Dip IFR

Diploma in
International
Financial Reporting
Thursday 6 December 2007

Time allowed
Reading and planning: 15 minutes
Writing: 3 hours

This paper is divided into two sections:

Do NOT open this paper until instructed by the supervisor.

The Association of Chartered Certified Accountants

1 Alpha holds investments in two other entities, Beta and Gamma. The balance sheets of the three entities at
30 September 2007 were as follows:
Alpha Beta Gamma
$’000 $’000 $’000
Assets
Non-current assets:
Property, plant and equipment (Notes 1 & 2) 132,000 100,000 90,000
Investments (Note 1) 139,000 Nil Nil
–––––––– –––––––– –––––––
271,000 100,000 90,000
–––––––– –––––––– –––––––
Current assets:
Inventories (Note 3) 40,000 34,000 32,000
Trade receivables (Note 4) 40,000 32,000 30,000
Financial assets (Note 5) 10,000 Nil Nil
Cash and cash equivalents 9,000 11,000 8,000
–––––––– –––––––– –––––––
99,000 77,000 70,000
–––––––– –––––––– –––––––
Total assets 370,000 177,000 160,000
–––––––– –––––––– –––––––
Equity and Liabilities
Equity
Share capital ($1 shares) 100,000 60,000 70,000
Retained earnings 138,000 48,000 29,000
–––––––– –––––––– –––––––
Total equity 238,000 108,000 99,000
–––––––– –––––––– –––––––
Non-current liabilities:
Long-term borrowings 60,000 30,000 25,000
Deferred tax 30,000 12,000 10,000
–––––––– –––––––– –––––––
Total non-current liabilities 90,000 42,000 35,000
–––––––– –––––––– –––––––
Current liabilities:
Trade and other payables (Note 4) 35,000 20,000 20,000
Short-term borrowings 7,000 7,000 6,000
–––––––– –––––––– –––––––
Total current liabilities 42,000 27,000 26,000
–––––––– –––––––– –––––––
Total equity and liabilities 370,000 177,000 160,000
––––––––
–––––––– ––––––––
–––––––– –––––––
–––––––
Note 1 – investments
Investment in Beta:
Alpha subscribed for 48 million shares in Beta at par on the date of Beta’s incorporation on 1 October 1999. This
investment is shown at original cost.
Investment in Gamma:
On 1 April 2007 Alpha purchased 49 million shares in Gamma for a cash payment of $91 million. This investment
is also shown at original cost.
The profit of Gamma for the year ended 30 September 2007 was $8 million. Gamma did not pay or declare any
dividends in the period.
The directors of Alpha carried out a fair value exercise to measure the identifiable assets and liabilities of Gamma at
1 April 2007. The following matters emerged:
A property having a carrying value of $20 million had an estimated market value of $30 million (including
non-depreciable land of $15 million). The estimated future economic life of the depreciable element at 1 April 2007
was 30 years. In the year ended 30 September 2007 Gamma charged depreciation of $320,000 on this property.

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Plant and equipment having a carrying value of $60 million had an estimated market value of $65 million. The
estimated future economic life of the plant at 1 April 2007 was five years.
Inventory having a carrying value of $10 million had an estimated fair value of $12 million. All of this inventory was
sold prior to 30 September 2007.
The fair value adjustments will be regarded as temporary differences for the purposes of computing deferred tax.
Note 2 – sale of plant to Beta
On 1 October 2006 Alpha purchased an item of plant for $4 million and immediately sold it to Beta for $4·4 million.
The estimated useful economic life of the plant is four years from 1 October 2006.
Note 3 – intra-group sale of inventories
The inventories of Beta and Gamma at 30 September 2007 included components purchased from Alpha during the
year at a cost of $25 million to Beta and $15 million to Gamma. Alpha supplied these components at cost plus a
mark up of 25%. All the supplies were made after 1 April 2007.
Note 4 – trade receivables and payables
The trade receivables of Alpha included $6 million receivable from Beta and $5 million receivable from Gamma in
respect of the purchase of components (see Note 3). The trade payables of Beta and Gamma include an equivalent
amount payable to Alpha.
Note 5 – financial assets
During the period Alpha made a temporary investment of $10 million in listed securities and designated the
investments as fair value through profit and loss. The market value of the portfolio (none of which was sold before
the year end) was $9·5 million.
Note 6 – other information
The goodwill arising on acquisition of Gamma has not suffered any impairment since 1 April 2007.
The rate of tax to apply to temporary differences is 25%. You can ignore the temporary differences caused by any
adjustments for unrealised profits.

Required:
Prepare the consolidated balance sheet of Alpha at 30 September 2007.

(25 marks)

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

2 Delta’s financial statements for the year ended 30 September 2007 are being prepared and you are provided with the
following trial balance at that date:
$’000 $’000
Revenue (Note 1) 325,000
Inventories at 1 October 2006 50,000
Raw material purchases 160,000
Production costs 40,000
Distribution costs 15,000
Administrative expenses 25,000
Property, plant and equipment:
– at cost (Note 3) 160,000
– accumulated depreciation at 30 September 2006 (Note 3) 35,000
Suspense account (Note 4) 10,000
Interest paid on long-term borrowing 11,000
Income tax account (Note 5) 500
Deferred tax (Note 5) 5,000
Trade receivables 125,000
Cash and cash equivalents 54,500
Trade payables 55,000
Long-term borrowings at 10% interest rate 110,000
Equity share capital ($1 shares) 100,000
Equity dividend paid 30 September 2007 25,000
Retained earnings at 30 September 2006 45,000
–––––––– ––––––––
675,500 675,500
–––––––– ––––––––
Notes to the trial balance
Note 1 – Revenue
On 20 September 2007 Delta sold goods that cost Delta $6 million to manufacture at a gross profit margin of 20%.
Delta recognised the sale as revenue when the goods were sent to the customer. The goods were supplied on a sale
or return basis, with a right to return up to and including 31 January 2008. The customer had returned 50% of the
goods by 30 November 2007. It is uncertain as to how many of the remaining goods will be returned prior to
31 January 2008.
Note 2 – Inventories
On 30 September 2007 the value of the inventories at Delta’s premises was $55 million.
Note 3 – Property, plant and equipment
Cost Accumulated depreciation at
30 September 2006
$’000 $’000
Property 80,000 20,000
Plant and equipment 80,000 15,000
–––––––– –––––––
160,000 35,000
–––––––– –––––––
(i) Depreciation of all property, plant and equipment should be charged to cost of sales.
(ii) The depreciable element of the property has an allocated cost of $40 million and is being depreciated on a
straight-line basis over 50 years.
(iii) On 1 October 2006 the property was revalued to its market value of $90 million. It was estimated that
$56 million of this value was attributable to the depreciable element. This revaluation has not yet been recorded
in the accounting records of Delta.
(iv) No change in the estimated useful economic life of the depreciable element was anticipated at the date of the
revaluation. The directors of Delta wish to make an annual transfer of excess depreciation on revalued assets from
the revaluation reserve to retained earnings.

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(v) The plant and equipment is being depreciated on a straight-line basis over five years, with a full year’s
depreciation in the year of purchase and no depreciation in the year of disposal. None of the plant and equipment
held at 30 September 2007 was fully depreciated at that date. No disposal of property, plant and equipment
occurred in the period.
Note 4 – Suspense account
On 1 October 2006 Delta began to lease a number of specialised production machines under a finance lease. The
lease was of four years duration and Delta was required to pay a deposit of $10 million on 1 October 2006 followed
by three further payments of $5 million each on 1 October 2007, 2008 and 2009. The rate of interest implicit in the
lease is 8% and the fair value of the leased assets at 1 October 2006 was approximately $22·9 million. The only
entry made by Delta was to debit the deposit paid to the suspense account.
Note 5 – Income tax
(i) On 30 June 2007 Delta made full and final payment to discharge the income tax liability for the year ended
30 September 2006. The balance on the income tax account in the trial balance is the residue after making that
payment.
(ii) The estimated income tax liability for the year ended 30 September 2007 is $10 million.
(iii) A credit of $2·4 million is required to the deferred tax account. This does not include any deferred tax that needs
to be recognised on the property revaluation (see note 3 above).
(iv) Delta pays income tax at a rate of 25% on net taxable gains.

Required:
(a) Prepare the income statement for Delta for the year ended 30 September 2007. (9 marks)

(b) Prepare the statement of changes in equity for Delta for the year ended 30 September 2007. (5 marks)

(c) Prepare the balance sheet for Delta as at 30 September 2007. (11 marks)
Note: notes to the income statements and balance sheet are not required.

(25 marks)

5 [P.T.O.
3 Epsilon is a listed entity. You are the financial controller of the entity and its consolidated financial statements for the
year ended 30 September 2007 are being prepared. Your assistant, who has prepared the first draft of the statements,
is unsure about the correct treatment of a number of transactions and has asked for your advice. Details of the
transactions are given below:

Transaction (a)
On 1 October 2006 Epsilon signed a contract to construct a dam at a fixed price of $50 million. The contract has a
scheduled completion date of 30 September 2008. However, if the contract is completed satisfactorily on or before
30 June 2008 Epsilon becomes entitled to a bonus of $5 million. If the contract is completed later than 31 December
2008, then Epsilon will forfeit $15 million of the fixed price and only receive $35 million. Latest estimates regarding
completion dates are as follows:
Prior to 1 July 2008 – 20% probability.
1 July 2008 to 31 December 2008 – 70% probability.
After 31 December 2008 – 10% probability.
Epsilon incurred costs of $28 million on the contract up to 30 September 2007 and expects to incur further costs of
$12 million to complete the contract. Your assistant has shown a net balance of $13 million in inventories on the
balance sheet. This is the difference between the costs incurred to date ($28 million), the loss of $5 million
($35 million – ($28 million + $12 million)) that would arise on the contract if it was completed after 31 December
2008, and a progress payment of $10 million made by the customer before 30 September 2007. The loss of
$5 million has been charged to the income statement and justified by the assistant on the grounds of prudence. An
independent expert has recently certified that at 30 September 2007 the construction of the dam was 45% complete.
The assistant proposes deferring recognition of any revenue until the contract is completed. (8 marks)

Transaction (b)
On 1 October 2006 Epsilon opened a new factory in an area designated by the government as an economic
development area. On that day the government provided Epsilon with a grant of $20 million to assist them in the
development of the factory. This grant was in two parts:
(i) $12 million of the grant related to the construction of a large factory at a cost of $60 million. The land was leased
so the whole of the $60 million is depreciable over the estimated 30 year useful life of the factory.
(ii) The remaining $8 million was received subject to keeping at least 200 employees working at the factory for a
period of at least five years. If the number drops below 200 at any time in any financial year in this five year
period then 20% of the grant is repayable in that year. From 1 October 2006 250 workers were employed at the
factory and estimates are that this number is likely to increase over the next four years.
Your assistant has recognised the $12 million received in respect of the factory as a credit to the income statement
in the current year, on the basis that the factory has been constructed and brought into use. He has not recognised
any of the $8 million employment grant on the basis that this is potentially repayable. He has charged $2 million in
depreciation to the income statement. (10 marks)

Transaction (c)
On 1 October 2006 Epsilon purchased an aircraft for use by its executives on business trips. The purchase price paid
was $15 million plus recoverable sales taxes of $1·5 million. The expected useful economic life of the aircraft is
15 years. Every five years the aircraft needs a major overhaul in order to renew its safety certificate. The current cost
of such overhauls is $1·8 million. Your assistant has included $16·5 million ($15 million + $1·5 million) in property,
plant and equipment and has charged depreciation of $1·1 million ($16·5 million x 1/15) to the income statement.
He has charged $360,000 ($1·8 million x 1/5) to the income statement in respect of the overhaul, intending to build
up a provision of $1·8 million over the next five years in order to cover the cost of the first overhaul. (7 marks)

Required:
Evaluate the proposed accounting treatments and (where incorrect) explain the appropriate accounting treatment
(preparing relevant calculations where necessary) of the three transactions in the financial statements for the year
ended 30 September 2007.
Note: the mark allocation is shown against each of the transactions above.

(25 marks)

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4 (a) As the worldwide financial community gets more and more sophisticated the nature of financial instruments is
changing rapidly. Entities can use financial instruments to radically alter their risk profile and users are entitled
to information about the impact of financial instruments on the business.

Required:
(i) Define a financial asset, a financial liability and an equity instrument in accordance with IAS 32 –
Financial instruments: presentation. (4 marks)
(ii) Explain where the following financial instruments would be presented in the balance sheet:
1 A portfolio of listed investments held for trading.
2 An investment in the shares of a supplier that is being held for the long term.
3 A loan made to the company that is repayable in equal instalments over the next five years.
4 Preference shares issued by the company that require payment of a dividend each year and are
redeemable at the option of the investor. (5 marks)
(iii) Describe the categories into which IAS 39 – Financial instruments: recognition and measurement –
requires financial assets and financial liabilities to be classified. For each category explain how the
financial assets and liabilities should be measured in the balance sheet. Where the financial assets or
liabilities are measured at fair value, your explanation should include the way in which changes in fair
value are recognised in the performance statements (income statement and statement of changes in
equity). (9 marks)

(b) Kappa is a listed entity whose year end date is 30 September 2007. On 1 October 2006 Kappa issued a
$6 million convertible loan note. The quoted rate of interest on the loan note was 2% per annum, payable on
30 September in arrears. The loan note was repayable at an amount of $7 million on 30 September 2009. As
an alternative to repayment the lender may choose to receive 1 million shares in Kappa (having a nominal value
of $1 each).
The required rate of return for providers of this type of loan finance at 1 October 2006 was 10% per annum.

Required:
Prepare extracts that show how the loan would be presented in the financial statements of Kappa for the
year ended 30 September 2007. (7 marks)

(25 marks)

7 [P.T.O.
5 Omega prepares financial statements using International Financial Reporting Standards. In the year ended
30 September 2007 the following transactions occurred:

(a) On 1 October 2006 Omega acquired a new subsidiary, Sigma, purchasing all 150 million shares of Sigma. The
terms of the sale agreement included the exchange of four shares in Omega for every three shares acquired in
Sigma. On 1 October 2006 the market value of a share in Omega was $10 and the market value of a share in
Sigma $12·00.
The terms of the share purchase included the issue of one additional share in Omega for every five acquired
Sigma if the profits of Sigma for the two years ending 30 September 2008 exceeded a target figure. Current
estimates are that it is 80% probable that the management of Sigma will achieve this target.
Legal and professional fees associated with the acquisition of Sigma shares were $1,200,000, including
$200,000 relating to the cost of issuing shares. The senior management of Omega estimate that the cost of their
time that can be fairly allocated to the acquisition is $200,000. This figure of $200,000 is not included in the
legal and professional fees of $1,200,000 mentioned above.
The individual balance sheet of Sigma at 1 October 2006 comprised net assets that had a fair value at that date
of $1,200 million. Additionally Omega considered Sigma possessed certain intangible assets that were not
recognised in its individual balance sheet:
Customer relationships – reliable estimate of value $100 million. This value has been derived from the sale
of customer databases in the past.
An in process research and development project that had not been recognised by Sigma since the necessary
conditions laid down in International Financial Reporting Standards for capitalisation were only just satisfied
at 30 September 2007. However, the fair value of the whole project (including the research phase) is
estimated at $50 million.
Employee expertise – directors’ estimate of value $80 million.
The market value of a share in Omega on 30 September 2007 was $11.

Required:
Compute the goodwill on consolidation of Sigma that will appear in the consolidated balance sheet of Omega
at 30 September 2007. (10 marks)

(b) On 1 October 2005 Omega granted 1,000 employees options to purchase 5,000 shares each in the entity. The
options vest on 1 October 2008 for those employees who remain employed by the entity until that date. The
options allow the employees to purchase the shares for $9 per share. The market price of the shares and the fair
values of the share options (estimated using an appropriate option pricing model) varied as follows:
Date Market price of share Fair value of option
1 October 2005 $9 $2
1 October 2006 $10 $2·50
1 October 2007 $11 $2·70
When preparing the financial statements for the year ended 30 September 2006 the directors estimated that 50
of the relevant employees would leave in each of the years ended 30 September 2006, 2007 and 2008. 50 of
the relevant employees did leave in both of the years ended 30 September 2006 and 2007. However, the
directors now believe that no further relevant employees will leave in the year ended 30 September 2008.
Omega is entitled to a tax deduction in respect of the options when they are exercised based on their intrinsic
value at that date. The intrinsic value of a share option at a particular date is the difference between the exercise
price of the option and the market value of the share at that date. The rate of corporate income tax in the
jurisdiction in which Omega operates is 25%.

8
 Required:
Prepare extracts that show the amounts that will appear in the balance sheet of Omega as at 30 September
2007 in respect of the share options and the amounts that will appear in the income statement for the year
ended 30 September 2007. You should state where in the balance sheet and where in the income statement
the relevant amounts will be presented. (7 marks)

(c) On 31 July 2007 Omega decided to dispose of a 100% owned subsidiary Theta. The business activities of Theta
are substantially different from those of the rest of the group. The net assets of Theta at 31 July 2007 were
included in the consolidated financial statements of Omega at a net carrying amount of $200 million, made up
as follows:
$m
Unimpaired goodwill 40
Other assets 260
Liabilities (100)
–––––
200
–––––
On 31 July, Omega immediately began to seek a buyer and initial expectations were that the sale price (net of
incremental selling costs) would be $170 million. None of the identifiable assets of Theta had suffered obvious
impairment at 31 July. The carrying value of the identifiable net assets of Theta in the consolidated balance sheet
at 30 September 2007 was approximately the same as their carrying amount on 31 July 2007. The latest
position is that negotiations are at a relatively advanced stage with a buyer who is expected to pay $170 million
(net of selling costs). Completion of the transaction is expected in early 2008.

Required:
Explain how the prospective sale of Theta will affect the consolidated financial statements of Omega for the
year ended 30 September 2007 (preparing relevant calculations where necessary). (8 marks)

(25 marks)

End of Question Paper