JS20/SBR/ME2

Thursday 02 July 2020

Please attempt all questions

Duration 3 hours 15 minutes

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This is a blank page.

Question 1 begins on page 3

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Section A – BOTH questions are compulsory and MUST be attempted

1 Trailer

(a) Trailer, a public limited company, operates in the manufacturing sector. Trailer
purchased an investment in part during the reporting period. Extracts from the draft
statements of financial position at 31 May 20X3 are as follows:

Trailer Park
EQUITY
Share capital 1,750 1,210
Retained earnings 1,240 930
Other components of
equity 125 80
TOTAL EQUITY 3,115 2,220

The following information is relevant to the preparation of the group financial

statements:

1. Trailer has made a loan of $50 million to a charitable organisation for the building
of new sporting facilities. The loan was made on 1 June 20X2 and is repayable on
maturity in three years’ time. The interest rate on the loan is 3%, but Trailer
assesses that an unsubsidised rate for such a loan would have been 6%. The first
interest payment was made on 31 May 20X3. Trailer initially recorded a financial
asset at $50 million and reduced this by the interest received during the period.
The loss allowance has been correctly dealt with.

2. Trailer has announced two major restructuring plans. The first plan is to reduce
its capacity by the closure of some of its smaller factories, which have already
been identified. This will lead to the redundancy of 500 employees, who have all
individually been selected and communicated with. The costs of this plan are $14
million in redundancy costs and $4 million in retraining costs. The second plan is
to re-organise the finance and information technology department over a one-
year period but it does not commence for two years. The plan results in 20% of
finance staff losing their jobs during the restructuring. The costs of this plan are
$10 million in redundancy costs and $6 million in retraining costs. No entries have
been made in the financial statements for the above plans.

3. On 1 June 20X2, Trailer acquired 60% of the equity interests of Park, a public
limited company. The purchase consideration comprised cash of $1,250 million.
On 1 June 20X2, the fair value of the identifiable net assets acquired was $1,950
million and retained earnings of Park were $650 million and other components of
equity were $55 million. The excess in fair value is due to plant and machinery
with a remaining useful life of 7 years as at the acquisition date. It is the group’s
policy to measure the non-controlling interest (NCI) at acquisition at its
proportionate share of the fair value of the subsidiary’s net assets.

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4. The goodwill of Park was impairment tested at 31 May 20X3. The recoverable
amount of the net assets of Park was $2,083 million. There was no impairment of
the net assets of Park before this date.

Required:

(i) Discuss, with suitable workings, how the loan to the charitable organisation
(note 1) should be dealt with in the consolidated financial statements for the
year ended 31 May 20X3. (6 marks)

(ii) Discuss how the restructuring plans (note 2) should be dealt with in the
consolidated financial statements for the year ended 31 May 20X3. (6 marks)

(iii) Prepare the equity section of the consolidated statement of financial position
as at 31 May 20X3. (13 marks)

(b) It is the Trailer group’s policy to measure the NCI at acquisition at its proportionate
share of the fair value of the subsidiary’s net assets. The directors of Trailer have used
this policy for several years and do not know the implications, if any, of accounting for
the NCI at fair value. The fair value of the NCI of Park at 1 June 20X2 was $800 million.

Required:

Explain to the directors, with suitable calculations, the impact on the financial statements
if goodwill arising on the acquisition of Park had been calculated using the fair value of the
NCI. (5 marks)

(Total: 30 marks)

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2 May

May plc is a multi-national European company. Paul has just been appointed as the financial
controller reporting to the finance director. The finance director has asked Paul to review the
draft financial statements.

May plc has a defined benefit plan for its employees. At the reporting date the plan has a
surplus of $200 million, all of which is recognised as an asset in the statement of financial
position. The terms of the pension fund stipulate that no refunds can ever be repaid to the
company, and owing to the minimum funding requirements reduced payments can only be
marginally reduced and the present value of this benefit has been estimated at $150 million.

At the start of the accounting period May plc has implemented a share option plan for key
employees. Under the terms of the plan staff were granted options to subscribe to the
company’s shares for $10 per share in three years time. At the reporting date the company’s
share price has fallen to $8 per share. On this basis the finance director considers that at the
reporting date these options have no value and accordingly their issue has not been reflected
in the financial statements.

During the reporting period May plc received notification that a former customer was suing
May plc for breach of contract and claiming material damages. The finance director has
reviewed the case and taken legal advice. It is likely that the claim against May plc will
succeed. Shortly after the reporting date court papers were filed claiming damages against
May plc of $400 million. A contributory factor to the breach of contract was that goods
supplied to May plc were sub-standard. The legal advice is that if May plc does eventually lose
the case against the former customer then May plc will probably be able to recover 100% of
the damages against the supplier of the faulty goods. On the basis that at the reporting date
there was not a reliable measure of the claim and that May plc has a claim against the supplier
the finance director has not made a provision.

Revaluation gains on property plant and equipment have been recognised directly in equity
and reported in the statement of other comprehensive income where they have been
included under a sub-heading entitled gains that can be reclassified to profit or loss. The
finance director has not provided for any deferred tax liability and tax charge on these gains
on the basis that there is no present obligation to sell these assets and therefore no liability
exists as there is no present obligation to pay tax.

Required:

Discuss the ethical and accounting implications of the above situations from the perspective
of the financial controller Paul.
(Consider the courses of action open to him and the potential impact on stakeholders if the
finance director’s suggested accounting treatments are adopted in the final financial
statements)
A maximum of 2 professional marks will be awarded for clarity in presentation and answer.
(20 marks)

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Section B – BOTH questions are compulsory and MUST be attempted

Q3

a) Transport is a public limited company and currently seeking advice on several financial issues.
Transport identified the following operating segments.

(i) Segment 1 local train operations

(ii) Segment 2 inter-city train operations
(iii) Segment 3 railway constructions

The finance director has determined that segments 1 and 2 should be aggregated into a single
reportable operating segment on the basis of their similar business characteristics, and the
nature of their products and services.

The characteristics of each market are as follows:

 Local train market: the local transport authority awards the contract and pays Transport
for its services; contracts are awarded following a competitive tender process; the ticket
prices paid by passengers are set by and paid to the transport authority.

 Inter-city market: ticket prices are set by Transport and the passengers pay Transport for
the service provided.

The managing director is pleased about this as segment 1 has seen a sharp decline in profits
during the year, whereas segment 2 has shown improved margins. The managing director does
not believe that segment information is relevant to investors, he believes that investors simply
provide funds and are not interested in how management derives a return from them.

Required:

(i) Discuss whether it is appropriate to aggregate segments 1 and 2 with reference to IFRS 8
Operating Segments. (4 marks)

(ii) Discuss, with reference to Transport, whether the disclosure of segment information is
relevant to an investor’s appraisal of the financial statements and comment on the
managing director’s opinion that investors are not interested in how management
derives a return from their investment. (4 marks)

b) Stone has recently employed a new managing director. The managing director has convinced
the board that investment in a new cryptocurrency, iCoin, would generate excellent capital
gains. Consequently, Stone purchased 50 units of iCOin for $250,000 on 20 December 2011. The
finance director has expressed concern about how to report this investment in Stone’s 31
December 2011 financial statements. Given the lack of an accounting standard for such
investments, he sees no alternative but to include it as a cash equivalent. As the amount
invested is less than the quantitative threshold Stone has used to assess materiality, he is not
planning to provide any further information about the investment in the financial statements.

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Required:

(i) In the absence of a specific accounting standard on cryptocurrencies, discuss how Stone
should determine how to account for the investment in iCoin under IFRS Standards.
(4 marks)
(ii) Discuss the finance director’s decision not to provide any further disclosures about the
investment in the financial statements, making reference to IFRS Practice Statement 2
Making Materiality Judgements. (4 marks)

c) Uni meets the definition of a small entity in its jurisdiction and complies with the IFRS for SMEs
standard. Uni has entered into the following transactions during the year ended 31 May 2016.

(i) Uni requires a new machine, which will be included as part of its property, plant and
equipment. Uni therefore commenced construction of the machine on 1 February 2016,
and this continued until its completion which was after the year end 31 May 2016. The
direct costs were $2 million in February 2016 and the $1 million in each subsequent
month until the year end. Uni has incurred finance costs on its general borrowings during
the period, which would have been avoided if the machine had not been constructed.
Uni has calculated that the weighted average cost of borrowings for the period 1 February
– 31 May 2016 on an annualised basis amounted to 9% per annum.

(ii) Uni has incurred $1 million of research expenditure to develop a new product in the year
to 31 May 2016. Additionally, it incurred $0.5 million of development expenditure to
bring another product to a stage where it is ready to be marketed and sold.

Required:

(i) By reference to relevant accounting standards, advise the directors of Uni on how notes
i and ii would be accounted for in the year ended 31 May 2016. (6 marks)

(ii) Discuss how the two transactions would be dealt with under IFRS for SMEs in the year
ended 31 May 2016. (3 marks)

(Total: 25 marks)

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Q4
a) Super operates in the power industry, and owns 45% of the voting shares in Extra. Extra has
four other investors which own the remaining 55% of its voting shares and are all technology
companies. The largest of these holdings is 18%. Extra is a property developer and purchases
property for its renovation potential and subsequent disposal. Super has no expertise in this
area and is not involved in the renovation or disposal of the property. The board of directors of
Extra makes all of the major decisions but Super can nominate up to four of the eight board
members. Each of the remaining four board members are nominated by each of the other
investors. Any major decisions require all board members to vote and for there to be a clear
majority. Thus, Super has effectively the power of veto on any major decision. There is no
shareholder agreement as to how Extra should be operated or who will make the operating
decisions for Extra. The directors of Super believe that Super has joint control over Extra
because it is the major shareholder and holds the power of veto over major decisions. The
directors of Super would like advice as to whether they should account for Extra under IFRS® 11
Joint Arrangements. (6 marks)

b) Focus is a public limited entity. It designs and manufactures children’s toys. It has a reporting
date of 31 December 2017 and prepares its financial statements in accordance with
International Financial Reporting Standards. The directors require advice about the following
situations.

(i) Focus sells $50 gift cards. These can be used when purchasing any of Focus’s products
through its website. The gift cards expire after 12 months. Based on significant past
experience, Focus estimates that its customers will redeem 70% of the value of the gift
card and that 30% of the value will expire unused. Focus has no requirement to remit
any unused funds to the customer when the gift card expires unused. The directors are
unsure about how the gift cards should be accounted for. (6 marks)

(ii) Focus’s best-selling range of toys is called Paw. In 2016 Luna, another listed company,
entered into a contract with Focus for the rights to use Paw characters and imagery in
a monthly comic book. The contract terms state that Luna must pay Focus a royalty fee
for every issue of the comic book which is sold. Before signing the contract, Focus
determined that Luna had a strong credit rating. Throughout 2016, Luna provided Focus
with monthly sales figures and paid all amounts due in the agreed-upon period. At the
beginning of 2017, Luna experienced cash flow problems. These were expected to be
short term. Luna made nominal payments to Focus in relation to comic sales for the
first half of the year. At the beginning of July 2017, Luna lost access to credit facilities
and several major customers. Luna continued to sell Paw comics online and through
specialist retailers but made no further payments to Focus. The directors are unsure
how to deal with the above issues in the financial statements for the year ended 31
December 2017. (6 marks)
Required:

Advise the accountant on the matters set out above with reference to International
Financial Reporting Standards

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c) The directors of Lullaby Co consider environmental, social and governance issues to be

extremely important in a wide range of areas, including new product development, reputation
building and overall corporate strategy. The company is taking a proactive approach to
managing sustainability and is actively seeking opportunities to invest in sustainable projects
and embed them in their business practices. The company’s financial year end is 30 September
2015.

Lullaby Co is worried that the poor remuneration package offered to employees is putting the
company at risk of reputational damage. Consequently, Lullaby Co changed its pension scheme
on 30 September 2015 to include all of its staff. The benefits accrue from the date of their
employment but only vest after two years additional service from 30 September 2015. The net
pension obligation at 30 September 2015 of $78 million has been updated to include this
change. During the year, benefits of $6 million were paid under the scheme and Lullaby Co
contributed $10 million to the scheme. These payments had been recorded in the financial
statements. The following information relates to the pension scheme:

$m
Net pension obligation at 30 September 2015 78
Net pension obligation at 30 September 2014 59
Service cost for year 18
Past service cost relating to scheme amendment at 30 September 2015 9
Discount rate at 30 September 2014 5.5%
Discount rate at 30 September 2015 5.9%

Required:

Advise Lullaby Co on the principles of accounting for the pension scheme, including calculations,
for the year to 30 September 2015. (7 marks)

(25 marks)
(Total: 100 marks)

End of questions