The Chartered Institute of Management Accountants 2008

November 2008 Examinations

Managerial Level






Paper P8 Financial Analysis






Question Paper 2

Examiners Brief Guide to the Paper 18

Examiners Answers 20






The answers published here have been written by the Examiner and should provide a helpful
guide for both tutors and students.

Published separately on the CIMA website (www.cimaglobal.com/students) from February is
a Post Examination Guide for the paper which provides much valuable and complementary
material including indicative mark information.






The Chartered Institute of Management Accountants. All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical,
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P8 2 November 2008



Financial Management Pillar
Managerial Level Paper
P8 Financial Analysis
18 November 2008 Tuesday Afternoon Session

Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or sub-
questions). The question requirements for questions in Sections B and C are
highlighted in a dotted box.
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
Answer the ONE compulsory question in Section A. This has seven objective
test questions on pages 2 to 4.
Answer ALL THREE questions in Section B on pages 5 to 7.
Answer TWO of the three questions in Section C on pages 8 to 13.
Maths Tables are provided on pages 15 to 17.
The list of verbs as published in the syllabus is given for reference on the
inside back cover of this question paper.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
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November 2008 3 P8

SECTION A 20 MARKS

[indicative time for answering this Section is 36 minutes]

ANSWER ALL SEVEN SUB-QUESTIONS




Instructions for answering Section A:

The answers to the seven sub-questions in Section A should ALL be
written in your answer book.

Your answers should be clearly numbered with the sub-question number and
then ruled off, so that the markers know which sub-question you are answering.
For multiple choice questions, you need only write the sub-question
number and the letter of the answer option you have chosen. You do not
need to start a new page for each sub-question.

For sub-questions 1.3 and 1.7, you should show your workings as marks are
available for method for these sub-questions.



Question One

1.1 On 31 August 2007, the consolidated balance sheet of MIP included minority interests
of $77,600. One year later, on 31 August 2008, the minority interests balance was
$64,700. During the year ended 31 August 2008, MIP had disposed of its holding of
75% of the ordinary share capital of its subsidiary NJ Z. At the date of disposal the net
assets of NJ Z totalled $64,000. The minority interests in the MIP groups profits for the
year ended 31 August 2008 was $6,500.

What amount was included in the consolidated cash flow statement as a dividend paid to the
minority interests during the year ended 31 August 2008?

A $3,100
B $3,400
C $19,400
D $22,400
(2 marks)


1.2 BJ J is planning to acquire a subsidiary, XZZ, for $13 million. The fair value of the net
assets recognised by XZZ in its own financial statements amounts to only $400,000.
BJ J s directors are confident that the difference between the amounts is accounted for
principally by unrecognised intangible assets. BJ J s directors wish, if possible, to
recognise these assets on acquisition.

Describe the conditions that must be met, in accordance with IFRS 3 Business Combinations,
in order to be able to recognise intangible assets upon acquisition of a subsidiary.
(2 marks)



P8 4 November 2008

1.3 J SX, a listed entity, has a defined benefits pension scheme. The following information
relates to the pension scheme for the year ended 31 October 2008:
$
Current service cost 362,600
Contributions to scheme 550,700
Benefits paid 662,400
Fair value of scheme assets at 1 November 2007 10,660,000
Fair value of scheme assets at 31 October 2008 11,204,000
Interest cost in respect of defined benefit obligation 730,600
The expected return on scheme assets for the year ended 31 October 2008 was 62%.

Calculate the actuarial gain or loss on J SXs pension scheme assets for the year ended
31 October 2008.
(4 marks)


1.4 Describe the principal characteristics common to joint venture arrangements, as
identified by IAS 31 Interests in Joint Ventures.
(2 marks)


1.5 During its 2008 financial year GZP makes the following investments:

1. A loan of $1,000,000 to one of its suppliers. The loan agreement stipulates that
GZP will not transfer or assign the loan to a third party. The supplier is obliged to
repay the loan in five years time and to pay interest at 2% over bank base rate
annually during the term of the loan.

2. Purchase of a small holding of shares in a listed company, ANG. GZPs
intention is to realise this investment towards the end of its financial year when
seasonal fluctuations in its business make a cash shortfall probable.

Neither asset is classified by GZP as being at fair value through profit or loss.

Explain how each of these financial assets should be

(i) initially classified; and

(ii) measured, subsequent to initial classification, in accordance with IAS 39 Financial
Instruments: Recognition and Measurement.
(4 marks)


1.6 Which ONE of the following statements is correct?

A derivative financial instrument

A can be recognised only if it is highly effective.
B requires little or no initial net investment.
C invariably forms part of a hedging relationship.
D should be valued at cost.
(2 marks)





November 2008 5 P8

1.7 On 1 April 2005, APL bought 30% of the 1 million $1 ordinary shares of CST for
$12 million, thus achieving significant influence over CSTs operations and policies.
The retained earnings of CST at the date of acquisition were $16 million.

Between the date of acquisition and 30 September 2008, APL groups financial year
end, CST had earned profits of $320,000.

APL sells goods to CST at a mark up of 25%. At 30 September 2008, CSTs
inventories included $100,000 of goods at cost that had been purchased from APL.

In the financial year ended 30 September 2007, CST paid a dividend of 10 per share
to its investors. Before that, no dividend had been paid by CST since 1 April 2005, and
there have been no changes in its issued share capital.

Identify the method of accounting that APL should use for CST in its consolidated financial
statements and, using this method, calculate the amount of the investment in CST for
inclusion in the consolidated balance sheet at 30 September 2008.

(4 marks)


(Total for Question One = 20 marks)



Reminder

All answers to Section A must be written in your answer book.

Answers to Section A written on the question paper will not be
submitted for marking.


End of Section A

P8 6 November 2008

SECTION B 30 MARKS

[indicative time for answering this Section is 54 minutes]

ANSWER ALL THREE QUESTIONS



Question Two

CIMAs Official Terminology defines intellectual capital as knowledge which can be used to
create value.

Currently, IFRS permit the recognition of only a limited range of internally generated
intellectual assets including, for example, copyrights.



Required:

(a) Explain the advantages that could be gained by entities and their stakeholders if
the scope of IFRS were expanded to permit the recognition in the balance sheet
of a wider range of intellectual assets, such as know-how, the value of the
workforce, and employee skills.
(5 marks)

(b) Explain the principal reasons why IFRS do not currently permit the recognition in
the balance sheet of intellectual assets such as know-how, the value of the
workforce, and employee skills.
(5 marks)

Total for Question Two = 10 marks













Section B continues on the next page


November 2008 7 P8

Question Three

AGZ is a listed entity. You are a member of the team drafting its financial statements for the
year ended 31 August 2008.

Extracts from the draft income statement, including comparative figures, are shown below:

2008 2007
$million $million
Profit before tax 2764 2627
Income tax expense 850 800
Profit for the period 1914 1827

At the beginning of the financial year, on 1 September 2007, AGZ had 750 million ordinary
shares of 50 in issue. At that date the market price of one ordinary share was 876.

On 1 December 2007, AGZ made a bonus issue of one new ordinary 50 share for every
three held.

In 2006, AGZ issued $75 million convertible bonds. Each unit of $100 of bonds in issue will
be convertible at the holders option into 200 ordinary 50 shares on 31 August 2012. The
interest expense relating to the liability element of the bonds for the year ended 31 August
2008 was $63 million (2007 $62 million). The tax effect related to the interest expense
was $20 million (2007 $18 million).

There were no other changes affecting or potentially affecting the number of ordinary shares
in issue in either the 2008 or 2007 financial years.



Required:

(a) Calculate earnings per share and diluted earnings per share for the year ended
31 August 2008, including the comparative figures.
(8 marks)

(b) Explain the reason for the treatment of the bonus shares as required by IAS 33
Earnings per Share.
(2 marks)

Total for Question Three = 10 marks




P8 8 November 2008

Question Four

At its year end on 31 August 2008, DNT held investments in two subsidiaries, CM and BL.

Details of the investments were as follows:

1. Several years ago DNT purchased 850,000 of CMs 1 million ordinary $1 shares when
CMs retained earnings were $1,775,000 (there were no other reserves). At 31 August
2008, CMs retained earnings were $2,475,000.

2. On 31 May 2008, DNT purchased 175,000 of BLs 250,000 $1 ordinary shares. At
1 September 2007, BLs retained earnings were $650,000 (there were no other
reserves). During the year ended 31 August 2008, BL made a loss after tax of
$40,000. It can be assumed that BLs revenue and expenses accrue evenly throughout
the year.

No adjustments to fair value of the subsidiaries net assets were required at either of the
acquisitions.

On 1 March 2007 CM sold an item of machinery to DNT for $75,000. The carrying amount of
the item at the date of sale was $60,000, and CM recorded a profit on disposal of $15,000.
The remaining useful life of the item at the date of sale was 25 years. The group
depreciation policy in respect of machinery is the straight line basis with a proportionate
charge in the years of acquisition and of disposal.

DNTs retained earnings balance at 31 August 2008 was $2,669,400.


Required:

Calculate the amounts of consolidated retained earnings and minority interest for
inclusion in the DNT groups balance sheet at 31 August 2008.

Total for Question Four = 10 marks









End of Section B

Section C starts on the next page


November 2008 9 P8

SECTION C 50 MARKS

[indicative time for answering this Section is 90 minutes]

ANSWER TWO QUESTIONS OUT OF THREE



Question Five

On 1 November 2003, DX invested in 100% of the share capital of EY, a new entity
incorporated on that date. EYs operations are located in a foreign country where the
currency is the Franc. DX has no other subsidiaries.

The summary financial statements of the two entities at their 31 October 2008 year-end were
as follows:

Summary income statements for the year ended 31 October 2008

DX EY
$000 Franc 000

Revenue 3,600 1,200
Cost of sales, other expenses and income tax (2,800) (1,000)
Profit for the period 800 200

Summary statements of changes in equity for the year ended 31 October 2008

DX EY
$000 Franc 000

Brought forward at 1 November 2007 5,225 1,500
Profit for the period 800 200
Dividends (200) -
Carried forward at 31 October 2008 5,825 1,700

Summary balance sheets at 31 October 2008
DX EY
$000 Franc 000

Property, plant and equipment 5,000 1,500
Investment in EY 25 -
Current assets 4,400 2,000
9,425 3,500

Share capital 1,000 50
Retained earnings 4,825 1,650
Current liabilities 3,600 1,800
9,425 3,500

Relevant exchange rates were as follows:

1 November 2003 1$ =20 francs
31 October 2007 1$ =23 francs
31 October 2008 1$ =27 francs
Average rate for year ended 31 October 2008 1$ =26 francs

P8 10 November 2008



Required:

(a) Explain the meaning of the term functional currency as used by IAS 21 The
Effects of Changes in Foreign Exchange Rates, and identify THREE factors that
an entity should consider in determining its functional currency.
(4 marks)

(b) Prepare:

(i) the summary consolidated income statement for the year ended
31 October 2008;
(2 marks)

(ii) the summary consolidated balance sheet at 31 October 2008.
(6 marks)

(c) Prepare the summary consolidated statement of changes in equity for the year to
31 October 2008 and a calculation that shows how the exchange gain or loss for
the year has arisen.
(13 marks)

Total for Question Five = 25 marks
Work to the nearest $















Section C continues on the next page


November 2008 11 P8

Question Six

You are assistant to the Chief Financial Officer (CFO) of SWW, a large fashion retailer.
SWWs merchandise is sourced from many different suppliers around the world. SWWs
senior management has a business policy of building lasting relationships with suppliers
either by investing in their shares, or by making loans to them at favourable rates of interest.

A request has recently been received from a supplier, TEX, for a loan of $25 million to allow it
to invest in up to date machinery. The directors of TEX claim that the investment will result in
efficiency improvements which, in the short to medium term, will allow it to reduce prices to its
customers. SWW is a major customer of TEX, buying approximately 10% of TEXs annual
output of cotton clothing.

In support of the application, TEXs CFO has supplied a one page report on the state of the
business, and a balance sheet and income statement for the year ended 30 September 2008.
The 2008 figures are unaudited. TEX has not paid a dividend in the last five years. TEXs
shares are listed on a local stock exchange, although the entitys founding family has retained
a minor holding. TEXs functional and presentation currency is the $, and its financial
statements are prepared in accordance with IFRS.

The financial statements supplied by TEX are as follows:

TEX: Consolidated income statement for the year ended 30 September 2008

2008 2007
$million $million
Revenue 2563 2817
Cost of sales (2266) (2431)
Gross profit 297 386
Selling and distribution costs (92) (89)
Administrative expenses (187) (156)
Finance costs (54) (62)
Share of losses of associate (13) (68)
(Loss)/profit before tax (49) 11
Income tax expense 15 (04)
(Loss)/profit for the period (34) 07

Attributable to:
Equity holders of parent (32) 06
Minority interest (02) 01
(34) 07

P8 12 November 2008

TEX: Consolidated balance sheet at 30 September 2008

2008 2007
$million $million $million $million
ASSETS
Non-current assets:
Property, plant and equipment 2214 2273
Investment in associate 138 151
Available for sale investments 26 48
2378 2472

Current assets:
Inventories 1324 1256
Trade and other receivables 517 582
Cash - 48
1841 1886
4219 4358

EQUITY AND LIABILITIES
Equity
Share capital ($1 shares) 250 250
Retained earnings and other reserves 1032 1062
Minority interest 137 139
1419 1451
Non-current liabilities:
Long-term borrowings 572 671
Deferred tax 180 258
Defined benefit obligation 260 242
1012 1171

Current liabilities:
Trade and other payables 1501 1612
Borrowings 287 124
1788 1736
4219 4358


Required:

Produce a report to the CFO of SWW that:

(a) analyses and interprets the information given above from the point of view of
SWW as a potential lender;
(20 marks)
(b) describes the areas of uncertainty in the analysis and the nature of any
additional information that will be required before a lending decision can be
made.
(5 marks)

Note: Up to 8 marks are available in part (a) for the calculation of relevant accounting
ratios.

Total for Question Six = 25 marks





November 2008 13 P8

Question Seven

Ned is a recently appointed non-executive director of ABC Corp, a listed entity. ABCs
corporate governance arrangements permit non-executives to seek independent advice on
accounting and legal matters affecting the entity, where they have any grounds for concern.
Ned has asked you, an independent accountant, for advice because he is worried about
certain aspects of the draft financial statements for ABCs year ended 30 September 2008.

The ownership of most of ABCs ordinary share capital is widely dispersed, but the three
largest institutional shareholders each own around 10% of the entitys ordinary shares. In
meetings with management, these shareholders have made it clear that they expect
improvements in the entitys performance and position. ABC appointed a new Chief Financial
Officer (CFO) at the start of the 2007/08 financial year, and the board has set ambitious
financial targets for the next five years.

The 2007/08 targets were expressed in the form of three key accounting ratios, as follows:

Return on capital employed (profit before interest as a percentage of debt +equity): 7%
Net profit margin (profit before tax as a percentage of revenue): 5%
Gearing (long-term and short-term debt as a percentage of the total of debt +equity):
below 48%

The draft financial statements include the following figures:

$
Revenue 31,850,000
Profit before interest 2,972,000
Interest 1,241,000
Equity 22,450,800
Debt 18,253,500

The key ratios, based on the draft financial statements, are as follows:

Return on capital employed 73%
Net profit margin 54%
Gearing 448%

Neds copies of the minutes of board meetings provide the following relevant information:

1. On 1 October 2007 ABC sold an item of plant for $1,000,000 to XB, an entity that
provides financial services to businesses. The carrying value of the plant at the date of
sale was $1,000,000. XB has the option to require ABC to repurchase the plant on
1 October 2008 for $1,100,000. If the option is not exercised at that date, ABC will be
required under the terms of the agreement between the entities to repurchase the plant
on 1 October 2009 for $1,210,000. ABC has continued to insure the plant and to store
it on its business premises. The sale to XB was recognised as revenue in the draft
financial statements and the asset was derecognised.

2. A few days before the 30 September 2008 year end, ABC entered into a debt factoring
agreement with LM, a factoring business. The terms of the agreement are that ABC is
permitted to draw down cash up to a maximum of 75% of the receivables that are
covered under the factoring arrangement. However, LM is able to require repayment of
any part of the receivables that are uncollectible. In addition, ABC is obliged to pay
interest at an annual rate of 10% on any amounts it draws down in advance of cash
being received from customers by LM. As soon as the agreement was finalised, ABC
drew down the maximum cash available in respect of the $2,000,000 receivables it had
transferred to LM as part of the agreement. This amount was accounted for by debiting
cash and crediting receivables.

P8 14 November 2008

3. In October 2007, ABC issued 2,000,000 $1 preference shares at par. The full years
dividend of 8% was paid before the 30 September 2008 year end, and was recognised
in the statement of changes in equity. The preference shares are redeemable in 2015,
and the entity is obliged to pay the dividend on a fixed date each year. The full
$2,000,000 proceeds of the issue were credited to equity capital.



Required:

(a) Discuss the accounting treatment of the three transactions, identifying any errors
that you think have been made in applying accounting principles with references,
where appropriate, to IFRS. Prepare the adjustments that are required to correct
those errors and identify any areas where you would require further information.
(15 marks)
(b) Calculate the effect of your adjustments on ABCs key accounting ratios for the
year ended 30 September 2008.
(7 marks)
(c) Explain, briefly, the results and the implications of your analysis to the non-
executive director.
(3 marks)

Total for Question Seven = 25 marks





End of Section C. End of Question Paper


November 2008 15 P8

MATHS TABLES AND FORMULAE

Present value table

Present value of $1, that is (1 +r)
-n
where r =interest rate; n =number of periods until payment or
receipt.

Interest rates (r) Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621
6 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239
16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218
17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198
18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180
19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164
20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Interest rates (r) Periods
(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065
16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054
17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045
18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038
19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031
20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026

P8 16 November 2008

Cumulative present value of $1 per annum,

Receivable or Payable at the end of each year for n years
r
r
n
+ ) (1 1


Interest rates (r) Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145
11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367
15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606
16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824
17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022
18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201
19 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365
20 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514

Interest rates (r) Periods
(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 7.793 4.611 4.439
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675
16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730
17 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775
18 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812
19 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843
20 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870



November 2008 17 P8

FORMULAE


Annuity
Present value of an annuity of $1 per annum receivable or payable for n years, commencing
in one year, discounted at r% per annum:

PV =

n
r
r
] [1
1
1
1


Perpetuity
Present value of $1 per annum receivable or payable in perpetuity, commencing in one year,
discounted at r% per annum:

PV =
r
1


Growing Perpetuity
Present value of $1 per annum, receivable or payable, commencing in one year, growing in
perpetuity at a constant rate of g% per annum, discounted at r% per annum:

PV =
g r
1




P8 18 November 2008


LIST OF VERBS USED IN THE QUESTION REQUIREMENTS
A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for
each question in this paper.

It is important that you answer the question according to the definition of the verb.
LEARNING OBJECTIVE VERBS USED DEFINITION
1 KNOWLEDGE

What you are expected to know. List Make a list of
State Express, fully or clearly, the details of/facts of
Define Give the exact meaning of
2 COMPREHENSION

What you are expected to understand. Describe Communicate the key features
Distinguish Highlight the differences between
Explain Make clear or intelligible/State the meaning of
Identify Recognise, establish or select after
consideration
Illustrate Use an example to describe or explain
something
3 APPLICATION

How you are expected to apply your knowledge. Apply
Calculate/compute
To put to practical use
To ascertain or reckon mathematically
Demonstrate To prove with certainty or to exhibit by
practical means
Prepare To make or get ready for use
Reconcile To make or prove consistent/compatible
Solve Find an answer to
Tabulate Arrange in a table
4 ANALYSIS

How are you expected to analyse the detail of
what you have learned.
Analyse
Categorise
Examine in detail the structure of
Place into a defined class or division
Compare and contrast Show the similarities and/or differences
between
Construct To build up or compile
Discuss To examine in detail by argument
Interpret To translate into intelligible or familiar terms
Produce To create or bring into existence
5 EVALUATION

How are you expected to use your learning to
evaluate, make decisions or recommendations.

Advise
Evaluate
Recommend
To counsel, inform or notify
To appraise or assess the value of
To advise on a course of action




November 2008 19 P8

The Examiner for Financial Analysis offers to future candidates and to tutors
using this booklet for study purposes, the following background and guidance
on the questions included in this examination paper.
Section A Question One Compulsory
1.1 OTQ that required calculation of the amount, of a dividend for minority interests, for
inclusion in the consolidated cash flow statement of the entity concerned. Tested
learning outcome A (iii).
1.2 Short question that required a description of the conditions to be met to recognise
intangible assets upon acquisition of a subsidiary. Tested learning outcome A (iii).
1.3 Short question that required calculation of the actuarial gain/loss on the pension
scheme assets of the entity concerned. Tested learning outcome B (vi).
1.4 Short question that tested knowledge of the principal characteristics common to joint
venture arrangements. Tested learning outcome A (vi).
1.5 Short question that required initial classification and subsequent measurement, in
accordance with the current International Standard, of two financial assets. Tested
learning outcome B (v).
1.6 OTQ that tested knowledge of the nature of derivative financial instruments. Tested
learning outcome B (v).
1.7 Short question that required both identification of the method of accounting an entity
should use and calculation of the amount of investment by this entity in another for
inclusion in its consolidated balance sheet. Tested learning outcome A (vi).
Section B Compulsory
Question Two required an explanation, with regard to intellectual capital, as to the
advantages that might be gained by entities, were they permitted to allow its wider recognition
in financial statements, together with the reasons as to why International Standards do not
currently permit such recognition. Tested learning outcome D (iv).
Question Three part (a) required calculations of EPS and diluted EPS for a listed entity. Part
(b) required an explanation for the reason for the treatment of bonus shares as required by
the applicable International Standard. Tested learning outcome C (i).
Question Four required calculation of the amounts of consolidated retained earnings and
minority interest for inclusion in the group balance sheet of the entity concerned. Tested
learning outcome A (iii).
Section C Answer two from three questions
Question Five required in part (a) an explanation of the meaning of the term functional
currency and identification of three factors to be considered in determining a functional
currency. Part (b) required preparation of the summary consolidated income statement and
balance sheet of the entity concerned and, in part (c), the summary consolidated statement of
changes in equity, together with a calculation as to how an exchange gain/loss has arisen.
Tested learning outcome A (x).
Question Six required preparation of a report that analysed and interpreted scenario
information from the view of the entity concerned as a lender and described any areas of
uncertainty in the analysis and interpretation, together with an indication of any additional
information required prior to a lending decision being made. Tested learning outcome B (i)
and C (ii), (iii) and (iv).

P8 20 November 2008

Question Seven part (a) required a discussion of the three transactions described in the
scenario identifying any errors made and their adjustment. Part (b) required calculation of the
effect of such adjustments on the key accounting ratios of the entity concerned. Finally part
(c) required a brief explanation of the results and implications. Tested learning outcomes B (i),
(iii) and (iv) and C ((iii).




November 2008 21 P8




Managerial Level Paper
P8 Financial Analysis
Examiners Answers

SECTION A



Answer to Question One

1.1

$
Balance brought forward 77,600
Disposal: 25% x 64,000 (16,000)
Share of profit for the period 6,500
Dividend paid (balancing figure) (3,400)
Balance carried forward 64,700

The correct answer is B



1.2 IFRS 3 permits recognition of an intangible asset upon acquisition of a subsidiary only
if:

(a) it meets the definition provided by IAS 38 Intangible Assets.

(b) its fair value can be measured reliably.



1.3 JSX: Calculation of actuarial gain or loss on pension scheme assets for the year
ended 31 October 2008

$
Fair value of scheme assets at 1 November 2007 10,660,000
Expected return on scheme assets (10,660,000 x 62%) 660,920
Contributions to scheme 550,700
Benefits paid (662,400)
Actuarial loss on scheme assets (balancing figure) (5,220)
Fair value of scheme assets at 31 October 2008 11,204,000




P8 22 November 2008

1.4 The principal characteristics common to joint venture arrangements are that joint
control is established by two or more venturers who are bound by a contractual
arrangement.



1.5 GZP

1.

(i) The facts that the loan to the supplier is intended to be held until its fixed maturity, and
that determinable payments of interest are to be made, make it clear that this should be
classified as a held-to-maturity investment.

(ii) Subsequent measurement is at amortised cost using the effective interest rate method.

2.

(i) The investment in shares of a listed company should be classified as an available-for-
sale financial asset.

(ii) Subsequent measurement is at fair value with any gains or losses before derecognition
to be recognised in equity.



1.6 The correct answer is B



1.7 Investment in CST to be recognised in the consolidated financial statements of
APL for the year ended 30 September 2008

The investment should be measured using the equity accounting method, as follows:

$
Cost of investment 1,200,000
Add: share of post-acquisition profits of the associate: $320,000 x 30% 96,000
Less: dividend paid in 2007 financial year: 10 x 300,000 shares (30,000)
Less: provision for unrealised profit in inventory:
25/125 x $100,000 x 30% =
(6,000)
Investment in associate 1,260,000




November 2008 23 P8


SECTION B



Answer to Question Two

(a)

The recognition of intangible assets, and of intellectual capital assets in particular, has been
much discussed in recent years. The traditional business model involving exploitation of
physical assets in the form of tangible non-current assets and inventory is no longer so
prevalent. For many service businesses, the most significant category of asset relates to
the skills and talents of the people who work for them. If accounting regulation and practice
permitted the recognition of such assets as part of the business balance sheet, there could be
some positive effects.

Under current accounting practice, the balance sheets of many types of business recognise
few intangible assets. Recognition of a wider range of assets would provide a more realistic
view of the productive capacity of the business, which could be helpful to many categories of
stakeholder. For example, existing and potential investors would find it easier to relate the
flow of revenue to the assets that had produced it, thus improving understanding of the
nature of the business and its ability to generate positive income streams.

A related point is that realistic analysis of the financial statements would be much easier
where a greater range of assets was recognised. Under current IFRS many of the standard
accounting ratios make little sense because the recognised asset base is so low. Accounting
ratios such as asset turnover, return on assets and return on capital employed are essentially
meaningless in businesses that rely principally on intellectual capital assets. With full
recognition of intellectual assets, comparisons between the productivity of different types of
business would become more realistic.

From the point of view of the employee stakeholder group, recognition of intellectual assets
would increase the prominence of the value they add to the organisation. Instead of being
viewed as a cost to be borne by the business, the amounts incurred in remunerating and
training employees could be seen as an investment by the business. If a formal valuation
process were adopted in respect of individuals their status and prospects could be improved.

(b) The principal problems relating to the recognition of intellectual assets are as follows:

Intellectual assets such as know-how and skills do not usually fall into the Framework
definition of an asset (a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity). The problem is one of
control: skills are in the possession of the individual employee who has the option to cease
working for the entity and to take his or her skills elsewhere. Where resources cannot be
controlled their value to the entity is questionable.

Realistic measurement of intellectual assets presents a challenge that may well be
insuperable in practice. Although some guidance is provided by market salary rates from
which a capital value could in theory be extrapolated, any such values would necessarily be
vague and imprecise. The difficulties involved in reaching realistic values would rule out valid
inter-firm comparability.

Finally, because of the problems of arriving at consistent and robust measurement
techniques, there would be scope for creative accounting by the unscrupulous.




P8 24 November 2008

Answer to Question Three

(a)

2008 2007
Earnings per share: 1914/1,000 191 1827/1,000 183
(W1) (W1)

Diluted earnings per share
(W3) 1,150
(W2) 7 195 170
(W3) 1,150
(W2) 1 187 163

Workings

1. Bonus issue of shares: 1 new share for every 3 already in issue =750 million/3 x 4 =
1,000 million.

2. Diluted earnings adjustments

2008 2007
Profit for the period 1914 1827
Add back interest 63 62
Less: tax effects (20) (18)
43 44
1957 1871

3. Fully diluted shares

If all conversion options are taken up:

150m 200 x
100
$75m
=

Added to the existing shares this gives a fully diluted number of shares of 1,150m (1,000m +
150m).

(b)

Bonus shares are issued for no consideration, and so there is no increase in resources
associated with them. All other things being equal, no increase in earnings can be expected
following a bonus issue; the effect is that the same amount of earnings is divided by a greater
number of shares. In order to ensure continuing comparability, the bonus issue is adjusted
for as if it had taken place at the beginning of the earliest period presented.




November 2008 25 P8

Answer to Question Four

Consolidated retained earnings
$
DNTs retained earnings 2,669,400
Group share of CMs post-acquisition earnings (W2) 582,250
Consolidation adjustment: additional depreciation (W3) 9,000
Group share of BLs post-acquisition loss (W4) (7,000)
3,253,650

Minority interest
$
CM: share capital (1,000,000 - 850,000) 150,000
CM: retained earnings (2,475,000 - 15,000) x 15% 369,000
BL: share capital (250,000 - 175,000) 75,000
BL: retained earnings (650,000 - 40,000) x 30% 183,000
777,000

Workings

1. DNTs holding in CM: 850,000/1,000,000 =85%
DNTs holding in BL: 175,000/250,000 =70%

2. Group share of CMs post-acquisition earnings
$
Post-acquisition earnings (2,475,000 - 1,775,000) 700,000
Less: profit on intra-group disposal (15,000)
685,000
85% of post acquisition earnings 582,250

3. Additional depreciation adjustment
Required in respect of the additional depreciation on the item of machinery. 15 years
(out of a remaining life of 25 years) have elapsed since the intra-group purchase.
($75,000 60,000) x 15/25 9,000

4. Group share of BLs post-acquisition loss
3/12 x 40,000 x 70% 7,000



P8 26 November 2008


SECTION C



Answer to Question Five

(a)

An entitys functional currency is the currency of the primary economic environment in which it
operates. Entities need to consider the following factors in determining their functional
currency:

Which currency primarily influences selling prices for goods and services?
Which countrys competitive forces and regulations principally determine the selling
prices of the entitys goods and services?
In which currency are funds for financial activities (debt and equity instruments)
generated?
In which currency are receipts from operations generally kept?
Which currency influences labour, material and other costs of providing goods or
services?

(b)

(i) Income statement for the year ended 31 October 2008

EY Rate EY DX Consolidation
adjustment
Consolidated
Franc $ $ $
Revenue 1,200,000 260 461,538 3,600,000 4,061,538
Expenses 1,000,000 260 384,615 2,800,000 3,184,615
Profit 200,000 76,923 800,000 876,923

(ii) Balance sheet at 31 October 2008

EY Rate EY DX Consolidation
adjustment
Consolidated
Franc $ $ $
PPE 1,500,000 270 555,556 5,000,000 5,555,556
Investment 25,000 (25,000) -
Current assets 2,000,000 270 740,741 4,400,000 5,140,741
3,500,000 1,296,297 9,425,000 (25,000) 10,696,297

Share capital 50,000 200 25,000 1,000,000 (25,000) 1,000,000
Retained
earnings
1,650,000 Bal
f
i
g
604,630 4,825,000 5,429,630
Current
liabilities
1,800,000 270 666,667 3,600,000 4,266,667
3,500,000 1,296,297 9,425,000 (25,000) 10,696,297



November 2008 27 P8

(c)

Statement of changes in equity for the year ended 31 October 2008

$
Brought forward at 1 November 2007 (W1) 5,852,174
Profit for the period (from income statement) 876,923
Dividend (200,000)
Exchange loss (balancing figure) (99,467)
Closing equity (1,000,000 +5,429,630) 6,429,630

Working

1. Equity brought forward at 1 November 2007

Post-acquisition retained earnings in EY $
Opening equity in EY (1,650,000 +50,000 200,000) 1,500,000 francs @ 230 652,174
Less: share capital in EY (50,000 @ 2.00) (25,000)
627,174
DX equity 5,225,000
5,852,174

Exchange loss for the year

Opening equity in EY (1,500,000 francs as above):

$ $
Translated at opening rate (1,500,000/230) 652,174
Translated at closing rate (1,500,000/270) 555,556
Exchange loss 96,618

Profit for the year in EY (200,000):

Translated at average rate (200,000/260) 76,923

Translated at closing rate (200,000/270) 74,074
Exchange loss 2,849
99,467



P8 28 November 2008

Answer to Question Six

From: Accountant

To: CFO

Report on TEX loan application

(a) TEXs performance has deteriorated significantly between 2007 and 2008. Revenue in
2008 has decreased by 9% on the previous years figure, and the fall in gross
profitability has been even more significant. Gross margin in 2007 was 137%, falling
to only 116% in 2008, and the business is now loss-making. Non-current asset
turnover has decreased, which may suggest inefficiencies in operation, or possibly
deteriorating performance from old machinery. Performance is not helped by the
results of the associate whose loss, although not as large as in 2007, has contributed
significantly to the overall loss. The balance sheet valuation of the investment in
associate has not, apparently, been reduced by the recognition of any impairment
losses. If the investment is impaired, the impairment loss would further increase the
loss for the year.

Turning to the balance sheet, the position is worse in most respects than in 2007. The
business is holding a very large amount of inventory, even more than in 2007, thus
tying up cash and incurring holding costs. A significant proportion of inventory could be
raw material and there may be good reasons why large amounts should be held at the
end of September. However, it is also possible that some of the inventory is obsolete,
and should be written off, which again would increase the loss for the year.
Receivables turnover is slow, but that could be expected in this business. It has
actually improved slightly between 2007 and 2008, which may mean that management
has made a definite effort to speed up cash collection.

By the end of September 2008 the business has no cash in hand, and its balance of
available for sale investments which could, presumably, be realised in an emergency,
is almost halved from the previous year end. Borrowings net of cash at the 2007 year
end were $747 million ($671 +124 48), but by the end of 2008 they had increased
to $859 ($572 +287), and gearing had increased substantially. The large increase in
borrowings is a worrying sign, but so also is the fact that a much higher proportion of
the total is classified in current liabilities. On the face of it, the business will have
difficulty meeting its current liabilities as they fall due, an impression which is reinforced
by the very low quick ratio. Trade and other payables have fallen, but the total of
$1501 million outstanding at the end of 2008 is extremely high in the context of the
other balance sheet figures. It is likely that many of TEXs suppliers are not in a
position to complain about non-payment of amounts owing, but there is the danger that
it could force some of its suppliers out of business.

The level of interest cover is not attractive to a potential lender. It is surprising to note
that interest has actually fallen in 2008 compared to 2007. This may mean that at other
times of year the position is not as bad as it appears at the year end. Nevertheless, the
position is so poor as to provide a significant deterrent to SWW as a potential lender.
There are additional sources of concern in the other long-term liabilities. The net
liability on the pension scheme is significant in size at both year ends, and it may
indicate on-going difficulties in funding the obligations under the scheme. The deferred
tax balance is also significant and is a prospective, if not immediate, cause for concern.

If the position and performance of TEX continues to deteriorate in line with current
trends, it is quite possible that the business will become insolvent in the foreseeable
future. On the evidence provided so far, a loan to TEX would be very risky, and there
would be a significant probability of non-recovery.


November 2008 29 P8

(b)

The analysis above is subject to a great deal of uncertainty. Some of the significant
uncertainties, and the information required to resolve them, are as follows:

1. The information for 2008 is both incomplete and unaudited. We would need to see a
full, audited, annual report at least, and it is quite likely that we would need additional
information about, for example, the age and condition of property, plant and equipment
and inventory.
2. The only amount recognised separately in the financial statements in respect of the
defined benefits pension scheme is the net liability. Many detailed disclosures are
required by IAS 19, and we would need to scrutinise these carefully. The costs of the
scheme are presumably recognised somewhere within the income statement, and their
location could affect our analysis of the statements.
3. The associate has been turning in significant losses. We would need information about
it in order to understand the groups involvement and continuing commitment.
4. If present trends continue the group could face insolvency before too long. There has
been no dividend in the recent past, and return on equity, poor in 2007, is now
negative. It would be necessary to know more about the principal shareholders and the
extent to which they are likely to continue to support the business. It is possible that a
takeover bid could be made for the business, and if we had lent significant amounts to
the business, our relationship could be jeopardised.
5. The existing level of gearing is high, and as previously remarked, some of the
borrowings fall due to be repaid within the short term. We would need to know a great
deal more about the existing lenders, terms of loans and the nature and extent of
security provided.

P8 30 November 2008

APPENDIX
Relevant ratios
2008 2007
Gross profit margin:
0 10 x
Revenue
profit Gross
6% 1 1 100 x
3 256
7 9 2
=

% 7 3 1 100 x
7 281
6 8 3
=

Net (loss)/profit margin:
100 x
Revenue
profit Net(loss)/
%) 3 1 ( 100 x
3 256
) 4 (3
=

% 2 0 100 x
7 281
7 0
=

Return on shareholders equity
100 x
Equity
tax before fit (Loss)/pro
%) 5 3 ( 100 x
9 41 1
) 9 (4
=

% 8 0 100 x
1 145
1 1
=

Inventories turnover:
100 x
sales of Cost
s Inventorie
days 3 3 1 2 365 x
6 226
4 132
=

days 6 88 1 365 x
1 243
6 125
=

Receivables turnover:
365 x
Revenue
s Receivable
days 6 73 365 x
3 256
7 51
=

days 4 75 365 x
7 281
2 58
=

Non-current asset turnover:
equipment and plant Property,
Revenue
16 1
4 221
3 256
=

24 1
3 227
7 281
=

Gearing:
100 x
Equity
Debt
6% 60 100 x
9 141
7 28 2 57
=

+
8% 4 5 100 x
1 145
4 2 1 1 67
=

+
Interest cover:
costs Finance
costs finance before Profit
33 0
4 5
) 7 18 2 9 7 29 (
=

27 2
2 6
) 6 15 9 8 6 38 (
=

Current ratio:
Current assets : current
liabilities
1 : 03 1
8 178
1 184
=

1 : 09 1
6 173
6 188
=

Quick ratio:
Current assets less inventories:
current liabilities
1 : 29 0
8 178
7 51
=

1 : 36 0
6 173
) 8 4 2 58 (
=

+





November 2008 31 P8

Answer to Question Seven

(a) Transaction 1

The relevant accounting principle that should be applied in this case is that of substance over
form, which, according to the Framework for the Preparation and Presentation of Financial
Statements, is an important aspect of the qualitative characteristic of financial statement
reliability. While this transaction apparently has some of the characteristics of a sale, in
substance it is a financing arrangement. The substance of the transaction is that ABC has
borrowed $1,000,000 at an interest rate of 10%. IAS 18 Revenue permits the recognition of
revenue only where the selling entity has transferred the risks and rewards of ownership to
the buyer. This is clearly not the case in respect of this transaction as ABC continues to
insure and to store the plant.

Correcting accounting entries should be made to remove $1,000,000 from sales and cost of
sales and the asset should be reinstated as part of plant and machinery. A charge to
depreciation should be made for the year ended 30 September 2008, but there is insufficient
information available in the facts presented to estimate the amount and impact of this charge.
The amount of $1,000,000 should be recognised as borrowings, either long-term if the liability
is to be settled on 1 October 2009, or short-term if it is settled on 1 October 2008. Interest of
$100,000 should be charged to profit or loss for the year, with a corresponding credit entry to
borrowings.

The correcting journal entries to correspond with the above description would be:

DR Revenue 1,000,000
CR Cost of sales 1,000,000
DR Plant 1,000,000
DR Interest payable 100,000
CR Borrowings 1,100,000

Transaction 2

Like the first transaction, this one should be reflected in the financial statements according to
the principle of substance over form. ABC continues to bear the risks relating to all the
receivables covered by the factoring arrangement; this is indicated by the fact that LM can
require repayment in respect of any uncollectible element. The substance of the transaction
is that ABC has borrowed $1,500,000 (75% of the total of $2,000,000 transferred to LM),
against the security of its receivables. Interest is chargeable on these amounts at a rate of
10%.

Insufficient information is available to calculate the charge for interest, but because the
agreement was made only a few days before the year end the interest would not be a very
significant amount. The amount of $1,500,000 should, however, be reinstated as part of
receivables and a short-term payable of the same amount should be recognised.

The correcting journal entry would be:

DR Receivables 1,500,000
CR Borrowings 1,500,000

Transaction 3

The relevant accounting standard in this case is IAS 32 Financial Instruments: Presentation.
One of the objectives of this standard is to establish principles for presenting financial
instruments as liabilities or equity. The classification as equity or liability must be made in
accordance with the substance of the contract, so this transaction provides another instance
where substance over form must be considered. The preference shares in this case are
redeemable on a specific date, and this fact, together with the unavoidable obligation to pay
annual interest, points towards the instrument being a liability rather than equity. The

P8 32 November 2008

preference shares should therefore be reclassified as a long-term liability. The dividend (8%
x $2,000,000 =$160,000) in respect of the shares appears in the statement of changes in
equity in the draft financial statements, but this should be reclassified as interest in the
income statement.

(b)

Effects of the adjustments on ABCs key ratios

Before adjustment saction 1 saction 2 saction 3 After adjustment
$ $ $ $ $
Revenue 31,850,000 -1,000,000 30,850,000
Profit before interest 2,972,000 2,972,000
Interest 1,241,000 +100,000 +160,000 1,501,000
Equity 22,450,800 -100,000 -2,000,000 20,350,800
Debt 18,253,500 +1,100,000 +1,500,000 +2,000,000 22,853,500

Key ratios recalculated:

Return on capital employed

% 9 6
500 , 753 , 22 800 , 350 , 20
000 , 972 , 2
=
+

Cant get into box change 22,753,500 to 22,853,500

Net profit margin

% 8 4
800 , 850 , 30
000 , 471 , 1
=

Change 30850800 to 30,850,000

Gearing

% 8 52
500 , 753 , 22 800 , 350 , 20
000 , 753 , 22
=
+


Change top line from 22,753,000 to 22,853,500
Change bottom line from 22,753,500 to 22,853,500
Change ratio from 52.8% to 52.9%

(c)

To: Ned
From: Independent accountant

After making the adjustments in respect of the three transactions that you have identified as
questionable, all three of the key ratios fail to meet the targets set by the directors, although
the shortfall is not great in respect of any of the three. A greater cause for concern is the fact
that the transactions have not been accounted for in accordance with IFRS. This suggests a
willingness on the part of the CFO to engage in creative accounting. You have identified
three instances, but there may be others that are less obvious. In future years, performance
and position may continue to be misstated in order to meet budgets and targets, and the ways
in which the misstatements are achieved may be more subtle.