BMAN21020 FINANCIAL REPORTING AND ACCOUNTABILITY 2018
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BMAN21020
FINANCIAL REPORTING AND ACCOUNTABILITY
2018
SECTION A (COMPULSORY)
Answer BOTH questions
1. Accounting Treatment and Positive Accounting Theory.
The finance director of Oak plc (Oak) has prepared the following draft financial statements which she intends to present to the bank that has lent the business £40m. The loan agreement requires a gearing ratio (calculated as “interest-bearing Debt divided by Equity”) below 0.5, otherwise the loan becomes repayable. Based on these draft financial statements, the finance director claims that gearing is 0.36 (40/110).
Summarised Statement of Financial Position (Draft, not finalised) At 31st March 2018
Assets
Non-Current Assets
Current Assets
Total Assets
Equity
Ordinary Share capital
Reserves
5% Convertible Bonds (note 1, below)
Total Equity
Non-Current Liabilities: Bank Loan Current Liabilities
Total Equity and Liabilities
£m
120
60
180
60
20
30
110 40 30 |
180 |
Additional Notes:
You have been provided with the following additional notes. No adjustment has been made for this information in the above draft financial statements:
1) The 5% Convertible Bonds, which were issued at par for £30m on 31 March 2018, can either be converted into 50 ordinary shares per £100 of debentures or redeemed at par at any date from 31 March 2022 (in 4 years’ time). Interest is paid annually in arrears on 31 March. The interest rate on similar debentures without the conversion option is 8%. The extract from discount tables (right) will assist in your answer.
Discount Tables
Year
1 2 3 4 5 |
8% Discount Factor 0.926 0.857 0.794 0.735 0.681 |
8% Cumulative Annuity 0.926 1.783 2.577 3.312 3.993 |
2) On 20 February 2018 the board of Oak decided to close down a large factory and transfer production to other factories. The closure is expected to occur on 30 June 2018. This decision was announced to the employees and other interested parties on 1 March 2018, and at that time a formal plan was drawn up, in which overall costs of this closure were foreseen as £10 million.
3) Oak sells goods which carry a one-year repair warranty. If minor repairs were to be required for all goods sold in the year ending March 2018, the cost would be £3m. If major repairs were to be needed for all goods sold in the same year, the cost would be £5m. Oak estimates that 60% of goods sold will have no defects, 25% will have minor defects and 15% will have major defects.
4) Production machinery with a carrying value (net book value) of £5m is included in non-current assets used specifically in the production of a product which is due to end soon. The estimated present value of future net cash inflows expected from using the machinery (and from its disposal) are £3.8m. Similar machinery can be sold on 31 March 2018 for £4.2m, although costs of removing the machinery would be £0.3m.
Required:
a) Using the definitions of equity and liability from the IASB’s Conceptual Framework, explain - with calculations - how the convertible bonds (outlined in note 1) should be accounted for in the Statement of Financial Position in accordance with IFRS.
(9 marks)
b) Explain how notes 2, 3 and 4 should be accounted for under IFRS, showing any adjustments needed to equity or debt in each case. The mark allocation for this requirement is: 3 marks for note 2, 3 marks for note 3 and 5 marks for note 4.
(11 marks)
c) Calculate a revised gearing ratio, based on your answers to parts (a) and (b), and comment briefly on your findings.
(5 marks)
d) Discuss whether Positive Accounting Theory explains the motivation of the Finance Director to present the financial statements as shown in their draft format, without accounting for the additional information.
(5 marks)
(Total 30 marks)
2. Normative Accounting Theories
“When it comes to apportioning blame for Carillion’s dramatic demise, fingers are being pointed in all directions. But most are missing the real culprit: faulty accounts appear to have allowed Carillion to overstate profits and capital, thereby permitting them to load up on debt while paying out cash dividends and bonuses. Prudent accounts are a fundamental pillar of the UK’s capital maintenance regime: profits and capital may not be overstated. It is also illegal under company law to pay dividends out of capital.”1
Required:
Discuss the appropriateness of the Historic Cost model for accounting in the light of the recent corporate failure of Carillion. Explain whether you think capital maintenance problems would be resolved by turning to the following alternative accounting models:
Current Purchasing Power (CPP)
Current Cost Accounting (CCA)
Exit Price Accounting (CoCoA)
(Total 20 marks)
SECTION B
Answer TWO questions. Use a SEPARATE answer book for each question.
3. Taxation.
a) On 1 January 2017, Doggle had an opening debit balance of £12,000 on its tax account, which represented the amount underprovided in respect of its previous year’s liability. Doggle had a credit balance on its deferred tax account of £1,358,000 at the same date.
Doggle has calculated that it should expect to pay tax of £940,000 on its trading profits for the year ended 31 December 2017 and increase its deferred tax account balance by £37,000.
Required:
Prepare extracts from the income statement for the year ended 31 December 2017, statement of financial position at that date and notes to the accounts showing the tax entries required.
(5 marks)
b) On 1 January 2017 Berlin Limited revalued a building for the first time. It was originally purchased 6 years ago for £374,400 and was revalued on 1 January 2017 to £460,800.
The difference between the carrying value of the assets in the SOFP and the tax base at 31 December 2017 was £155,520. On 1 January 2017 the deferred tax liability was £7,979 and the tax rate is 20%
Required:
Explain the treatment for the deferred tax under IAS 12 and show the Journal entries to record any change in provision for deferred tax as a result of the revaluation.
(10 marks)
c) Write an overview of the rationale for accounting for deferred tax in a set of financial statements. Although you do not need to give detailed calculations you should detail the arguments for and against providing for deferred tax, the alternative methods that could be used when accounting for deferred tax and conclude with the preferred methods used by IAS 12.
(10 marks)
(Total 25 marks)
4. Capital Reconstruction
FEI plc (FEI) has been making trading losses. An extract from the Statement of Financial Position of FEI as at 31 December 2017 was as follows:
Ordinary share capital (£1 shares) Less: Accumulated losses
10% debentures (£1)
Net assets at book value
£'000
1,000
(800)
200 600 |
800 |
The directors of FEI propose the following reconstruction scheme:
Write off losses and reduce asset values to £700,000.
Cancel all existing ordinary shares and debentures.
Issue 1,200,000 new ordinary shares of 25p each and 400,000 12.5% debentures of £1 each as follows:
- existing shareholders are to be issued with 800,000 ordinary 25p shares;
- existing debenture holders are to be issued with 400,000 ordinary 25p shares and the debentures.
Required
a) Prepare journal entries for FEI plc’s reconstruction scheme.
(10 marks)
b) The most common cause of capital reconstruction is a company undergoing financial difficulties. What are the typical indicators of financial difficulty? Why do companies undergoing financial difficulties need reconstruction?
(6 marks)
c) In a capital reconstruction, stakeholders other than shareholders (e.g., creditors) also have to surrender existing rights and amount owing in exchange for new rights. Why would the stakeholder be willing to do this?
(4 marks)
d) What are the general principles in reconstruction?
(5 marks)
(Total 25 marks)
5. Interpretation of Financial Statements and Accounting Information.
Karl is a public listed manufacturing company. Its summarised financial statements for the year ended 30 September 2017 and 2016 comparatives are:
Income Statements for the year ended 30 September:
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Investment income
Finance costs
Profit (loss) before taxation Income tax (expense) relief Profit (loss) for the year
Statements of financial position as at 30 September:
Assets
Non-current assets
Property, plant and equipment Investments
Current assets
Inventory and work-in-progress Trade receivables
Tax asset
Bank
Total assets
Equity and liabilities
Equity shares of £1 each
Share premium
Revaluation reserve
Retained earnings
Total equity
Non-current liabilities
Bank loan
Deferred tax
Current liabilities
Trade payables
Current Tax payable
Total equity and liabilities
2017 £'000 29,500 |
2016 £'000 36,000 |
|||||||||||
(25,500) (26,000) |
||||||||||||
|
||||||||||||
2017 2016 £'000 £'000 £'000 £'000 |
||||||||||||
|
||||||||||||
2,200 2,200 600 1,200 |
1,900 2,800 - 6,200 100 4,800 |
|||||||||||
26,200 33,300 |
||||||||||||
|
||||||||||||
4,000 5,000 1,200 700 5,200 5,700
3,400 2,800 - 1,800 3,400 4,600 26,200 33,300 |
Extracts from Chairman's Statement for the year ending 30 September 2017:
“Market conditions during 2017 proved very challenging due largely to difficulties in the global economy and steep falls in share prices and property values.
Plant Property and Equipment
Our properties suffered impairment losses of £6 million in the year: the revaluation reserve was eliminated and a £1.5 million charge was made to cost of sales in addition to the normal depreciation charge. There were no additions or disposals.
Investments
Our investments (recorded at fair value) fell in value, resulting in a loss of £1.6 million (included in administrative expenses).
Redundancy costs
In response to the downturn, the company has unfortunately had to make employees redundant, incurring severance costs of £1.3 million (included in cost of sales) and has undertaken cost savings in advertising and other administrative expenses.
Finance
The difficulty in the credit markets has meant that the finance cost of our variable rate bank loan has increased from 4.5% to 8%. In order to help cash flows, the company made a rights issue during the year and halved the dividend per share.”
Ratios (based on Financial Statements):
Gross Profit Margin
Net Profit Margin (based on reported profit for the year)
Return on Equity (based on reported profit for the year)
Net Asset (taken as Equity) Turnover
Debt to Equity ratio
Current ratio
Quick Ratio
Receivables collection (in days)
Inventory and work-in-progress holding period (in days)
2017
13.6%
(7.1)%
(11.9)%
1.7
22.7%
1.8
1.2
27.2
31.5
2016
27.8%
9.7%
15.2%
1.6
21.7%
1.0
0.6
28.4
26.7
Required:
a) Explain why 2017 ratios for Gross Profit Margin, Net Profit margin and Return on Equity provided above require adjustment to provide more meaningful interpretation of Karl’s underlying performance, and recalculate them.
(5 marks)
b) Analyse and discuss the financial performance (profitability) and position (liquidity and gearing) of Karl based on all information provided, including your recalculated ratios from part (a).
(20 marks)
(Total 25 marks)
2022-05-09