital gains are probable.
QUESTION 39 Page 5 of 5

REQUIRED: Marks

(a) Prepare the property, plant and equipment note to the statement of financial
position of Lefatshe Ltd as at 30 June 20.13 according to the disclosure
requirements of IAS16.73(d) and IAS16.73(e). The total column and comparative
figures are not required. [38]

Communication skills: Presentation and layout [2]

(b) Prepare a reconciliation of the balance of the revaluation surplus at the beginning
and end of the current financial year (30 June 20.13) for each item of property,
plant and equipment [14]

Please note:

~ Start you reconciliation with the opening balance on 1 July 20.12

~ Show each movement before the related deferred tax effect (gross)
~ Show each deferred tax implication separately
~ Your reconciliation should include the following headings:

Machinery Warehouse Land Office buildings

R R R R
Carrying amount at
1 July 20.12

Communication skills: Presentation and layout [1]

(c) Discuss the deferred tax consequences of the disposal group directly after the
initial classification as held for sale. Your discussion should include calculations [14]

Communication skills: Logical flow and conclusion [1]

Please note:

~ Round off all amounts to the nearest Rand

~ Your answer must comply with International Financial Reporting Standards (IFRS)
QUESTION 39 (Suggested Solution) Page 1 of 9

Part (a)

LEFATSHE LTD

NOTES FOR THE YEAR ENDED 30 JUNE 20.13

PROPERTY PLANT AND EQUIPMENT

QUESTION 39 (Suggested Solution) Page 2 of 9

Part (b)

REVALUATION SURPLUS RECONCILIATION

REVALUATION SURPLUS
QUESTION 39 (Suggested Solution) Page 3 of 9

Part (c)

Held for sale

According to IAS12 the measurement of deferred tax asset should reflect the tax
consequences that would follow from the manner in which the entity expects to recover
the carrying amount of asset. 0.5
The deferred tax effect of re-classification as held for sale changes the manner of recovery
of the items in the disposal group, which has an effect on the deferred taxation. 0.5
After classification as held for sale, the asset will now be recovered through sale 0.5
Each item in the disposal group needs to be assessed individually 0.5.

Land (initial classification to HFS):

IAS12.51B specifies that the carrying amount of a revalued non-depreciable asset,

such as land, will be recovered by means of a sale only. 0.5
The measurement of the deferred tax associated with land will therefore be at the capital
gains tax rate. 0.5
No adjustment should therefore be made to the deferred tax account relating to land upon
classification as held for sale, since the carrying amount will still be recovered through a
sale transaction. 0.5

Land (Fair value adjustment):

An impairment loss on land of R72 000 [C9] is recognised after re-classification 1.5
This impairment loss represents a reduction in a potential capital gain and therefore a
reduction in the deferred tax liability relating to land 0.5
The tax effect in profit or loss will be calculated at 66.6% x 28% 0.5
The journal that will be processed is Dr Deferred tax (SFP) and
Cr Income tax (Deferred tax) (P/L) with R13 427 (R72 000 x 66.6% x 28%) 1.5

Office buildings (initial classification to HFS):

The office building is a revalued asset and a revaluation surplus might attract capital gains
tax upon disposal 0.5
When the office building is classified as held for sale, the manner of recovery changes,
since the carrying amount will now be recovered through a sale transaction and no longer
through use 0.5
The only tax consequences on office buildings will be the gain in excess of the original cost
of R6 000 000. 0.5
This excess represents a potential gain, which will attract capital gains tax at capital gains
tax rates 0.5
There are no recoupments up to the original cost price since SARS never allowed any tax
allowance on this office building. 0.5
This means that upon reclassification to held for sale, an adjustment should be made in
order to reflect the capital gains tax on the revalued amount above the original cost of the
office building. 0.5
The deferred tax charge of R294 000 on the revaluation surplus before classification must
be reduced with R238 056 to reflect the deferred tax liability of R55 944 [C8] 0.5
This adjustment of R238 056 should be accounted for in other comprehensive income
(revaluation surplus account) and not in profit or loss. The journal that will be processed is
Dr Deferred tax (SFP) Cr Revaluation surplus (OCI) 1
QUESTION 39 (Suggested Solution) Page 4 of 9

Office building (Fair value adjustment):

An impairment loss R252 000 p[C9] (on the office building) is recognised after
classification. 0.5
This impairment loss represents a reduction in a potential capital gain and therefore a 0.5
reduction in the deferred tax liability relating to the building. The tax effect in profit or loss
will be calculated at 66.6% x 28% 0.5
The journal that will be processed is Dr Deferred tax (SFP) and
Cr Income tax (Deferred tax) (P/L) with R46 933 (R252 000 x 66.6% x 28%) 1.5
Total 15
Max 14
Communication skills: Logical flow and conclusion 1
CALCULATIONS

C1. Machinery

Carrying amount
Total Revaluation Historical
1 1
01/07/20.10 Purchase 7 200 000 7 200 000
2 2
Depreciation (1 200 000) _______ (1 200 000)
30/06/20.11 CA 6 000 000 1
3
01/07/20.11 Revaluation 750 000 750 000 0.5 -
01/07/20.11 6 750 000 750 000 6 000 000
4 5
Depreciation (1 350 000) (150 000) 0.5 (1 200 000)
30/06/20.12 CA (1 800 x 3) 5 400 000 600 000 4 800 000
4 5
Depreciation (1 350 000) (150 000) 0.5 (1 200 000)
CA 4 050 000 450 000 3 600 000
Impairment (725 545) (450 000) (275 545)
3 324 445 3 324 455
Additions [C3] 3 000 000 3 000 000
Borrowing costs
[C3] 17 500 17 500
30/06/20.13 CA 6 341 955 - 6 341 955

1 2 400 000 x 3
2 7 200 000 / 6
3 6 750 000 – 6 000 000
4 (1 800 000 x 3) / (6 – 2)
5 1 350 000 – 1 200 000
QUESTION 39 (Suggested Solution) Page 5 of 9

C2. Impairment loss

Carrying amount 30 June 20.11 (from [C1]]) 4 050 000 0.5

Recoverable amount 3 324 455

Highest of:
Value in use 3 324 455 1.5
Future cash flows
Annual cash inflows (1 080 000 + 250 000) 330 000
Additional salaries
Relocation cost (excluded IAS36.44(a)) (40 000)
Employee termination cost
(excluded IAS36.44(b)) -
1 290 000 1.5

Discount rate (l) 8% 0.5

CFj0 0
CFj1 1 290 000
CFj2 1 290 000
CFj3 1 290 000 0.5
NPV = ? 3 324 455 0.5

OR

PMT = 1 290 000

N = 3
I = 8
PV = ? 3 324 455

Fair value less costs of disposal

(1 105 000 x 3 x 98%) 3 248 700 0.5

Total impairment 725 545

Through P/L (balancing) 275 545 0.5
Through OCI [C1] 450 000 0.5
6
QUESTION 39 (Suggested Solution) Page 6 of 9

C3. Borrowing costs

KRW ZAR ZAR1 = KRW

LOAN 1 June 20.13 360 000 000 3 000 000 120 0.5
Interest June 20.13
((360 000 000 x 4%) / 12) 1 200 000 9 917 121 1
361 200 000 3 009 917

Restatement to closing rate 3 035 294 119

Principle (360 000 000 / 119) 3 025 210 0.5
Interest accrual (1 200 000 / 119) 10 084 0.5

Exchange difference
(3 035 294 – 3 009 917) 25 377
Principle amount (3 025 210 – 3 000 000) 25 210 0.5
Interest accrual (10 084 – 9 917) 167 0.5

Total borrowing cost

Foreign interest 9 917
Accrued interest forex 167
Principle forex 25 210
35 294

ZAR loan interest (3 000 000 x 7%) / 12 17 500 1

Limited to: 17 500 0.5
5
QUESTION 39 (Suggested Solution) Page 7 of 9

C4. Vehicles

Excavators Trucks Total

1 [C5]
2011/20.12 Purchase 6 032 000 1 17 515 000 2 23 547 000
2 3
Depreciation (487 200) 1 (1 019 055) 1 (1 506 255)
30/06/20.12 CA 5 544 800 16 495 945 22 040 745
Depreciation
5
(Excavators) (624 264) 2 (624 264)
Derecognition
deemed
component [C6] (165 120) 3 (165 120)
Additions new
tyres 192 000 0.5 192 000
6
Depreciation tyres (3 200) 1 (3 200)
Depreciation
8
4 trucks (1 910 727) 2 (1 910 727)
Depreciation
remainder truck
11
D1 _________ (316 709) (316 709)
4 920 536 14 292 189 19 212 725

1 Purchased price 6 000 000

Transport cost 30 000
Testing 2 000
Advertising cost (no allowed IAS16.19(b)) -
Borrowing cost – not qualifying asset -
6 032 000
2 6 021 00 000 x 10 500 / 130 000 (65 000 x 2)
3 17 515 000 x 16 000 / 275 000 (55 000 x 5)
4 (6 032 000 – 487 200) – 400 000 (residual value)
= 5 144 800 (depreciable amount) 1
5 5 144 700 x 14 500 / (119 500 (130 000 – 10 500)) 1
6 192 000 x 500 / 30 000 hours 1
7 17 515 000 / 5 0.5
7
8 (17 515 000 – 3 503 000 ) x 30 000 (35 000 – 5 000) / 220 000
(55 000 x 4) 1.5
9 3 503 000 x 4 500 / 55 000 = 286 609 1
10 (3 503 000 – 192 000) x 500 / 55 000 1
9 10
11 286 609 + 30 100
QUESTION 39 (Suggested Solution) Page 8 of 9

C5. Finance lease

Calculate PV of minimum lease PMTs:

PMT 4 155 000
N 5
I 6%
PV? 17 502 372 1

Lower of fair value or PV of minimum lease PMTs 17 500 000

Direct cost 15 000 0.5
17 515 000
2

C6. Deemed component

Useful life (hours) 55 000

Total hours (16 000 / 5) = 3 200 + 5 000 – 500) 7 700 1
Cost 192 000 0.5
Accumulated depreciation deemed (192 000 x 7 700 / 55 000)
component 1 May 20.13 26 880 1
Carrying amount deemed component (192 000 – 26 880) 165 120 0.5
3

C7. Warehouse

Carrying amount
Total Revaluation Historical
01/07/20.10 Purchase 2 200 000 2 200 000
1 1
Depreciation (110 000) _______ (110 000)
30/06/20.11 CA 2 090 000 2 090 000
6
01/07/20.11 Revaluation 190 000 190 000 0.5 -
2
01/07/20.11 2 280 000 0.5 190 000 2 090 000
3 7
Depreciation (120 000) 0.5 (10 000) 0.5 (110 000)
30/06/20.12 CA 2 160 000 180 000 1 980 000
4 8
01/05/20.13 Depreciation (100 000) 0.5 (8 333) 1 (91 667)
2 060 000 171 667 1 888 333
5
Revaluation 160 000 0.5 160 000 -
01/05/2013 Transfer to IP 2 220 000 331 667 1 888 333

1 2 200 000 / 20 0.5

2 2 160 000 / 18 x 19 0.5
3 2 280 000 / 19 years 0.5
4 120 000 / 12 x 10 months 0.5
5 2 220 000 – 2 060 000 0.5
6 2090 000 / 2 280 000 0.5
7 190 000 / 19 years 0.5
8 10 000 / 12 x 10 months 1
QUESTION 39 (Suggested Solution) Page 9 of 9

C8. Rustenburg office building

Carrying amount
Deferred
Temporary tax at 28%
Revaluation/ differences asset /
Total Fair value Historical Tax base at 100% (liability)
30/06/20.11 CA 5 700 0001 5 700 000 - Exempt Exempt
(IAS12.22) (IAS12.22)
01/07/20.11 Revaluation 1 140 0003 1 140 000 - - 1 140 000 (319 000)
6 840 0002 1 140 000 (319 000)
Depreciation (360 000)4 (60 000) 5
(300 000) - (60 000) 16 800
30/06/20.12 6 480 000 1 080 000 5 400 000 - 1 080 000 (302 400)
31/12/20.12 Depreciation (180 000)6 (30 000)7 (150 000) - (30 000) 8 400
6 300 000 1 050 000 5 250 000 - 1 050 000 (294 000)
01/01/20.13 Correction
deferred tax _______ 238 0568
01/01/20.13 HFS 6 300 000 (55 944)

1 6 000 000 x 19 / 20
2 6 480 000 x 19 / 18 0.5
3 6 840 000 – 5 700 000 1
4 6 840 000 / 19 years 0.5
5 1 140 000 / 19 years or (360 000 – 300 000) 0.5
6 360 000 x 6 / 12 0.5
7 60 000 x 6 / 12 or (180 000 – 150 000) 0.5
8 Correction of deferred tax – Intention held for sale: 294 000 – (6 300 000 – 6 000 000
(CGT base cost)) x 66.6% x 28%) 2

C9. Held for sale

Carrying amount 31 December 20.12

Land (given) 1 800 000
Building [C8] 6 300 000
8 100 000 0.5
Fair value less costs to sell (given) 7 776 000
Fair value adjustment (impairment) 324 000 0.5
Land (324 000 x 1 800 000 / 8 100 000) 72 000 0.5
Building (324 000 x 6 300 000 / 8 100 000) 252 000 0.5
2
QUESTION 39 (Suggested Solution) Page 1 of 9

Part (a)

LEFATSHE LTD

NOTES FOR THE YEAR ENDED 30 JUNE 20.13

PROPERTY PLANT AND EQUIPMENT

Machinery Motor vehicles Land Buildings

R R R R
Carrying amount at 1 July 20.12 5 400 000 22 040 745 1 800 000 8 640 000
1 [C4] 4 5
Gross carrying amount or cost 6 750 000 1 23 547 000 3 1 800 000 0.5 9 120 000 1
2 [C4] 6
Accumulated depreciation and impairment losses (1 350 000) 1 (1 506 255) 2 - 0.5 (480 000) 1
Movements for 20.13
[C3]
Additions 3 000 000 0.5 192 000 0.5 - -
[C3]
Borrowing costs 17 500 4.5 - - -
[C7]
Revaluations - - - 160 000 0.5
C2]
Impairment losses: (275 545)[ 0.5 - - -
through profit or loss (included in other income)
[C2]
Impairment loss: (450 000) 5.5 - - -
through other comprehensive income
3 7
Depreciation for the year (1 350 000) 0.5 (2 854 900) 7 - (280 000) 1
C6]
De-recognition - (165 120)[ 3 - -
Transfer to investment properties - - - (2 220 000) 0.5
4
Transfer to held for sale - - (1 800 000) 0.5 (6 300 000) 0.5
Carrying amount at 30 June 20.13 6 341 955 1 19 212 725 1 - 0.5 - 0.5
Gross carrying amount or cost 9 767 500 23 547 000 - -
4
Accumulated depreciation and impairment losses (3 425 545) ___ (4 334 275) ___ - -
14.5 16.5 2 5
Total 38
Communication skills: Presentation and layout 2

1 (1 800 000 x 3) x 5 / 4 (remaining useful life) = 6 750 000

2 6 750 000 / 5 years = 1 350 000
3 624 264 + 3 200 + 1 910 727 + 316 709 = 2 854 900 [C4]
4 Given or balancing
5 2 280 000 [C7] (0.5) + 6 840 000 [C8] (0.5) = 9 120 000
6 120 000 [C7] (0.5) + 360 000 [C8] (0.5) = 480 000
7 100 000 [C7] (0.5) + 180 000 [C8] (0.5) = 280 000
QUESTION 39 (Suggested Solution) Page 2 of 9

Part (b)

REVALUATION SURPLUS RECONCILIATION

REVALUATION SURPLUS

Machinery Warehouse Land Buildings

R R R R
Carrying amount at 1 July 20.12 432 000 129 600 244 056 777 600
1 5 11 [C8]
Gross carrying amount 600 000 0.5 180 000 1 300 000 0.5 1 080 000 1.5
2 6 12 13
Deferred tax (168 000) 0.5 (50 400) 0.5 (55 944) 0.5 (302 400) 0.5
Movements for 20.13
Realised to retained earnings (108 000) (6 000) - (21 600)
[C7] C8]
Gross (150 000) 0.5 (8 333) 1 - (30 000)[ 0.5
3 7 14
Deferred tax 42 000 0.5 2 333 0.5 - 8 400 0.5
Revaluation - 115 200 - -
8
Gross - 160 000 0.5 - -
9
Deferred tax - (44 800) 0.5 - -
Impairment (324 000) - - -
Gross (450 000) 0.5 - - -
4
Deferred tax 126 000 0.5 - - -
Correction of deferred tax –
10 [C8]
change in manner of recovery - 1 870 1 - 238 056 2
Carrying amount at 30 June 20.13 - 240 670 244 056 994 056
Gross carrying amount - 331 667 300 000 1 050 000
Deferred tax - _ (90 997) _ (55 944) _ (55 944) _
3 5 1 5
Total 14
Communication skills: Presentation and layout 1

1 750 000 – 150 000 [C1] 8 (2 200 000 – 2 060 000) + (2 220 000 – 2 200 000 = 160 000
2 600 000 x 28% 9 (160 000 x 28%)
3 150 000 [C1] x 28% 10 Correction above cost now CGT rates:
4 450 000 [C2] x 28% 2 220 000 – 2 200 000 = 20 000 x 33.4% x 28% = 1 870
5 190 000 – 10 000 [C7] 11 1 800 000 – 1 500 000
6 180 000 x 28% 12 300 000 x 66.6% x 28%
7 8 333 x 28% 13 1 080 000 x 28%
14 30 000 x 28%
QUESTION 40 Page 1 of 5

Iron Ore Ltd (Iron Ore) is a large manufacturing company with operations throughout South
Africa. The company is listed on the JSE Limited and has a 31 December reporting date.

Iron Ire’s 20.13 financial year

Iron Ore experienced significant operational and financial difficulties during the 20.13 financial
year. This was due to prolonged strike actions instituted by trade unions and unrealistic demands
for wage increases by factory workers. The company is also experiencing a general decline in
the demand for its products and downward pressure on sales prices.

At a board meeting during the second half of the 20.13 financial year, the board made the
following decisions to ensure the financial survival of the company:

Retrenchments at the Northern Cape and Limpopo divisions

The board identified that both the Northern Cape and Limpopo divisions are currently overstaffed
and decided to retrench 50% of the factory workers at both divisions. Retrenchments were
undertaken in terms of the specifications contained in trade unions agreements to which Iron Ore
is a party.

Thee two divisions have existing supply contracts with customers ending 30 June 20.14. The
staff members who will be retrenched (the ‘affected employees’) will be offered the opportunity
to stay in the employment of Iron Ore until this date, since the expertise is required in delivering
on these contracts. Affected employees who decide to stay until 30 June 20.14 will receive a
lump sum payment of R50 000 per employee at that date, whereas affected employees who
elect to leave before 30 June 20.14, will receive a lump sum payment of R20 000 per employee
as a retrenchment package. Iron Ore expects 20% of the affected employees to leave before
30 June 20.14.

The following is an analysis of the workforce (before retrenchment) of Iron Ore in these divisions:

Northern Cape Limpopo

Full time factory workers 120 150

Management visited both divisions during November 20.13 to present the details of the
retrenchment plan to the factory workers. Individual affected employees had not yet been
identified, since a formal process of consultation would be conducted by the human resources
department of Iron Ore during January 20.14.

Up until 30 November 20.13, Iron Ore did not recognize any retrenchment costs.

Decreased production at Mpumalanga plant

On 31 December 20.13 Iron Ore decided to reduce production at the Mpumalanga manufacturing
plant. The manufacturing plant was constructed in 20.8 and Iron Ore entered into an agreement
with Eskom to construct a power station on the plant premises. The power station was
constructed to satisfy the electricity requirements of the plant. Eskom completed the construction
of the power station on 1 January 20.9 and the related ten-year electricity supply agreement
became effective at that date. In terms of the agreement, Iron Ore neither gained significant
exposure to the risks and rewards associated with ownership of the power station nor did it
receive legal title to the power station at any time.

The agreement further indicated that Iron Ore would pay R2.00 per kilowatt hour (kWh) for the
electricity generated by the power station, subject to a minimum use requirement of 100 000 kWh
per month. The manufacturing plant consistently used approximately 120 000 kWh per month
since 20.9.
QUESTION 40 Page 2 of 5

Iron Ore would have to pay a once-off payment of R3 200 000 to Eskom in the event of a
unilateral cancellation of this agreement prior to the end of its term.

As a result of the reduced production, Iron Ore expected to use 70 000 kWh per month from
1 November 20.13 for the remainder of the term of the electricity supply agreement with Eskom.
In terms of the agreement Iron Ore is not entitled to resell any of the electricity generated by the
power station on its premises.

Iron Ore’s current cost of borrowing is 7% (before tax) per annum.

Disposal of the Eastern Cape division

The board identified its Eastern Cape division as the worst performing division of the entity.
Several attempts over the past few years to turn this division around have been unsuccessful.
The board therefore decided to dispose of the division and initiated an active programme to
locate a buyer. All the requirements for the classification as a discontinued operation and
disposal group held for sale in terms of IFRS5 Non-Current Assets Held for Sale and
Discontinued Operations, were satisfied on 30 September 20.13. Iron Ore tests disposal for
impairment in terms of IAS36 Impairment of Assets before applying IFRS5 Non-Current Assets
Held for Sale and Discontinued Operations when deciding to dispose of non-current assets or
disposal groups.

The following is a summary of the assets and liabilities of the Eastern Cape division, prepared
from its management accounts as at 30 September 2013, before the division was classified as
a disposal group held for sale. You may assume that the below figures have been calculated
correctly.

1 January 20.13 30 September 20.13

Notes R R
Assets
Property, plant and equipment 1 ? ?
Financial assets 2 ?
Inventory 3 9 500 000
Trade receivables 4 8 500 000

Liabilities
Deferred tax (545 245)
Bank overdraft (1 933 102)

Notes

1. The following is a schedule of property, plant and equipment

Carrying amount
1 January 20.13
Subsequent measurement R
Land Prior years: Cost model 2 495 000
Thereafter: Revaluation method
Administrative buildings Revaluation method 2 100 000
Factory buildings Cost model ?
Manufacturing equipment Cost model ?

You may assume that the above amounts are correct.

QUESTION 40 Page 3 of 5

Land

The land was acquired on 1 January 20.6 and Iron Ore accounts for land on the cost model.
However on 30 June 20.13, the interim reporting date, the fair value of land was a fairer
presentation of the value of the property, hence Iron Ore changed the accounting method
thereof to the revaluation method. A net amount of R813 520 was credited to the revaluation
surplus on this date.

The fair value less cost of disposal for land amounted to R3 000 000 on 30 September 20.13.
Iron Ore was unable to determine the value in use.

Administration buildings

Administrative buildings were erected at a cost of R1 200 000. These buildings are
depreciated on the straight-line basis over a period of 17 years. The buildings became
available for use on 1 July 20.6 though Iron Ore occupied these buildings on 1 September
20.6. There has been no change in the remaining useful life of the building after the
revaluations were performed.

The fair value less cost of disposal for administration buildings amounted to R1 250 000 on
30 September 20.13. Iron Ore was unable to determine the value in use.

Factory buildings

Factory buildings were erected at a cost price of R4 400 000. These buildings are
depreciated on the straight-line basis over a period of 16 years. The factory buildings only
became available for use on 30 September 20.6 and were occupied from that date.

Manufacturing equipment

Manufacturing equipment was acquired for R5 200 000 on 1 January 20.11. The equipment
is depreciated on the straight-line basis over a period of five years.

On 1 January 20.13, Iron Ore replaced the conveyor belt of the manufacturing equipment

Cost

R
Old conveyor belt (At initial acquisition of manufacturing equipment) 600 000
New conveyor belt
(To be replaced in 2.5 years time; which is the useful life of conveyor belts 700 000

2. Financial assets

Financial assets consist of an investment in debentures. The debentures were acquired on

1 October 20.11 at a market yield of 9% per annum. The debentures bear coupon interest at
5% per annum and will be redeemed by the issuer at a premium of 20% on the face value of
R1 million on 30 September 20.16. Iron Ore incurred directly attributable transaction costs of
R50 000 on obtaining these debentures. The coupon interest is paid annually in arrears on
30 September. Iron Ore has determined that the amortised cost model is the appropriate
measurement model to subsequently measure the investment in debentures in its annual
financial statements in terms of IFRS9 Financial Instruments.

The accountant at the Eastern Cape division received notice on 30 September 20.13 that the
issuer of the debentures would not be able to honour the remaining coupon payments on
their scheduled dates because of cash flow constraints.
QUESTION 40 Page 4 of 5

The issuer of the debentures proposed the following amendments:

i. The redemption date of the debentures would be postponed on 30 September 20.19 and
interest is calculated up until this date
ii. Debenture holders would be compensated by increasing the coupon interest rate to 6%
and
iii. The debenture holders will not pay the 20% premium on the redemption date.

The Eastern Cape division agreed to these revised terms but the accountant has not yet
processed any journal entries or performed any calculation to account for the revision of the
terms.

3. Inventory

Inventory is measured at net realizable value at 30 September 20.13.

4. Trade receivables

An allowance of R1 500 000 for credit losses has been recognised against the trade
receivables as at 30 Sept 20.13

Information regarding the impairment of the Eastern Cape division

The Eastern Cape division, a cash-generating unit according to IAS36 Impairment of Assets,
obtained an offer to the amount of R25 250 000 (excluding deferred tax). The costs of disposal of
the cash-generating unit are estimated at R750 000. The value in use amounts to R23 600 000.
The value in use was calculated inclusive of working capital cash flows, using a discount rate of
8% (before tax) per annum.

Additional information

* The company has elected to transfer the revaluation surplus to retained earnings when
the asset is sold in accordance with IAS16 Property, plant and equipment

* There has not been any impairment losses recognised in prior periods

* The current tax rate is 28% and capital gains is included in taxable income at an inclusion
rate of 66.6%

* Ignore the effect of Value Added Taxation

QUESTION 40 Page 5 of 5

REQUIRED: Marks

(a) Discuss, with supporting calculations, the appropriate accounting recognition and
measurement of the decisions taken regarding the staff of the Northern Cape and
Limpopo divisions in the financial statements of Iron Ore Ltd for the financial year
ended 31 December 20.13. [15]

Please note:

~ Ignore tax
Communication skills: Logical flow and conclusion [1]

(b) Discuss, with supporting calculations, the appropriate accounting recognition and
measurement of the reduced electricity usage of the Mpumalanga plant of Iron Ore
on 31 December 20.13 [9]

Please note:

~ Ignore tax
Communication skills: Logical flow and conclusion [1]

(c) Prepare the journal entries that should have been processed on 30 September
20.13 by the Eastern Cape division of Iron Ore Ltd to account for the following:

(i) the revised terms proposed by the issuer of the debentures; [11]
(ii) the effects of the possible impairment of the Eastern Cape division on this date [23]

Please note:

~ Ignore any tax journals

Please note:

~ Ignore taxation
~ Round interest rate calculation to four decimals
~ Round off all amounts to the nearest Rand
~ Your answer must comply with International Financial Reporting Standards (IFRS)
QUESTION 40 (Suggested Solution) Page 1 of 7

Part (a)

Discuss, with supporting calculations, the appropriate accounting recognition and

measurement of the decisions taken regarding the staff of the Northern Cape and
Limpopo divisions in the financial statements of Iron Ore Ltd for the financial year
ended 31 December 20.13.

Recognition

Employee benefits provided in accordance with the terms of an employee benefit plan
are termination benefits if they result from both an entity’s decision to terminate an
employees’ employment and are not conditional on future service being provided
(IAS19.163) 1.5

~ The termination benefits are provided for in accordance with the terms of an existing
employee benefit plan, since the retrenchments were undertaken in terms of the
specification contained in the trade union agreements. 0.5
~ It was Iron Ore’s decision to terminate the employees’ employment and not those of
the employees. 0.5

The lump sum payments offered to retrenched employees of the two affected divisions
consist of payments in exchange for services as well as termination benefits, because
employees who complete their service requirements until 30 June 20.25 are paid an amount
of R30 000 (IR50 000 less R20 000) in return for rendering their services, the payment of
which should be classified as salaries (short-term employee benefits) in terms
of IAS19. 2

The plan establishes R20 000 as the termination benefit, for the incremental R30 000
paid to employees who elect to stay in the employ of Iron Ore until 30 June 2014 is not paid
as a termination benefit but rather in return for services rendered by those employees,
based on the completion of existing client contracts. 1

In terms of IAS19.165 Iron Ore will recognize a liability and an expense for the termination
benefits at 30 November 20.13. On this date Iron Ore has not recognised any costs for
a restructuring that is within the scope of IAS37 which involves the payment of termination
benefits, but the entity can no longer withdraw the offer of the benefits to its
employees, since the board members have visited the affected divisions and have
communicated to the affected employees (factory workers) their plan of termination
which meets all the following criteria: 2.5

(a) From the actions acquire to complete the plan it is clear that it is unlikely that significant
changes will be made to the plan
0.5
(b) The plan identifies the number of employees, 50% of the factory workers, whose
employment is to be terminated; their job classification or functions, factory workers
(the plan does not need identify each individual employee); and their locations,
Northern Cape and Limpopo as well as the expected completion date of 30 June
2014 4

(c) The plan establishes the termination benefits that employees will receive in sufficient
detail that employees can determine the type and amount of benefits they will receive
when their employment is terminated 0.5
QUESTION 40 (Suggested Solution) Page 2 of 7

Measurement

Since the termination benefits are expected to be settled wholly before 12 months after
the end of the annual reporting date in which the termination benefit is recognised
(the 2013 financial year), the requirements for short-term employee benefits will be
applied by Iron Ore in terms of IAS19.169 1

The number of employees accepting the immediate early retirement package (20%) versus
the number of employees staying in the employ of Iron Ore until 30 June 20114, is not
relevant when recognizing the termination benefits, since all employees will qualify for
termination benefits of only R20 000 per employee. 1

The following termination benefits should therefore be measured at initial recognition on

30 November 20.13 0.5

~ Northern Cape division: 120 employees x 50% retrenched x R20 000 = R1 200 000 0.5
~ Limpopo division: 150 employees x 50% retrenched x R20 000 = R1 500 000 0.5

These termination benefits will not be discounted as they are measured in terms of
short-term employee benefits as required by IAS19.169 (< 12 months) 1

The remaining R30 000 per employee of those employees who decide to stay on until
30 June 2014, will be expensed over the seven months form 1 December 20.13 to
30 June 20.14 as the services are rendered by the employees. This is also in line with
the requirements of accounting for short-term employee benefits, in terms of IAS19. 0.

Northern Cape division: 120 x 50% x 80% x R30 000 x 1 / 7 = R205 714 0.5
Limpopo division: 150 x 50% x 80% x R30 000 x 1 / 7 = R257 143 0.5
Total = R462 857
Total 22
Max 15
Communication skills: Logical flow and conclusion 1
Part (b)

Discuss, with supporting calculations, the appropriate accounting recognition and

measurement of the reduced electricity usage of the Mpumalanga plant of Iron Ore
on 31 December 20.13

Onerous Contract

Upon the restructuring of the manufacturing plant in Mpumalanga, the agreement between
Iron Ore and Eskom becomes an onerous contract, since Iron Ore is still obliged to either
honour the contractual payments or to cancel the contract under favourable terms (penalty
involved) 2

An onerous contract is a contract in which the unavoidable costs of meting the obligations
under the contract exceed the economic benefits expected to be received under it. 1

If an entity has a contract that is onerous, the present obligation under the contract shall be
recognised and measured as a provision (IAS37.66) 1

The least net cost of exiting the contract should be recognised on 31 October 20.13
as a provision for an onerous contract in terms of IAS37. 1

The least net cost is the lower of the cost of fulfilling it and any compensation or penalties
arising from failure to fulfill it. 1
QUESTION 40 (Suggested Solution) Page 3 of 7

Onerous portion of the lease agreement

Iron Ore pays Eskom for 100 000 kWh per month but is only expected to utilize
70 000 kWh during the remainder of the contract term with Eskom. Since Iron Ore cannot
resell the unutilized 30 000 kWh this represents the onerous portion of the contract 1.5

Onerous portion of contract: 30 000 kWh x R2 = R60 000 per month for the remaining
62 months (1 November 20.13 to 31 December 20.18) 1.5

Present value of the onerous portion of the lease agreement

SHARP EL-733 SHARP EL-738 HP10bll

(12 payments per year) 12 P/YR 12 P/YR
PMT R60 000 PMT R60 000 PMT R60 000 0.5
i 7/12 = 0.583 I/Y 7% I/YR 7% 0.5
n 62 N 62 N 62 0.5
FV 0 FV 0 FV 0
COMP PV → R3 114 033 COMP PV → R3 114 033 COMP PV → R3 114 033

Provision: Lowest between: 0.5

~ Fulfilling the agreement: R3 114 033 and 0.5
~ Cost to cancel the agreement: R3 200 000 0.5
Therefore the amount of R3 114 033 will be recognised as a provision on 31 October 20.13
Total 12
Max 9
Communication skills: Logical flow and conclusion 1

Part (c)(i)

Prepare the journal entries that should have been processed on 30 September 20.13 by
the Eastern Cape division of Iron Ore Ltd to account for the revised terms proposed by
the issuer of the debentures.

Journal entry: Debenture

Dr Cr
R R
30 September 20.13
J1 Impairment loss (P/L) [C1] 171 156 10.5
Allowance for impairment or investment in debentures (SFP) 171 156 0.5
Recognition of impairment loss on investment in debentures
QUESTION 40 (Suggested Solution) Page 4 of 7

Part (c)(ii)

Prepare the journal entries that should have been processed on 30 September 20.13 by the
Eastern Cape division of Iron Ore Ltd to account for the effects of the possible impairment
of the Eastern Cape division on this date

Dr Cr
R R
30 September 20.13
J1 Revaluation surplus (OCI) [C3] 1 183 873 3
Impairment loss (P/L) [C2] 1 778 704 0.5
Accumulated impairment - Land (SFP) 495 000 0.5
Accumulated impairment – Administrative buildings (SFP) 688 873 0.5
Accumulated impairment – Factory buildings (SFP) 874 338 0.5
Accumulated impairment – Manufacturing equipment (SFP) 904 366 0.5
Recognition of impairment loss
Calculations 17.5
Total 23
CALCULATIONS

C1. Debentures

(a) Calculation of fair value of investment in debentures

SHARP EL-733 SHARP EL-738 HP10bll

(1 payment per year) 1 P/YR 1 P/YR
a a a
PMT R50 000 PMT R50 000 PMT R50 000 1
i 9% I/Y 9% I/YR 9% 0.5
n 5 N 5 N 5 0.5
b b b
FV R1 200 000 FV R1 200 000 FV R1 200 000 1
COMP PV → R974 400 COMP PV → R974 400 COMP PV → R974 400

a PMT = R50 000 (being 5% coupon interest on nominal value of R1 million)

b FV = R1 200 000 (being 20% premium on face value of R1 million)
New PV: R974 400 + R50 000 (transaction costs) = R1 024 400 1

(b) Determine effective interest rate

SHARP EL-733 SHARP EL-738 HP10bll

(1 payment per year) 1 P/YR 1 P/YR
PV (R1 024 400) PV (R1 024 400) PV (R1 024 400)
FV R1 200 000 FV R1 200 000 FV R1 200 000
PMT R50 000 PMT R50 000 PMT R50 000
n 5 N 5 N 5
COMP I → 7.8137% COMP I/Y → 7.8137% I/YR → 7.8137% 1
QUESTION 40 (Suggested Solution) Page 5 of 7

(c) Balance

SHARP EL-733 SHARP EL-738 HP10bll

nd
2 AMRT AMRT 2 ENT 2 F FV (AMRT
nd
AMRT ▼ 2ENT 2 F FV (AMRT)
AMRT ▼ =
→ R1 086 834.63 → R1 086 834.63 → R1 086 834.63 1

(d) Present value of future cash flows on 30 September 20.13, with revised cash flows at
original effective rate.

SHARP EL-733 SHARP EL-738 HP10bll

(1 payment per year) 1 P/YR 1 P/YR
PMT R60 000 PMT R60 000 PMT R60 000 1
i 7.8137% I/Y 7.8137% I/YR 7.8137% 0.5
n 6 N 6 N 6 0.5
FV R1 000 000 FV R1 000 000 FV R1 000 000 1
COMP PV → R915 679 COMP PV → R915 679 COMP PV → R915 679

(e) Loss on modification

Previous carrying amount (refer (c)) 1 086 835 0.5

New present value of investment (915 679) 0.5
171 156
8

C2. Eastern Cape division

Recoverable amount of cash-generating unit, being the higher of - 0.5

* Fair value less costs of disposal: R25 250 000 – R750 000 = R24 500 000 0.5
* Value in use: R23 600 000 0.5
Hence, the recoverable amount is R24 500 000

Carrying amount of the cash-generating unit on 30 September 20.13 and allocation of the
impairment loss to the assets in the cash-generating unit:

Carrying Allocation of New Carrying

amount impairment amount
R R R
Financial assets 915 679 N.A 915 679 0.5
Inventory 9 500 000 N.A. 9 500 000 0.5
Trade receivables 8 500 000 N.A 8 500 000 0.5
Bank overdraft (1 933 102) N.A (1 933 102) 0.5
16 982 577
Property, plant and equipment
4 4
Land 3 495 000 495 000 3 000 000
1 5
Administration building 1 950 000 688 873 1 261 127
2 6
Factory buildings 2 475 000 874 338 1 600 662
3 7
Manufacturing equipment 2 560 000 904 366 1 655 634
10 480 000 ________ _________
Total 27 462 577 2 962 577 24 500 000
QUESTION 40 (Suggested Solution) Page 6 of 7

Impairment loss for the cash-generating unit

= R27 462 577 – R27 500 000 1
= R2 962 577
1
Administration buildings

R
CA: 1 Jan 2013 2 100 000
2 100 000 / (17 years – 6.5 years) x 9 / 12 (150 000) 1
1 950 000

2
Factory buildings

R
Cost: 31 Oct 2006 4 400 000
4 400 000 / 16 x 7 (1 925 000) 1
2 475 000

3
Manufacturing equipment

Initial Component
R R
1 January 2011 5 200 000
5 200 000 / 5 x 2 (2 080 000) 1
3 120 000
2013
Component: 600 000 x 3 / 5 1.5
Or [600 000 – (600 000 / 5 x 2)] (360 000) 700 000
2 760 000
2 760 000 / 3 x 9 / 12 (690 000) 1
700 000 / 2.5 x 9 / 12 ________ (210 000) 1.5
2 070 000 490 000

Total carrying amount: R2 070 000 + R490 000 = R2 560 000 0.5
4
Revaluation on Land:

- At capital gains tax: 66.6% x 28% = 0.18648 0.5

813 520 / (1 – 0.18648) = 1 000 000 0.5
2 495 000 + 1 000 000 = 3 495 000 0.5
3 495 000 / 10 480 000 x 2 962 577 (impairment loss) = R987 997
(impairment limited to fair value of asset
3 495 000 – 3 000 000 (fair value of land) = 495 000 1.5

5
Allocate remainder of impairment loss over the following assets:

R
Administration building 1 950 000
Factory buildings 2 475 000
Manufacturing equipment 2 560 000
6 985 000
0.5
QUESTION 40 (Suggested Solution) Page 7 of 7

Unallocated impairment:

R2 962 577 – R495 000= R2 467 577 0.5

1 950 000 / 6 985 000 x 2 467 577 = R688 873 0.5
6
2 475 000 / 6 985 000 x 2 467 577 = R874 338 0.5
7
2 560 000 / 6 985 000 x 2 467 577 = R904 366 0.5
17.5

C3. Calculate the existing revaluation surpluses on items of PPE

R R
OCI
Administrative buildings
Revalued carrying amount on 30 September 20.13 1 950 000
Less: Historic carrying amount on 30 September 20.13 (688 235) 2
(R1.2m x 9.75 years / 17 years) OR
(R1.2m – (R1.2m / 17 years x 7.25 years)) _______
Revaluation on administration building 1 261 765 (688 873)
4
Revaluation on land 1 000 000 (495 000) 0.5
2 261 765 _______
Impairment loss reversed in OCI 1 183 873 2.5
QUESTION 41 Page 1 of 3

Quest Ltd (Quest) is a manufacturer of hiking and camping equipment. Quest has a
30 June 20.15 financial year end. You are a consultant, appointed to assist Quest with their year
end financial statements.

The following transactions took place during the 20.14 and 20.15 financial years:

1. Finance lease

1.1 Quest leased test manufacturing equipment from Pergola Ltd (Pergola) on 1 July 20.13.
Five annual lease payments of R32 025 (including VAT) each, are payable in arrears
on 30 June and a guaranteed residual value of R21 441 (including VAT) is payable on
30 June 20.18. On 1 July 20.13 the net cost of the equipment amounted to R142 940
(including VAT) and the first instalment was payable on 30 June 20.14. Quest had to
pay commission of R12 865 (including VAT) to secure the finance lease agreement.
This amount was paid in cash. Quest is aware that the unguaranteed residual value of
the equipment amounts to R10 006 (including VAT). Quest will carry all the risks and
rewards incidental to ownership of the equipment.
1.2 Quest estimated the useful life of the test manufacturing equipment on 1 July 20.13 at
five years with no residual value. The South African Revenue Services (SARS) allows
a wear and tear allowance of 40% : 20% : 20% : 20% per year. Both Quest and
Pergola are registered VAT vendors. The VAT is financed through the lease and the
equipment is issued to produce taxable supplies.

2. Investment in listed bonds

2.1 On 1 July 20.13 Quest purchased 25 000 listed bonds in Gear Ltd (Gear) at its fair
value. This investment is held within a business model with the objective to realise
fair value gains or losses resulting from the frequent buying and selling of these
investments. The listed bonds were purchased on the following terms.

Coupon interest rate 8.5% per annum

Interest payment Annually, in arrears
First interest payment date 30 June 20.14
Maturity date 30 June 20.18
Redemption At nominal value
Brokerage fee (paid in cash on 1 July 20.13) R5 906

2.2 The directors of Quest decided during a board meeting held on 15 November 20.13 to
significantly change the business model objective for managing all its investments in
listed bonds. The effective date of this decision was 30 November 20.13. The new
business model for listed bonds has the objective to hold these listed bonds to collect
contractual cash flows. Quest will therefore cease the frequent buying and selling of
listed bonds.
QUESTION 41 Page 2 of 3

2.3 The credit risk assessment performed by the risk management department of Quest
indicated the following credit risk information regarding the investment in listed bonds:

Date Time of 12-month Lifetime Fair value

assessment / expected expected of listed
valuation credit losses credit losses bonds.
R / bond R / bond R / bond
1 July 20.13 7 am 7 594 25 313 6.75
30 November 20.13 6 pm 7 442 24 807 6.69
30 June 20.14 6 pm 7 144 23 815 6.66
1 July 20.14 7 am 7 073 23 577 6.66
30 June 20.15 6 pm 6 790 22 634 6.73

The above values are applicable from the date the risk assessments were performed.

The credit risk department determined on 30 June 20.14 that the risk of defaulting
on the listed bonds did not increase significantly since 1 July 20.13. The credit risk
assessment results on 30 June 20.15 indicated that the risk of defaulting has increased
significantly during the 20.15 financial year.

2.4 It is the company’s accounting policy to include interest in the net gains or losses
on financial assets measured at fair value through profit or loss.

3. Share register information

3.1 Quest had 257 000 ordinary shares in issue on 1 July 20.14, while the authorized
ordinary share capital amounted to 950 000 ordinary shares. On 31 August 20.14, a
capitalization issue took place at a ratio of one ordinary share for every two ordinary
shares held at that date.
3.2 On 15 February 20.15, Quest had a rights issue of one ordinary share for every four
ordinary shares held. The exercise price of the rights was R18 per share and the
last day to exercise the rights was 31 March 20.15. All the rights were exercised
by 31 March 20.15. The rights traded separately from the ordinary shares from
15 February 20.15. The market value of one ordinary share at the close of the last day
on which the shares traded together with the rights, amounted to R31 per share.

4. Debt instrument

4.1 Quest issued 600 7% convertible debentures with a face value of R1 000 each on
30 November 20.14. Interest is payable annually in arrears until 30 November 20.18.
the debentures will be converted, at the option of the holder, into Quest’s ordinary
shares after four years at a conversion ration of 250 ordinary shares for every
debenture held. If the debentures are not converted into ordinary shares by the
maturity date, it will be settled in cash at face value. The market interest rate for similar
debentures without conversion rights was 9% per annum
4.2 On 31 December 20.14 Quest obtained a short-term loan of R20 000 from Finance Ltd
and is required to settle the total loan within 12 months in as many ordinary shares of
Quest that will amount to the value of R21 800. The loan from Finance Ltd was still
outstanding on 30 June 20.15.

Additional information

1. The numerator for basic earnings were correctly calculated at R13 500 000 (after taking
into account the above information)
2. Assume a SA normal tax rate of 28% and a VAT rate of 14%.
3. All amounts are considered to be material.
QUESTION 41 Page 3 of 3

REQUIRED: Marks
(a) Disclose the reconciliation of the finance lease liability (transaction 1), as
required by IAS17.31(b), in the financial statements of Quest Ltd for the year
ended 30 June 20.15. Comparative information is not required. [9]
Communication skills: Presentation and layout [1]

(b) Calculate the deferred taxation balance in the financial records of Quest Ltd, as it
relates to transaction 1, for the year ended 30 June 20.15. Also clearly indicate
whether the balance is a deferred tax asset or liability. Comparative information is
not required. [10]

(c) Prepare all the journal entries relating to the investment in listed bonds
(transaction 2) for the financial years ended 30 June 20.14 and 30 June 20.15.
Journal narrations are not required, but the journals must be dated. All forms of
taxation should be ignored. [17]

(d) Assume the directors decided that the new business model for managing all its
investments in listed bonds (transaction 2) will be changed on 30 November 20.13
to have the objective of both the collection of contractual cash flows and the selling
of financial assets.

Discuss (with reason) the classification and measurement (subsequent

measurement and impairment) of the listed bonds in the financial records of
Quest Ltd as a result of the assumed change in business model for the years
ended 30 June 20.14 and 30 June 20.15 in terms of IFRS9 Financial Instruments.
Calculations are not required. All forms of taxation should be ignored. [9]
Communication skills: Logical flow and conclusion [1]

(e) Write a memorandum to the financial director of Quest Ltd, explaining the correct
classification of the short-term loan (transaction 4.2) from Finance Ltd in Quest
Ltd’s financial statements for the year ended 30 June 20.15 in accordance with
IAS31 Financial instruments: Presentation [6]
Communication skills: Logical flow and conclusion [1]

(f) Calculate the interest saving to be taken into account in the reconciliation of
numerators used in the calculation of diluted earnings per share in the notes to
the annual financial statements of Quest Ltd for the year ended 30 June 20.15.
Comparative information is not required. [4]

(g) Prepare the reconciliation of denominators (weighted average number of shares)

that the financial manager will use in the calculation of basic and diluted earnings
per share in the notes to the annual financial statements of Quest Ltd for the year
ended 30 June 20.15. Comparative information is not required. [12]

Please note:
~ Concerning the convertible debentures, you may assume for earnings per share
purposes, that the option to convert into shares is more dilutive than the cash
settlement option.

Please note:
~ Comparative figures are not required
~ Round off all amounts to the nearest Rand
~ Your answer must comply with International Financial reporting Standards (IFRS)
QUESTION 41 (Suggested Solution) Page 1 of 7

(a) Disclose the reconciliation of the finance lease liability (transaction 1), as required by
IAS17.31(b), in the financial statements of Quest Ltd for the year ended 30 June 20.15.
Comparative information is not required.

QUEST LTD

NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 30 JUNE 20.15

6. Interest-bearing borrowings – finance lease

Reconciliation between the total minimum lease payments and their present value:

Up to 2–5 More than

1 year years 5 years Total
Minimum lease payments 32 025 85 491* - 117 516 2
Finance costs [C3; C4] (9 185) (11 653) - (20 838) 6
Present value 22 840 73 838 - 96 678 1
Total 9
* (32 025 x 2) + 21 441
Communication skills: Presentation and layout 1

CALCULATIONS

C1. Calculation if implicit interest rate

PMT R32 025 0.5

N 5 0.5
PV (R142 940) 0.5
FV (GRV + UGRV) R31 447 (R21 441 + 10 006) 0.5
Comp I = ? 9.5%

C2. Calculation of present value on initial recognition

PMT R 32 025 0.5

N 5 0.5
FV (“GRV) R21 441 0.5
I 9.5% 0.5
Comp PV = ? R136 587

C3. Calculation of interest for July 20.15 – June 20.16

SHARP EL – 733A SHARP EL – 738 HP10bll

1. 3P1 / P2 3P1 / P2 ACC 1. AMRT 3 ENT ▼ 3 ENT 1. 3 INPUT 3
nd
2. 2 F FV (AMORT)
2. = R9 185 [INT] 2. ▼▼ = R9 185 [INT] 4. =; = R9 185 [INT]
3. = R73 838 [BAL] 3. ▼= R73 838 [BAL] 4. = R73 838 [BAL] 1
5
C4. Calculation of interest for July 20.16 – June 20.18

SHARP EL – 733A SHARP EL – 738 HP10bll

1. 4P1 / P2 5P1 / P2 ACC 1. AMRT 4 ENT ▼ 5 ENT 1. 4 INPUT 5
nd
2. = R11 653 [INT] 2. ▼▼ = R11 653 [INT] 2. 2 FV (AMORT)
3. =; = R11 653 [INT] 1
QUESTION 41 (Suggested Solution) Page 2 of 7

(b) Calculate the deferred taxation balance in the financial records of Quest Ltd, as it
relates to transaction 1, for the year ended 30 June 20.15. Also clearly indicate whether
the balance is a deferred tax asset or liability. Comparative information is not required.

Deferred taxation balance on 30 June 20.15:

Deferred
Carrying Temporary taxation @ 28%
amount Tax base difference asset / (liability)
R R R R
Finance lease liability
[C5; C6] (96 678) (11 362) (85 316) 23 888 4
Leased equipment [C7] 52 127 - 52 127 (14 596) 5
(33 189) 9 292 0.5

Deferred tax balance on 30 June 20.15 is a deferred tax asset 0.5

Total 10

CALCULATIONS

C5. Calculation of present value on 30 June 20.15

SHARP EL – 733A SHARP EL – 738 HP10bll

2 AMRT; AMRT 2 AMRT 2 INPUT 2
= R96 678 ▼▼▼ 2ndF FV (Amort) = =
= R96 678 = R96 678 0.5

C6. Calculation of tax base for lease liability

R
VAT: (R142 940 x 14 / 114) 17 554 1
Remaining payments (R32 025 x 3) + R21 441 117 516 1.5
Total payments (R32 025 x 5) + R21 441 181 566 1

Tax base: R17 554 x R17 516 / R181 566 11 362

3.5

C7. Calculation of equipment carrying amount

R
PV of minimum lease payments less VAT (136 587 – 17 554) 119 033 1
Fair value (excl VAT) (142 940 – 17 554) 125 386 1

Initial recognition of asset (lowest of above) 119 033 0.5

Transaction cost (excl VAT) (12 865 x 100 / 114) 11 285 1
130 318
Depreciation (2014 & 2015) 130 318 x 20% x 40% (78 191) 1
52 127
QUESTION 41 (Suggested Solution) Page 3 of 7

(c) Prepare all the journal entries relating to the investment in listed bonds
(transaction 2) for the financial years ended 30 June 20.14 and 30 June 20.15. Journal
narrations are not required, but the journals must be dated. All forms of taxation
should be ignored.

Dr Cr
R R
1 July 20.13
J1 Financial asset at fair value through P/L: 168 750 1.5
Listed bonds (SFP) 168 750 0.5
Bank (SFP)
J2 Transaction cost (P/L) (given) 5 906 1
Bank (SFP) 5 906 0.5
30 November 20.13
No entry
30 June 20.14
J3 Fair value loss (P/L) (25 000 x (6.75 – 6.66) 2 250 1.5
Financial asset at FV through P/L: Listed bonds (SFP) 2 250 0.5
1 July 20.14
J4 Financial asset at amortised cost: Listed bonds (SFP) 166 500 0.5
Financial asset at fair value through P/L: 166 500 1.5
Listed bonds (SFP)*
Impairment loss (P/L) (given) 7 073 1
Allowance for expected credit losses (SFP) 7 073 0.5
30 June 20.15
J6 Bank (SFP) (25 000 x 6.75 x 8.5%) 14 344 2
Financial asset at amortised cost: Listed bonds (SFP) 493 1
Effective interest income (P/L) [C8 & C9] 14 837 3
J7 Impairment loss (P/L) (22 634 – 7 073) 15 561 1.5
Allowance for expected credit losses (SFP) 15 561 0.5
Total 17
* 168 750 – 2 250

CALCULATIONS

C8. Calculation of new effective interest rate on 1 July 20.14

PV (R166 500) 0.5

PMT R14 344 0.5
FV R168 750 0.5
n 4 0.5
i=? 8.91%

C9. Calculation of effective interest for the year ended 30 June 20.15

SHARP EL – 733A SHARP EL – 738 HP10bll

1. 1P1 / P2 1P1 / P2 ACC 1. AMRT 1 ENT ▼ 1 ENT 1. 1 INPUT 1
nd
2. 2 F FV (AMORT)
2. = = R14 837 [INT] 2. ▼▼ = R14 837 [INT] 3. = = R14 837 [INT] 0.5
QUESTION 41 (Suggested Solution) Page 4 of 7

(d) Assume the directors decided that the new business model for managing all its
investments in listed bonds (transaction 2) will be changed on 30 November 20.13 to
have the objective of both the collection of contractual cash flows and the selling of
financial assets.

Discuss (with reason) the classification and measurement (subsequent measurement

and impairment) of the listed bonds in the financial records of Quest Ltd as a result
of the assumed change in business model for the years ended 30 June 20.14 and
30 June 20.15 in terms of IFRS9 Financial Instruments. Calculations are not required.
All forms of taxation should be ignored.

Change in business model

Classification
A financial asset shall be measured at fair value through other comprehensive income
if both the following conditions are met:
(a) the financial asset is held within a business model whose objective is achieved
by both collecting contractual cash flows and selling financial assets; and
(b) the contractual terms give rise on specified dates to cash flows that are solely
payments of principal and interest on the principal amount outstanding
(FIRS9.4.1.2A) 1
Quest’s business model for managing all its investments in debt instruments changed on
30 November 20.13. Quest now has the objective of collecting contractual cash flows
(as discussed below) and to sell those bonds if it is profitable to do so. Therefore
requirement (a) of IFRS9.4.1.2A is met. 1.5
The listed bonds give rise to payments of interest and principal on 30 June of every year
until 30 June 20.18. Therefore Quest will collect contractual cash flows on specified
dates on the bonds and requirements (b) of IFRS9.4.1.2A is met. 1.5
The bonds are consequently classified as measured at fair value through OCI. 0.5

Application of reclassification
In terms of IFRS9.5.6.1 Quest shall apply the reclassification prospectively from the
reclassification date. 0.5
Appendix A of IFRS9 defines the reclassification date as the first day of the first reporting
period following the change in business model that results in the reclassification of the
asset, therefore it will be 1 July 20.14 1

Measurement
1 July 20.13 – 30 June 20.14
Due to the reclassification only taking place on 1 July 20.14, the measurement of the
bonds will be based on the requirements for “financial assets measured at fair value
through profit or loss” for the entire (continue measure at fair value) financial year ended
30 June 20.14 1

Fair value adjustments will therefore be recognised in profit or loss 0.5

1 July 20.14 – 30 June 20.14

The financial assets will continue to be measured at fair value (IFRS9.5.6.6). From
1 July 20.14, Quest will need to recognize a loss allowance for expected credit losses in
OCI (IFRS9.5.5.1-2). 1
The total movement in the listed bonds’ fair value will be split between the effective
interest portion and that of the actual fair value movement. The effective interest will be
measured and then accounted for in profit or loss, whereas the actual fair value
movement (gain or loss) will be recognised in other comprehensive income
(IFRS9.5.7.10; IFRS9.5.7.11) 1.5
QUESTION 41 (Suggested Solution) Page 5 of 7

The effective interest date is determined on the basis of the fair value of the asset at
the reclassification date and the date of reclassification is treated is the date of initial
recognition (IFRS9.B5.6.2) 1
It will be thus be calculated and recognised by using the listed bonds’ fair value on
1 July 20.14, therefore R6.66. 1

As the investment in listed bonds were originally classified as financial asset at fair value
through profit or loss and Quest’s accounting policy stipulated that they did not
separately recognize interest revenue or impairment gains and losses, all movements
were allocated directly to profit or loss as changes in fair value. 1.5
Impairment losses will continue to be recognised in profit or loss and not in other
comprehensive income (IFRS9.5.7.10) 0.5
As there has been a significant increase in credit risk, impairment losses for the 20.15
financial year will be measured by using the lifetime expected credit losses. 0.5

Conclusion
From 1 December 20.13 up to 30 June 20.14 the investment in listed bonds will remain
being classified as measured at fair value through profit or loss. 0.5
The reclassification will lead to the listed bonds being classified and measured as
financial assets measured at fair value through OCI from the reclassification date,
being 1 July 20.14 1
Total 16
Max 9
Communication skills: Logical flow and conclusion 1

(e) Write a memorandum to the financial director of Quest Ltd, explaining the correct
classification of the short-term loan (transaction 4.2) from Finance Ltd in Quest Ltd’s
financial statements for the year ended 30 June 20.15 in accordance with IAS32
Financial instruments: Presentation

MEMORANDUM

To: Financial Director – Quest Ltd

From: Consultant

A financial liability is
(a) contractual obligation to deliver cash or another financial asset; or to exchange
financial assets / liabilities under unfavourable terms to the entity; or
(b) contract that will or may be settled in the entity’s own equity instruments and is a
non-derivative for which the entity is or may be obliged to deliver a variable number
of the entity’s own equity instruments (IAS32.11) 1
An equity instrument is any contract that evidences a residual interest in the asset of an
entity after deducting all its liabilities (IAS32.11). In terms of the agreement, Quest has
no contractual obligation to deliver cash or another financial asset to settle the loan.
Quest is however required to settle the loan with its own share (equity instruments).
Quest is required to deliver its own equity instruments, however that does not
automatically classify the loan as an equity instrument (IAS32.21). 2
To determine the correct classification, it is essential to consider the substance of the
contract (IAS32.15). In other words, is the number of shares to be issued by Quest in
terms of the contract fixed or variable (IAS32.21). The amount that Quest needs to
settle is fixed at R21 800. However, the number of shares that Quest will need to settle
the loan varies as the number of shares issued on settlement date is dependent on the
share price of the ordinary shares. 2.5
QUESTION 41 (Suggested Solution) Page 6 of 7

Conclusion
The contract will therefore be settled by delivering a variable number of Quest’s own
shares in exchange for a fixed amount. The short term loan therefore cannot be
classified as an equity instrument and should thus be classified as a financial liability
(IAS32.11; IAS32.21). 1.5
Total 7
Max 6
Communication skills: Logical flow and conclusion 1

(f) Calculate the interest saving to be taken into account in the reconciliation of
numerators used in the calculation of diluted earnings per share in the notes to the
annual financial statements of Quest Ltd for the year ended 30 June 20.15.
Comparative information is not required.

FV 600 000 0.5

PMT 42 000 0.5
N 4 0.5
I 9% 0.5
PV = ? 561 123

Financial liability 561 123

Equity (balancing) 38 877
Total proceeds 600 000

Interest saving:

(561 123 x 95 x 7 / 12) x 72% = 21 210 2

Total 4

(g) Prepare the reconciliation of denominators (weighted average number of shares) that
the financial manager will use in the calculation of basic and diluted earnings per share
in the notes to the annual financial statements of Quest Ltd for the year ended 30 June
20.15. Comparative information is not required.

Reconciliation of denominators – basic and diluted earnings per share

Basic EPS

Number of Weighted #
shares Fraction of shares
outstanding of year outstanding
In issue on 1 July 20.14 257 000 12 257 000 0.5
Capitalization issue (257 000 / 2) 128 500 12 128 500 0.5
385 500 385 500
1 April 20.15
Rights issue – bonus shares [C10] 35 292 12 35 292 6
Rights issue – full value (96 375 – 35 292) 61 083 3 15 271 1
436 063
QUESTION 41 (Suggested Solution) Page 7 of 7

Diluted EPS

Number of Weighted #
shares Fraction of shares
outstanding of year outstanding
Basic number of shares (above) 436 063 0.5
Convertible debentures (600 x 250) *[C11] 150 000 7 87 500 3
523 563
Total 12

CALCULATIONS

C10. Rights issue

Fair value before exercise of rights (385 500 x 31) 11 950 500 1
Rand value received from exercise (385 500 / 4 x 18) 1 734 750 1
13 685 250

# shares outstanding before exercise of rights 385 500 0.5

# shares issued as part of the exercise of rights (385 500 / 4) 96 375 0.5
481 875

Method 1:

Theoretical ex-right value: (13 685 250 / 481 875) 28.40 0.5
Adjustment factor: (31 / 28.40) 1.09154930 1
# of Bonus shares: (385 500 x 1.09154930) – 385 500 35 292 1
5.5
Method 2:

Shares issued for value

96 375 x 18
= 28.40 1

= 61 083

Thus bonus share = 96 375 – 61 083 = 35 292 1

C11. Test for dilution

Weighted
number Earnings
Earnings of shares per share
Basic earnings per share 13 500 000 436 063 30.96 1
Convertible debentures 21 210 87 500
Diluted earnings per share 13 521 210 523 563 25.73 1
2
QUESTION 42 Page 1 of 6

Part 1 (Level 2)

Conquest Ltd, is a company that deals extensively in financial instruments. The profit before tax
for the year ended 28 February 2012 is R5 446 642. This profit excludes the items listed below.
The balance of loans granted by Conquest Ltd at 28 February 2012 was R500 000. No journals
with regard to these loans have to date been passed. (Refer para 8 below).

1. The 100 000 shares in JC Ltd were purchased on 1 January 2009 at R5 per share. The
investment was classified fair value through profit or loss. The fair value at the various dates
were as follows:

1 January 2010 R5
28 February 2011 R6
28 February 2012 R9

2. On 1 February 2010, 20 000 shares were purchased in KC Ltd at R5 per share. The
investment was classified at FV with an OCI election. The fair value of the shares was as
follows:

28 February 2010 R5,00

28 February 2011 R8,50
28 February 2012 R4,50

3. On 1 March 2011, Conquest issued 8% redeemable preference shares of R500 000. A

preference dividend of R80 000 was declared in 28 February 2012. The preference shares
were issued on the basis that the preference share capital would be repayable on redemption
and that every year preference dividends must be paid regardless of whether any dividend is
declared to ordinary shares.

4. On 1 August 2011, the transaction date, Conquest Ltd purchased stock for $100 000.
Payment for the inventory was to be made on 1 April 2012. Conquest Ltd took out a
forward exchange contract on 1 August 2011 until 30 September 2011. On expiry of the
FEC a new FEC was not taken out. The applicable exchange rates are as follows:

SR FEC

1 August 2011 6,80 6,87 (2 months)

30 September 2011 6,75 6,85 (5 months)
28 February 2012 6,70
1 April 2012 6,65

5. On 1 March 2010, Conquest Ltd acquired 100 000 Percy Ltd R1 10% compulsory redeemable
debentures at a discount of 5% on their face value. The debentures are redeemable at a
premium of 20% on their par value on 28 February 2015.

6. On 1 March 2010, Conquest grants 100 share each to 200 employees conditional upon the
employees remaining in its employ during a vesting period of 3 years. By the end of
28 February 2011, 7 employees actually left and it is expected that a further 9 employees will
leave by the end of 28 February 2012. By the end of 28 February 2012 six employees actually
left and it is expected that a further 4 employees will leave. The shares had a fair value of
R30 each on 1 March 2010.
QUESTION 42 Page 2 of 6

7. Conquest Ltd obtained the right to buy $100 000 at a rate of $1 = R7,00 on 1 August 2011 in
terms of a foreign currency option contract to settle an installment on a foreign loan on
28 February 2012. The applicable information with regard to the foreign currency option
contract is as follows:
Option price Exchange rates
1 August 2011 5 000 R7,00
31 December 2011 7 500 R7,10
28 February 2012 R7,25

8. The following loans were granted during the year:

* Loan 1 of R400 000 granted to a customer on 28 February 2011. The loan is repayable on
28 February 2012 and bears interest at a rate of 10% p.a. compounded annually, which can
be considered a market related interest rate for all loans.
* Loan 2 of R100 000 granted to an employee on 1 August 2011. The loan bears interest at a
rate of 5% compounded annually and is repayable with interest on 31 July 2015

9. Assume that Conquest Ltd has decided to early adopt IFRS9 that was issued on 29 October
2011 and consequently the adoption of IFRS9 is applied from 1 January 2012.

10. Assume that Conquest Ltd has more than one business unit for managing investment in
debentures.

11. Ignore taxation

12. Conquest Ltd has always had in issue 2 million shares. On 1 September 2011, Conquest Ltd
had a rights issue of 1 share for every 4 shares held. The issue price of each share was R3
but the fair value was R4.

13. Conquest Ltd has in issue 10% 100 000 debentures of R10 each. They may be convertible
into ordinary shares on the basis of two ordinary shares for one debenture held.

REQUIRED: Marks

(a) Discuss the initial and subsequent recognition and measurement of the debenture
in para 5 above [5]

(b) Provide the journals for the loans in para 8 for the year ended 28 February 2012 [5]

(c) Calculate the net profit before tax to be disclosed in the statement of profit or loss
and other comprehensive income for the year ended 28 February 2012 [20]

(d) Assume that the profit for the period (after tax) and after preference dividend in
(c) above is R3 565 000. Calculate the earnings per share and diluted earnings [9]
per share for the year ended 28 February 2012.
QUESTION 42 Page 3 of 6

Part 2

The soft drink, tonic, was invented in May 18.86 by Dr John Pemberton, a pharmacist from
Atlanta in the United States. South Africa is the largest consumer of Tonic on the African
continent. In order to meet this demand, Tonic Distributors South Africa Ltd (TDSA) produces
and distributes Tonic soft drinks to all types of outlets throughout South Africa, from tuck shops
to supermarket groups and wholesalers.

You have been asked to assist Mr Goodwill, the accountant of TDSA, in finalising the financial
statements of TDSA for the year ended 30 June 20.14. The outstanding matters on which he
requires your assistance is explained below:

1. Expansion project

On 2 July 20.13 TDSA announced a R50 million investment in a new plant in Alrode,
Gauteng, as part of the company’s continued efforts to support the local economy by
expanding its manufacturing capabilities. TDSA currently has two plants, one at Caledon
in the Western Cape which produces about 20 million units of Tonic a year and an existing
plant at Alrode which produces 10 million units of Tonic a year. The existing Alrode plant is
about 40 years old and coming towards the end of its economic life. It will be
decommissioned once the new plant is completed in May 20.20.

TDSA Ltd funded the R39 million expansion project as follows:

~ R30 million of the project is funded by TDSA’s existing cash reserves;

~ On 1 August 20.13 TDSA issued 180 000 convertible cumulative preference shares to a
local investment bank at an issue price of R50 per preference share. The maturity date of
the preference shares is 1 August 20.20. The investment bank has the option to convert
each preference share into five ordinary shares at any time until maturity date. If the
preference shares are not converted into ordinary shares by the maturity date, TDSA will
redeem the preference share in cash on 1 August 20.20. The dividend rate is an 8%
cumulative preference dividend per annum calculated on the issue price. It is the intention
of management to declare preference dividends annually. All accumulated (unpaid)
dividends will accumulate until conversion date or maturity date. On 1 August 20.13 the
prevailing market yield for similar preference shares without conversion rights was 8.36%
per annum.

2. Investment in Iqhwa Ltd bonds

TDSA acquired 1 000 unlisted bonds in Iqhwa Ltd on 1 July 20.13 when the interest rate was
7.5%. This investment is held within a business model with the objective of realising fair
value gains by selling investments. The bonds were acquired at fair value and will be
redeemed at a premium of 10% on 30 June 20.18. The bonds have a face value of R500
each and carry a coupon rate of 7% per annum which is payable bi-annually on 30 June and
31 December.

Fair value of investment in Iqhwa Ltd bonds

R
30 June 20.14 and 1 July 20.14 (market interest rate = 8.0%) 519 703

It is the policy of TDSA to split the interest and fair value adjustments for debt instruments
(including bonds) carried at fair value in terms of IFRS7B5(e).
QUESTION 42 Page 4 of 6

During March 20.14, TDSA acquired the business of Carbonate Investments Ltd. Carbonate
Investments Ltd is a specialist investment company with excellent track records, technical
expertise and computer software to manage investments. The effective date of the
acquisition was 30 April 20.14.

As a result of the acquisition of the investment business, all investments of TDSA will in
future be held together with the investments acquired from Carbonate Investment Ltd, within
the business models of the investment business. The investment business has two business
models:

~ All debt instruments are held within a business model with the objective of collecting
contractual cash flows.
~ Only equity instruments are managed within a business model with the objective of
realizing fair value gains by actively buying and selling equity instruments.

As a result of the above business models, the investment in Iqhwa Ltd bonds will be held
within the business model with the objective of collecting contractual cash flows form the
reclassification date (refer IFRS9, Appendix A Defined terms)

3. Convertible debentures

TDSA issued 20 000 convertible debentures on 1 July 20.13 at par value of R100 per
debenture. The debentures have a four year term and interest is payable annually on
30 June at a nominal interest rate of 6% per year which is market related for similar
convertible instruments. Each debenture is convertible at the option of the holder at any time
up to maturity into 100 ordinary shares in TDSA. The debentures that are not converted into
ordinary shares by maturity date will be settled in cash at par value. The market interest rate
for similar debentures without conversion options was 9% per annum on 1 July 20.13.
Transaction costs directly attributable to the issue of these debentures were R16 000.

Based on past experience of transactions of this nature, TDSA is of the opinion that all
the debentures will be converted into ordinary shares by maturity date.

4. Investment in equity shares

TDSA invested in 20 000 ordinary shares of Region Bottles Ltd on 10 January 20.14 which
represents 10% of the issued shares of Region Bottles Ltd. As TDSA is dependent on
Region Bottles Ltd as a supplier of bottles for its products and regards this investment as a
strategic investment, it has elected to present the changes in the fair value of the shares in
other comprehensive income. This investment in Region Bottles Ltd is the only investment
for which TDSA has elected to recognize the changes in the fair value of the shares in other
comprehensive income.

It is the policy of TDSA to transfer cumulative fair value gains recognized in the mark-to-
market reserve to retained earnings when the investments are sold.

The investment was acquired on 10 January 20.14 at fair value when the share price of
Region Bottles Ltd shares was R6.20 per share. Transaction costs directly attributable to
the acquisition were R2 300 and the fair value on 30 June 20.14 was R8.05 per share.
TDSA sold 25% of its investment in Region Bottles Ltd on 30 June 20.14 at fair value.
This investment qualifies as a capital gains tax asset for tax purposes and the transaction
costs are included in the tax base of the investment.
QUESTION 42 Page 5 of 6

5. Deferred tax asset

Mr Goodwill recognized a deferred tax asset of R425 000 for the financial year ended
30 June 20.14. You may assume the deferred tax asset amount was correctly calculated.
The deferred tax asset originated due to an assessed capital tax loss in the 20.13 financial
year, due to land that was sold at a loss. The financial director informed Mr Goodwill that he
must reverse the deferred tax asset as SARS will definitely not reimburse the deferred tax
asset to TDSA. Mr Goodwill raised this issue with you and asked you to discuss this matter
with the financial director. He also indicated that TDSA will have sufficient future capital
profits and presented a detailed budget indicating a high likelihood that TDSA will have
capital profits within the next six months.

6. Other information

The income tax rate is 28% and the inclusion rate for capital gains tax is 66.6%.

Ignore Dividends Tax and Value Added Tax (VAT)

The balance of the mark-to-market reserve on 30 June 20.13 was Rnil.

QUESTION 42 Page 6 of 6

REQUIRED: Marks

(a) Discuss the classification of the convertible preference shares (matter 1) in the
financial statements of TDSA Ltd for the year ended 30 June 20.14 in accordance
with IAS32 Financial Instruments: Presentation [7]
Communication skills: Logical flow and conclusion [1]

(b) Calculate the deferred tax relating to the convertible preference shares issued
(matter 1) in the records of TDSA Ltd for the year ended 30 June 20.14.
Clearly indicate a deferred tax asset or liability [6]

(c) The accountant of TDSA Ltd is unsure about the impact of the convertible
preference shares in matter 1 on the earnings per share figure for 20.14.
Discuss the effect of the convertible preference shares on the calculation of basic
and diluted earnings per share of TDSA Ltd for the year ended 30 June 20.14.
Support you discussion with calculations if appropriate [9]
Communication skills: Logical flow and conclusion [1]

(d) In respect of the investment in Iqhwa Ltd bonds (matter 2)

(i) Provide the journal entries in the accounting records of TDSA Ltd to account
for the investment in the Iqhwa Ltd bonds for the year ended 30 June 20.14. [10]
(ii) With regards to the reclassification, prepare the note as required by IFRS7.12B
Financial Instruments: Disclosures for the financial year ended 30 June 20.15. [4]
Comparative figures are not required.
Communication skills: Presentation and layout [1]

(e) Calculate the amounts at which the convertible debentures (matter 3) must be
recognized in the accounting records of TDSA Ltd on 1 July 20.13. Your
calculations must clearly indicate the liability and equity portion. [7]

(f) For the investment in the equity shares of Region Bottles Ltd (matter 4), calculate
the closing balance of the mark-to-market reserve, net of tax, for the year ended
30 June 20.14. [5]

(g) Write a memo to the financial director in which you discuss, in terms of The
Conceptual Framework for Financial Reporting, whether the deferred tax asset
(matter 5) may be recognized as an asset in TDSA Ltd’s financial statements for
the year ended 30 June 20.14. [8]
Communication skills: Logical flow and conclusion [1]

Please note
~ Your answer must comply with International Financial Reporting Standards (IFRS)
~ Ignore tax for purposes of (d) to (e) above
~ Journal narrations are not required
~ Round off all amounts to the nearest Rand
~ Round off all effective interest rates calculated to five decimals
QUESTION 42 (Suggested Solution) Page 1 of 11

Part 1

(a) Consider the provisions of IFRS9 (issued on 28 October 2010)

Initial recognition

Financial instruments are only recognised when Conquest Ltd becomes party to the
contractual provisions of the instrument which is on 1 January 20.11 ((IFRS9.3.1) 1

Classification

Conquest Ltd shall classify financial assets as subsequently measured at either fair value
or amortised cost (IFRS9.4.4.1) 1

Measure at amortised cost if

(a) asset is held within business model of which the objective is to hold assets in order to
collect contractual cash flows - Conquest Ltd has more than one business model, AND 1

(b) contractual terms of asset give rise on specified dates to cashflows that are solely
payments of principle and interest on principle amount outstanding. 1

- The debentures in Percy Ltd will be classified and subsequently measured at amortised
cost because:

* Conquest Ltd has a business model with the objective to hold assets in order to collect
contractual cash flows;

* as the contractual cashflows are payments of principle and interest on the principle
amount outstanding and will be held until maturity (plus transaction costs). 1

Initial measurement of debentures

Debentures in Percy Ltd: Fair value of the debentures including transaction costs on trade
date (1 January 20.11). 1

Subsequent measurement of debentures

Debentures in Percy Ltd: Amortised cost and Conquest Ltd must apply the impairment
requirements of IAS39. 1
7
QUESTION 42 (Suggested Solution) Page 2 of 11

(b) A loan should, at intial recognition, be recognised at fair value. In the case of the loan to the
personnel member, the interest rate is lower than a market related interest rate and
consequently the fair value is the present value of the future cash flows discounted at the
market-related rate.

Journals Dr Cr
R R
Loan 1
Loan 400 000 0,5
Bank 400 000 0,5

Loan 2
Loan to employee (SFP) 100 000
Bank (SFP) 100 000 0,5
Personnel costs (P/L) 20 753 1,5
Loan to employees (SFP)
(100 000 - 79 247) [C2] 20 753 1,5

Loan to employees (SFP) 3 962 1,5

Interest received (P/L) (10% x 79 247 x 6/12)(P/L) 3 962 1,5

CALCULATION

C2. n =5
FV = 127 628 (100 000 + 5% p.a. for 5 years) (original capital plus interest
compounded @ 5% per annum)
i = 10% (market related interest rate)
PV = 79 247
Fair value thus R79 247
Adjustment R100 000 - R79 247 = R20 753
QUESTION 42 (Suggested Solution) Page 3 of 11

(c)
Provisional Profit Before Tax 5 446 642 0,5

INVESTMENT IN JC LTD
FV adjustment through profit or loss (9 - 6) x 100 000 300 000 2

INVESTMENT IN KC LTD
Since investment in KC is designated as FV through OCI there is
no FV movement in profit or loss - 1

REDEEMABLE PREFERENCE SHARES

Since preference shares are compulsory redeemable, the preference shares
are classified as a long term loan and the preference dividend are therefore
recognised as interest in statement of profit and loss (80 000) 2

FOREIGN EXCHANGE TRANSACTION

1 Aug 30 Sep 28 Feb 1 April

2011 2011 YR END PAY
TRANS

6,80 6,75 6,70 6,65

FEC
6,87 Expired
not renewed

Loss on expiry of FEC $100 000 x (6,87 - 6,75) (12 000) 1

Gain on restatement of creditors $100 000 x (6,80 - 6,70) 10 000 1

INVESTMENT IN DEBENTURES
FV = 120 000; PV = 95 000; PMT = 10 000; n = 5 ... i = 14,4705% 2
Interest income 2011 14,4705% x 95 000 = 13 747. Difference between
13 747 and actual interest of 10 000 = 3 747 is debited to the investment
of R95 000 therefore 3 747 + 95 000 = 98 747
interest income 2012: R98 747 x 14,4705% 14 289 2

SHARE OPTIONS
Expense at 28 February 2011 (200 - 7 - 9) x 100 x R30 x 1/3 = 184 000 2
Expense at 28 February 2012 (200 - 7 - 6 - 4) x 100 x R30 x 2/3 = 366 000 2
Less expense in 2011 182 000 (182 000) 1

FOREIGN CURRENCY OPTION CONTRACT

The contract is exercised as the contract to purchase at R7 on 28 February 2012
Is less than the spot rate of R7,25 therefore profit [$100 000 x (7,25 - 7)] - R5 000
Loan recorded at spot rate on 28 February 2012 at R725 000. The option contract
is covered at R700 000 + R5 000 (option price not refundable). Therefore profit is
R725 000 - R705 000 20 000 3

LOANS
Refer journals in part (b) i.r.o the loans
Personnel costs P/L (20 753) 1
Interest received 3 962 1
Net profit before tax 5 500 140

Presentation & layout 1

Max 20
QUESTION 42 (Suggested Solution) Page 4 of 11

(d) Earnings per share

EPS = 3 605 000 [W1] / 2 321 430 [W2] 3,5

= 155c 0,5

DIL EPS = 3 677 000 [W1] / 2 521 430 [W2] 3

= 145c 0,5

W1. Earnings

Profit after tax (given) 3 565 000 0,5

Add: Preference dividends 80 000 1
Less: Preference dividend (Preference shares are assumed to be (40 000) 1
cumulative, therefore subtract the fixed preference dividend i.e.
8% of R500 000
3 605 000

Diluted Earnings

Profit after tax [W1] 3 605 000

Interest on debenture no longer paid 10% of (100 000 x R10) x 72% 72 000 2
3 677 000

W2. Weighted Average No of Shares (WAN)

Rights Issue

Ex Rights = (2m x R3 + 500 000 x R2) / (2m + 500 000)

=R7m / 2,5m
= R2,8 3

Adjustment factor: R3 / 2,8 = 1,07143 1

Therefore WAN = 2 000 000 x 1,07143 x 6 / 12 + 2 500 000 x 6 / 12 = 2 321 430 2

Diluted Weighted Average No of Shares

WAN 2 321 430

Share issued to debenture holders 100 000 x 2 OS 200 000 1
2 521 430
QUESTION 42 (Suggested Solution) Page 5 of 11

Part 2

Part (a)

On initial recognition the instrument should be classified in accordance with the substance
of the contractual arrangement and the definitions of a financial liability, a financial asset
and an equity instrument. 0.5

IAS32 requires the issuer of a financial instrument to evaluate the terms of the financial
instrument to determine whether it contains both a liability or an equity component
(IAS32.28) 0.5

Preference dividends 0.5

A financial liability is a contractual liability to deliver cash or another financial asset to

another entity (IAS32.11). 0.5
Since all accumulated (unpaid) dividends will roll up until conversion date or maturity date,
TDSA Ltd has a contractual obligation to deliver cash in the form of preference dividends to
the investment bank on or before 1 August 20.20. 1
The obligation to pay preference dividends to the investment bank is therefore a financial
liability. 1

Embedded option 0.5

The investment bank has a call option (the right to exchange the preference shares for
ordinary shares) exercisable at any time before maturity date. 1
However, a contract is not an equity instrument solely because it may result in the delivery
of the entity’s own equity instruments (IAS32.21). 1
If the contract is settled by issuing a fixed number of own equity instruments for a fixed
amount of cash or another financial asset, it is an equity instrument (IAS32.22). 1
The investment bank paid a fixed amount to obtain the preference shares on 1 August
20.13 and holds the right to convert these preference shares into a fixed number of ordinary
shares in TDSA Ltd. 1
The embedded call option is therefore classified as an equity instrument 1

Principle amount 0.5

If the investment bank (holder) does not exercise its option to convert to ordinary shares,
TDSA Ltd will have to redeem the preference shares on 1 August 20.20. 1
TDSA Ltd therefore has a contractual obligation to deliver cash until it is extinguished
through conversion or maturity of the preference shares (IAS32.30). 1
Therefore this obligation to redeem the preference shares is a financial liability. 0.5

Conclusion

The convertible preference shares should be classified as a compound financial instrument

in the financial statements of TDSA Ltd for the year ended 30 June 20.14. 1
Total 13.5
Max 7
Communication skills: Logical flow and conclusion 1
QUESTION 42 (Suggested Solution) Page 6 of 11

Part (b)

Deferred
tax asset
Carrying Temporary /
Deferred tax amount Tax base difference (liability)
Convertible preference shares
Liability component [C1] (8 833 371) (9 000 000) (166 629) (46 656) 2.5
Subsequent amortization
[(9 000 000 x 8% x 11 / 12) –
676 931 [C1] (16 931) - 16 931 4 741 3
Deferred tax liability (8 850 302) (9 000 000) (149 698) (41 915) 0.5
Total 6
CALCULATIONS

C1. Calculation of present value of liability component

N =7 0.5
I = 8.36 (market interest rate) 0.5
PMT = 720 000 (9 000 000 x 8%) 0.5
FV = 9 000 000 (180 000 x R50) 0.5
PV = 8 833 371

Financial liability 8 833 371

Equity component (balancing figure) 166 629
Proceeds on the preference shares (180 000 x R50) 9 000 000
Finance cost for 20.14 (8 833 371 x 8.36% x 11 / 12) 676 931 1
3
Part (c)

Basic earnings per share

Basic earnings per share is calculated by dividing profit or loss attributable to equity holders
of the parent by the weighted average number of ordinary shares outstanding during the
period (IAS33.10) 1

Impact of convertible preference shares

The convertible preference shares will have no impact on the basic earnings per share of
TDSA Ltd since the preference shares are not mandatory convertible. 1

The profit attributable to ordinary shareholders will not be adjusted with the cumulative
preference dividend when calculating the basic earnings figure, since the preference
dividend on the convertible preference shares has already been accounted for as interest
in the profit. 1

Diluted earnings per share

Diluted earnings per share is calculated by adjusting the profit or loss attributable to ordinary
equity holders of the parent and the weighted average number of shares outstanding for the
effects of all dilutive potential ordinary shares (IAS33.31) 1
QUESTION 42 (Suggested Solution) Page 7 of 11

Impact of convertible preference shares

The convertible preference shares are potential ordinary shares because they comprise a
financial instrument that entitles the holder to ordinary shares in TDSA Ltd 1

Since the convertible debentures give the holder the choice of settlement in ordinary shares
of TDSA Ltd or cash, the more dilutive of cash settlement and share settlement should be
used to calculate diluted earnings per share. 1

Assuming that share settlement is the more dilutive of the two options as the settlement in 1
shares is likely to have a larger impact on the ordinary shares of TDSA Ltd, it needs to be
determined whether the convertible preference shares are dilutive or anti-dilutive. 1

The earnings figure for testing whether the convertible preference shares are dilutive or
anti-dilutive and the calculation for diluted earnings per share (if they are dilutive) is
calculated by adjusting the earnings figure used for basic earnings with the after tax effect 1
of:
0.5
~ Any interest recognized in the period related to the convertible financial instrument

The preference divided was accounted for as interest in the profit for the year of TDSA Ltd
based on its classification in terms of IAS32 Financial Instrument: Presentation 1

The earnings figure should therefore be adjusted with the after tax saving of the interest
recognized in the profit for the year i.e. R487 390 (676 931 [C1] x 72%). 1.5

The potential ordinary shares is the number of ordinary shares to be received by the
investments banker (holder) upon conversion i.e. 900 000 ordinary shares (180 000 x 5) 1.5

The potential ordinary shares above should be weighted for the period that they are
outstanding. This would be for 11 months since the convertible preference shares were 0.5
only issued on 1 August 20.13. 0.5

The weighted potential ordinary shares are therefore 825 000 (900 000 x 11 / 12) 1
Total 15.5
Max 9
Communication skills: Presentation and layout 1
QUESTION 42 (Suggested Solution) Page 8 of 11

Part (d) (i) Journals for the year ended 30 June 20.14 for investment in Iqhwa Ltd bonds

Dr Cr
R R
1 July 20.13
J1 Investment in Iqhwa Ltd bonds (SFP) [C1] 524 335 2.5
Bank (SFP) 524 335 0.5
Recognize investment in bonds at fair value

31 December 20.13
J2 Bank (SFP) ]C1] 17 500 1
Investment in Iqhwa Ltd bonds (SFP) [C1] 2 163 1
Interest income (P / L) [C1] 19 663 1
Recognize interest income received for first six months

30 June 20.14
J3 Bank (SFP) 17 500 0.5
Investment in Iqhwa Ltd bonds (SFP) 2 244 0.5
Interest income (P / L) 19 744 0.5
Recognize interest income received for second six months

J4 Fair value adjustment (P / L) [C2] 9 038 2

Investment in Iqhwa Ltd bonds (SFP) 9 038 0.5
Fair value adjustment at year end (loss)

Total 10

CALCULATIONS

C1. Fair value of Iqhwa Ltd bonds on 1 July 20.13

Set financial calculate on 2 P / YR

N 10 (5 x 2) 0.5
I 7.50% (market interest rate) 0.5
PMT 17 500 (1 000 x R500 x 7% x 6 / 12) 0.5
FV 550 000 (1 000 x R500 x 110%) 0.5
PV = 524 335
Interest and capital per financial calculator:
31 December 20.13
1 Amort (interest) 19 663 0.5
1 Amort (principle) (2 163) 0.5

30 June 2014
2 Amort (interest) 19 744 0.5
2 Amort (principle) (2 244) 0.5
Amortised cost balance on 30 June 20.14
(2 Amort (balance)) 528 741

C2. Fair value adjustment on 30 June 20.14

Fair value on 30 June 20.14 (given) 519 703 0.5

Amortised cost balance on 30 June 20.14 [C1] (528 741) 1
Fair value adjustment (loss) (9 038)
5.5
QUESTION 42 (Suggested Solution) Page 9 of 11

Part (d) (ii)

TDSA LTD

NOTES FOR THE YEAR ENDED 30 JUNE 20.14

4. Reclassification of the investment in Iqhwa Ltd bonds

* TDSA Ltd reclassified its investment in Iqhwa Ltd bonds on 1 July 20.14
(IFRS7.12B(a)) 1
* TDSA Ltd’s business model for managing the investment in Iqhwa Ltd bonds changed
as a result of the acquisition of the investment business of Carbonate Investments Ltd
that became effective on 30 April 20.14. 1
* The investment business has two business models in which all investments of TDSA
Ltd will be managed in future (IFRS7.12B(b)) 1
* All debt instruments, including the investment in Iqhwa Ltd bonds, will in future be held
within the business model with the objective of collecting contractual cash flows 1
* As a result, the investment in Iqhwa Ltd bonds was reclassified from financial assets
measured at fair value through profit or loss to financial assets measured at amortised
cost (IFRS7.12B(b)) 1
* The category of financial assets measured at fair value through profit or loss
decreased with R519 703 while the category of financial assets measured at
amortised cost increased by R519 703 (IFRS7.12B(c)) 1
Total 6
Max 4
Communication skills: Presentation and layout 1

Part (e) Convertible bonds on 1 July 20.13

Fair value of financial liability

Set financial calculator on 1 P / YR

N 4 0.5
I 9% 0.5
PMT 120 000 (20 000 x R100 x 6%) 0.5
FV 2 000 000 (20 000 x R100) 0.5
PV = 1 805 617

Present value of financial liability 1 805 617

Equity component (balancing) 194 383 1
Proceeds on issue of bonds 2 000 000

Apportionment of transaction costs

Financial liability (16 000 x 1 805 617 / 2 000 000) 14 445 1.5
Equity (16 000 x 194 383 / 2 000 000) 1 555
16 000
Amortised recognized on 1 July 20.13
Financial liability (1 805 617 – 14 445) 1 791 172 0.5
Equity (19 383 – 1 555) 192 828 0.5
Total 17
QUESTION 42 (Suggested Solution) Page 10 of 11

Part (f) Closing balance of mark-to-market reserve on 30 June 20.14

Fair value on 10 January 20.14 (20 000 x R6.20) 124 000 1

Capitalize transaction costs 2 300 1
126 300
Fair value on 30 June 20.14 (20 000 x R8.05) 161 000 1
Fair value adjustment (gain) (mark-to-market reserve) 34 700
Tax (R34 700 x 66.6% x 28%) (6 471) 1
Mark-to-market reserve (net of tax) 28 229
25% of investment sold transferred to retained earnings (R28 229 x 25%) (7 057) 1
Closing balance on 30 June 20.14 21 172
Total 5

Part (g)

To: Financial Director

From: Student
Date: 19 September 20.14
Subject: Deferred tax asset

Dear Sir

In relation to the recognition of the deferred tax in respect of TDSA Ltd, find attached Appendix A.
Should you have further enquiries, please contact us on XXX XXX XXX

Yours faithfully

In terms of the Conceptual Framework an asset is:

* A resource which is controlled by an entity;

* As a result of a past event;
* From which future economic benefits are expected will flow to the entity;

The recognition criteria should be complied with:

* It should be probable that economic benefits will flow to the entity;

* The item should have a cost or value which can be measured reliably.

It must therefore be determined whether the above definition and recognition criteria are satisfied.

Definition

A resource which is controlled by the entity. 0.5

The deferred tax asset (capital loss) will be used to reduce future capital profits and
therefore represents a resource. Since the deferred tax assets (capital loss) can only be
used by TDSA Ltd, TDSA Ltd controls the deferred tax asset (capital loss) by denying any
other party access to the asset. 2
As a result of a past event. 0.5
The event is the fact that TDSA Ltd had an capital loss in the 20.13 financial year due to
land that was sold at a loss. 1
From which future economic benefits are expected to flow to the entity. 0.5
The deferred tax asset (capital loss) will in the future result in a decrease of capital gains tax
payable / liability. The future economic benefits will therefore increase as there will be a
reduction in the tax payable / liability 1
QUESTION 42 (Suggested Solution) Page 11 of 11

Recognition criteria

It should be probable that economic benefits will flow to the entity. 0.5
It is expected that TDSA Ltd will have future capital profits within the next six months as
proven by the detailed budget. As TDSA Ltd will have capital profits, they will be able to
use the deferred tax asset (capital loss) against the future capital profits. It is therefore
probable that economic benefits (profits) will flow to TDSA Ltd 2

The item should have a cost or value which can be measured reliably 0.5

The deferred tax asset has a value of R425 000, measured in terms of IAS12. 1

Therefore the deferred tax asset meets the definition and recognition criteria of an asset in
terms of The Conceptual Framework on 30 June 20.14 and may be recognized as an asset
in the financial statements. 1
Total 10.5
Max 8
Communication skills: Logical flow and conclusion 1