（a) Kayte operates in the shipping industry and owns vessels for transportation. In June 2

Section B – TWO questions ONLY to be attempted

(a) Cate is an entity in the software industry. Cate had incurred substantial losses in the fi nancial years 31 May 2004 to 31 May 2009. In the fi nancial year to 31 May 2010 Cate made a small profi t before tax. This included signifi cant non-operating gains. In 2009, Cate recognised a material deferred tax asset in respect of carried forward losses, which will expire during 2012. Cate again recognised the deferred tax asset in 2010 on the basis of anticipated performance in the years from 2010 to 2012, based on budgets prepared in 2010. The budgets included high growth rates in profi tability. Cate argued that the budgets were realistic as there were positive indications from customers about future orders. Cate also had plans to expand sales to new markets and to sell new products whose development would be completed soon. Cate was taking measures to increase sales, implementing new programs to improve both productivity and profi tability. Deferred tax assets less deferred tax liabilities represent 25% of shareholders’ equity at 31 May 2010. There are no tax planning opportunities available to Cate that would create taxable profi t in the near future. (5 marks)

(b) At 31 May 2010 Cate held an investment in and had a signifi cant infl uence over Bates, a public limited company. Cate had carried out an impairment test in respect of its investment in accordance with the procedures prescribed in IAS 36, Impairment of assets. Cate argued that fair value was the only measure applicable in this case as value-in-use was not determinable as cash fl ow estimates had not been produced. Cate stated that there were no plans to dispose of the shareholding and hence there was no binding sale agreement. Cate also stated that the quoted share price was not an appropriate measure when considering the fair value of Cate’s signifi cant infl uence on Bates. Therefore, Cate estimated the fair value of its interest in Bates through application of two measurement techniques; one based on earnings multiples and the other based on an option–pricing model. Neither of these methods supported the existence of an impairment loss as of 31 May 2010. (5 marks)

(c) At 1 April 2009 Cate had a direct holding of shares giving 70% of the voting rights in Date. In May 2010, Date issued new shares, which were wholly subscribed for by a new investor. After the increase in capital, Cate retained an interest of 35% of the voting rights in its former subsidiary Date. At the same time, the shareholders of Date signed an agreement providing new governance rules for Date. Based on this new agreement, Cate was no longer to be represented on Date’s board or participate in its management. As a consequence Cate considered that its decision not to subscribe to the issue of new shares was equivalent to a decision to disinvest in Date. Cate argued that the decision not to invest clearly showed its new intention not to recover the investment in Date principally through continuing use of the asset and was considering selling the investment. Due to the fact that Date is a separate line of business (with separate cash fl ows, management and customers), Cate considered that the results of Date for the period to 31 May 2010 should be presented based on principles provided by IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. (8 marks)

(d) In its 2010 fi nancial statements, Cate disclosed the existence of a voluntary fund established in order to provide a post-retirement benefi t plan (Plan) to employees. Cate considers its contributions to the Plan to be voluntary, and has not recorded any related liability in its consolidated fi nancial statements. Cate has a history of paying benefi ts to its former employees, even increasing them to keep pace with infl ation since the commencement of the Plan. The main characteristics of the Plan are as follows:

(i) the Plan is totally funded by Cate;

(ii) the contributions for the Plan are made periodically;

(iii) the post retirement benefi t is calculated based on a percentage of the fi nal salaries of Plan participants dependent on the years of service;

(iv) the annual contributions to the Plan are determined as a function of the fair value of the assets less the liability arising from past services.

Cate argues that it should not have to recognise the Plan because, according to the underlying contract, it can terminate its contributions to the Plan, if and when it wishes. The termination clauses of the contract establish that Cate must immediately purchase lifetime annuities from an insurance company for all the retired employees who are already receiving benefi t when the termination of the contribution is communicated. (5 marks)

Required:

Discuss whether the accounting treatments proposed by the company are acceptable under International Financial Reporting Standards.

Professional marks will be awarded in this question for clarity and quality of discussion. (2 marks)

The mark allocation is shown against each of the four parts above.

income. The purpose of the statement of profit or loss and other comprehensive income is to show an entity’s financial performance in a way which is useful to a wide range of users so that they may attempt to assess the future net cash inflows of an entity. The statement should be classified and aggregated in a manner which makes it understandable and comparable. However, the International Integrated Reporting Council (IIRC) is calling for a shift in thinking more to the long term, to think beyond what can be measured in quantitative terms and to think about how the entity creates value for its owners. Historical financial statements are essential in corporate reporting, particularly for compliance purposes, but it can be argued that they do not provide meaningful information. Preparers of financial statements seem to be unclear about the interaction between profit or loss and other comprehensive income (OCI) especially regarding the notion of reclassification, but are equally uncertain about whether the IIRC’s Framework constitutes suitable criteria for report preparation. A Discussion Paper on the Conceptual Framework published by the International Accounting Standards Board (IASB) has tried to clarify what distinguishes recognised items of income and expense which are presented in profit or loss from items of income and expense presented in OCI.

Required:

(a) (i) Describe the current presentation requirements relating to the statement of profit or loss and other comprehensive income. (4 marks)

(ii) Discuss, with examples, the nature of a reclassification adjustment and the arguments for and against allowing reclassification of items to profit or loss. Note: A brief reference should be made in your answer to the IASB’s Discussion Paper on the Conceptual Framework. (5 marks)

(iii) Discuss the principles and key components of the IIRC’s Framework, and any concerns which could question the Framework’s suitability for assessing the prospects of an entity. (8 marks)

(b) Cloud, a public limited company, regularly purchases steel from a foreign supplier and designates a future purchase of steel as a hedged item in a cash flow hedge. The steel was purchased on 1 May 2014 and at that date, a cumulative gain on the hedging instrument of $3 million had been credited to other comprehensive income. At the year end of 30 April 2015, the carrying amount of the steel was $8 million and its net realisable value was $6 million. The steel was finally sold on 3 June 2015 for $6·2 million.

On a separate issue, Cloud purchased an item of property, plant and equipment for $10 million on 1 May 2013. The asset is depreciated over five years on the straight line basis with no residual value. At 30 April 2014, the asset was revalued to $12 million. At 30 April 2015, the asset’s value has fallen to $4 million. The entity makes a transfer from revaluation surplus to retained earnings for excess depreciation, as the asset is used.

Required:

Show how the above transactions would be dealt with in the financial statements of Cloud from the date of the purchase of the assets.

Note: Candidates should ignore any deferred taxation effects. (6 marks)

Professional marks will be awarded in question 4 for clarity and quality of presentation. (2 marks)

Section B – TWO questions ONLY to be attempted

(a) Chemclean trades in the chemical industry. The entity has development and production operations in various countries. It has entered into an agreement with Jomaster under which Chemclean will licence Jomaster’s knowhow and technology to manufacture a chemical compound, Volut. The know-how and technology has a fair value of $4 million. Chemclean cannot use the know-how and technology for manufacturing any other compound than Volut. Chemclean has not concluded that economic benefits are likely to flow from this compound but will use Jomaster’s technology for a period of three years. Chemclean will have to keep updating the technology in accordance with Jomaster’s requirements. The agreement stipulates that Chemclean will make a non-refundable payment of $4 million to Jomaster for access to the technology. Additionally, Jomaster will also receive a 10% royalty from sales of the chemical compound.

Additionally, Chemclean is interested in another compound, Yacton, which is being developed by Jomaster. The compound is in the second phase of development. The intellectual property of compound Yacton has been put into a newly formed shell company, Conew, which has no employees. The compound is the only asset of Conew. Chemclean is intending to acquire a 65% interest in Conew, which will give it control over the entity and the compound. Chemclean will provide the necessary resources to develop the compound. (8 marks)

(b) In the year to 30 June 2015, Chemclean acquired a major subsidiary. The inventory acquired in this business combination was valued at its fair value at the acquisition date in accordance with IFRS 3 Business Combinations. The inventory increased in value as a result of the fair value exercise. A significant part of the acquired inventory was sold in the post acquisition period but before 30 June 2015, the year end.

In the consolidated statement of profit or loss and other comprehensive income, the cost of inventories acquired in the business combination and sold by the acquirer after the business combination was disclosed on two different lines. The inventory was partly shown as cost of goods sold and partly as a ‘non-recurring item’ within operating income. The part presented under cost of goods sold corresponded to the inventory’s carrying amount in the subsidiary’s financial statements. The part presented as a ‘non-recurring item’ corresponded to the fair value increase recognised on the business combination. The ‘non-recurring item’ amounted to 25% of Chemclean’s earnings before interest and tax (EBIT). Chemclean disclosed the accounting policy and explained in the notes to the financial statements that showing the inventory at fair value would result in a fall in the gross margin due to the fair value increase. Further, Chemclean argued that isolating this part of the margin in the ‘non-recurring items’, whose nature is transparently presented in the notes, enabled the user to evaluate the structural evolution of its gross margin. (6 marks)

(c) In the consolidated financial statements for 2015, Chemclean recognised a net deferred tax asset of $16 million, which represented 18% of its total equity. This asset was made up of $3 million taxable temporary differences and $19 million relating to the carry-forward of unused tax losses. The local tax regulation allows unused tax losses to be carried forward indefinitely. Chemclean expects that within five years, future taxable profits before tax would be available against which the unused tax losses could be offset. This view was based on the budgets for the years 2015-2020. The budgets were primarily based on general assumptions about the development of key products and economic improvement indicators. Additionally, the entity expected a substantial reduction in the future impairment of trade receivables and property which the entity had recently suffered and this would result in a substantial increase in future taxable profit.

Chemclean had recognised material losses during the previous five years, with an average annual loss of $19 million. A comparison of Chemclean’s budgeted results for the previous two years to its actual results indicated material differences relating principally to impairment losses. In the interim financial statements for the first half of the year to 30 June 2015, Chemclean recognised impairment losses equal to budgeted impairment losses for the whole year. In its financial statements for the year ended 30 June 2015, Chemclean disclosed a material uncertainty about its ability to continue as a going concern. The current tax rate in the jurisdiction is 30%. (9 marks)

Required:

Discuss how the above items should be dealt with in the financial statements of Chemclean under International Financial Reporting Standards.

Note: The mark allocation is shown against each of the three issues above.

Professional marks will be awarded in question 2 for clarity and quality of presentation. (2 marks)

veral financial reporting issues.

(a) Klancet produces and sells its range of drugs through three separate divisions. In addition, there are two laboratories which carry out research and development activities.

In the first of these laboratories, the research and development activity is funded internally and centrally for each of the three sales divisions. It does not carry out research and development activities for other entities. Each of the three divisions is given a budget allocation which it uses to purchase research and development activities from the laboratory. The laboratory is directly accountable to the division heads for this expenditure.

The second laboratory performs contract investigation activities for other laboratories and pharmaceutical companies. This laboratory earns 75% of its revenues from external customers and these external revenues represent 18% of the organisation’s total revenues.

The performance of the second laboratory’s activities and of the three separate divisions is regularly reviewed by the chief operating decision maker (CODM). In addition to the heads of divisions, there is a head of the second laboratory. The head of the second laboratory is directly accountable to the CODM and they discuss the operating activities, allocation of resources and financial results of the laboratory.

Klancet is uncertain as to whether the research and development laboratories should be reported as two separate segments under IFRS 8 Operating Segments, and would like advice on this issue. (8 marks)

(b) Klancet has agreed to sell a patent right to another pharmaceutical group, Jancy. Jancy would like to use the patent to develop a more complex drug. Klancet will receive publicly listed shares of the Jancy group in exchange for the right. The value of the listed shares represents the fair value of the patent. If Jancy is successful in developing a drug and bringing it to the market, Klancet will also receive a 5% royalty on all sales.

Additionally, Klancet won a competitive bidding arrangement to acquire a patent. The purchase price was settled by Klancet issuing new publicly listed shares of its own.

Klancet’s management would like advice on how to account for the above transactions. (7 marks)

(c) Klancet is collaborating with Retto Laboratories (Retto), a third party, to develop two existing drugs owned by Klancet.

In the case of the first drug, Retto is simply developing the drug for Klancet without taking any risks during the development phase and will have no further involvement if regulatory approval is given. Regulatory approval has been refused for this drug in the past. Klancet will retain ownership of patent rights attached to the drug. Retto is not involved in the marketing and production of the drug. Klancet has agreed to make two non-refundable payments to Retto of $4 million on the signing of the agreement and $6 million on successful completion of the development.

Klancet and Retto have entered into a second collaboration agreement in which Klancet will pay Retto for developing and manufacturing an existing drug. The existing drug already has regulatory approval. The new drug being developed by Retto for Klancet will not differ substantially from the existing drug. Klancet will have exclusive marketing rights to the drug if the regulatory authorities approve it. Historically, in this jurisdiction, new drugs receive approval if they do not differ substantially from an existing approved drug.

The contract terms require Klancet to pay an upfront payment on signing of the contract, a payment on securing final regulatory approval, and a unit payment of $10 per unit, which equals the estimated cost plus a profit margin, once commercial production begins. The cost-plus profit margin is consistent with Klancet’s other recently negotiated supply arrangements for similar drugs.

Klancet would like to know how to deal with the above contracts with Retto. (8 marks)

Required:

Advise Klancet on how the above transactions should be dealt with in its financial statements with reference to relevant International Financial Reporting Standards.

Note: The mark allocation is shown against each of the three issues above.

Professional marks will be awarded in question 3 for clarity and quality of presentation. (2 marks)

the context of financial reporting quality in that it requires the exercise of considerable management judgement and reporting discretion. The importance of this issue is heightened during periods of ongoing economic uncertainty as a result of the need for companies to reflect the loss of economic value in a timely fashion through the mechanism of asset write-downs. There are many factors which can affect the quality of impairment accounting and disclosures. These factors include changes in circumstance in the reporting period,the market capitalisation of the entity, the allocation of goodwill to cash generating units, valuation issues and the nature of the disclosures.

Required:

Discuss the importance and significance of the above factors when conducting an impairment test under IAS 36 Impairment of Assets. (13 marks)

(b) (i) Estoil is an international company providing parts for the automotive industry. It operates in many different jurisdictions with different currencies. During 2014, Estoil experienced financial difficulties marked by a decline in revenue, a reorganisation and restructuring of the business and it reported a loss for the year. An impairment test of goodwill was performed but no impairment was recognised. Estoil applied one discount rate for all cash flows for all cash generating units (CGUs), irrespective of the currency in which the cash flows would be generated. The discount rate used was the weighted average cost of capital (WACC) and Estoil used the 10-year government bond rate for its jurisdiction as the risk free rate in this calculation. Additionally, Estoil built its model using a forecast denominated in the functional currency of the parent company. Estoil felt that any other approach would require a level of detail which was unrealistic and impracticable. Estoil argued that the different CGUs represented different risk profiles in the short term, but over a longer business cycle, there was no basis for claiming that their risk profiles were different.

(ii) Fariole specialises in the communications sector with three main CGUs. Goodwill was a significant component of total assets. Fariole performed an impairment test of the CGUs. The cash flow projections were based on the most recent financial budgets approved by management. The realised cash flows for the CGUs were negative in 2014 and far below budgeted cash flows for that period. The directors had significantly raised cash flow forecasts for 2015 with little justification. The projected cash flows were calculated by adding back depreciation charges to the budgeted result for the period with expected changes in working capital and capital expenditure not taken into account.

Required:

Discuss the acceptability of the above accounting practices under IAS 36 Impairment of Assets. (10 marks)

Professional marks will be awarded in question 4 for clarity and quality of presentation. (2 marks)

ial instruments to spread the risk of fl uctuation in the price of the edible oils. The entity operates in an environment where the transactions are normally denominated in dollars. The functional currency of Seltec is the dollar.

(a) The entity uses forward and futures contracts to protect it against fl uctuation in the price of edible oils. Where forwards are used the company often takes delivery of the edible oil and sells it shortly afterwards. The contracts are constructed with future delivery in mind but the contracts also allow net settlement in cash as an alternative. The net settlement is based on the change in the price of the oil since the start of the contract. Seltec uses the proceeds of a net settlement to purchase a different type of oil or purchase from a different supplier. Where futures are used these sometimes relate to edible oils of a different type and market than those of Seltec’s own inventory of edible oil. The company intends to apply hedge accounting to these contracts in order to protect itself from earnings volatility. Seltec has also entered into a long-term arrangement to buy oil from a foreign entity whose currency is the dinar. The commitment stipulates that the fi xed purchase price will be denominated in pounds sterling.

Seltec is unsure as to the nature of derivatives and hedge accounting techniques and has asked your advice on how the above fi nancial instruments should be dealt with in the fi nancial statements. (14 marks)

(b) Seltec has decided to enter the retail market and has recently purchased two well-known brand names in the edible oil industry. One of the brand names has been in existence for many years and has a good reputation for quality. The other brand name is named after a famous fi lm star who has been actively promoting the edible oil as being a healthier option than other brands of oil. This type of oil has only been on the market for a short time. Seltec is fi nding it diffi cult to estimate the useful life of the brands and therefore intends to treat the brands as having indefi nite lives.

In order to sell the oil, Seltec has purchased two limited liability companies from a company that owns several retail outlets. Each entity owns retail outlets in several shopping complexes. The only assets of each entity are the retail outlets. There is no operational activity and at present the entities have no employees.

Seltec is unclear as to how the purchase of the brands and the entities should be accounted for. (9 marks)

Required:

Discuss the accounting principles involved in accounting for the above transactions and how the above transactions should be treated in the fi nancial statements of Seltec.

Professional marks will be awarded in this question for clarity and quality of discussion. (2 marks)

The mark allocation is shown against each of the two parts above.

hased from the manufacturer.

Carpart has entered into supply arrangements for the supply of car seats to two local companies, Vehiclex and Autoseat.

(i) Vehiclex

This contract will last for five years and Carpart will manufacture seats to a certain specification which will require the construction of machinery for the purpose. The price of each car seat has been agreed so that it includes an amount to cover the cost of constructing the machinery but there is no commitment to a minimum order of seats to guarantee the recovery of the costs of constructing the machinery. Carpart retains the ownership of the machinery and wishes to recognise part of the revenue from the contract in its current financial statements to cover the cost of the machinery which will be constructed over the next year. (4 marks)

(ii) Autoseat

Autoseat is purchasing car seats from Carpart. The contract is to last for three years and Carpart is to design, develop and manufacture the car seats. Carpart will construct machinery for this purpose but the machineryis so specific that it cannot be used on other contracts. Carpart maintains the machinery but the know-how has been granted royalty free to Autoseat. The price of each car seat includes a fixed price to cover the cost of the machinery. If Autoseat decides not to purchase a minimum number of seats to cover the cost of the machinery, then Autoseat has to repay Carpart for the cost of the machinery including any interest incurred.

Autoseat can purchase the machinery at any time in order to safeguard against the cessation of production by Carpart. The purchase price would be the cost of the machinery not yet recovered by Carpart. The machinery has a life of three years and the seats are only sold to Autoseat who sets the levels of production for a period.

Autoseat can perform. a pre-delivery inspection on each seat and can reject defective seats. (9 marks)

(iii) Vehicle sales

Carpart sells vehicles on a contract for their market price (approximately $20,000 each) at a mark-up of 25%

on cost. The expected life of each vehicle is five years. After four years, the car is repurchased by Carpart at 20% of its original selling price. This price is expected to be significantly less than its fair value. The car must be maintained and serviced by the customer in accordance with certain guidelines and must be in good condition if Carpart is to repurchase the vehicle.

The same vehicles are also sold with an option that can be exercised by the buyer two years after sale. Under this option, the customer has the right to ask Carpart to repurchase the vehicle for 70% of its original purchase price. It is thought that the buyers will exercise the option. At the end of two years, the fair value of the vehicle is expected to be 55% of the original purchase price. If the option is not exercised, then the buyer keeps the vehicle.

Carpart also uses some of its vehicles for demonstration purposes. These vehicles are normally used for this

purpose for an eighteen-month period. After this period, the vehicles are sold at a reduced price based upon their condition and mileage. (10 marks)

Professional marks will be awarded in question 3 for clarity and quality of discussion. (2 marks)

Required:

Discuss how the above transactions would be accounted for under International Financial Reporting Standards in the financial statements of Carpart.

Note. The mark allocation is shown against each of the arrangements above.

ar ended 31 March 2005. The

company applies newly issued IFRSs at the earliest opportunity. The group comprises three companies, Ashlee, the

holding company, and its 100% owned subsidiaries Pilot and Gibson, both public limited companies. The group

financial statements at first appeared to indicate that the group was solvent and in a good financial position. However,

after the year end, but prior to the approval of the financial statements mistakes have been found which affect the

financial position of the group to the extent that loan covenant agreements have been breached.

As a result the loan creditors require Ashlee to cut its costs, reduce its operations and reorganise its activities.

Therefore, redundancies are planned and the subsidiary, Pilot, is to be reorganised. The carrying value of Pilot’s net

assets, including allocated goodwill, was $85 million at 31 March 2005, before taking account of reorganisation

costs. The directors of Ashlee wish to include $4 million of reorganisation costs in the financial statements of Pilot for

the year ended 31 March 2005. The directors of Ashlee have prepared cash flow projections which indicate that the

net present value of future net cash flows from Pilot is expected to be $84 million if the reorganisation takes place

and $82 million if the reorganisation does not take place.

Ashlee had already decided prior to the year end to sell the other subsidiary, Gibson. Gibson will be sold after the

financial statements have been signed. The contract for the sale of Gibson was being negotiated at the time of the

preparation of the financial statements and it is expected that Gibson will be sold in June 2005.

The carrying amounts of Gibson and Pilot including allocated goodwill were as follows at the year end:

The fair value of the net assets of Gibson at the year end was $415 million and the estimated costs of selling the

company were $5 million.

Part of the business activity of Ashlee is to buy and sell property. The directors of Ashlee had signed a contract on

1 March 2005 to sell two of its development properties which are carried at the lower of cost and net realisable value

under IAS 2 ‘Inventories’. The sale was agreed at a figure of $40 million (carrying value $30 million). A receivable of

$40 million and profit of $10 million were recognised in the financial statements for the year ended 31 March 2005.

The sale of the properties was completed on 1 May 2005 when the legal title passed. The policy used in the prior

year was to recognise revenue when the sale of such properties had been completed.

Additionally, Ashlee had purchased, on 1 April 2004, 150,000 shares of a public limited company, Race, at a price

of $20 per share. Ashlee had incurred transaction costs of $100,000 to acquire the shares. The company is unsure

as to whether to classify this investment as ‘available for sale’ or ‘at fair value through profit and loss’ in the financial

statements for the year ended 31 March 2005. The quoted price of the shares at 31 March 2005 was $25 per share.

The shares purchased represent approximately 1% of the issued share capital of Race and are not classified as ‘held

for trading’.

There is no goodwill arising in the group financial statements other than that set out above.

Required:

Discuss the implications, with suitable computations, of the above events for the group financial statements of

Ashlee for the year ended 31 March 2005.

(25 marks)

es. The plan provides a

pension of 1% of the final salary for each year of service. The cost for the year is determined using the projected unit

credit method. This reflects service rendered to the dates of valuation of the plan and incorporates actuarial

assumptions primarily regarding discount rates, which are based on the market yields of high quality corporate bonds.

The expected average remaining working lives of employees is twelve years.

The directors have provided the following information about the defined benefit plan for the current year (year ended

31 October 2005):

(i) the actuarial cost of providing benefits in respect of employees’ service for the year to 31 October 2005 was

$40 million. This is the present value of the pension benefits earned by the employees in the year.

(ii) The pension benefits paid to former employees in the year were $42 million.

(iii) Savage should have paid contributions to the fund of $28 million. Because of cash flow problems $8 million of

this amount had not been paid at the financial year end of 31 October 2005.

(iv) The present value of the obligation to provide benefits to current and former employees was $3,000 million at

31 October 2004 and $3,375 million at 31 October 2005.

(v) The fair value of the plan assets was $2,900 million at 31 October 2004 and $3,170 million (including the

contributions owed by Savage) at 31 October 2005. The actuarial gains recognised at 31 October 2004 were

$336 million.

With effect from 1 November 2004, the company had amended the plan so that the employees were now provided

with an increased pension entitlement. The benefits became vested immediately and the actuaries computed that the

present value of the cost of these benefits at 1 November 2004 was $125 million. The discount rates and expected

n 1 April 2006. The

purchase consideration was one million ordinary shares of Leigh which had a market value of $2·50 per share

at that date and the fair value of the net assets of Handy was $9 million. The retained earnings of Handy were

$4 million and other reserves of Handy were $3 million at that date. Leigh appointed two directors to the Board

of Handy, and it intends to hold the investment for a significant period of time. Leigh exerts significant influence

over Handy. The summarised balance sheet of Handy at 31 May 2007 is as follows: