CHARTERED ACCOUNTANTS EXAMINATIONS

LICENTIATE LEVEL

L1: FINANCIAL REPORTING

SERIES: JUNE 2013

TOTAL MARKS – 100 TIME ALLOWED: THREE (3) HOURS

INSTRUCTIONS TO CANDIDATES

1. You have fifteen (15) minutes reading time. Use it to study the examination paper
carefully so that you understand what to do in each question. You will be told when
to start writing.

2. This paper is divided into TWO sections:

Section A: Two Compulsory Questions.

Section B: Three (3) Optional Questions. Attempt any Two (2).

3. Enter your student number and your National Registration Card number on the front
of the answer booklet. Your name must NOT appear anywhere on your answer
booklet.

4. Do NOT write in pencil (except for graphs and diagrams).

5. The marks shown against the requirement(s) for each question should be taken as
an indication of the expected length and depth of the answer.

6. All workings must be done in the answer booklet.

7. Present legible and tidy work.

8. Graph paper (if required) is provided at the end of the answer booklet.
SECTION A

ATTEMPT BOTH QUESTIONS IN THIS SECTION

QUESTION ONE

Given below are the summarised financial statements for Mukuni, Kaindu and Bunda for the
year ended 31 December 2012.

Income Statements for the year ended 31 December 2012

Mukuni Kaindu Bunda

K'm K'm K'm
Revenue 72,000 28,000 19,000
Cost of sales (50,000) (20,000) (13,000)
Gross profit 22,000 8,000 6,000
Operating expenses (7,000) (2,000) (1,000)
Profit before tax 15,000 6,000 5,000
Income tax expense (4,000) (2,000) (1,500)
PROFIT FOR THE YEAR 11,000 4,000 3,500

Statements of financial position as at 31 December 2012

Mukuni Kaindu Bunda

K'm K'm K'm
Non-current assets
Property, plant and equipment 23,000 15,600 10,400
Investments 6,500 – –
29,500 15,600 10,400
Current assets 18,000 8,400 4,600
Total assets 47,500 24,000 15,000
Equity
Share capital – ordinary shares of K1 each 7,000 2,000 2,000
Retained earnings 31,000 19,000 10,200
38,000 21,000 12,200
Current liabilities 9,500 3,000 2,800
Total equity and liabilities 47,500 24,000 15,000

The following information is relevant:

1. Mukuni acquired 1,200 million K1 ordinary shares in Kaindu on 1 January 2010 on
the following terms:

 an immediate cash payment of K4,300m;and

 a share exchange of two shares in Mukuni for every three shares in Kaindu.

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 The stock market price of Mukuni’s shares at 1 January 2010 was K10 per share. At
that date Kaindu had retained earnings of K10,500 million.

The immediate payment has been recorded in Mukuni’s financial statements, but the
share issue has not been recorded.

Mukuni acquired 500 million K1 ordinary shares in Bunda on 1 July 2010 at a cost of
K4.40 per share when the retained earnings of Bunda stood at K4,000 million.
Mukuni has significant influence over the operations of Bunda.

2. The fair value of Kaindu’s assets were equal to their book values at the date of
acquisition with the exception of its plant which had a fair value of K2,000
million in excess of its book value. The remaining life of the plant had been 5
years at the date of acquisition and this period has not changed as a result of
the acquisition. Depreciation of plant is on the straight line basis and charged to
cost of sales. Kaindu has not adjusted the value of its plant as a result of the fair
value exercise.

Group policy is to measure non-controlling interests at the date of acquisition at

fair value. The non-controlling interests on the acquisition of Kaindu were
measured at their fair value of K8 per share.

3. During the year Kaindu sold goods to Mukuni with a selling price of K8,000
million. These sales were made at a profit margin of 25%. At 31 December 2012
one quarter of these goods were still in the inventories of Mukuni, but they have
already been paid for.

4. During the year Bunda sold goods to Mukuni for K1,800 million. These goods
were sold at a mark-up on cost of 20%. At 31 December 2012 Mukuni still held
all of these goods in its inventories.

5. At 31 December 2012 the directors of Mukuni carried out an impairment review

and determined that the recognised goodwill in Kaindu had been impaired by
K200 million. There had been no impairment loss on the investment in Bunda.

Required:

(a) Discuss how the investments made by Mukuni in Kaindu and Bunda should be
treated in Mukuni’s consolidated financial statements. (4 marks)

(b) Prepare a consolidated income statement for the year ended 31 December
2012 and a consolidated statement of financial position at that date for the
Mukuni Group. (26 marks)

(Total 30 marks)

3
QUESTION TWO

The following trial balance relates to Nabwalya plc as at 31st March 2010.

K’m K’m
Revenue 2,080
Cost of sales 1, 171.6
Distribution costs 30.4
Administration expenses 79.2
Loan interest paid 19.2
Property:
Cost 800
Accumulated depreciation at 1st April 2009 150
Plant and equipment
Cost 674.4
Accumulated depreciation at 1st April 2009 194.4
Licence:
Cost 160
Amortization at 1st April 2009 64
Trade receivables 172.8
Inventory at 31st March 2010 75.2
Bank 7.8
Trade payables 140.8
Equity shares of K280 per share 280
Share premium 52
12% loan note (Issued 1 April 2009) 160
Taxation 8
Retained earnings at 1 April 2009 _______ 45.8
3,182.80 3,182.80

Additional information

(a) On 1st April 2009, Nabwalya plc revalued its property to K960 million, of which K240
million relates to the land. The property’s original cost on 1st April 1999 of K800
million included K200 million for the land.
(b) The building had an estimated life of 40 years when it was acquired and this has not
changed as a result of the revaluation. Depreciation is charged on a straight line
basis. The revaluation has not yet been recorded in the books. Nabwalya plc has a
policy of transferring any excess depreciation to retained earnings.

(c) During the year, Nabwalya plc sold some plant that cost K80 million on 1st December
2007. The proceeds of this sale were K48 million and these have been credited to
cost of sales. No other entries have been made relating to the disposal.

(d) Plant and equipment is to be depreciated on the reducing balance basis at a rate of
20% per annum. Nabwalya plc charges a full year’s depreciation in the year of
acquisition and none in the year of disposal.

(e) The licence is being amortised on the straight line basis at a rate of 20% per annum.

(f) All depreciation and amortization is to be charged to cost of sales.

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(g) The directors have estimated the provision for income tax for the year to 31st March
2010 at K50.8 million.

(h) Nabwalya plc has not paid an ordinary dividend during the year, just before the year
end the directors declared a dividend of K224 per share.

Required:

(i) Prepare the Nabwalya Plc Statement of Comprehensive income for the year
ended 31st March 2010. (12 marks)

(ii) Prepare the Nabwalya plc Statement of Changes in Equity for the ended 31st
March 2010; and (6 marks)

(iii) Prepare the Nabwalya Plc Statement of Financial Position as at 31st March
2010, in a form suitable for presentation to the shareholders and in accordance
with the requirements of international accounting standards. (12 marks)

(Total: 30 marks)

5
SECTION B
Attempt any two (2) questions in this section.

QUESTION THREE

Musole limited has a central warehouse and office and nine retail selling branches spread
across the country, in each of the nine provincial capitals of Zambia.

Branches are notified of the expected selling price of goods sent from head office and prices
can be reduced only by agreed procedure, head office being informed of the details.

All accounting records are kept at head office. Credit up to an agreed limit can be given at
the branches, the head office sending out invoices and statements following advice from
branches.

Accounts are kept in such a way as to enable actual inventory (at selling price) to be
checked at intervals. Whilst head office have information accessible on the cost price as well
as the selling price of goods sent to branches, for other purposes an average mark up of
50% on cost is assumed.

The following figures relate to one of the branches of Musole limited branch for the year
ended 31st March 2010.
Selling price
K’m
Opening inventory 1 April 2009 (cost K61,000 million) 91,500
Goods from head office (cost K548,200 million) 822,300
Transfer to other branches 7,500
Transfer from other branches 6,000
Returns to head office 12,000
Increases in selling price for goods already at branch as

Notified by head office 4,300

Reductions in selling price notified to head office 22,500
Credit sales at branch 106,500
Returns by credit customers to branch 3,000
Cash sales 662,000
Closing inventory (actual) 107,100

Required:

(a) Prepare the following branch accounts:

(i) Branch inventory account (6 marks)
(ii) Goods sent to branch (2 marks)
(iii) Branch mark up account (3 marks)

(b) Explain briefly two main approaches used to account for inventory loss or damage
under branch accounts. (4 marks)

(c) Explain any five (5) key differences between public and private sector entities.
(5 marks)
(Total: 20 marks)

6
QUESTION FOUR

You are the newly appointed Chief Financial Officer of Mbuji plc, a well known construction
company. The following two transactions have been brought to your attention:

1. Mbuji plc entered into an agreement with Ntongo Estates Ltd to lease office space
on 1 April 2011 for a fixed period of five years. Ntongo Estates is responsible for
insurance, repairs and maintenance of the asset. As an incentive to the lessee, the
lessor granted Mbuji plc a one year rent free period at the commencement of the
agreement. In addition, Mbuji plc would be required to pay an annual rental fee of
K180 million from 1 April 2012 in arrears.

2. Mbuji Ltd entered into another lease agreement on 1 October 2011 with Chivweka
Finance Plc. The agreement was to lease a block making machine with a market
price of K2, 000 million. The machine was modified slightly for Mbuji Ltd’s use, the
cost of which was incorporated into the rentals. Mbuji Ltd is responsible for insuring
the machine over the lease term and will undertake regular maintenance checks.
The lease requires five annual payments of K500 million payable in advance,
commencing on 1 October 2011. Mbuji Ltd is expected to return the machine at the
end of the five year period. This type of lease has an implicit interest rate of 12.5%.

Required:

(a) Explain the key features of a finance lease and operating lease and state, with
reasons how Mbuji’s two leases would be categorised according to IAS 17 Leases.
(10 marks)

(b) Prepare extracts of the financial statements for Mbuji plc for the year ended 31
March 2012 (10 marks)
(Total: 20 marks)

7
QUESTION FIVE

The following are extracts of Chinyama plc as at 31 December 2009.

Statement of financial position as 31 December 2009 K’000

Ordinary shares (K0.50) 100,000
Share premium 50,000
Retained earnings 30,000
Shareholders’ funds 180,000

The profit for the years ended 31 December 2009 and 2010 was K400 million and K450
million respectively.

On 31 March 2010, the company made a 1 for 4 rights issue at a price of K200 each. The
cum rights price was K350 each.

Required:

(a) Calculate the earnings per share for the year ended 31 December 2010 and the
restated earnings per share for the year ended 31 December 2009. (8 marks)

(b) Briefly explain the benefits and drawbacks of cash and accruals basis of accounting
as applied in public sector accounting. (8 marks)

(c) Describe the circumstances under which intangible assets should be recognised and
the accounting treatment allowed as per IAS 38 for business research and
development costs. (4 marks)

(Total: 20 marks)

END OF PAPER

8
 L1

FINANCIAL REPORTING

SUGGESTED SOLUTIONS
JUNE 2013

9
Solution 1

(a) Mukuni owns 1,200 million of the K1 ordinary shares in Kaindu which is a 60%
holding. Normally such a holding would give Mukuni control of Kaindu meaning that Mukuni
has the ability to direct the operating and financial policies of Kaindu. If, as is likely, this is
the case then Kaindu would be a subsidiary of Mukuni. In which case Mukuni must prepare
consolidated financial statements for itself and Kaindu as though they were a single
economic entity. (2 marks)

Mukuni also owns 500 million of the K1 ordinary shares in Bunda which gives Mukuni a 25%
holding. This will not in normal circumstances allow Mukuni to have control over Bunda but
it will normally mean that Mukuni has significant influence over Bunda’s operating and policy
decisions which would mean that Bunda will be an associate of Mukuni. According to IAS 28
Investments in Associates and joint ventures Bunda will be included in the consolidated
financial statements of Mukuni using the equity method of accounting. (2 marks)

b) Mukuni Group
Consolidated income statement for the year ended 31 December 2012
K'm
Revenue (72,000 + 28,000 – (W3) 8,000) 92,000 2
Cost of sales (50,000 + 20,000 – (W3) 8,000 + (W3) 500 + (W2) 400) (62,900) 3
Gross profit 29,100
Impairment of goodwill (200) ½
Operating expenses (7,000 + 2,000) (9,000) 1
Share of profit of associate ((3,500 x 25%) – (W3) 75) 800 1½
Profit before tax 20,700
Income tax expense (4,000 + 2,000) (6,000) ½
PROFIT FOR THE YEAR 14,700
Profit attributable to:
Owners of the parent 13,540 ½
Non-controlling interests [(4,000 – (W3) 500 – (W2) 400) x 40%] - 1,160 2
(W7)80
14,700
TOTAL 11 MARKS

10
Mukuni Group
Consolidated statement of financial position as at 31 December 2012

K'm
Non-current assets
Property, plant and equipment (23,000 + 15,600 + (W2) 800) 39,400 1½
Goodwill (W4) 4,000 3
Investment in associate (W5) 3,750 1½
47,150
Current assets (18,000 + 8,400 – (W3) 500 – (W3) 75) 25,825 1½
72,975
Equity attributable to owners of the parent
Share capital – ordinary shares of K1 (7000 + W4 800) 7,800 1½
Share premium W4 7,200 1
Retained earnings (W6) 36,435 3
51,435
Non-controlling interests (W7) 9,040 1½
60,475
Current liabilities (9,500 + 3,000) 12,500 ½
72,975

TOTAL: 15 MARKS
Workings
1) Group structure

Mukuni

60% 25%

Kaindu Bunda

2. Fair value adjustments

Acquisition Movement Year

11
 end
K'm K'm K'm
Plant 2,000 *(1,200) 800
2,000 (1,200) 800

* 2,000m/5 years = K400m per annum x 3 years

3. Intragroup trading
Cancel intragroup sale/purchase:
K'm
DR Group revenue 8,000
CR Group cost of sales 8,000

Eliminate unrealised profit:

K'm
DR Cost of sales/retained earnings of Kaindu (8,000 x 25% x 1/4) 500
CR Group inventories 500

K'm
DR Cost of sales of Bunda/Group ret'd earnings (1,800 x 20%/120% x
25% share) 75
CR Group inventories (as Mukuni holds the inventories) 75

4.Goodwill in Kaindu
K'm K'm
Consideration transferred
Cash 4,300
Shares (2/3x1,200mx10) 8,000
Non-controlling interests (800m shares x K8) 6,400
Fair value of identifiable net assets at acq'n:
Share capital 2,000
Retained earnings 10,500
Fair value adjustment (W7) 2,000
(14,500)
Goodwill at acquisition 4,200
Less: impairment loss (200)
Goodwill at year end 4,000

Share issue will be recorded as follows (in Mukuni's books) K'm

DR Investment 8,000
CR Share capital (2/3x 1,200 x 1) 800
CR Share premium (2/3x 1,200 x 9) 7,200

5. Investment in associate

12
 K'm
Cost of associate 2,200
Group share of post acquisition profits (W6) 1,550
3,750

6. Retained earnings
Mukuni Kaindu Bunda
K'm K'm K'm
Per question 31,000 19,000 10,200
Provision for unrealised profit (W3)
(75) (500)
Fair value movement (W2) (1,200)
Pre-acquisition retained earnings (10,500) (4,000)

6,800 6,200
Group share of post acq'n ret'd earnings:
Kaindu (6,800 x 60%) 4,080
Bunda (6,200 x 25%) 1,550
Impairment loss (60%x200) (120)
36,435

7.Non-controlling interests
K'm
NCI at acquisition (W4) 6,400
NCI share of post acq'n ret'd earnings (6,800 W6 x 40%) 2,720
NCI share of goodwilll impairment (200x 40%) (80)
9,040

13
Solution 2

(a)

Nabwalya plc:

Statement of Comprehensive Income for Nabwalya plc for the year ended 31
march 2010.
K’m
Revenue 2,080.00 ½
Cost of sales (w1) (1,364.56) 7
Gross profit 715.44
Distribution costs (30.40) ½
Administrative expenses (79.20) ½
Operating profit 605.84
Finance costs (19.20) 1
Profit before tax 586.64
Income tax (50.8 - 8) (42.80) 1½
Profit for the year 543.84
Other comprehensive income - revaluation surplus 310.00 1

Total comprehensive income 853.84

(12 marks)
(b) Nabwalya plc
Statement of Changes in Equity for the year ended 31 March 2010

Share Share Retained Revaluation Total

capital premium Earnings Reserve
K’m K’m K’m K’m K’m
Balances b/d 280 52 45.80 1 - 377.80 ½
Profit for the
543.84 1 543.84
year
Dividends (224.00) ½ (224.00)
Revaluation
310 1 310
gain
Reserves
transfer ___ __ 9 ½ 9 ½
Balances c/d 280 52 374.64 301 1,007.64

(6 marks)

14
(c) Nabwalya plc
Consolidated Statement of Financial Position as at 31 March 2010

K’m
Non Current Assets
Plant and Equipment 343.04 2
Property 936 2
Licence 64.00 1
1,343.04
Current Assets
Inventory 75.20 1
Trade receivables 172.80 1
Total assets 1,581.04
Equity
Share capital 280.00
Share premium 52.00
Revaluation reserve 301.00
Retained earnings 374.64
Shareholders’ funds 1,007.64 1½
Non Current liabilities
12% loan notes 160.00 ½
Current liabilities
Bank overdraft 7.80 ½
Trade payables 140.80 ½
Dividends 224.00 1
Income tax 50.80 1
Total equity and liabilities 1,591.04

(12 marks)

Total: 30 marks

Workings
1.
Cost of sales K’m
As per trial balance 1,171.6 ½
NBV of disposal (w3) 51.2 2½
Plant and equipment –depreciation 85.76 1
Buildings – depreciation 24 1
Licence – amortization 32 1
1,364.56

15
2. Non Current Assets

Property Plant & Equip Licence Total

K’m K’m K’m K’m
Cost per T/B 800 674.40 160 1,634.40
Disposal (80) (80)
Revaluation 160 ____ - 160

960 594.4 160 1,714.40

Accumulated dep per T/B (150) (194.4) (64)
Revaluation 150
Disposal 28.80
Charge for the year
20% x 160 (32)
20% x (594.4) – (194.4 – (85.76)
28.8)
(960 – 240)
/(40 – 10)yrs (24) ______ -
NOV 936 343.04 64

3. Accumulated depreciation on disposal

K’m
Cost at 1 December 2007 80 ½
Dep for year ended 31 march 2008 (20% x 80) ½ (16) ½
64
Dep for year ended 31 march 2009 (20% x 64) ½ 12.8 ½
51.20

28.80 ½
Accumulated dep at disposal (16 + 12.8)

4. A loss on disposal of K3.2 million arises (proceeds of K48m – NVB of K51.2m).

However, the proceeds have already been credited to cost of sales and therefore it is only
necessary to debit the NBV of asset to cost of sales in order to record this loss.

Adjustment:

Dr cost of sales K51.2m

Dr accumulated dep K28.8m
Cr Asset at cost K80m

16
5. Revaluation:
Initial accounting: K’m
Valuation 960
NBV at 1 April 2009 (800 – 150) 650
Revaluation gain 310
Adjustment:
Dr Property (960 – 800) K160m
Dr Acc dep (600/40 yrs x 10 yrs) K150m
Cr Revaluation reserve (160, + K150m) K310
Reserve transfer
New depreciation (720m/30yrs) K24m
Old depreciation (K600m/40 yrs) K15m
Transfer excess depreciation K 9m
Adjustment
Dr Revaluation reserve K9m
Cr Retained earnings K9m

6. Declared dividend
Number of shares = K280m/K280 = 1m
Dividend = 1m x K244 = K224m
Adjustment
Dr Dividends (retained earnings) K224m
Cr Declared dividends K224m

7. Income tax
Year end estimate K50.80m
Over provision (K8.00m)
Tax charge K42.80m

17
Solution 3
(a) (i) Branch inventory account
K’m K’m
Balance b/d 91,500 Transfers to other Branches 7,500
Goods from H/Q 822,300 Returns to head office 12,000
Transfers from other 6,000 Branch mark up: 22,500
Branches Price reductions
Branch mark up: 4,300 Trade receivables – credit
106,500
Price increase sales
Cash sales 662,000
Trade receivables - 3,000 Branch mark up - inventory 9,500
Returns
927,100 Balance c/d 927,100

(½ a mark for each valid entry = 6 marks)

(ii) Goods sent to branch a/c

K’m K’m
Transfers to other 5,000 ½ Branch inventory 548,200 ½
branches a/c
Returns to head office
8,000 ½ Transfers from 4,000
other branches
Purchases a/c 539,200 ½
552,200 552,200

(iii) Branch mark up account

K’m K’m
Transfers to other 2,500 ¼ Balance b/d 30,500 ¼
Branches
Branch inventory a/c 274,100 ¼
Returns to head office 4,000 ¼ Transfers from other 2,000 ¼
Branches
Branch inventory a/c: 22,500 ½ Branch inventory a/c: price 4,300 ½
price reductions increase
Branch inventory a/c: 9,500 ¼
Inc/statement 236,700 ¼
Balance c/d 35,700 ¼
310,900 310,900

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(b) Inventory may be lost or damaged. The value lost will be a charge against the
Income statement. There are two possible treatment for damaged or lost inventory;
(i) Normal losses – if a loss is a normal one, inevitable in trade carried on, the
branch inventory account is credited with the selling price of the goods lost and the branch
mark up account debited with the full selling price amount. The entry on the branch
inventory account has the effect of reducing the balance to the true inventory amount, while
the debit to branch mark up account has two effects:
1. It eliminates the profit element on the goods lost, previously credited to the
account.
2. It charges the cost of the inventory lost against he branch gross profit in the
mark up account.
(ii) Abnormal losses. If the loss is abnormal, as when a whole consignment of
inventory is destroyed for some reason, it is still necessary to debit the mark up account
with the profit element on the goods, but the cost of the inventory is debited direct to profit
or loss so that the branch gross profit is not distorted.
(1 mark for a valid comment = 4 marks)
(c) Differences between public and private entities.
(i) Statutory obligation – public sector bodies exist because parliament says
they should, this carries with it a number of statutory requirements. A company, on the
other hand, exists because the shareholders want it, there is no statutory obligation for it to
exist.
(ii) Non profit trading – most (but not all) public sector organizations are non
trading entities so they provide services without charging at point of service.
(iii) Motivation – the primary objective of most companies is to make a profit.
Public sector organizations generally have the objective of providing services rather than
making a financial return.
(iv) Financing – a company gets its money from revenues (fees and charges) and
capital 9debt and equity). Public sector organizations with the objective of
service provision will largely finance spending from taxation. The main
distinction here is that the money given to a company is by choice (i.e a
customer does not need to buy, a shareholder does not need to invest).
Taxation on the other hand is extracted, and those liable have no legal choice.
This gives rise to the idea of public money and the public sector should be
accountable for amounts which have been levied on the taxpayer.
(v) Management – the management of a company is its board of directors, which is
appointed by the shareholders. Decisions in public service organizations are
largely made by a political grouping e.g. MPs or councilors.
(vi) Stewardship- the directors of a company have a stewardship role in the interest
of the shareholders. The management of a public sector organization has a
stewardship role for public money, which has wider implications for
accountability including the requirement to demonstrate value for money.
(1 mark for each valid point = 5 marks)
Solution 4
(a) A lease is an agreement for the hire of an asset between the lessor (owner)
and the lessee (user).

19
Leasing is a common and cheaper means of financing assets.
It provides tax benefits to both the lessee and the lessor.
IAS 17 identifies two types of leases
(i) Operating lease
 This is an agreement between the lessor and the lessee for the hire
of an asset where legal title and control remains with the lessor.
 The risks and rewards of ownership are retained by the lessor.
 The lessee pays a fee for the use/hire of an asset known as rentals.
 The rentals by the lessee will be treated as an expense on a straight
line basis over the terms of the lease.
 The lessor treats the rentals as income in his books.

(ii) Finance lease

It is an agreement for the hire of an asset where the lessor substantially transfers the risks
and rewards of ownership to the lessee.

Key features of a finance lease

(i) The lessor transfers ownership of the asset to the lessee by the end
of the lease term.
(ii) The lessee has the option to purchase the asset at a price expected
to be lower than fair value.
(iii) The lease term is for the major part of the economic life of the asset.
(iv) At the inception of the lease, the PV of the MLP (minimum lease
payment) amounts to at least substantially all of the fir value of the
leased asset.
(v) The leased asset is of a specialized nature such that only the lessee
can use them without major modifications being made.

The lease with Chivweka Finance should be categorised as a finance lease in accordance
with IAS 17 Leases as the risks and rewards associated with the ownership of an asset have
been passed to the lessee (i.e. Mbuji pays to insure, repair & maintain the asset and gets to
use it for its useful economic life). In addition, the lease has been modified for Mbuji’s use
which makes it more difficult for the leasing company to sell/re-lease the asset.
The lease with Ntongo Estates is an operating lease. This is so because the lessor (Ntongo
Estates) appears to be responsible for risks of ownership in that he is responsible for
maintenance, insurance and repair costs.
(b) Extracts of the financial statements for Mbuji plc for the year ended 31 March 2012

lncome Statement extract

K'm
Operating lease rental (K720m/5 yrs) (w4) 144
Depreciation expense (W2) 200
Finance costs (W3) 93.75

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Statement of financial position extract
K'm K'm
Non-current assets
Cost (W1) 2,000
Accumulated depreciation (W2) (200)
1,800

Non-current liabilities
Obligations under a finance lease(W3) 1,187.5

Current liabilities
Accrued interest (W3) 93.75

Obligations under a finance lease (W3)

(1593.75 – 1187.5 – 93.75) 312.5
406.25

Operating lease rental payable 144

Workings

(W1) Recognise lease asset and liability at inception

Dr Non-current
asset cost a/c K2000m
Cr Finance lease obligation K2000m

(W2) Depreciation
Dr Depreciation expense K200m
Cr Accumulated depreciation K200m
(2000m/5 × 6/12)
(W3) Finance lease liability –
amortised cost (figures in K’m)
Capital
Year b/fwd Rental outstanding Interest c/fwd Interest c/fwd
12.5 % 31/3/2010 12.5% 30/9/2010
(6/12) (6/12)

1 2,000 (500) 1,500 93.75 1,593.75 93.75 1,687.50

2 1,687.50 (500) 1,187.50

(W4) Operating lease
The total cost of leasing the office space is equal to K720 million (i.e. K180m x 4 years).
IAS 17 Leases states that the total cost of leasing an asset under operating lease that
includes a rent free period should be spread over the whole lease period to match income
from occupying the office space with associated expense. The operating lease expense will
therefore be K144m (K720/5yrs)

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Solution 5

(a) The EPS for the year ended 31 December 2010 can be calculated as follows:

Earnings available for ordinary shareholde rs

EPS =
Weighted averagenumber of shares in issue

Number of ordinary shares before the rights issue

= 100m/0.5= 200m shares ½

Number of ordinary shares after the rights issue

= 200m x 5/4 = 250m shares ½

Bonus fraction = Market price/ theoretical ex rights price (TERP)

TERP can be calculated as follows:

4 shares @ 350 each = K1,400

1 shares @ 200 each = K 200

5 shares = K1,600

Therefore TERP = 1,600/5 = K320 1 mark

Bonus fraction = K350/K320. The bonus fraction should be applied to the weighted average
number of shares before the rights issue.

K450m
EPS for 2010 =
[200m x 3/12 x 350/320]  [250 x 9/12]

= K1.86 / share

or 186 ngwee /share 1 mark

The restated EPS for 2009 will be found by multiplying the 2009 EPS by the reciprocal of
bonus fraction:
EPS for 2009 = 400/200 = K 2 per share 1 mark
EPS for 2009 restated = K2 x 320/350
= K1.83 / share
or 183 ngwee per share 2 marks

(b) Advantages of Cash Basis Accounting

Cash is clearly the livelihood of any organization. Through cash basis accounting
government would be able to assess from its use.

(i) how much tax to collect through budgets. It government spends less than
the budget states, then it is better off at year end and can spend excess cash
on other developmental issues, pay back borrowings or reduce tax.

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If it spends more than the budget, then it is worse off meaning money will have to be
borrowed or increase taxes.

(ii) Cash basis accounting is perceived to be easier to prepare and understand.

(iii) Cash reporting instills confidence in an organization from interested parties as

it reflects the ability of an organization to manage its finances.

(iv) Organizations are forced to priotise their activities and live within their limits
as funding is always not enough.

(v) Cash basis accounting is not subjective as it addresses actual activities.

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Disadvantages

Cash basis accounting has also come under criticism because:

(i) It focuses only on cash

(ii) How much an organization is worth not only cash but other assets and
liabilities. Therefore financial statements on cash basis are incomplete and
may be misleading about an organisation’s financial position.

Accruals Accounting

Revenue and costs are accrued (i.e. recognized as they are earned or incurred and not as
money is received or paid), matched with one another so far as their relationship can be
established or justifiably assumed, and dealt with in the income statement of the period to
which they relate.

Advantages

(i) It provides measures of the economic goods and services consumed,

transformed and earned.

(ii) Accruals accounting yields an income figure. More profit implies more
success.

(iii) Accruals accounting yields a measure of capital. Income is only recognized

after capital has been maintained in tact.

Disadvantages

(i) Accruals accounting introduces subjectivity into the accounts. It brings in

adjustments which are judgmental e.g. provision or allowance for doubtful
debts, which may distort accounting information instead of “true and fair”.

(ii) The relevance of accruals accounting, when it is linked with historic costs and
during periods of rising prices, is limited. Profit figures become merely
amounts which can be spent without impairing initial capital invested.

(iii) In comparison with cash basis accounting, accruals adjustments demand a

higher administrative and accounting cost.

(iv) It provides an opportunity for manipulation which is a problem associated

with financial control with cash based accounting manipulation of accounting
results could be effected by postponing cash payments just to show that the
organization is financially sound.

In accruals postponement of cash payments in receipts has no effect. Manipulation may

come by bringing in invoices for goods supplied just to ensure that the accounts are within
budget.
1 mark for each valid point – maximum 10 marks

c) An asset is a resource controlled by an entity from which future economic benefits is

expected to flow as a result of a past event. An intangible asset is defined in IAS 38

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 Intangible Assets as being identifiable non monetary asset with no physical form.
Examples of intangible assets include brand names, licences, patents, goodwill and
customer lists etc.

Internally generated intangible assets are not recognized unless an active market exists, this
is extremely rare in practice. Purchased intangible assets are to be recognized at cost and
then amortised over their useful economic life if they have a finite life. If the intangible has
an indefinite life then it should be reviewed annually for impairment.

Research is defined in IAS 38 as being ‘original and planned investigation undertaken with
the prospect of gaining new scientific knowledge and understanding’. Research is always
written off as an expense to the income statement.
Development is defined in IAS 38 as being ‘the application of research findings or other
knowledge to a plan or design for the production of new or substantially improved materials,
devices, products, processes, systems or services before the start of commercial production
or use. Development expenditure must be recognized as an intangible asset if, and only if,
an entity can demonstrate all of the following:
(i) Technical feasibility of completing the project.
(ii) Its intention to complete the asset and use it.
(iii) Its ability to use/sell the asset.
(iv) That the asset will generate future economic benefits
(v) Availability of adequate technical, financial and other resources to complete the
development and use/sell the asset.
(vi) Ability to measure expenditure reliably.

If the above criteria are not met development expenditure must be written off to the income
statement as it is incurred. It is only expenditure incurred after the recognition criteria have
been met which should be recognized as an asset. Development expenditure recognized as
an expense in profit or loss cannot subsequently be reinstated as an asset. Development
costs must be amortised as soon as commercial production begins
1 mark for each valid point – maximum 4 points

END

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