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2022 EXAMINATIONS

PART II          SECOND YEAR

ACCOUNTING AND FINANCE

Ac.F 212       PRINCIPLES OF FINANCIAL ACCOUNTING

QUESTION 1

ANSWER ALL PARTS OF THIS QUESTION

Explain how the following five pairs of topics, covered by the International Accounting Standards     Board’s (IASB’s) Conceptual Framework, are connected and why the linkages between them are im- portant for financial reporting standard setting.

a)    Objective-> Qualitative Characteristics

b)   Qualitative Characteristics -> Recognition

c)    Elements -> Recognition

d)    Elements -> Capital Maintenance

e)    Measurement -> Capital Maintenance

(5 marks each)

TOTAL 25 MARKS

QUESTION 2

ANSWER ALL PARTS OF THIS QUESTION

Explain how each of the following five ideas may be applied to financial reporting and hence why they are of significance to those interested in standard setting.

a)    Market for lemons

b)    Information asymmetry

c)    Goal congruence

d)    Regulatory capture

e)    Principles-based vs. Rules-based standards

(5 marks each)

TOTAL 25 MARKS

QUESTION 3

ANSWER ALL PARTS OF THIS QUESTION

Frest plc (Frest) is a large company manufacturing lifts and providing services around their installation and maintenance. In its financial statements for the fiscal year ended on 31 December 2021, Frest recognised a provision for the following pending lawsuit:

At the beginning of 2021, Frest entered into a contract with an operator of several shopping centres. The contract specified that Frest would install lifts in the operator’s shopping centres and provide maintenance services for the subsequent three years. Shortly after installation, lifts in one of the shop- ping centres caused a fire on a busy holiday weekend. The operator of the shopping centres sued Frest for negligent conduct during installation and loss of trade on an especially busy weekend.

At the end of 2021, the lawsuit was still pending. Frest’s lawyers expected Frest to be found liable and to have to pay damages to the operator of the shopping centres with a probability of 65%. They further expected damages to amount to £250,000 with a probability of 30%, £450,000 with a probability of 30% or, in the worst scenario, £750,000 with a probability of 40%. Finally, the lawyers expected the

court ruling to take place at the end of 2023. The lawyers’ estimates are based on outcomes of several prior lawsuits involving similar accusations as well as parties with similar financial resources.                The relevant discount rate for Frest is 8%.

REQUIRED:

a)    Explain why Frest was correct in recognising a provision for the lawsuit. Include in your expla- nation a short discussion of the recognition criteria for provisions under IAS 37.

(9 marks)

b)   Determine the amount of the provision at initial recognition and prepare the journal entry for the initial recognition of the provision in Frest’s financial statements for fiscal year 2021. Ex- plain each of your steps.

(5 marks)

c)    Assume that you are supposed to rewrite the above description of the lawsuit so that it results in a contingent liability and not a provision. Propose at least two changes that you would make to the description. Include in your answer an explanation of what contingent liabilities are and how they differ from provisions.

(7 marks)

d)   The above description of the lawsuits suggests that the recognition and measurement of pro- visions involves discretion. Identify at least two examples of discretionary decisions from the description of the lawsuit and explain how they can be used to manage earnings.

(4 marks)

TOTAL 25 MARKS

QUESTION 4

ANSWER ALL PARTS OF THIS QUESTION

Efil is large company operating in the taxi industry with a fiscal year ending on 31 December. On 31 December 2021, Efil acquired a five-year taxi licence for a price of £15,000 with the intention to use it for three years, after which the licence will be sold in the market for taxi licences. In this market, the fair value of the taxi licence is £9,000 on 31 December 2022 and £7,000 on 31 December 2023. In the same market, taxi licences with a remaining useful life of two years traded at a price of £3,000 on 31 December 2021 and do not change significantly in price in subsequent years.

Efil applies the straight-line amortisation method to all its intangible assets and the revaluation model according to IAS 38 to the taxi licences that it owns. The market for taxi licences qualifies as active market according to IAS 38 and is expected to continue to exist for the next years.

REQUIRED:

a)    Calculate the relevant amounts and prepare the journal entries for the initial recognition and

subsequent measurement of the taxi licence in Efil’s financial statements for fiscal years 2021, 2022 and 2023. Explain each of your steps.

(15 marks)

b)   Under the revaluation model according to IAS 38, revaluation increases and revaluation de- creases are to be treated differently and affect measures of financial performance differently.

i)     Explain the differences in the accounting treatment of revaluation increases and re- valuation decreases.

ii)    Explain which summary measures from the financial statements the IASB considers as measures of financial performance.

iii)   Based on your answers to i) and ii), discuss which measure of financial performance reflects the value development of assets measured under the revaluation model most comprehensively.

(10 marks)

TOTAL 25 MARKS

QUESTION 5

ANSWER ALL PARTS OF THIS QUESTION

The following is an extract from the notes to the financial statements of Ayube plc (Ayube) for the

fiscal year ended 31 December 2021:


Loans to key management personnel                                                                        2,150

Zero coupon bonds                                                                                                         1,300

Listed corporate bonds

6,995

6,728

REQUIRED:

a)   The above extract lists a loss allowance for debt investments at amortised cost. This loss al- lowance is a consequence of applying the expected loss model prescribed by IFRS 9.

i)     Explain the main requirements of the expected loss model of IFRS 9, including differ- ences in requirements across different categories of financial instruments. Use your own words.

ii)   Compare the application of the expected loss model with a situation in which the ex- pected loss model is not applied, i.e., credit losses are not accounted for until they are realized (or incurred). Explain how these two situations affect earnings, both within a specific year and over a period of several years.

(10 marks)

b)   On 31 December 2021, Ayube aquired the following financial instruments :

i)     Shares issued by another firm that is listed at the London Stock Exchange. Ayube ac- quired the shares for a price of £135,000 and paid transaction costs of £5,000. On 31 December 2022, the  market  price of the shares is £151,000. Ayube classified the shares as ‘Fair value through profit or loss’ (FVPL). Explain the accounting treatment according to IFRS 9 of each element listed above and prepare the journal entries for the initial recognition and subsequent measurement of the shares in Ayube’s financial statements for fiscal years 2021 and 2022.

ii)    Bonds with a term to maturity of eight years. Ayube acquired the bonds for a price of £44,000 and paid transaction costs of £1,675. For fiscal year 2022, Ayube receives £1,500 interest in cash and accounts for £1,756 interest income under the effective interest method. On 31 December 2022, the fair value of the bonds is £42,310. On 1 January 2023, Ayube sells the bonds for the price of £42,310. Ayube classified the

bonds as Fair value through other comprehensive income’ (FVOCI). Explain the ac- counting treatment according to IFRS 9 of each element listed above and prepare the journal entries for the initial recognition, subsequent measurement and sale of the bonds in Ayube’s financial statements for fiscal years 2021, 2022 and 2023.

(15 marks)

TOTAL 25 MARKS

QUESTION 6

ANSWER ALL PARTS OF THIS QUESTION

a)    Explain the purpose of consolidated financial statements.

[2 marks]

b)   As at 30 September 2020, the Statements of Financial Position of the two companies in ‘The Small Print group’, Terms plc and Conditions plc, were as given below.

Non-current assets

Property, Plant and Equipment

Investments (at cost)

Current Assets

Inventory

Receivables

Other current assets

Cash

Total Assets

Shareholders Equity

Ordinary Share Capital (£1 shares)

10% Preference shares (£1 shares)

Retained Earnings

Liabilities

Non-current liabilities

Current Liabilities

Payables

Current tax payable

Bank overdraft

Total Liabilities

Total Equity and Liabilities

Terms plc

£

2,975,000

1,029,000

4,004,000

 

616,000

1,029,000

259,000

252,000

2,156,000

 

6,160,000

2,100,000

-

1,099,000

3,199,000

 

1,050,000

 

 

1,288,000

623,000

-

1,911,000

 

2,961,000

 

6,160,000

Conditions plc

£

2,016,000

91,000

2,107,000

 

511,000

742,000

154,000

105,000

1,512,000

 

3,619,000

1,050,000

315,000

630,000

1,995,000

 

574,000

 

 

392,000

483,000

175,000

1,050,000

 

1,624,000

 

3,619,000

Other information

•    Each ordinary share of Conditions plc carries one vote and there are no other shares of the company having voting rights.

•    On 1 October 2018 Terms plc paid £840,000 to purchase 630,000 ordinary shares of Condi- tions plc.  At that date, the Retained Earnings of Conditions plc were £210,000.  It was agreed that the assets and liabilities of Conditions plc were shown at fair value in its financial state- ments at that date.

•    Since acquisition there has been an impairment of the goodwill arising on consolidation of £210,000.

•    During the year ended 30 September 2020, Terms plc sold inventory to Conditions plc for £175,000. The profit margin on these sales was 40%.  In that same year, Conditions plc resold 80% of that inventory.  At 30 September 2020, Conditions plc had unpaid invoices totalling £126,000 payable to Terms plc for the inventory purchased from it.

REQUIRED:

Prepare a consolidated Statement of Financial Position for The Small Print group’ as at 30 September 2020.   In producing the Statement, provide clear, detailed workings and explain carefully the purpose of each calculation undertaken and why you have used each of the fig- ures in the calculation.

[23 marks]

TOTAL 25 MARKS