Paper 2.

5(INT)
Financial
Reporting
(International Stream)

PART 2

THURSDAY 8 DECEMBER 2005

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A This ONE question is compulsory and MUST be

answered

Section B THREE questions ONLY to be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination

hall

The Association of Chartered Certified Accountants

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

1 Hedra, a public listed company, acquired the following investments:

(i) On 1 October 2004, 72 million shares in Salvador for an immediate cash payment of $195 million. Hedra agreed
to pay further consideration on 30 September 2005 of $49 million if the post acquisition profits of Salvador
exceeded an agreed figure at that date. Hedra has not accounted for this deferred payment as it did not believe
it would be payable, however Salvador’s profits have now exceeded the agreed amount (ignore discounting).
Salvador also accepted a $50 million 8% loan from Hedra at the date of its acquisition.
(ii) On 1 April 2005, 40 million shares in Aragon by way of a share exchange of two shares in Hedra for each
acquired share in Aragon. The stock market value of Hedra’s shares at the date of this share exchange was
$2·50. Hedra has not yet recorded the acquisition of the investment in Aragon.
The summarised balance sheets of the three companies as at 30 September 2005 are:
Hedra Salvador Aragon
Non-current Assets $m $m $m $m $m $m
Property, plant and equipment 358 240 270
Investments – in Salvador 245 nil nil
– other 45 nil nil
–––– –––– ––––
648 240 270
Current Assets
Inventories 130 80 110
Trade receivables 142 97 70
Cash and bank nil 272 4 181 20 200
–––– –––– –––– –––– –––– ––––
Total assets 920 421 470
–––– –––– ––––
Equity and liabilities
Ordinary share capital ($1 each) 400 120 100
Reserves:
Share premium 40 50 nil
Revaluation 15 nil nil
Retained earnings 240 295 60 110 300 300
–––– –––– –––– –––– –––– ––––
695 230 400
Non-current liabilities
8% loan note nil 50 nil
Deferred tax 45 45 nil 50 nil nil
–––– –––– ––––
Current liabilities
Trade payables 118 141 40
Bank overdraft 12 nil nil
Current tax payable 50 180 nil 141 30 70
–––– –––– –––– –––– –––– ––––
Total equity and liabilities 920 421 470
–––– –––– ––––
The following information is relevant:
(a) Fair value adjustments and revaluations:
(i) Hedra’s accounting policy for land and buildings is that they should be carried at their fair values. The fair
value of Salvador’s land at the date of acquisition was $20 million in excess of its carrying value. By
30 September 2005 this excess had increased by a further $5 million. Salvador’s buildings did not require
any fair value adjustments. The fair value of Hedra’s own land and buildings at 30 September 2005 was
$12 million in excess of its carrying value in the above balance sheet.
(ii) The fair value of some of Salvador’s plant at the date of acquisition was $20 million in excess of its carrying
value and had a remaining life of four years (straight-line depreciation is used).

2
 (iii) At the date of acquisition Salvador had unrelieved tax losses of $40 million from previous years. Salvador
had not accounted for these as a deferred tax asset as its directors did not believe the company would be
sufficiently profitable in the near future. However, the directors of Hedra were confident that these losses
would be utilised and accordingly they should be recognised as a deferred tax asset. By 30 September 2005
the group had not yet utilised any of these losses. The income tax rate is 25%.
(b) The retained earnings of Salvador and Aragon at 1 October 2004, as reported in their separate financial
statements, were $20 million and $200 million respectively. All profits are deemed to accrue evenly throughout
the year.
(c) An impairment test on 30 September 2005 showed that consolidated goodwill should be written down by
$20 million. Hedra has applied IFRS 3 Business combinations since the acquisition of Salvador.
(d) The investment in Aragon has not suffered any impairment.

Required:
Prepare the consolidated balance sheet of Hedra as at 30 September 2005.

(25 marks)

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

2 The following trial balance relates to Petra, a public listed company, at 30 September 2005:
$’000 $’000
Revenue (note (i)) 197,800
Cost of sales (note (i)) 114,000
Distribution costs 17,000
Administration expenses 18,000
Loan interest paid 1,500
Ordinary shares of 25 cents each fully paid 40,000
Share premium 12,000
Retained earnings 1 October 2004 34,000
6% Redeemable loan note (issued in 2003) 50,000
Land and buildings at cost ((land element $40 million) note (ii)) 100,000
Plant and equipment at cost (note (iii)) 66,000
Deferred development expenditure (note (iv)) 40,000
Accumulated depreciation at 1 October 2004 – buildings 16,000
– plant and equipment 26,000
Accumulated amortisation of development expenditure at 1 October 2004 8,000
Income tax (note (v)) 1,000
Deferred tax (note (v)) 15,000
Trade receivables 24,000
Inventories – 30 September 2005 21,300
Cash and bank 11,000
Trade payables 15,000
–––––––– ––––––––
413,800 413,800
–––––––– ––––––––
The following notes are relevant:
(i) Included in revenue is $12 million for receipts that the company’s auditors have advised are commission sales.
The costs of these sales, paid for by Petra, were $8 million. $3 million of the profit of $4 million was attributable
to and remitted to Sharma (the auditors have advised that Sharma is the principal for these transactions). Both
the $8 million cost of sales and the $3 million paid to Sharma have been included in cost of sales.
(ii) The buildings had an estimated life of 30 years when they were acquired and are being depreciated on the
straight-line basis.
(iii) Included in the trial balance figures for plant and equipment is plant that had cost $16 million and had
accumulated depreciation of $6 million. Following a review of the company’s operations this plant was made
available for sale during the year. Negotiations with a broker have concluded that a realistic selling price of this
plant will be $7·5 million and the broker will charge a commission of 8% of the selling price. The plant had not
been sold by the year end. Plant is depreciated at 20% per annum using the reducing balance method.
Depreciation of buildings and plant is charged to cost of sales.
(iv) The development expenditure relates to the capitalised cost of developing a product called the Topaz. It had an
original estimated life of five years. Production and sales of the Topaz started in October 2003. A review of the
sales of the Topaz in late September 2005, showed them to be below forecast and an impairment test concluded
that the fair value of the development costs at 30 September 2005 was only $18 million and the expected period
of future sales (from this date) was only a further two years.
(v) The balance on the income tax account in the trial balance is the under-provision in respect of the income tax
liability for the year ended 30 September 2004. The directors have estimated the provision for income tax for the
year ended 30 September 2005 to be $4 million and the required balance sheet provision for deferred tax at
30 September 2005 is $17·6 million.

4
Required:
Prepare for Petra:
(a) An income statement for the year ended 30 September 2005; and (10 marks)

(b) A balance sheet as at 30 September 2005. (10 marks)

Note: A statement of changes in equity is NOT required. Disclosure notes are NOT required.

(c) The directors hold options to purchase 24 million shares for a total of $7·2 million. The options were granted
two years ago and have been correctly accounted for. The options do not affect your answer to (a) and (b) above.
The average stock market value of Petra’s shares for the year ended 30 September 2005 can be taken as
90 cents per share.

Required:
A calculation of the basic and diluted earnings per share for the year ended 30 September 2005
(comparatives are not required). (5 marks)

(25 marks)

5 [P.T.O.
3 (a) IAS 36 Impairment of assets was issued in June 1998 and subsequently amended in March 2004. Its main
objective is to prescribe the procedures that should ensure that an entity’s assets are included in its balance sheet
at no more than their recoverable amounts. Where an asset is carried at an amount in excess of its recoverable
amount, it is said to be impaired and IAS 36 requires an impairment loss to be recognised.
Required:
(i) Define an impairment loss explaining the relevance of fair value less costs to sell and value in use; and
state how frequently assets should be tested for impairment; (6 marks)
Note: your answer should NOT describe the possible indicators of an impairment.
(ii) Explain how an impairment loss is accounted for after it has been calculated. (5 marks)

(b) The assistant financial controller of the Wilderness group, a public listed company, has identified the matters
below which she believes may indicate an impairment to one or more assets:
(i) Wilderness owns and operates an item of plant that cost $640,000 and had accumulated depreciation of
$400,000 at 1 October 2004. It is being depreciated at 121/2% on cost. On 1 April 2005 (exactly half way
through the year) the plant was damaged when a factory vehicle collided into it. Due to the unavailability of
replacement parts, it is not possible to repair the plant, but it still operates, albeit at a reduced capacity. Also
it is expected that as a result of the damage the remaining life of the plant from the date of the damage will
be only two years. Based on its reduced capacity, the estimated present value of the plant in use is
$150,000. The plant has a current disposal value of $20,000 (which will be nil in two years’ time), but
Wilderness has been offered a trade-in value of $180,000 against a replacement machine which has a cost
of $1 million (there would be no disposal costs for the replaced plant). Wilderness is reluctant to replace the
plant as it is worried about the long-term demand for the product produced by the plant. The trade-in value
is only available if the plant is replaced.
Required:
Prepare extracts from the balance sheet and income statement of Wilderness in respect of the plant for
the year ended 30 September 2005. Your answer should explain how you arrived at your figures.
(7 marks)
(ii) On 1 April 2004 Wilderness acquired 100% of the share capital of Mossel, whose only activity is the
extraction and sale of spa water. Mossel had been profitable since its acquisition, but bad publicity resulting
from several consumers becoming ill due to a contamination of the spa water supply in April 2005 has led
to unexpected losses in the last six months. The carrying amounts of Mossel’s assets at 30 September 2005
are:
$’000
Brand (Quencher – see below) 7,000
Land containing spa 12,000
Purifying and bottling plant 8,000
Inventories 5,000
–––––––
32,000
–––––––
The source of the contamination was found and it has now ceased.
The company originally sold the bottled water under the brand name of ‘Quencher’, but because of the
contamination it has rebranded its bottled water as ‘Phoenix’. After a large advertising campaign, sales are
now starting to recover and are approaching previous levels. The value of the brand in the balance sheet is
the depreciated amount of the original brand name of ‘Quencher’.
The directors have acknowledged that $1·5 million will have to be spent in the first three months of the next
accounting period to upgrade the purifying and bottling plant.
Inventories contain some old ‘Quencher’ bottled water at a cost of $2 million; the remaining inventories are
labelled with the new brand ‘Phoenix’. Samples of all the bottled water have been tested by the health
authority and have been passed as fit to sell. The old bottled water will have to be relabelled at a cost of
$250,000, but is then expected to be sold at the normal selling price of (normal) cost plus 50%.

6
Based on the estimated future cash flows, the directors have estimated that the value in use of Mossel at
30 September 2005, calculated according to the guidance in IAS 36, is $20 million. There is no reliable
estimate of the fair value less costs to sell of Mossel.

Required:
Calculate the amounts at which the assets of Mossel should appear in the consolidated balance sheet
of Wilderness at 30 September 2005. Your answer should explain how you arrived at your figures.
(7 marks)

(25 marks)

7 [P.T.O.
4 The following draft financial statements relate to Tabba, a private company.
Balance sheets as at: 30 September 2005 30 September 2004
$’000 $’000 $’000 $’000
Tangible non-current assets (note (ii)) 10,600 15,800
Current assets
Inventories 2,550 1,850
Trade receivables 3,100 2,600
Insurance claim (note (iii)) 1,500 1,200
Cash and bank 850 8,000 nil 5,650
–––––– ––––––– –––––– –––––––
Total assets 18,600 21,450
––––––– –––––––
Equity and liabilities
Share capital ($1 each) 6,000 6,000
Reserves:
Revaluation (note (ii)) nil 1,600
Retained earnings 2,550 2,550 850 2,450
–––––– ––––––– –––––– –––––––
8,550 8,450
Non-current liabilities
Finance lease obligations (note (ii)) 2,000 1,700
6% loan notes 800 nil
10% loan notes nil 4,000
Deferred tax 200 500
Government grants (note (ii)) 1,400 4,400 900 7,100
–––––– ––––––
Current liabilities
Bank overdraft nil 550
Trade payables 4,050 2,950
Government grants (note (ii)) 600 400
Finance lease obligations (note (ii)) 900 800
Current tax payable 100 5,650 1,200 5,900
–––––– ––––––– –––––– –––––––
Total equity and liabilities 18,600 21,450
––––––– –––––––
The following information is relevant:
(i) Income statement extract for the year ended 30 September 2005:
$’000
Operating profit before interest and tax 270
Interest expense (260)
Interest receivable 40
––––
Profit before tax 50
Net income tax credit 50
––––
Profit for the period 100
––––
Note: the interest expense includes finance lease interest.
(ii) The details of the tangible non-current assets are:
Cost Accumulated depreciation Carrying value
$’000 $000 $’000
At 30 September 2004 20,200 4,400 15,800
At 30 September 2005 16,000 5,400 10,600

8
 During the year Tabba sold its factory for its fair value $12 million and agreed to rent it back, under an operating
lease, for a period of five years at $1 million per annum. At the date of sale it had a carrying value of $7·4 million
based on a previous revaluation of $8·6 million less depreciation of $1·2 million since the revaluation. The profit
on the sale of the factory has been included in operating profit. The surplus on the revaluation reserve related
entirely to the factory. No other disposals of non-current assets were made during the year.
Plant acquired under finance leases during the year was $1·5 million. Other purchases of plant during the year
qualified for government grants of $950,000.
Amortisation of government grants has been credited to cost of sales.
(iii) The insurance claim relates to flood damage to the company’s inventories which occurred in September 2004.
The original estimate has been revised during the year after negotiations with the insurance company. The claim
is expected to be settled in the near future.

Required:
(a) Prepare a cash flow statement using the indirect method for Tabba in accordance with IAS 7 Cash flow
statements for the year ended 30 September 2005. (17 marks)

(b) Using the information in the question and your cash flow statement, comment on the change in the financial
position of Tabba during the year ended 30 September 2005. (8 marks)
Note: you are not required to calculate any ratios.

(25 marks)

9 [P.T.O.
5 (a) Elite Leisure is a private limited liability company that operates a single cruise ship. The ship was acquired on
1 October 1996. Details of the cost of the ship’s components and their estimated useful lives are:
component original cost ($million) depreciation basis
ship’s fabric (hull, decks etc) 300 25 years straight-line
cabins and entertainment area fittings 150 12 years straight-line
propulsion system 100 useful life of 40,000 hours
At 30 September 2004 no further capital expenditure had been incurred on the ship.
In the year ended 30 September 2004 the ship had experienced a high level of engine trouble which had cost
the company considerable lost revenue and compensation costs. The measured expired life of the propulsion
system at 30 September 2004 was 30,000 hours. Due to the unreliability of the engines, a decision was taken
in early October 2004 to replace the whole of the propulsion system at a cost of $140 million. The expected life
of the new propulsion system was 50,000 hours and in the year ended 30 September 2005 the ship had used
its engines for 5,000 hours.
At the same time as the propulsion system replacement, the company took the opportunity to do a limited
upgrade to the cabin and entertainment facilities at a cost of $60 million and repaint the ship’s fabric at a cost
of $20 million. After the upgrade of the cabin and entertainment area fittings it was estimated that their remaining
life was five years (from the date of the upgrade). For the purpose of calculating depreciation, all the work on the
ship can be assumed to have been completed on 1 October 2004. All residual values can be taken as nil.

Required:
Calculate the carrying amount of Elite Leisure’s cruise ship at 30 September 2005 and its related
expenditure in the income statement for the year ended 30 September 2005. Your answer should explain
the treatment of each item. (12 marks)

(b) Related party relationships are a common feature of commercial life. The objective of IAS 24 Related party
disclosures is to ensure that financial statements contain the necessary disclosures to make users aware of the
possibility that financial statements may have been affected by the existence of related parties.

Required:
(i) Describe the main circumstances that give rise to related parties. (4 marks)
(ii) Explain why the disclosure of related party relationships and transactions may be important.
(3 marks)
(iii) Hideaway is a public listed company that owns two subsidiary company investments. It owns 100% of the
equity shares of Benedict and 55% of the equity shares of Depret. During the year ended 30 September
2005 Depret made several sales of goods to Benedict. These sales totalled $15 million and had cost Depret
$14 million to manufacture. Depret made these sales on the instruction of the Board of Hideaway. It is
known that one of the directors of Depret, who is not a director of Hideaway, is unhappy with the parent
company’s instruction as he believes the goods could have been sold to other companies outside the group
at the far higher price of $20 million. All directors within the group benefit from a profit sharing scheme.

Required:
Describe the financial effect that Hideaway’s instruction may have on the financial statements of the
companies within the group and the implications this may have for other interested parties. (6 marks)

(25 marks)

End of Question Paper

10