CORPORATE REPORTING

PROFESSIONAL 1 EXAMINATION - AUGUST 2020

NOTES:
You are required to answer Questions 1, 2 and 3. You are also required to answer either Question 4 or 5.
Should you provide answers to both Questions 4 and 5, only your answer for Question 4 will be marked.

Provided are pro-forma:

Statements of Profit or Loss and Other Comprehensive Income By Expense, Statements of Profit or Loss
and Other Comprehensive Income By Function, and Statements of Financial Position.

TIME ALLOWED:
3.5 hours, plus 10 minutes to read the paper.

INSTRUCTIONS:
During the reading time you may highlight text and write notes on the examination paper, however, you
may not commence writing on the answer field until your Supervisor tells you to do so. Please read each
Question carefully.

Marks for each question are shown. The pass mark required is 50% in total over the whole paper.

You are reminded to pay particular attention to your communication skills, and care must be taken
regarding the format and literacy of your solutions. The marking system will take into account the
content of your answers and the extent to which answers are supported with relevant legislation, case
law or examples, where appropriate.

The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

 THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

CORPORATE REPORTING
PROFESSIONAL 1 EXAMINATION – AUGUST 2020

You are required to answer Questions 1, 2 and 3.

1. The following financial statements relate to Everett Plc (Everett) and its investee company, Redmond Plc
(Redmond).

Statements of Profit or Loss for year ended 31 March 2020

Everett Plc Redmond Plc

€ million € million
Revenue 900 276
Cost of Sales (420) (132)
Gross profit 480 144

Administration expenses (169) (54)

Distribution costs (35) (24)
Other income 21
Profit before taxation 297 66

Taxation (36) (6)

Profit for the year 261 60

Statements of Changes in Equity (Retained Earnings only) for year ended 31 March 2020

Everett Plc Redmond Plc

€ million € million
Balance 1 April 2019 289 57
Profit for the year 261 60
Dividends proposed (32) (24)
Balance 31 March 2020 518 93

Statements of Financial Position as at 31 March 2020

Everett Plc Redmond Plc

€ million € million

Non-current assets:
Property, plant & equipment 580 260
Investments 400 30
980 290

Current assets:
Inventories 76 34
Trade receivables 58 53
Cash & bank 20 12
154 99
Total assets 1,134 389

Page 1
 Equity:
Equity share capital of €1 each 500 200
Share premium 25 30
Retained earnings 518 93
1,043 323
Current liabilities:
Trade payables 41 32
Taxation 18 10
Dividends proposed 32 24
91 66
Total equity & liabilities 1,134 389

The following additional information is provided:

(i) Everett bought a 75% interest in the equity capital of Redmond on 1 August 2019. The cost of the investment was
€300 million, paid in cash. It was decided to apply the fair value method to calculate goodwill on acquisition. On
the acquisition date, the fair value of the non-controlling interest in Redmond was €95 million. Impairment losses
of €10.3 million have occurred since acquisition.

(ii) At the date of acquisition Redmond had some specialised equipment that was deemed to have a fair value of
€16 million in excess of its carrying value. This equipment had a 4-year useful economic life from its acquisition
date.

(iii) On an even basis over the entire year, Redmond sold goods to Everett for €12 million. Redmond earns 25%
margin on goods sold to Everett. €4 million of the goods purchased from Redmond remained in the inventory of
Everett at 31 March 2020. This inventory consisted of goods that were all purchased in the post-acquisition
period.

(iv) The remaining investments in the books of Everett consist of equity investments. These had a fair value of €96
million at 31 March 2020. No election was made under IFRS 9 to take gains or losses on any equity investments
to Other Comprehensive Income.

(v) On 31 March 2020, both companies declared and correctly recorded proposed dividends. In the case of
Redmond these were declared out of post-acquisition profits. Everett has not taken account of any dividends
receivable.

(vi) All calculations may be taken to the nearest €0.1 million. Assume all expenses and gains accrue evenly
throughout the year unless otherwise instructed. No new equity capital was issued by any group company during
the year.

REQUIREMENT:
(a) Prepare, in accordance with IFRS, the Consolidated Statement of Profit or Loss and Other Comprehensive
Income for the Everett group for year ended 31 March 2020.
(12 marks)

(b) Prepare, in accordance with IFRS, the Consolidated Statement of Financial Position for the Everett group as at
31 March 2020.
(18 marks)

[Total: 30 marks]

Page 2
2. Vernon Plc is a public listed company. Its summarised consolidated financial statements for the year ended 31
March 2020 (with 2019 comparatives) are as follows:

Vernon Group Plc: Consolidated Statements of Profit or Loss and Other Comprehensive Income for the
years ended 31 March

2020 2019
€ million € million
Revenue 836 466
Cost of sales (395) (230)
Gross profit 441 236
Operating costs (169) (78)
Gains on revaluation of financial assets 20 40
Share of results of associate company 14 0
Finance costs (30) (24)
Profit (loss) before taxation 276 174
Income tax expense (28) (21)
Profit for the year 248 153
Other Comprehensive Income

Amounts that will not be reclassified to profit or loss

Gains on revaluation of property 56 24
Total Comprehensive Income 304 177

Profit for the year attributable to:

Owners of the parent 233 153
Non-controlling interests 15 0
Profit for the year 248 153

Total Comprehensive Income for the year attributable to:

Owners of the parent 289 177
Non-controlling interests 15 0
Total Comprehensive Income for the year 304 177

Vernon Group Plc: Consolidated Statements of Financial Position as at 31 March

2020 2019
€ million € million
Non-current assets:
Property, plant and equipment 2,105 1,560
Intangible assets 145 160
Goodwill 60 0
Investment in associate company 64 0
Financial assets 210 230
2,584 1,950
Current assets:
Inventory 346 245
Trade receivables 402 341
Bank 0 65
748 651
Total assets 3,332 2,601

Equity:
Equity shares of €1 each 1,150 1,000
Share premium 500 350
Revaluation reserve 96 40
Retained earnings 973 765
2,719 2,155
Non-controlling interest 50 0
2,769 2,155

Page 3
 Non-current liabilities:
8% Debenture 2021 375 300
Current liabilities:
Trade payables and provisions 110 125
Interest payable 6 0
Bank overdraft 52 0
Current tax payable 20 21
188 146
Total equity and liabilities 3,332 2,601

The following information should be taken into account:

(i) Depreciation charged to profit or loss for the year was €235 million.

(ii) Equipment with a carrying value of €40 million was sold during the year for €56 million. Any gain or loss on
disposal has been netted off under operating costs.

(iii) The group adopts the revaluation model of IAS 16 - Property Plant & Equipment.

(iv) Intangible assets were acquired during the year at a cost of €12 million. No disposals of intangibles occurred
during the year.

(v) An associate company was purchased during the year for €54 million.

(vi) Financial assets with a carrying value of €40 million were sold during the year for €40 million. No purchase of
financial assets took place during the year.

(vii) On 1 October 2019, the group made an investment in a subsidiary. It was decided to use the proportion of net
assets method to value the non-controlling interest. The following information is relevant:

Cost of investment: €300 million cash

Percentage acquired: 80%
Assets and liabilities of acquired entity at acquisition: € million
Property plant & equipment 240
Inventory 24
Trade receivables 22
Cash and bank balances 16
Trade payables (10)
Total €292

An impairment loss was recognised on consolidated goodwill, and correctly charged to operating expenses.

REQUIREMENT:
(a) Prepare, in accordance with IFRS, the Consolidated Statement of Cash Flows for Vernon Plc for year ended 31
March 2020.
(20 marks)

(b) Analyse the consolidated statement of cash flows you have prepared and discuss any insights into the financial
health of Vernon Plc revealed by your analysis.
(10 marks)

[Total: 30 marks]

Page 4
3. The following multiple-choice question contains eight sections, each of which is followed by a choice of
answers. Each question carries equal marks.

1. The following figures appear in the inventory records of Birdie Ltd. on 31 March 2020.

Item Quantity Cost per unit in € Net Realisable Value per unit in €
R45 20 units 25 32
R46 40 units 25 22

Under IAS 2 - Inventory, what figure should be reported as inventory in the statement of financial position as at
31 March 2020?

(a) €1,380
(b) €1,500
(c) €1,520
(d) €1,640.

2. Under the IAS 32 - Financial Instruments: Presentation definition of a financial asset, which of the following would
NOT be considered a financial asset of an entity?

(a) Cash at bank.

(b) Trade receivables.
(c) Investment in the equity instruments of another entity.
(d) Debt instruments issued by the entity.

3. Eagle Ltd. offers a 12-month warranty on all goods sold. During the year ended 31 March 2020 it sold 14,000
units of product for total revenue of €700,000. At 31 March 2020, the directors estimated that 400 of these units
would prove defective within the warranty period. The average cost of repairing each defective unit is expected
to be €45 and the cost of replacing defective units is likely to be €40. There is an existing provision for warranty
costs amounting to €20,000 carried in the books at 31 March 2020. This dates from 1 April 2019.

Which of the following is the correct accounting entry to record the above information?

(a) Debit profit or loss €16,000, credit provision €16,000.

(b) Debit profit or loss €18,000, credit provision €18,000.
(c) Credit profit or loss €4,000, debit provision €4,000.
(d) Credit profit or loss €2,000, debit provision €2,000.

4. IFRS 9 - Financial Instruments: Recognition and Measurement sets out two tests which help determine whether
a financial asset should be measured at fair value or at amortised cost. The Cash Flow test requires that cash
flows from the asset must be generated from interest and principal only. The Business Model test requires that
the business plans to hold the asset to draw its contractual cash flows.

Which of the following is true?

(a) Assets that meet the Business Model test only are accounted for under the amortised cost method.
(b) Assets that meet the Cash Flow test and the business model test are accounted for at fair value.
(c) Assets that meet the Cash Flow test only are accounted for at fair value.
(d) Assets that meet neither test are accounted for under the amortised cost method.

Page 5
 The following information in respect of Albatross Ltd. is relevant to answering parts 5-8 below. Assume all relevant
information is included.

Statement of Profit or Loss and Other Comprehensive Income for year ended 31 March 2020

€ million
Sales revenue 540
Cost of sales (300)
Gross profit 240
Expenses (130)
Profit before tax 110
Taxation (14)
Profit for the year 96
Other comprehensive income 23
Total comprehensive income for the year 119

Other balances at 31 March 2020 € million

Equity capital (€0.50 each) 200
Retained earnings (net of equity dividends paid €80 million) 790
Other equity components 220
Total equity 1,210

Note: No long-term debt.

5. What was the basic earnings per share for year ended 31 March 2020, calculated in accordance with IAS 33?

(a) €0.24
(b) €0.2975
(c) €0.48
(d) €0.595.

6. If the share price is €3.50 per share on 31 March 2020 and the dividend is projected to increase by 12% what
is the prospective dividend yield for the coming year?

(a) 6.4%
(b) 7.4%
(c) 7.68%
(d) 12.8%.

7. What is the return on capital employed for the year ended 31 March 2020 (to one decimal place)?

(a) 7.9%
(b) 9.1%
(c) 9.8%
(d) None of the above.

8. The gross margin for year ended 31 March 2019 was 40%. Sales revenue for year ended 31 March 2019 was
€400 million. Which of the following is true?

(a) Gross profit has remained the same from 2019 to 2020.
(b) Cost of sales for year ended 31 March 2019 was €160 million.
(c) Gross profit has decreased from 2019 to 2020.
(d) Cost of sales for year ended 31 March 2019 was €240 million.

[Total: 20 marks]

Page 6
 Answer either question 4 or question 5
4. The International Accounting Standards Board (IASB) issued a revised version of the Conceptual Framework for
Financial Reporting in 2018. This revised framework document offers increased clarity on some matters, updates
others and provides new material to fill gaps left unanswered by previous versions of the Conceptual Framework.

It is apparent from studying the document that the qualitative characteristics of ’relevance and ‘faithful
representation’ form the basis for deciding whether information is useful. Judgments regarding the recognition,
derecognition and measurement of elements of financial statements hinge on whether such decisions improve
the usefulness of the financial statements. Information is useful if it is relevant and is faithfully representative of
reality.

REQUIREMENT:

(a) Analyse the concepts of ‘relevance’ and ‘faithful representation’ as described by the 2018 Conceptual Framework
for Financial Reporting.
(8 marks)

(b) Discuss when an asset and a liability should be recognised and derecognised in the financial statements,
according to Chapter 5 of the 2018 Conceptual Framework.
(12 marks)

[Total: 20 marks]

Page 7
5. IFRS 16 - Leases sets out guidance for accounting for contracts that are classified as leases. It can be stated that
the application of certain IFRS 16 principles is an example of “substance over form”.

On 1 April 2019, Roundpole Ltd. entered into a contract to acquire a specialised piece of equipment. The
agreement provided for 4 annual payments of €15.5 million, commencing on 31 March 2020. In addition,
payment of a deposit of €30 million was required on 1 April 2019. The agreement also provided that Roundpole
Ltd. could buy the residual asset outright at the end of the term for a nominal sum of money. At 1 April 2019, the
fair value of the equipment was €80 million. The present value of the agreed deposit & lease payments is also
€80 million. At 1 April 2019, the effective finance cost implicit in the contract is 9.2%. The equipment has a useful
economic life of 5 years.

REQUIREMENT:

(a) Critically discuss the concept of ‘substance over form’ and explain why applying the principles of IFRS 16 is a
good example of the concept being applied.
(8 marks)

(b) Demonstrate, with appropriate calculations, the accounting entries required to record the transaction above for
year ended 31 March 2020. Present relevant extracts from the Statement of Profit or Loss and Other
Comprehensive Income for the year ended 31 March 2020 and the Statement of Financial Position as at that
date.

(12 marks)

[Total 20 marks]

END OF PAPER

Page 8
 SUGGESTED SOLUTIONS
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

CORPORATE REPORTING
PROFESSIONAL 1 EXAMINATION – AUGUST 2020

SOLUTION 1

Marking Scheme:

(a) Basic consolidation (100% Everett + 100% Redmond * 8/12) 4

Removal of intra-group revenue and purchases 1
Calculation and inclusion of unrealised profit in cost of sales 1
Calculation and inclusion of depreciation on fair value adjustment 1
Inclusion of goodwill impairment 1
Inclusion of loss on remeasurement of investments 1
Calculation of NCI share in profit for year 2
Presentation 1
Subtotal 12

(b) Basic consolidation (100% Everett + 100% Redmond) 4

Calculation and inclusion of fair value adjustment within non-current assets 1
Calculation and treatment of goodwill (including NCI at acquisition date) 4
Calculation of correct investments figure 1
Elimination of unrealised profit from inventory 1
Dividends proposed 1
Retained earnings calculation and consolidation 4
NCI calculation and consolidation at reporting date 2
Presentation 1
Subtotal max 18

Total 30

SUGGESTED SOLUTION

(a) Everett Plc: Consolidated Statement of Profit or Loss and Other Comprehensive Income for year ended 31 March
2020
100% Everett + 100% Redmond * 8/12 € million
Revenue (900 + (276 * 8/12) - 8 (W5)) 1,076.0
Cost of Sales (420 + (132 * 8/12) - 8 (W5) + 1 (W5) +2.7 (W4)) (503.7)
Gross Profit 572.3
Administration expenses (169 + (54 * 8/12) + 10.3 (W1)) (215.3)
Distribution costs (35 + (24 * 8/12)) (51.0)
Other income (21) 21.0
Loss on remeasurement of financial assets W7 (4.0)
Profit before taxation 323.0
Taxation (36 + (6 *8/12)) (40.0)
Profit for the year 283.0

Profit for the year is attributable to:

Owners of the parent 276.5
Non-controlling interests W8 6.5
283.0

Page 9
(b) Everett Plc: Consolidated Statement of Financial Position as at 31 March 2020

€ million
Non current assets:
Property, plant and equipment (580 + 260 +13.3 (W4)) 853.3
Goodwill W1 61.7
Investments (400 + 30 - 300 - 4 (W7)) 126.0
1,041.0
Current assets:
Inventories (76 + 34 -1 (W5)) 109.0
Trade receivables (58 + 53) 111.0
Cash & bank (20 + 12) 32.0
252.0
Total assets 1,293.0
Equity:
Equity shares 500.0
Share Premium 25.0
Retained earnings W2 533.5
1,058.5
Non-controlling interest W3 95.5
1,154.0

Current liabilities:
Trade payables (41 + 32) 73.0
Dividends proposed (32 + 24 -18 (W6)) 38.0
Current taxation (18 + 10) 28.0
139.0
Total equity & liabilities 1,293.0

Workings:
Group structure:
Everett has 75% (controlling) equity in Redmond, bought 8 months prior to the reporting date

W1 - Goodwill on acquisition of Redmond € million

Cost of investment: 300.0
Value of NCI at acquisition (i) 95.0
Fair value of net assets at acquisition
Equity share capital 200
Share premium 30
Retained earnings (see note below) 77
Fair value adjustment (W4) 16 (323.0)

Goodwill 72.0
Impairment loss (i) (10.3)
Balance to consolidated SOFP 61.7

Action:
SOFP
Deduct from R/E of Redmond 10.3
Add to Group Non-current assets 61.7
SPLOCI
Include as expense NCI is affected 10.3

Note: Retained earnings of Redmond at acquisition are calculated from the information given in the statement of
changes in equity. Opening R/E were €57 million, but the acquisition date was 4 months later. By that date 4/12 of
the year’s profit had been earned (4/12 * 60 = 20) and no dividend had been declared or paid. Hence the retained
earnings at the acquisition date were (57 + 20) €77 million.

Page 10
W2 Retained earnings Everett Redmond
€ million € million
Balance at reporting date 518.0 93.0
less balance at acquisition (77.0)
goodwill impairment (i) (10.3)
Dividends receivable (W6) 18.0
Loss on remeasurement of investments (W7 (4.0)
Depreciation on fair value adjustment (W4) (2.7)
Unrealised profit on intra-group trading (W5) (1.0)
Subtotals 2
Consolidate Redmond (75% * 2) 1.5
Balance to SOFP 533.5

W3 - Non-controlling Interest Redmond

€ million
Balance at acquisition (W1) 95.0
Share of retained earnings of Redmond (25% * 2) 0.5
Balance to SOFP 95.5

W4 - Fair value adjustment € million

Balance at acquisition to goodwill working 16.0
Depreciation since acquisition 16 / 4 years * 8/12 (2.7)
Balance at reporting date to PPE in SOFP 13.3

Action:
SOFP
Deduct from R/E of Redmond 2.7
Add to Group PPE 13.3
SPLOCI
Include as expense (Cost of Sales) NCI is affected 2.7

W5 - Intra-group trading € million

Total goods traded intra-group 8 months post-acquisition 8.0
Unrealised profit 4 * 25% 1.0

Action:
SOFP
Deduct from R/E of Redmond 1.0
Deduct from group inventory 1.0
SPLOCI
Deduct from revenue 8.0
Deduct from cost of sales 8.0
Add to cost of sales (Redmond) NCI is affected 1.0

W6 - Intra-group dividends € million

Everett is due to receive 75% of Redmond's dividend proposed (24 * 75%) 18.0

Action:
SOFP
Add to retained earnings of Everett 18.0
Deduct from dividends proposed of Redmond 18.0
SPLOCI
No entry required

Page 11
 W7 - Investments € million
Loss on remeasurement of investments to fair value (100-97) (4.0)

Action:
SOFP
Deduct from investments 4.0
Deduct from retained earnings of Everett 4.0
SPLOCI
Include as expense NCI is not affected 4.0

W8 - Non-controlling interest in profit for year € million

Profit for year (per question) 60.0
Post acquisition portion 8/12 * 60 40.0
Goodwill impairment W1 (10.3)
Depreciation on fair value adjustment (2.7)
Unrealised profit in intra-group trading (1.0)
Adjusted profit for year 26.0
NCI percentage 25%
NCI share 6.5

Note: The adjustments affecting the subsidiary must be considered when calculating the non-controlling interest’s
share in the profit for the year. Goodwill impairment is also considered as the fair value method was used in
calculating goodwill at acquisition. Hence the impairment should be shared between all shareholders, parent and
NCI.

Study note: The consolidated statement of changes in equity links both of the above together. This was not required
by the question, but is included below in case any student might find it useful.

Everett Plc: Statement of Changes in Equity for year ended 31 March 2020

Equity SC Share P R/Earnings Subtotal NCI Total

€ million € million € million € million € million € million
Balance 1 April 2019 500.0 25.0 289.0 814.0 0.0 814.0
Acquisition 1 August ‘19 95.0 95.0
Profit for the year 276.5 276.5 6.5 283.0
Dividends proposed and paid (32.0) (32.0) (6.0) (38.0)
Balance 31 March 2020 500.0 25.0 533.5 1,058.5 95.5 1,154.0

(c) According to IFRS 9, equity investments should be carried at fair value at the reporting date. Any gain or loss on
remeasurement of the carrying value should be taken to profit or loss. Hence, this is the treatment adopted by me
in this solution.

IFRS 9 permits an entity to make an irrevocable election at the date of purchase of equity investments. The effect
of this election is that any gains or losses on remeasurement of these investments is taken to other comprehensive
income rather than to profit or loss. Had the election been made in this case, the loss of €4 million would have
been recognised in the OCI section of the performance statement.

Page 12
SOLUTION 2

Marking Scheme:

(a) Consolidated Statement of Cash Flows

Profit before tax 0.5
Finance costs 0.5
Share of results of associate 0.5
Gain on revaluation of financial assets 0.5
Depreciation 0.5
Gain on disposal of PPE 0.5
Amortisation of intangibles 1
Impairment of goodwill 1
Increase in inventory 1
Increase in trade receivables 1
Decrease in trade payables 1
Taxation paid 1
Interest paid 1
Proceeds of sale of equipment 0.5
Payments to acquire intangible assets 0.5
Payment to acquire associate 0.5
Payment to acquire subsidiary 0.5
Payments to acquire PPE 2
Dividend received from associate 1
Proceeds of sale of financial assets 0.5
Proceeds of issue of equity shares 0.5
Equity dividends paid 1
Dividends paid to Non-controlling interests 1
Proceeds of issue of debenture 0.5
Net cash flow for the year
Opening cash and cash equivalents 0.5
Closing cash and cash equivalents
Presentation 1
Subtotal 20

(b) Analysis
Ten valid points @ 1 mark each 10
Subtotal 10

Total 30

SUGGESTED SOLUTION

(a) Vernon Group Plc: Consolidated Statement of Cash Flows for year ended 31 March 2020
€ million
Operating Activities
non-cash adjustments
Profit before tax SPLOCI 276.0
Finance costs SPLOCI 30.0
Share of results of associate SPLOCI (14.0)
Gain on revaluation of financial assets SPLOCI (20.0)
Depreciation note (i) 235.0
Gain on disposal of PPE (56 - 40) (16.0)
Amortisation of intangibles W1 27.0
Impairment of goodwill W1 6.4
Increase in inventory W2 (77.0)
Increase in trade receivables W2 (39.0)
Decrease in trade payables W4 (25.0)
383.4
Taxation paid W4 (29.0)
Interest paid W4 (24.0)
Net cash flow from operating activities 330.4
Page 13
Investing Activities
Proceeds of sale of equipment note (ii) 56.0
Payments to acquire intangible assets note (iv) (12.0)
Payment to acquire associate note (v) (54.0)
Payment to acquire subsidiary 300 - 16 (284.0)
Payments to acquire PPE W1 (524.0)
Dividend received from associate W1 4.0
Proceeds of sale of financial assets note (vi) 40.0
Net cash flow from investing activities (774.0)

Financing Activities
Proceeds of issue of equity shares W3 300.0
Equity dividends paid W3 (25.0)
Dividends paid to Non-controlling interests W3 (23.4)
Proceeds of issue of debenture W4 75.0
Net cash flow from financing activities 326.6

Net cash flow for the year (117.0)

Opening cash and cash equivalents 65.0
Closing cash and cash equivalents (52.0)

Workings:
W1 - Non-current Assets PPE Intangible Goodwill Associate Financial
€ million € million € million € million € million
Balance 1 April 2019 1,560.0 160.0 0.0 0.0 230.0
Profit or loss (235.0) (27.0) (6.4) 14.0 20.0
OCI 56.0
Disposal (40.0) (40.0)
Acquisition of sub 240.0 66.4
Acquired for cash 524.0 12.0 54.0
Dividend received (4.0)
Balance 31 March 2020 2,105.0 145.0 60.0 64.0 210.0

W2 - Current assets Inventory Receivables

€ million € million
Balance 1 April 2019 245.0 341.0
Acquisition of sub 24.0 22.0
Adjustment to SOCF 77.0 39.0
Balance 31 March 2020 346.0 402.0

W3 - Equity Share Cap Share Prem Revaluation R/E NCI

€ million € million € million € million € million
Balance 1 April 2019 1,000.0 350.0 40.0 765.0 0.0
SPLOCI 56.0 233.0 15.0
Acquisition 58.4
Cash 150.0 150.0 (25.0) (23.4)
Balance 31 March 2020 1,150.0 500.0 96.0 973.0 50.0

W4 - Liabilities Debenture Payables Taxation Interest

€ million € million € million € million
Balance 1 April 2019 300.0 125.0 21.0 0.0
Profit or loss 28.0 30.0
Acquisition of sub 10.0
Cash 75.0 (29.0) (24.0)
Adjustment to SOCF (25.0)
Balance 31 March 2020 375.0 110.0 20.0 6.0

Page 14
 W5 - Acquisition (goodwill calculation)€ million
Cost of investment 300.0 Cash outflow net of cash received
Value of NCI (20% * 292) 58.4 Increase NCI
FV of NA acquired (292.0)Update relevant accounts except cash
Goodwill 66.4 Increase goodwill

(b) The following points could be made as part of a high-quality answer

The overall cash position has deteriorated over the year, going from #65 million positive to €52 million negative.
This deterioration however masks significant changes in the composition and activities of the company. There was
a significant acquisition during the year, which was cash neutral in the sense that Vernon raised €300 million in
new equity to fund a net cash outflow on the acquisition of €284 million.

The combined entity has sales revenue 80% higher than Vernon alone had the previous year. However this
understated the effect of the acquisition, as the subsidiary was acquired half way through the year. This means
only half the revenue from that company will have been included in group revenue. Hence a further significant
increase in reported revenue can be expected for the year ended 31 March 2021.

Given that the acquisition was not responsible for the reduction in cash balances, where then did it go?

Perusal of the statement of cash flows identifies a number of major outflows of cash. By far the most significant of
these is the acquisition of property plant and equipment. Over €500 million was invested in this during the year,
exceeding the depreciation charge by a significant margin. This suggests that Vernon Plc is expanding its operations
significantly. Any capital investment in excess of depreciation suggests expansion.

Working capital items have collectively absorbed €141 million. This is a very significant increase in inventory,
receivables and coupled with a reduction in trade payables, has resulted in the total cash outflow of €141 million.
This again suggests major expansion, but the company must be careful not to overtrade. Overtrading is when
operations expand beyond the ability of the available capital to support it.

In this case, whilst the rapid outflow of cash is somewhat alarming, the current ratios are solid, and the cash
generated from operations is still highly positive at €330 million. That suggests that the business is well capable of
recovering its cash flow once the increased sales and profits from the acquisition and expansion begin to flow
through as cash.

It is comforting to know the company can issue new equity as it has done so already in the current year. Also, if
there is a cash crunch for any reason, there are ample financial investments. While we have no information as to
the liquidity of these, should they be easily marketable, they do provide a buffer.

Overall, it seems that the company is suffering a temporary decline in cash availability due to massive expansion.
Should this expansion lead to greater sales and cash flows, as seems probable, the business should return to a
healthy cash position.

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SOLUTION 3

Each correct mark gains 2.5 marks. No partial marks are awarded. Workings are not marked.

1 Answer (a)

Each item is measured at the lower of cost and net realisable value. Item R45 is valued at (20 * 25) €500, and item
R46 at (40 * 22) €880. Total €1,380.

2. Answer (d)

Debt instruments issued by the entity are classified as financial liabilities.

3. Answer (c)

The required provision is the expected number of defective items times the minimum cost of honouring the
obligation. Hence 400 units * €40 or €16,000 is the required provision. As there is an existing provision of €20,000,
a reduction of €4,000 is required. This is recorded by crediting profit or loss and debiting the provision.

4. Answer (c)

If both tests are met, the amortised cost method should be used. If either or both tests is not met, the fair value
method should be used.

5. Answer (a)

IAS 33 earnings per share is defined as the profit for the year attributable to equity holders divided by the number
of equity shares. Here, that is 96 / 400 = 24c. OCI is excluded by definition.

6. Answer (a)

The projected dividend per share is 80/400 * 1.12 = 22.4c. Hence the prospective yield is 22.4/350 = 6.4%

7. Answer (b)

ROCE is the profit before interest and tax expressed as a percentage of equity plus debt. Here, that is 110 / 1,210
= 9.09%, or 9.1%.

8. Answer (d)

Gross margin of 40% implies gross profit must have been €160 million. Hence cost of sales must have been €240
million (400 – 160).

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SOLUTION 4

Marking Scheme:

(a) Relevance 4
Faithful Representation 4
Subtotal 8

(b) Recognition 6
Derecognition 6
Subtotal 12

Total 20

SUGGESTED SOLUTION

(a) Fundamental Characteristics are characteristics that distinguish useful information from that which is non-useful.
There are two such characteristics identified by the framework.

1. Relevance
Information should have the ability to influence decisions. This means it should have either predictive value
or confirmatory value. Materiality is an entity-specific aspect of relevance. Information is material if omitting
it could influence decisions that users make about a specific reporting entity.

2. Faithful representation
Information should faithfully represent the substance of what it purports to represent. This is more than just
the absence of untruthful information. It is possible to be truthful and still not be faithful to reality. Yet this does
not mean information needs to be perfectly accurate. Information often depends on estimates and the
accuracy of these estimates sometimes cannot be determined. However the information would still be
considered faithful if the uncertainties are managed honestly, and any material uncertainty disclosed. To be
faithful, information should be:

o Complete (no material information omitted);

o Neutral (cautious but unbiased estimates are used wherever necessary);
o Free from material error;
o Prepared on the basis of substance over form.

(b) Recognition of an element simply means including it in the financial statements. Derecognition means removing
an element from the financial statements. This chapter of the conceptual framework gives guidance on when to
include and remove elements from the financial statements.

These criteria mainly refer to assets and liabilities, as equity, expenses and gains are the consequences of
movements in the carrying values of assets and liabilities (as per the definitions provided by chapter 4). It is often
the case that the decision to recognise or derecognise an asset or liability automatically triggers the recognition of
a gain or loss through the operation of the double entry system.

The criteria for recognition and derecognition are based on the qualitative characteristics discussed in chapter 2,
particularly the fundamental ones.

Recognition
Recognition is defined as the process of capturing for inclusion in the financial statements an item that meets the
definition of an asset, liability, equity, income or expense. It is possible that an item that meets the definition in
chapter 4 fails to meet recognition criteria, and may not be recognised as a result.

Recognition is appropriate if it results in both relevant information about an element and a faithful representation of
those items (the fundamental qualitative characteristics of useful financial information). Remember the overall
purpose of our endeavour is to provide useful information to aid the decisions of the providers of resources to the
entity (as per chapter 1). Useful information is deemed to possess these two fundamental characteristics. Hence it
is appropriate that recognition should depend on the information provided being relevant and faithfully representing
reality.

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Recognition might not happen on the basis of relevance if there is an existence uncertainty or a low probability of
economic benefits being received by the entity. For example a customer owes the entity €10,000 but is in liquidation,
and it is considered unlikely that the debt will be recovered. No trade receivable would be recognised by the entity.

Recognition might not happen on the basis of faithful representation if there was a measurement uncertainty. An
example of this is the issue of internally generated intangibles. Existence might not be in question, but recognition
might not happen due to an inability to measure the asset’s cost or value reliably.

Derecognition
Derecognition is defined as the removal of an element from the financial statements.

For an asset, derecognition normally occurs when the entity loses control of a recognised asset. The most common
example of this is the sale of an asset. Another example is the payment to the entity of a receivable by the debtor.

For a liability, derecognition occurs when the entity no longer has a present obligation for the liability. This could be
due to discharge, when the entity performs the obligation associated with the liability, or due to changing
circumstances rendering the liability void.

For both assets and liabilities, partial derecognition is required when appropriate, for example when a liability is
partially discharged.

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SOLUTION 5

Marking Scheme:

(a) Explain “substance over form” 4

Explain why IFRS 16 is a good example of substance over form 4
Subtotal 8

(b) Journal entry to capitalise asset and liability 1

Treatment of initial deposit 1
Depreciation 2
Finance cost2
Lease payment 2
Split between current liability and non-current liability 2
Financial statement extracts 2
Subtotal 12

Total 20

SUGGESTED SOLUTION:

(a) Substance over form is a concept that is deemed essential in order that financial statements can be considered to
be a faithful representation of reality. It is mentioned in the conceptual framework as part of the qualitative
characteristics of financial information, particularly “faithful representation”.

“Form” means the legal construct of a transaction. It can be defined by contract, verbal or written, or simply implied
by the actions of the parties to the transaction.

“Substance” refers to the commercial effect of a transaction.

In most cases, the form and substance are exactly the same, and in these cases no issue arises. However,
sometimes the commercial reality of a transaction differs from its legal form. This can be due to many factors.
Examples include tax avoidance, limitation of liability, protection of legitimate interests, and indeed intentional
misrepresentation of reality.

In these cases where substance and form differ, we are required to account for transactions in accordance with
their substance.

One excellent example of a transaction where the substance differs from the form is a lease where substantially all
the economic benefits deriving from an asset are transferred from the lessor to the lessee.

The legal form of any lease is that of a rental agreement. The lessor grants the lessee the right to use the asset for
a specified period of time in return for a payment. The ownership of the asset remains with the lessor throughout.

For some leases, the commercial substance is different. The terms of some leases are such that the lessee is
effectively paying for the entire economic benefit associated with the leased asset, and it is understood that the
residual value remaining at the expiry of the lease will be negligible, or will transfer to the lessee for a nominal
payment. In this case, the commercial substance of the transaction is more like a purchase with a finance agreement
than a lease.

In the above scenario, IFRS 16 requires that the transaction be accounted for as a purchase, and the present value
of the lease payments be accounted for as a loan. This is despite the legal fact that ownership title will not transfer
to the lessee until all agreed payments have been made. The effect is that the risks and rewards are “in substance”
associated with the asset accrue to the lessee. Hence the asset should be accounted for as such.

(b)
(i) As the present value of the minimum lease payments is equal to the fair value of the leased asset we can conclude
that all the risks and rewards associated with the leased asset are borne by the lessee from the inception date.

Hence, the asset should be capitalised in the books of Roundpole Ltd on 1 April 2019, and depreciated from that
date over 5 years.

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The lease obligation should be recognised as a liability at the same date, and amortised using the effective rate of
9.2%.

Journal entries are as follows: Dr € million Cr € million

1 April 2019
Dr Property, plant & equipment 80
Cr Lease obligation 80
(acquisition of plant under lease)

Dr Lease obligation 30
Cr Cash 30
(payment of deposit required under the lease)

31 March 2020
Dr profit or loss (80 / 5 years) 16
Cr Accumulated depreciation PPE 16
(depreciation of leased asset)

Tutorial note: IFRS 16 requires that a leased asset be depreciated over the shorter of the lease term or the useful
economic life of the asset unless it is virtually certain that the option to purchase will be exercised at the end of the
lease term. If so, the useful economic life of the asset should be used. It appears to be virtually certain in this case
that the option to purchase will be exercised.

31 March 2020
Dr profit or loss (50 * 9.2%) 4.6
Cr Lease obligation 4.6
(finance cost on remaining lease obligation)

31 March 2020
Dr Lease obligation 15.5
Cr Cash 15.5

Tutorial note:
The closing lease obligation is 80 – 30 + 4.6 - 15.5 = €39.1 million
This is recorded as a liability at 31 March 2020.
In order for the liability to be recorded correctly, it must be split into current and non-current. The current liability is
the amount of the €39.1 million that will be repaid within 12 months. This is equal to €15.5 million due in 12 months
less the finance cost for the next 12 months (39.1 * 9.2% = €3.6 million). Hence the current liability will be €11.9
million.

Roundpole Ltd: Statement of Profit or Loss for year ended 31 March 2020 (Extract)
€ million
Depreciation of leased asset 16
Finance cost 4.6

Roundpole Ltd: Statement of Financial Position as at 31 March 2020 (Extract)

€ million
Non-current assets:
Property plant & equipment (80 – 16) 64

Non-current liabilities:
Lease obligation (39.1 – 11.9) 27.2

Current liabilities:
Lease obligation 11.9

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