Paper 3.

6 (SGP) Mock Exam

ACCA
Part Three

Paper 3.6 (SGP) (Singapore Stream)

December 2003 Mock Exam
Question Paper: Time allowed This paper is divided into two sections Section A This questions is compulsory and MUST be attempted THREE questions ONLY to be attempted 3 hours

Section B

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

Paper 3.6 (SGP) Mock Exam

Section A This ONE question is compulsory and MUST be answered

SVEN

Sven, a public limited company, acquired two subsidiary companies, Ulrika and Nancy, both public limited companies. The details of the acquisitions are as follows: Subsidiary Date of acquisition Ordinary Accumulated Cost of Share Reserves Investment Capital of $1 $m 400 200 $m 1,098 600 Ordinary Share Capital acquired $1 shares $m 600 320 Fair Value of net assets on acquisition $m 1,400 650

Ulrika Nancy

$m 1 January 2001 800 1 June 2001 400

The draft income statements for the year ended 31 May 2002 are: Sven $m 2100 (1550) _____ 550 (140) (110) _____ 300 (18) 70 _____ 352 (80) _____ 272 _____ 600 Ulrika $m 1200 (1020) _____ 180 (36) (42) _____ 102 (6) _____ 96 (26) _____ 70 _____ 450 Nancy $m 1080 (960) _____ 120 (48) (54) _____ 18 (28) _____ (10) (4) _____ (14) _____ 200

Revenue Cost of Sales Gross Profit Distribution costs Administrative expenses Profit from operations Interest expense Investment income (including inter company dividends) Profit/(loss) before taxation Income tax expense Net profit from ordinary activities Accumulated profit at 1 June 2001

The following information is relevant to the preparation of the group financial statements: (i) On 1 December 2001, Sven sold the following shareholdings in the subsidiary companies Ordinary Shares Proceeds of $1 sold $m $m 120 280 160 250

Ulrika Nancy

Sven maintains significant influence over Nancy after the disposal of shares. (ii) Ulrika sold $95 million of goods to Sven during the year at a profit of 20% on selling price. The opening inventory of such goods held by Sven was $10 million and the closing inventory $15 million.

Paper 3.6 (SGP) Mock Exam (iii) At the date of acquisition, the fair value of the tangible depreciable non-current assets of Ulrika was $20 million above their carrying value and that of non depreciable land was $180 million above its carrying value. The fair value of the tangible non-current assets of Nancy was equivalent to its carrying value. Depreciation is charged on all group tangible non-current assets at 20% per annum on the carrying value of the asset with a full years charge in the year of acquisition. The policy of the group is to write off goodwill over four years. A full years charge is made in the year of acquisition. Sven is carrying out a review of the carrying value of goodwill as at 31 May 2002. This first year review is based upon the following information: Ulrika On acquisition, the management of Sven expected pre-tax profits in the year to 31 May 2002 to be $65 million. Nancy On acquisition, it was anticipated that Nancy would be profitable for at least five years. At 31 May 2002 changes in business regulations have resulted in the net assets having a value in use of $ 685 million and an estimated net selling price of $ 670 million as at 31 May 2002 of Nancy as an income generating unit. (v) (vi) Sven had paid a dividend of $25 million and Ulrika had paid a dividend of $50 million in April 2002. The fair value adjustments had not been incorporated into the subsidiaries records, and the sales of shares had not been accounted for by Sven. Assume that profits accrue evenly and that there are no other items of income, expense, or capital other than those stated in the question. Taxation on any capital gain can be ignored.

(iv)

Required: (a) Prepare a consolidated income statement for the Sven Group for the year ended 31 May 2002 in accordance with International Accounting Standards. (The amount of the consolidated profit dealt with in the holding companys accounts is not required.) (25 marks) Depreciation and amortisation are charged to the income statement as part of cost of sales. Ignore any inter company profit in inventory when calculating the gain/loss on the disposal of shares. (25 marks)

Paper 3.6 (SGP) Mock Exam Section B - THREE questions ONLY to be attempted 2 ARNIE

Arnie is an incorporated enterprise based in Ruritania. It is involved in the wholesale distribution of home electrical goods. The directors of Arnie have prepared draft financial statements for the year ended 30th June 2002 and have stated that these have been prepared in accordance with FRS. These are to be used in support of a loan application from a financial institution. Arnies employees own 5% of the ordinary shares of the company. The employees representatives have expressed concern about the loan application and are seeking advice on certain of the policies Arnie has used in drafting the financial information. The draft income statements for the year ended 30th June 2002 are: 2002 $m 210.0 (155.0) _____ 55.0 (25.0) _____ 30.0 _____

Revenue Cost of Sales Gross Profit Other operating costs Profit/(loss) before taxation

The employees representatives wish an explanation of the following. Early in the year Arnie entered into an agreement with Sonear, a Japanese manufacturer of household electronic goods, under which it would have sole distribution rights in Ruritania. Under this agreement Sonear supplies goods which Arnie stores, repackages and sells on to retailers. The terms of the distribution agreement are as follows:

Legal title to all inventory is retained by Sonear until Arnie sells it to third a third party. Arnie purchases the products from Sonear immediately before the sale to the third party at a price fixed by Sonear. The sale to the third party is at a margin set by Sonear under the terms of the distribution agreement. This margin is retained by Arnie. Sonear retains product liability and is responsible for any manufacturing defects. Arnie has the right to return any inventory to Sonear without any penalty. Credit risk: If a third party subsequently does not pay for the goods supplied by Arnie, Sonear writes off the amount it is owed for these goods from Arnie. Arnies loss is limited to the margin.

Arnie has recognised revenue of $15 million on this contract. This is the value of the goods sold to third parties. The figure includes a mark up of $3 million. Packaging and storage costs of $2 million are included in other operating costs. Arnie has received an order from Meteor, a major retailer, for the supply of 100, 1 metre, flat screen television sets. These are aimed at the top end of the market and retail for $15,000. The sales price to Meteor will be $10,000 per unit. Meteor has paid Arnie a deposit of $1,000 per unit. The TV sets will be delivered to Meteor only on payment of the balance owed. Meteor must do this by 31st August or it will forfeit the deposit paid. The TV sets have been imported from Arnies supplier (which in this case is not Sonear) at a cost to Arnie of $7,000 per unit, and have been set aside in Arnies main distribution centre to await the receipt of the final payment. Arnie has recognised the revenue and costs of this transaction when preparing the draft financial information.

Paper 3.6 (SGP) Mock Exam On 1st June 2002 Arnie obtained a contract to supply 100,000 units of the D cup, a new games console produced by Sicromoft, to Dock Green, a major retailer, for $200 per unit. Dock Green has made part payment at the time the contract was signed. The contract specifies delivery of the units at specific dates. Arnie only has an inventory of 20,000 D cups and these have been set aside to meet the needs of this contract and are ready for delivery at 30th June. Delivery of 10,000 units per month will be made to Dock Green starting at the end of September. The contract allows Arnie to charge a holding fee for setting aside units of 1/2 % of the unit cost (to Arnie) per month. . Arnie has signed a contract to purchase a further 80,000 units from Sicromoft and these are scheduled for delivery in two batches of 40,000 each at the end of July of August. They cost Arnie $120 per unit. Arnie has included the revenue and costs from the sale of 100,000 units in the above figures. It has not yet recognised any amount for the holding fee. On 1st July 2001 Arnie diversified into the provision of cable TV services. It purchased a licence from TNL which gives it exclusive rights to use a cable network in the capital city of Ruritania for a period of 25 years. To secure this right Arnie must pay $10 million per annum, in advance for a period of five years. There are no rentals to be paid by Arnie in the last 20 years of the agreement. The $10 million rental paid at the start of the year has been expensed as part of other operating costs. The cable network has an estimated total life of 100 years. Arnie in turn allows TV channel distributors to use this asset (on a non exclusive basis) in return for prepaid rentals. To date, Arnie has sold one such agreement BWTV paid $5 million for 5 years use on 1st January 2002. Arnie has recognised the revenue from this in full in the above draft income statement. Required: Prepare a report which explains the suitability of the Arnies accounting policies for the transactions listed above and recommends the correct treatment where appropriate. The report should contain an income statement adjusted in line with your recommendations. (25 marks)

Paper 3.6 (SGP) Mock Exam 3 CONNECT

Connect is a listed incorporated enterprise. It is quoted on its local exchange. This exchange is a member of IOSCO and has recently announced that it is going to change its listing regulations to require all registrants to prepare financial statements in accordance with IAS, instead of local GAAP, for all accounting periods beginning on or after 1st January 2004. Furthermore, it will allow members of the exchange, to use IAS for filing purposes, with immediate effect. Connect has decided to adopt IAS immediately. Local GAAP has undergone considerable convergence with IAS in recent years and there are no major recognition and measurement implications for existing members. However the local GAAP disclosure requirements are less demanding than IAS in several areas. One of these is that there is no local regulation on the need to disclose related party transactions. Connect has asked for your help in identifying relevant related party transactions in accordance with IAS and for guidance on the disclosures that need to be made. Mr Joint, the finance director of Connect, has provided the following information: 1) The two major shareholders of Connect are Big Boy Investment Fund (BBIF) which holds 45% of the share capital and Mr Big who holds 10%. Mr Big is a multimillionaire. He set up BBIF several years ago and is the majority investor in the fund. No other shareholder owns more than 1%. Connect has 14 subsidiaries. There is considerable inter-company trading between the members of this group. Transfer prices are generally below market rates for members of the group. The total inter group sales in the period are $110 million. This is at cost plus 10%. Normal trading terms would be at cost plus 30%. The group revenue was over $800 million in the last financial year. Connect has recently signed an advertising contract with JJ Advertising. JJ Advertising is an agency owned by Janet Joint. She is the wife of the finance director. The contract is worth $10 million per annum. This contract was won in a competitive tender. Connect has recently sold a tract of land to Weld. Weld is an incorporated enterprise. The land was sold for $4.5 million (net of a selling cost of $100,000). The market value of the land was $5.3 million and its value in use was $3.8 million. It was carried at a book value of $5.8 immediately prior to the sale. Mr Big is a director and major investor in Weld. Three of the directors of Connect have set up a consultancy which provides services to Connect. Connect paid $2.6 million in respect of these services in the last financial year.

2)

3)

4)

5)

Required: Write a report to directors setting out the reasons why it is important to disclose related party transactions and the nature of any disclosure required for the above transactions under IAS / FRS 24 Related Part Transactions. (25 marks)

Paper 3.6 (SGP) Mock Exam 4 JAUDEAU

Jaudeau plc is a quoted company domiciled in a country which is a member of the European Union. Mr Bernard, the finance director, has become aware of the European Commission proposal to require the consolidated financial statements of all quoted companies to be prepared in accordance with IAS by 2005. He has noted that this decision has been ratified by the European parliament in March of 2002. Mr Bernard is concerned with the effect that this is going to have on Jaudeau plc and what his organisation should be doing to prepare for the event. Ms Roulard, the chief executive of Jaudeau thinks that the EU proposal is of no consequence because local legislation requires that financial statements are prepared according to local GAAP. Mr Bernard has read a recent article in Accountancy (a well respected accounting journal) that has worried him further. The author of the article claimed that the transition to IAS was not just a matter of applying new accounting rules but had further implications. The article mentioned that organisations need to rethink the performance measures they use to communicate with stakeholders and the consequent impact on their internal reporting systems. The changeover also has implications for the information systems of organisations. Mr Bernards local accounting institute has issued an overview document in which it has identified that there will be a major impact on accounting for the following areas when organisations change from local GAAP to IAS:

Segment reporting Local GAAP requires disclosure of revenue and operating profit for business and geographical segments. The regulation applies to all companies with revenue above 5 million euro per annum but companies are allowed to ignore the requirement if they consider that it would be prejudicial to reveal the information. Deferred taxation Local GAAP requires full provision of deferred tax on timing differences. These are defined as items of income (or expense) that are charged to reported profit in one period but are taxable (allowable) in the tax computations in a different period. Recognition and measurement of financial assets Local GAAP requires that financial assets are carried at cost. Leases Local GAAP requires that all lease rentals are expensed on an accruals basis.

Required: Mr Bernard has asked you to prepare a briefing document which he can present to the management board of Jaudeau. The briefing notes should do the following: (i) (ii) (iii) (iv) Address Ms Roulards opinion, (1 mark) Explain the wider impact of the adoption of IAS as referred to in the Accountancy article (8 marks) Set out an outline action plan of what an organisation such as Jaudeau plc needs to do to prepare for the changeover, and (8 marks) Explain in brief outline the accounting impact of changing from local GAAP to IAS in each of the areas identified by the local accounting body. (You are not required to give a detailed explanation of the accounting treatment laid down by IAS, nor to address the hedging rules in IAS / FRS 39). (8 marks) (25 marks)

Paper 3.6 (SGP) Mock Exam 5 GOODGUY

Goodguy is an international group whose principal activities are the manufacture of plastics and refrigeration gases. The company runs its business in a responsible and ethical manner. It has recently published a mission statement as follows: Goodguys mission is to increase the value of our shareholders investment. We do this through sales growth, cost control and wise investment in resources. We believe that our continued commercial success is built upon our being a good corporate citizen. This means:

Ethical business practices Transparency of financial reporting Employing and maintaining a highly trained and motivated workforce Taking care of the environment

The directors of Goodguy wish to ensure that their corporate reports are of a very high quality and of maximum use to their stakeholders. The financial statements contained in the annual report are entirely IAS compliant. In fact, Goodguy have received an award given by the local regulatory authority for the quality of their IAS financial statements. They now wish to improve the quality of the information published with the financial statements and are actively considering including the following in their next financial report:

An operating review. This will try to give a detailed overview on the business performance in the year A financial review. This will analyse the financial position of the enterprise. An environmental review. This will explain the policies adopted and the practices followed by Goodguy to ensure that they fulfil their wider social responsibilities.

Goodguy have approached you to act as a consultant on this project. Required: a) b) Explain why companies like Goodguy might feel a need to improve their corporate report by providing extra information such as that above. (10 marks) Explain the purpose served by the extra information that Goodguy is planning to provide. State the information that you would expect to see in such reports. (15 marks) (25 marks)