Advanced Consolidation Question 54

QUESTION 54: ADVANCED CONSOLIDATION

The following draft group financial statements relate to Warrburt, a public limited company:

Warrburt Group: Statement of financial position as at 30 November 2008

30 Nov 2008 30 Nov 2007
$m $m
Assets
Non-current assets
Property, plant and equipment 350 360
Goodwill 80 100
Other intangible assets 228 240
Investment in associate 100 –
FVTOCI financial assets 142 150
900 850
Current assets
Inventories 135 198
Trade receivables 92 163
Cash and cash equivalents 312 323
539 684
Total assets 1,439 1,534
Equity and Liabilities
Equity attributable to owners of the parent:
Share capital 650 595
Retained earnings 391 454
Other components of equity 25 20
1,066 1,069
Non-controlling interest 70 53
Total equity 1,136 1,122
Non-current liabilities:
Long-term borrowings 20 64
Deferred tax 28 26
Long-term provisions 100 96
Total non-current liabilities 148 186
Current liabilities:
Trade payables 115 180
Current tax payable 35 42
Short term provisions 5 4
Total current liabilities 155 226
Total liabilities 303 412
Total equity and liabilities 1,439 1,534

Warrburt Group: Statement of comprehensive income for the year ended 30 November 2008
$m
Revenue 910
Cost of sales (886)
Gross profit 24
Other income 31
Distribution costs (40)
Administrative expenses (35)
Finance costs (9)
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Advanced Consolidation Question 54

Share of profit of associate 8

Loss before tax (21)
Income tax expense (31)
Loss for the year from continuing operations (52)
Loss for the year (52)
Other comprehensive income for the year (after tax):
FVTOCI financial assets gain 27
Gains on property revaluation 2
Actuarial losses on defined benefit plan (4)
Other comprehensive income for the year (after tax) 25
Total comprehensive income for the year (27)
Profit/loss attributable to:
Owners of the parent (74)
Non-controlling interest 22
(52)
Total comprehensive income attributable to:
Owners of the parent (49)
Non-controlling interest 22
(27)

Warrburt Group: Statement of changes in equity for the year ended 30 November 2008
FVTOCI Total
SC RE RS Total NCI
Reserves Equity
$m $m $m $m $m $m $m
Balance at 1 December 2007 595 454 16 4 1,069 53 1,122
Share capital issued 55 55 55
Dividends (9) (9) (5) (14)
Total comprehensive income for the (78) 27 2 (49) 22 (27)
year
Transfer to retained earnings 24 (24)
Balance at 30 November 2008 650 391 19 6 1,066 70 1,136

Note to Statement of changes in equity:

$m
Profit/Loss attributable to owners of parent (74)
Actuarial losses on defined benefit plan (4)
Total comprehensive income for year – retained earnings (78)

The following information relates to the financial statements of Warrburt:

(i) Warrburt holds FVTOCI financial assets which are owned by the holding company. The
following schedule relates to those assets.
$m
Balance 1 December 2007 150
Less sales of FVTOCI financial assets at carrying value (38)
Add gain on revaluation of FVTOCI financial assets 30
142

The sale proceeds of the FVTOCI financial assets were $45 million. Profit on the sale of
FVTOCI financial assets is shown as ‘other income’ in the financial statements. Deferred

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tax of $3 million arising on the revaluation gain above has been taken into account in ‘other
comprehensive income’ for the year. The profit held in equity on the FVTOCI financial
assets that were sold of $24 million, has been transferred to retained earnings.

(ii) The retirement benefit liability is shown as a long-term provision in the Statement of
Financial Position and comprises the following:
$m
Liability at 1 December 2007 96
Expense for period 10
Contributions to scheme (paid) (10)
Actuarial losses 4
Liability at 30 November 2008 100
Warrburt recognises actuarial gains and losses in the statement of comprehensive income
in the period in which they occur. The benefits paid in the period by the trustees of the
scheme were $3 million. There is no tax impact with regards to the retirement benefit
liability.

(iii) The property, plant and equipment (PPE) in the Statement of Financial Position comprises
the following:
$m
Carrying value at 1 December 2007 360
Additions at cost 78
Gains on property revaluation 4
Disposals (56)
Depreciation (36)
Carrying value at 30 November 2008 350

Plant and machinery with a carrying value of $1 million had been destroyed by fire in the
year. The asset was replaced by the insurance company with new plant and machinery
which was valued at $3 million. The machines were acquired directly by the insurance
company and no cash payment was made to Warrburt. The company included the net gain
on this transaction in ‘additions at cost’ and ‘other income’.

The disposal proceeds were $63 million. The gain on disposal is included in administrative
expenses. Deferred tax of $2 million has been deducted in arriving at the ‘gains on property
revaluation’ figure in ‘other comprehensive income’.

The remaining additions of PPE comprised imported plant and equipment from an overseas
supplier on 30 June2008. The cost of the PPE was 380 million dinars with 280 million
dinars being paid on 31 October 2008 and the balance to be paid on 31 December 2008.

The rates of exchange were as follows:

Dinars to $1
30 June 2008 5
31 October 2008 4·9
30 November 2008 4·8
Exchange gains and losses are included in administrative expenses.

(iv) Warrburt purchased a 25% interest in an associate for cash on 1 December 2007. The net
assets of the associate at the date of acquisition were $300 million. The associate made a

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profit after tax of $24 million and paid a dividend of $8 million out of these profits in the year
ended 30 November 2008. Assume a tax rate of 25%.

(v) An impairment test had been carried out at 30 November 2008, on goodwill and other
intangible assets. The result showed that goodwill was impaired by $20 million and other
intangible assets by $12 million.

(vi) The short term provisions relate to finance costs which are payable within six months.

Warrburt’s directors are concerned about the results for the year in the statement of
comprehensive income and the subsequent effect on the cash flow statement. They have
suggested that the proceeds of the sale of property, plant and equipment and the sale of FVTOCI
financial assets should be included in ‘cash generated from operations’. The directors are afraid of
an adverse market reaction to their results and of the importance of meeting targets in order to
ensure job security, and feel that the adjustments for the proceeds would enhance the ‘cash
health’ of the business.

Required:
(a) Prepare a group statement of cash flows for Warrburt for the year ended 30
November 2008 in accordance with IAS 7, ‘Statement of Cash Flows’, using the
indirect method. (35 marks)
(b) Discuss the key issues which the statement of cash flows highlights regarding the
cash flow of the company. (10 marks)

ACCA P2 – December 2008 – Q1a

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Advanced Consolidation Question 54

ANSWER TO QUESTION 54: ADVANCED CONSOLIDATION

Part (a)
Warrburt Group
Statement of Cash flows for year ended 30 November 2008
Cash flows from operating activities $m
Loss before taxation (21)
Adjustments:
FVTOCI financial assets W2 & (i) (7)
Retirement benefit expense (ii) non cash 10
Depreciation (iii) 36
Profit on sale of PPE W5 & (iii) (7)
Exchange loss W6 & (iii) 2
Gain on insurance proceeds (3 – 1) W4 & (iii) (2)
Associate’s profit (iv) (8)
Impairment of goodwill and intangible assets 20 + 12 (v) 32
Finance costs (SPL) 9
Other investment income (i) [31 – 7 profit on disposal – 2 insurance] (22)
Operating profit before working capital changes 22
Decrease in trade receivables 163 – 92 71
Decrease in inventories 198 - 135 63
Decrease in trade payables W8 & (iii) (86)
Cash generated from operations 70
Cash paid to retirement benefit scheme (ii) (10)
Finance costs paid W9 & (vi) (8)
Income taxes paid W10 (39)
Net cash from operating activities 13

Cash flows from investing activities

Sale of FVTOCI financial assets W2 & (i) 45
Purchase of property, plant and equipment (PPE) W6 & (iii) (57)
Proceeds from sale of PPE W5 & (iii) 63
Dividend received from associate W7 & (iv) 2
Purchase of associate W7 & (iv) (96)
Other investment income received (as calculated above) 22
Net cash used in investing activities (21)

Cash flows from financing activities

Proceeds of issue of share capital (SCE) 55
Repayment of long term borrowings 64 – 20 (44)
Non-controlling Interest dividend (SCE) (5)
Dividends paid (SCE) (9)
Net cash used in financing activities (3)

Net decrease in cash and cash equivalents (11)

Cash and cash equivalents at beginning of period 323
Cash and cash equivalents at end of period 312

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Advanced Consolidation Question 54

W1 FVTOCI Investments W2 Disposal of FVTOCI Investments

b/d 150 Disposal β 38 Investments W1 38 Cash 45
Gain 30 c/d 142 P&L β 7
180 180 45 45

W3 PPE W4 Disposal Machinery

b/d 360 Disposal Other 56 Carrying value 1 Insurance claim 3
Insurance 2 Depreciation 36 P&L 2
Overseas 76 3 3
Revaluation 4 c/d 350
442 442

W5 Disposal Other W6 PPE Payable

Carrying value 56 Cash 63 Cash 57 PPE Addition 76
P&L 7 [D280/4.9] [D380 / 5]
63 63 E. Loss - settle 1
57 – [D280/5]
Exchange Loss
– closing
c/d [d100/4.8] 21 21 – [100/5] 1
78 78

W7 Investment in associate W8 Payable

b/d 0 Share of tax 2 Cash β 86 b/d 180
Cash β 96 ($8 x 25%) c/d 115 – 21 W6 94
Share of profit 8 Cash dividend 2 180 180
($8 x 25%)
c/d 100
104 104

W9 Finance cost provision W10 Tax

Cash 8 b/d 4 Associate 2 b/d 26
c/d 5 P&L 9 Cash 39 b/d 42
13 13 P&L 31
OCI (i) 3
c/d 28 OCI (iii) 2
c/d 35
104 104

W11 Revaluation surplus

Deferred tax 2 b/d 4
c/d 6 P&L 4
8 8

Part (b)
Financial statement ratios can provide useful measures of liquidity but an analysis of the
information in the cash flow statement, particularly cash flow generated from operations, can
provide specific insights into the liquidity of Warrburt. It is important to look at the generation of
cash and its efficient usage. An entity must generate cash from trading activity in order to avoid

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the constant raising of funds from non-trading sources. The ‘quality of the profits’ is a measure of
an entity’s ability to do this. The statement of cash flow shows that the company has generated
cash in the period despite sustaining a significant loss ($92m cash flow but $21m loss). The
problem is the fact that the entity will not be able to sustain this level of cash generation if losses
continue. An important measure of cash flow is the comparison of the cash from operating activity
to current liabilities. In the case of Warrburt, this is $92m as compared to $155m. Thus the cash
flow has not covered the current liabilities.

Operating cash flow ($92 million) determines the extent to which Warrburt has generated sufficient
funds to repay loans, maintain operating capability, pay dividends and make new investments
without external financing. Operating cash flowappears to be healthy, partially through the release
of cash from working capital. This cash flow has been used to pay contributions to the pension
scheme, pay finance costs and income taxes. These uses of cash generated would be normal for
any entity. However, the release of working capital has also financed in part the investing activities
of the entity which includes the purchase of an associate and property, plant and equipment. The
investing activities show a net cash outflow of $43 million which has been financed partly out of
working capital, partly from the sale of PPE and FVTOCI financial assets and partly out of cash
generated from operations which include changes in working capital. It seems also that the issue
of share capital has been utilised to repay the long term borrowings and pay dividends. Also a
significant amount of cash has been raised through selling FVTOCI investments. This may not
continue in the future as it will depend on the liquidity of the market.

This action seems to indicate that the long term borrowings have effectively been ‘capitalised’. The
main issue raised by the cash flow statement is the use of working capital to partially finance
investing activities. However, the working capital ratio and liquidity ratios are still quite healthy but
these ratios will deteriorate if the trend continues.

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