2-5int 2001 Dec A

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Part 2 Examination – Paper 2.5(INT)

Financial Reporting (International Stream) Answers
1 (a) Consolidated Balance Sheet of Horsefield as at 31 March 2002:

Non-current assets $000 $000
Intangible
Property, plant and equipment (8,050 + 3,600) 11,650
Goodwill (1,170 – 468 (w (i))) 702
Licence (180 – 60) (w (iii)) 120
________
12,472
Investments
Associated company (w (v)) 705
Others (4,000 + 910 – 3,240 (Sandfly) – 630 (Anthill) + 120 (fair value)) 1,160
______ 1,865
________
14,337
Current assets
Inventory (830 + 340) 1,170
Accounts receivable (520 + 290 – 40 cash in transit) 770
Bank (240 + 40 cash in transit) 280
______ 2,220
________
Total assets 16,557
________
Equity and liabilities
Capital and reserves:
Ordinary shares of $1 each 5,000

Accumulated profits (w (iii)) 8,203
________
13,203
Minority interest (w (ii)) 364
Non-current liabilities
10% Loan notes (500 + 240) 740
Current liabilities
Accounts payable (420 + 960) 1,380
Dividend payable to minority (w (iii)) 10
Taxation (220 + 250) 470
Proposed dividend – Horsefield 200
Overdraft 190
______ 2,250
________
Total equity and liabilities 16,557
________
Workings (Note: all figures in $000)

(i) Cost of control
Investments (1,200 × 90% × $3) 3,240 Ordinary shares (90% × 1,200) 1,080
Pre acq profit (w (iii)) 720
Fair value adjustments (w (iv)) 270
______ Goodwill 1,170
______
3,240
______ 3,240
______
The goodwill relating to Sandfly of $1,170,000 is depreciated over a five-year life at $234,000 per annum for two years
= $468,000.
(ii) Minority interest
Balance c/f 364 Ordinary shares (10% × 1,200) 120
Accumulated profits (w (iii)) 214
______ Fair value adjustments (w (iv)) 30
______
364
______ 364
______
(iii) Accumulated profits

Horsefield Sandfly Horsefield Sandfly
Unrealised profit in inventory (see below) 3 B/f 7,300 2,200
Depreciation – licence (180/6 × 2 years (w (iv))) 60 Post acq profit – Sandfly 1,206
Minority interest (10% × (2,200 – 60)) 214 Proposed dividend (see below) 90
Pre-acq profit (90% × 800) 720 Post acq profit – Anthill (w (v)) 90
Post acq profit (90% × (2,200 – 800 – 60) 1,206
Goodwill amortisation – Sandfly (w (i)) 468
– Anthill (w (v)) 12
Balance c/f 8,203
______ ______ ______ ______
8,686
______ 2,200
______ 8,686
______ 2,200
______
13
The unrealised profit in the inventory sold to the associate is $65,000 × 30/130 × 2/3 × 30% = $3,000.
The proposed dividend of Sandfly must be allocated 10% ($10,000) to the minority, and shown as a creditor as it will
be paid in the near future, and 90% ($90,000) credited to group reserves.
(iv) Fair value adjustments
Group share 90% 270 Investment property 120
Minority 10% 30
_____ Licence 180
_____
300
_____ 300
_____
(v) Associated company – calculation of goodwill

Investment at cost (600 × 30% × $3·50) 630
Net assets on acquisition (30% × 1,700 see below) (510)
____
Goodwill 120
____
This is depreciated for six months of a five-year life = $12,000

The net assets at the date of acquisition will be equal to the shareholders’ funds at that date:
Share capital 600
Accumulated profit b/f 800
Half of the profits for the year ($600,000 × 1/2) 300
______
1,700
______
Associated company – carrying value in consolidated balance sheet

Investment at cost 630
Post acquisition profit (30% × (600 × 1/2)) 90
____
720
Amortisation of goodwill above (12)
Unrealised profit in inventory (3)
____
705
____
(b) In order for an investment to be classified as an investment in associated company the investor must have ‘significant
influence’ over the investee. Significant influence is presumed to exist where there is a holding of 20% or more of the voting
power unless the investor can clearly demonstrate that this is not the case. Conversely a holding of less than 20% is presumed
not to be an associate, unless it can be clearly demonstrated that the investor can exercise significant influence. The voting
rights can be held directly or through subsidiaries. IAS 28 ‘Accounting for Investments in Associates’ excludes subsidiaries
and joint ventures from the definition of an associate. Presumably this is for clarity as the definition of a subsidiary would also
meet the definition of an associate, and whilst joint ventures are in many ways similar to associates, they are covered by a
different International Standard and may require a different accounting treatment. Somewhat controversially IAS 28 says that
a majority holding by one investor does not preclude another investor having significant influence. An investing company
owning a majority holding in another company normally has control over the investee and would thus class it as a subsidiary.
In normal circumstances it is difficult to see how a company could be controlled by one entity and be significantly influenced
by a different entity unless ‘control’ was passive. The 20% test is not definitive and the following other evidence should be
considered.
Does the investing company:
have representation on the Board of the investee;
participate in the policy making processes (operational and financial);
have material transactions with investee;
interchange managerial personnel with the investee; or
provide technical expertise to the investee?
14
2 (a) Balance sheet of Deltoid as at 31 March 2002

Non-current assets $000 $000
Property, plant and equipment (12,110 + 600 – 20 (w (i)) – 120 (w (iii))) 12,570
Current assets
Inventory 3,850
Trade accounts receivable 2,450
Bank 250
______ 6,550
_______
Total assets 19,120
_______
Equity and liabilities:
Capital and reserves:
Ordinary shares of 50p each (2,000 + 500 bonus issue) 2,500
Conversion rights (equity element of convertible loan note (w (iv))) 186
_______
2,686
Reserves
Share premium 1,000
Revaluation reserve (3,000 – 500 bonus issue) 2,500
Accumulated profits (note (i)) 3,409
______ 6,909
_______
9,595
Non-current liabilities
Environmental provision – revised amount 2,150
Finance lease (w (iii)) 371
6% Convertible loan note (2,814 + 101 accrued interest (w (iv))) 2,915

Current liabilities
Trade accounts payable 2,820
Accrued interest (w (iii)) 24
Finance lease (w (iii)) 105
Taxation 1,140
______ 4,089
_______
19,120
_______
Note: The directors have proposed a final dividend of $400,000 (w (v)).
Workings:
(i) Recalculation of accumulated profits:
Retained profit for year to 31 March 2002 from question 2,000
Additional depreciation of: plant (w (ii)) (20)
leased plant (w (iii)) (120)
_____ (140)
Add back: lease rentals (w (iii)) 150
Addition finance costs: for loan notes (281 – 180 (w (iv))) (101)
for leased plant (w (iii)) (50)
_____ (151)
Additional environmental provision (245 – 180) (65)
______
Restated retained profit for year 1,794
Retained profit b/f at 1 April 2001 from question 2,500
Prior year effect of error in environmental provision (2,150 – 1,200 – 65) (885)
______
Accumulated profit in balance sheet 3,409
______
(ii) Change of depreciation policy:

current policy group policy
Year to 31 March 2001 ((250 – 50) × 2,000/8,000) 50 (250 × 20%) 50
Year to 31 March 2020 ((250 – 50) × 800/8,000)) 20 (200 × 20%) 40
The net effect of this is an increase in the depreciation charge of $20,000 for the current year only.
15
(iii) Leased plant – this has been treated as an operating lease whereas it should be treated as a finance lease:
$000
Fair value/cost 600
1st payment 1 April 2001 (75)
_____
525
interest to 30 September 2001 (10% for 6 months) 26
_____
551
2nd payment 1 October 2001 (75)
_____
capital outstanding at 31 March 2002 476
accrued interest to 31 March 2002 (10% for 6 months) 24
_____
total outstanding at 31 March 2002 500
3rd payment due 1 April 2002 (75)
_____
425
interest to 30 September 2002 (10% for 6 months) 21
_____
446
4th payment 1 October 2002 (75)
_____
capital outstanding at 31 March 2003 371
_____
Summarising:
– the lease payments of $150,000 should be eliminated from expenses and replaced with a depreciation charge of
$120,000 ($600,000 × 20% pa)
– interest of $50,000 ($26,000 paid, $24,000 accrued) should be included as a finance cost
– current liabilities are $24,000 for accrued interest and $105,000 ($476,000 – $371,000) for the capital element
of the finance lease
– non-current liabilities $371,000 for the capital element of the finance lease.
(iv) The convertible loan note is a compound financial instrument and IAS 32 ‘Financial Instruments: Disclosure and
Presentation’ requires that the debt element and the equity element of such instruments are accounted for separately.
The amount of the issue proceeds attributable to the conversion rights is classed as equity. This amount is normally
calculated as the ‘residue’ after the value of the debt has been calculated:
cash flows factor at 10% present value $000
year 1 interest 180 0·91 164
year 4 interest, redemption premium and capital 3,480 0·68 2,366
______
total value of debt component 2,814
proceeds of the issue 3,000
______
equity component (residual amount) 186
______
The interest cost in the income statement should be increased from $180 to $281 (10% of 2,814) by accruing $101,
and this accrual should be added to the carrying value of the debt.
(v) Proposed dividend:
At the current value of $2 per share the market capitalisation of the ordinary shares is $10 million (2·5 × 2 × $2), a
4% yield on this would be $400,000.
(b) Basic earnings per share:

Profit attributable to ordinary shareholders (w (i)) $1,794,000
Number of shares ranking for dividend (2·5 million × 2) 5 million
Earnings per share 35·9 cents
Diluted earnings per share:
The potential dilution of the convertible loan note must be assessed. On an assumed conversion to ordinary shares there
would be an increase in shares of 1·5 million (3 million × 50/100). The effect on earnings is that there will also be an increase
based on the after tax finance costs saved. Although the finance costs are $281,000, only the actual interest paid of
$180,000 is available for tax relief, thus the after tax increase in earnings will be $281,000 – ($180,000 × 25%) =
$236,000. The diluted earnings per share is:
Earnings (1,794 basic earnings + 236 above) $2,030,000
Number of shares (5 million + 1·5 million) 6·5 million
Diluted earnings per share 31·2 cents
16
3 (a) (i) An impairment loss arises where the carrying value of an asset, or group of assets, is higher than their recoverable
amounts. In effect the Standard requires that assets should not appear on a balance sheet at a value which is higher
than they are ‘worth’. The recoverable amount of an asset is defined as the higher of its net realisable value (i.e. the
amount at which it can be sold for net of direct selling expenses) or its value in use (i.e. its estimated future net cash
flows discounted to a present value). IAS 36 ‘Impairment of Assets’ recognises that many assets do not produce
independent cash flows and therefore the value in use may have to be calculated for a group of assets – a
cash-generating unit.
The Standard recognises that it would be too onerous for companies to have to test for impaired assets every year and
therefore only requires impairment reviews when there is some indication that an impairment has occurred. The
exception to this general principle is where goodwill or other intangible assets are being depreciated over a period of
more than 20 years, in which case an impairment review is required at least annually. This also applies where any
tangible non-current asset, other than land, has a remaining life of more than 50 years.
(ii) Impairments generally arise where there has been an event or change in circumstances. It may be that something has
happened to the assets themselves (e.g. physical damage) or there has been a change in the economic environment
relating to the assets (e.g. new regulations may have come into force).
The Standard gives several examples of indicators of impairment, which may be available from internal or external
sources:
(i) poor operating results. This could be a current operating loss or a low profit. One year’s losses in itself does not
necessarily mean there has been an impairment, but if this is coupled with previous losses or expected future losses
then this is an indication of impairment;
(ii) a significant decline in an asset’s market value (in excess of normal depreciation though use or the passage of time)
or evidence of obsolescence (through market changes or technology) or physical damage;

(iii) evidence of a reduction in the useful economic life or estimated residual value of assets;
(iv) adverse changes in the market or economy such as the entrance of a major competitor, new statutory or regulatory
rules or any indicator of value that has been used to value an asset (e.g. on acquisition a brand may have been
valued on a ‘multiple of sale revenues’. If subsequent sales were below expectations this may indicate an
impairment.);
(v) a commitment to a significant reorganisation or restructuring of the business;
(vi) loss of key employees or major customers;
(vii) increases in long-term interest rates (this could materially impact on value in use calculations thus affecting the
recoverable amounts of assets);
(viii) where the carrying amount of an enterprise’s net assets is more than its market capitalisation.
(b) (i) On the acquisition of a subsidiary, the purchase consideration must be allocated to the fair value of its net assets with
the residue being classed as goodwill (or negative goodwill if the assets have a greater fair value than the purchase
consideration). IAS 22 ‘Business Combinations’ recognises that it is not always possible to accurately determine the
value of some assets at the date of acquisition and therefore allows an ‘investigation period’ up to the end of the first full
reporting period following the period of acquisition. As the revision to the value of Halyard’s assets was due to more
detailed information becoming available, the fall in its asset values should be treated as an adjustment to provisional
valuations made at the time of acquisition. In effect the net assets and goodwill should be restated to $7 million and $5
million respectively; the fall of $1 million is not an impairment loss and should not be charged to the income statement.
This revision will have the effect of increasing the amortisation of goodwill from $800,000 to $1 million per annum
(based on a five-year life). The above assumes that the recoverable value of the company as a whole is greater than
$12 million.
The fall in value of Mainstay’s assets is the result of events that occurred after the acquisition (i.e. physical damage to
the plant) and this does constitute an impairment loss. The plant and machinery should be written down to its
recoverable amount and the loss charged to the income statement. On the assumption that the recoverable value of the
company as a whole has not fallen, goodwill will not be affected.
(ii) On the basis of the original estimates, Shiplake’s earth-moving plant was not impaired, the value in use of $500,000
being greater than its carrying value. However due to the ‘dramatic’ increase in interest rates causing Shiplake’s cost of
capital to increase, the value in use of the plant will have to be recalculated. As the discount rate has risen this will
cause the value in use to fall. There is insufficient information to be able to quantify this fall. If the new discounted value
is above the carrying value $400,000 there is still no impairment. If it is between $245,000 and $400,000, this will
be the recoverable amount of the plant and it should be written down to this value. As the plant can be sold for
$250,000 less selling costs of $5,000, $245,000 is the least amount that the plant should be written down to even
if its revised value in use is below this figure.
(iii) The treatment of the research and development costs in the year to 31 March 2001 was correct due to the element of
uncertainty at the date. The development costs of $75,000 written off in that same period should not be capitalised at
a later date even if the uncertainties leading to its original write off are favourably resolved. The treatment of the
development costs in the year to 31 March 2002 is incorrect. The directors’ decision to continue the development is
logical as (at the time of the decision) the future costs are estimated at only $10,000 and the future revenues are
expected to be $150,000. It is also true that the project is now expected to lead to an overall deficit of $135,000
(120 + 75 + 80 + 10 – 150 (in $000)). However, at 31 March 2002 the unexpensed development costs of $80,000
are expected to be recovered. Provided the criteria in IAS 38 ‘Intangible Assets’ are met these costs of $80,000 should
17
be recognised as an asset in the balance sheet and ‘matched’ to the future earnings of the new product. Thus the
directors’ logic of writing off the $80,000 development cost at 31 March 2002 because of an expected overall loss is
flawed. The directors do not have the choice to write off the development expenditure.
(iv) An impairment loss relating to an income generating unit should be allocated on the following basis:
first to any obviously impaired assets (none in this example);
then to goodwill;
then to the remaining asset on a pro-rata basis;
but no asset should be written down to less than its net realisable value. Applying this to the impairment loss of
$130 million ($370m – $240m):
Cost Impairment Restated value
$000 $000 $000
Goodwill 80,000 (80,000) nil
Franchise costs 50,000 (20,000) 30,000
Restored vehicles 90,000 nil 90,000
Plant 100,000 (20,000) 80,000
Other net assets 50,000
________ (10,000)
_________ 40,000
________
370,000
________ (130,000)
_________ 240,000
________
Note: the franchise cost cannot be written down to less than its realisable value, the restored vehicles have a realisable
value higher than their cost and should not be written down at all, the remaining impairment loss (after the goodwill
and franchise write downs) of $30 million is apportioned pro-rata to the plant and the other net assets.
4 (a) A company that is a wholly owned subsidiary is a related party of its parent company. This means that the financial
statements may have been affected by related party transactions. Such transactions may or may not be at ‘arm’s length’ i.e.
on normal commercial terms. Even where related party transactions are at arm’s length, it is still important to realise that they
are related party transactions. This is because it is quite possible that they would not have occurred but for the relationship.
For example a parent company may purchase all of its motor vehicle fleet requirements from one of its subsidiaries on normal
commercial terms. Whilst this may appear perfectly proper, it may mean that, but for the custom of its parent, the subsidiary’s
sales and profits would have been much less. The types of transaction that may occur between related parties are:
purchases and sales, possibly at favourable prices or advantageous settlement terms;
provision of finance, again possibly at artificially low (favourable) rates of interest;
equipment or other property may be provided under favourable terms;
favourable agency arrangements;
provision of services, such as sharing technical knowledge from research and development activities or allowing patented
goods to be produced under licence; and
guarantees for loans or overdrafts.
All of the above would mean that there is hardly any area of financial reporting that could not be influenced by the presence
of related party transactions with the possibility that this may cause severe distortion of the financial statements.
Although there is a requirement to disclose related party relationships and transactions there are exemptions available to
wholly owned subsidiaries.
Apart from related party issues, a common error when dealing with individual subsidiaries is to assume that the liabilities of
an individual subsidiary may be ‘covered’ by assets owned by other members of the group, or that the parent company will
guarantee a subsidiary’s liabilities. This is not usually the case.
(b) Ms A B Conrad
Chief Executive
Report on the Financial Position of Breadline
Introduction:
The following report is based on the available financial statements of Breadline for the year to 31 December 2001, which
include comparative figures for the year to 2000. The comments have been based on taking the financial statements at face
value. Towards the end of the report under ‘causes of concern’ I have expressed matters that could seriously affect the position
of Breadline as portrayed in its financial statements.
Profitability:
Breadline’s overall profitability has shown a creditable improvement from a ROCE of 41% to 47·1%. Calculation of the asset
turnover and profit margins reveal that this improvement has arisen from increased profit margins (at both the gross and net
level) as the asset turnover of Breadline has declined from 2·6 to 2·0 times.
Liquidity:
This is an area of concern as both the current ratio and the quick ratio (acid test) have deteriorated considerably from normal
and acceptable positions in 2000 to worrying low levels of 1·1:1 (current) and 0·77:1 (quick) in 2001.
18
Looking in more depth at the composition of these ratios:

Inventory holding has gone from 18 days to 23 days. In general these are relatively low levels, but given the trade of Breadline
(bakery), large inventory holdings would not be expected.
The accounts receivable collection period shows a modest decline from 34 days in 2000 to 41 days in 2001; despite the
worsening of this ratio it is still an efficient collection period.
The accounts payable period: two figures have been calculated for this ratio. The figure for the payment of our own balance
shows a very serious worsening of the payment period from 46 days (which was in line with our credit terms) in 2000 to an
unacceptable period of 103 days for 2001. The payment period when our own balance is excluded also shows an increasing
payment period from 45 days in 2000 to 53 days in 2001, however this is nothing like the increase for our own account.
Although the increasing payment period is partly responsible for the worsening of the liquidity ratios of Breadline, it is the
deterioration in the cash position that is the main cause. It has gone from a balance in hand of $250,000 in 2000 to an
overdraft of $220,000 in 2001. Further evidence of a deteriorating cash flow position is the company having to raise a loan
(of $500,000) in the current year.
Gearing and financing:
Gearing is not a significant issue for Breadline. The company had nil gearing in 2000 and the issue of the loan note (at the
beginning of the current year) has created modest gearing of 12%.
The company appears to have made an issue of shares during the year to the amount of $600,000 cash ($400,000 capital
+ $200,000 premium – see below). This is a significant amount representing 17% of net assets at the end of 2000.
It would appear the composition of the accumulated profits at 31 December 2001 is made up of a brought forward balance
of $1,700,000 plus $600,000 retained profit for the current year and the transfer of the revaluation reserve of $700,000 to
realised profits (as the company’s freehold has now been sold). Thus it must be a cash issue of shares that has caused the
increase in share capital and share premium.
Causes of concern/further investigations:
Sale of property:
The company appears to have sold its freehold premises and leased it back as a leasehold property. The main reason for this
conclusion is that our company is aware that Breadline traded from the same business address in both 2000 and 2001.
There is no indication of how long the lease is, but even if it is for a long period, its cost ($2·5 million) is likely to have been
less than the freehold was sold for as even a long lease would be worth less than the freehold. Therefore there must have
been a large profit on the sale of at least $1,250,000. This should be $2,500,000 (minimum value of the freehold) less
$1,250,000 (the carrying value of the freehold). This profit has been included in the income statement as a reduction of the
cost of sales. This profit seems to be largely responsible for the improvement in Breadline’s margins and overall profitability.
If the ROCE is calculated excluding this profit it would be 17·4% [(1,970 +10 – 1,250)/(3,700 + 500) × 100)], which is
much worse than the previous year’s 41%. Normally this type and size of profit is separately disclosed either on the face of
the income statement or in a note to the financial statements. It should not be considered as a reduction of the cost of sales.
Clearly any prospective purchaser of Breadline cannot expect to repeat this type of profit in future periods.
Issue of Loan note/Share capital
The most striking feature of the issue of the loan note is the interest rate it carries. At only 2% this is well below the
commercial rate of 8%. It is possible that the loan note has been issued to Breadline’s parent company, and the low interest
rate is a feature of the related party relationship. If it is not a related party transaction, it may be that the low interest is
compensated for by high premium on its redemption. If this is so the premium should be amortised over the life of the loan
note to give a higher finance charge. One way or another it appears that the issue of the loan note has led to an artificially
low finance cost and is another example of flattering profitability.
The issue of the shares is even more perplexing. As Breadline is a 100% owned subsidiary of Wheatmaster, the shares must
have been issued to Wheatmaster. It is not immediately obvious why this share issue occurred. The practical effect of the
issue is that Breadline received $600,000 from its parent. What is interesting is that Breadline paid a dividend of $900,000
to its parent company during the year. Given the size of Breadline’s overdraft, it may have had insufficient cash to pay the
dividend without the receipt from the proceeds of the share issue. Thus the issue may have been a mechanism to enable
Breadline to transfer some of its profits to its parent company.
Conclusion
The apparent improvement in Breadline’s profitability seems largely due to related party issues and the sale and leaseback of
the freehold property. Thus it is illusory rather than a genuine commercial improvement. The company’s liquidity is also poor
and its most valuable asset (the freehold property) has now been replaced by a leasehold property of unknown duration. All
of these may be symptoms of the parent company preparing to sell the business and attempting to improve the financial
position of Breadline. There is insufficient information to conclude whether Breadline would be a good (or poor) acquisition,
but it is important that such an evaluation is made based on ‘non-manipulated’ information.
A more immediate concern is the deterioration in the payment period to our company. Breadline must be contacted
immediately to find out why the account is so late in being paid. It would not be advisable to allow any further trading on
credit until the account is within the stated credit terms. Enquiries should be made as to why our internal credit control
procedures have allowed the situation to develop this far.
D E Franks
Assistant Financial Controller
19
Appendix
Performance ratios 2001 2000
Return on capital employed (1,970 + 10)/(3,700 + 500) × 100 47·1% (1,025/2,500) × 100 41·0%
Net assets turnover (8,500/4,200) 2·0 times (6,500/2,500) 2·6 times
Gross profit margin (see below) (2,550/8,500) × 100 30% (1,690/6,500) × 100 26%
Net profit (after tax) margin (1,500/8,500) x100 17·6% (850/6,500) x 100 13·1%
Current ratio (1,330/1,250) 1·1:1 (1,090/590) 1·8:1
Quick ratio (960/1,250) 0·77:1 (850/590) 1·4:1
Inventory holding period (370/5,950) × 365 23 days (240/4,810) × 365 18 days
Accounts receivable collection period (960/8500) × 365 41 days (600/6,500) × 365 34 days
Accounts payable payment period (see below) (excluding Judicious)
(1,030 – 340)/(5,950 – 1,200)) × 365 53 days (590 – 100)/(4,810 – 800) × 365 45 days
Judicious payment period (340/1,200) × 365 103 days (100/800) × 365 46 days
Gearing (500/4,200) × 100 12% nil
The 2% loan note has been treated as a financing item in calculating the net asset turnover.
The accounts payable payment period is based on the cost of sales as the purchases figure is not available.
5 (a) (i) Merryview – Income statement (extracts) – year to 31 March 2001

$000
Sales revenue (40,000 × 35% (w (i))) 14,000
Cost of sales (w (i)) (9,100)
______
Profit on contract 4,900

______
Balance sheet (extracts) as at 31 March 2001

Non-current assets
Plant and machinery (3,600 – 900 (w (ii))) 2,700
Current assets
Amount due from customer (w (iii)) 1,500
(ii) Merryview – Income statement (extracts) – year to 31 March 2002
$000
Sales revenue (40,000 × 75% – 14,000 (w (i))) 16,000
Cost of sales (22,500 – 9,100 (w (i))) (13,400)
_______
Profit on contract 2,600
_______

Non-current assets
Plant and machinery (3,600 – 900 – 1,200 (w (ii))) 1,500
Current assets
Amount due from customer (w (iii)) 1,000
Workings (all figures $000):
(i) Contract costs as at 31 March 2001:
Architects’ and surveyors’ fees 500
Materials used (3,100 – 300 inventory) 2,800
Direct labour costs 3,500
Overheads (40% of 3,500) 1,400
Plant depreciation (9 months (w (ii))) 900
______
Cost at 31 March 2001 9,100
Estimated cost to complete:
Excluding depreciation 14,800
Plant depreciation (3,600 – 600 – 900) 2,100
______ 16,900
_______
Estimated total costs on completion 26,000
_______
Percentage of completion at 31 March 2001 (9,100/26,000) = 35%
20
Contract costs as at 31 March 2002:

Summarised costs excluding depreciation 20,400
Plant depreciation (21 months at $100 per month) 2,100
_______
Cost to date 22,500
Estimated cost to complete:
Excluding depreciation 6,600
Plant depreciation (9 months) 900
______ 7,500
_______
Estimated total costs on completion 30,000
_______
Percentage of completion at 31 March 2002 (22,500/30,000) = 75%

(ii) The plant has a depreciable amount of $3,000 (3,600 – 600 residual value)
Its estimated life on this contract is 30 months (1 July 2000 to 31 December 2002)
Depreciation would be $100 per month i.e. $900 for the period to 31 March 2001;
$1,200 for the period to 31 March 2002; and a further $900 to completion.
(iii) Amount due from customer at 31 March 2001:
Contract cost incurred (9,100 + 300 materials inventory) 9,400
Recognised profit 4,900
_______
14,300
Cash received at 31 March 2001 (12,800
_______ )
Amount due at 31 March 2001 1,500
_______
Amount due from customer at 31 March 2002:

Contract costs incurred 22,500
Recognised profit (4,900 + 2,600) 7,500
_______
30,000
Cash received – 31 March 2001 (12,800)
– 31 March 2002 (16,200)
_______ (29,000
_______ )
Amount due at 31 March 2002 1,000
_______
(b) Merryview Income statement (extracts) – year to 31 March 2002

Note: workings in brackets are in $000 $000 $000
Depreciation: head office – 6 months to 1 October 2001 (1,200/25 × 6/12) 24,000
– 6 months to 31 March 2002 (1,350/22·5 (w (i)) × 6/12) ________
30,000 54,000
training premises – 6 months to 1 October 2001 (900/25 × 6/12) 18,000
– 6 months to 31 March 2002 (600/10 × 6/12) 30,000
Impairment loss (w (ii)) 210,000
________ 258,000

Non-current assets
Land and buildings – head office (700 + 1350 – 30) 2,020,000
– training premises (350 + 600 – 30) 920,000
__________
2,940,000
__________
Revaluation reserve
Head office land (700 – 500) 200,000
Building (1,350 – 1,080 (w (i))) 270,000
Training premises land (350 – 300) 50,000
________ 520,000
Transfer to realised profit (270/22·5 (w (i)) × 6/12 re depreciation of buildings) (6,000)
_________
514,000
_________
Workings:
(i) The date of the revaluation is two and a half years after acquisition. This means the remaining life of the head office
would be 22·5 years. The net book value of the head office building at the date of revaluation is $1,080,000 i.e. its
cost less two and a half years at $48,000 per annum ($1,200,000 – $120,000).
(ii) Impairment loss: the net book value of training premises at date of revaluation is $810,000 i.e. its cost less two and a
half years at $36,000 per annum ($900,000 – $90,000). It is revalued down to $600,000 giving a loss of $210,000.
As the land and the buildings are treated as separate assets the gain on the land cannot be used to offset the loss on
the buildings.
21

Part 2 Examination – Paper 2.5(INT)

Financial Reporting (International Stream) Marking Scheme:
This marking scheme is given as a guide in the context of the suggested answers. Scope is given to markers to award marks for
alternative approaches to a question, including relevant comment, and where well-reasoned conclusions are provided. This is
particularly the case for written answers where there may be more than one definitive solution.
Marks
1 (a) Calculation of goodwill and its depreciation 3
licence 2
leasehold 1
property, plant and equipment 1
associate 3
other investments 2
inventory 1
accounts receivable 1
bank and overdraft (shown separate) 1
accounts payable 1
dividend to minority 1
tax and dividend of Horsefield 1
minority interest 2
accumulated profits 4
available 24
maximum 20
(b) 1 mark per relevant point to maximum 5

Maximum for question 25
2 (a) Balance sheet

non-current assets 4
inventory 1
amounts receivable/payable from question 1
current liability lease (interest and capital) 2
tax provision 1
convertible loan note 4
environmental provision 1
finance lease: non-current liability 1
ordinary shares 1
share premium and revaluation reserve 1
note of proposed dividends 2
Accumulated profits working:
add back lease rentals 1
additional finance costs 2
environmental provision: current year 1
prior year effect 1
available 24
maximum 20
(b) basic earnings per share 2

diluted earnings per share 3
maximum 5
23
Marks
3 (a) (i) definition of impairment loss 1
definition of recoverable amount 1
review not required unless there are indicators 1
goodwill/intangibles over 20 years 1
available 4
maximum 3
(ii) indicators of impairments:
one mark per example maximum 7
(b) (i) Halyard’s loss is a revision of estimated values 1

Mainstay’s loss is an impairment 1
effect on net assets including goodwill 1
maximum 3
(ii) an impairment loss may arise due to higher discount rate 1
if value in use above $400,000 no loss 1
lowest recoverable amount is $245,000 1
value in use between $400,000 and $245,000 will determine impairment loss 1
maximum 4
(iii) 31 March 2001 is correct 1
cannot reinstate previously expensed development costs 1
correct decision to continue project 1

$80,000 in 2002 should not be written off 1
the directors do not have choice in this matter 1
available 5
maximum 4
(iv) allocation of impairment loss:
one mark per asset group maximum 4
24
Marks
4 (a) 1 mark per relevant point to a maximum of 5
(b) format and presentation of report 1

calculation of relevant ratios – up to 6
appropriate comments on above ratios 10
references to areas of concern 5
available 22
maximum 20
5 (a) (i) sales revenue in 2001 1

contract cost to date for 2001 4
contract cost to complete 2001 1
percentage complete 2001 1
balance sheet items 2001 – plant 1
balance sheet items 2001 – due from customer 2
available 10
maximum 8
(ii) sales revenue in 2002 2
contract cost to date for 2002 1
contract cost to complete 2002 1

percentage complete 2002 1
balance sheet items 2002 – plant 1
balance sheet items 2001 – due from customer 2
available 8
maximum 7
(b) depreciation 2002 – head office 2

– training premises 2
impairment loss 2
non-current assets 1 mark each property 2
revaluation reserve 1 mark each item 3
transfer to realised profit 1
available 12
maximum 10
25

2-5int 2001 Dec A

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Part 2 Examination – Paper 2.5(INT)

1 (a) Consolidated Balance Sheet of Horsefield as at 31 March 2002:

Ordinary shares of $1 each 5,000

Workings (Note: all figures in $000)

(iii) Accumulated profits

(v) Associated company – calculation of goodwill

This is depreciated for six months of a five-year life = $12,000

Associated company – carrying value in consolidated balance sheet

2 (a) Balance sheet of Deltoid as at 31 March 2002

6% Convertible loan note (2,814 + 101 accrued interest (w (iv))) 2,915

(ii) Change of depreciation policy:

(b) Basic earnings per share:

or evidence of obsolescence (through market changes or technology) or physical damage;

Looking in more depth at the composition of these ratios:

5 (a) (i) Merryview – Income statement (extracts) – year to 31 March 2001

Profit on contract 4,900

Balance sheet (extracts) as at 31 March 2001

Balance sheet (extracts) as at 31 March 2002

Percentage of completion at 31 March 2001 (9,100/26,000) = 35%

Contract costs as at 31 March 2002:

Percentage of completion at 31 March 2002 (22,500/30,000) = 75%

Amount due from customer at 31 March 2002:

(b) Merryview Income statement (extracts) – year to 31 March 2002

Balance sheet (extracts) as at 31 March 2002

ACCA Learning Web：en.52acca.com ACCA Forum：forum.52acca.com

Part 2 Examination – Paper 2.5(INT)

(b) 1 mark per relevant point to maximum 5

2 (a) Balance sheet

(b) basic earnings per share 2

(b) (i) Halyard’s loss is a revision of estimated values 1

correct decision to continue project 1

(b) format and presentation of report 1

5 (a) (i) sales revenue in 2001 1

contract cost to complete 2002 1

(b) depreciation 2002 – head office 2

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