ZAMBIA INSTITUTE OF CHARTERED ACCOUNTANTS

CHARTERED ACCOUNTANTS EXAMINATIONS

PROFESSIONAL LEVEL

P1: ADVANCED FINANCIAL REPORTING

SERIES: DECEMBER 2012

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: Attempt this ONE compulsory question.

Section B: Attempt any THREE questions.

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.

9. Formulae, Present Value and Annuity tables are attached at the end of this
question paper.
SECTION A

Question one is compulsory and must be attempted.

QUESTION ONE

The following is an extract of the summarised financial statements of Lusaka Ltd, Kinshasa
Ltd and Solwezi Ltd for the year to 30 September 2012:

Statement of financial position

Lusaka Kinshasa Solwezi
K’m CDF’m K’m
Assets:
Non-current assets
Property, plant and equipment 24,500 14,000 7,000
Investment in: Kinshasa 18,200 - -
Solwezi 3,150 - -
Financial Asset 1,000 - -
46,850 14,000 7,000

Current assets 9,500 7,710 3,500

Total assets 56,350 21,710 10,500

Equity and Liabilities:

Share capital 7,000 3,500 3,500
Res 42,350 12,250 5,250
49,350 15,750 8,750

Current liabilities 7,000 5,250 1,750

Non current liabilities 710
Total equity and liabilities 56,350 21,710 10,500

Lusaka Kinshasa Solwezi

K’m CDF’m K’m
Revenue 16,100 7,700 5,600
Cost of sales and operating expenses (12,950) (5,600) (3,850)
Profit before tax 3,150 2,100 1,750
Income tax (700) (525) (350)
Profit for the year 2,450 1,575 1,400
Other comprehensive income:
Revaluation of property, plant and equipment 700 420 245
Total comprehensive income 3,150 1,995 1,645

1
Notes

1. The functional currency of both Lusaka and Solweziis the Zambian Kwacha (ZMK or K)
and the functional currency of Kinshasa is the Congolese Franc (CDF).

2. Lusaka acquired 80% of Kinshasa on 1 October 2010 for K18,200m when the reserves of
Kinshasa were CDF6,300m. The investment is held at cost in the individual financial
statements of Lusaka Ltd.

3. Lusaka Ltd acquired 40% of Solwezi on 1 October 2007 for K3,150m when the reserves
of Solwezi Ltd were K2,450m. The investment is held at cost in the individual financial
statement of Lusaka.

4. Lusaka advanced a 5 year loan of K1,000m to Kinshasa on 30 September 2011. This

loan is included in the financial assets and non-current liabilitiesof Lusaka and Kinshasa
respectively. Kinshasa had recorded the loan at the exchange rate ruling at 30
September 2011.

5. An impairment test conducted at 30 September 2012 revealed that cumulative

impairment losses of in respect of the investment in Solwezi were K1000m, of which
K250m relates to the current year. No impairment losses were necessary in respect of
the investment in Kinshasa.

6. The group policy is to value the non-controlling interest at fair value at the date of
acquisition. The fair value of the non-controlling interest of Kinshasa Ltd at 1 October
2010 was CDF2,100m.

7. Lusaka has a building which is located in the same country as Kinshasa. The building
was acquired on 30 September 2011 and is carried at cost of CDF 2,500 million. The
property is depreciated over 10 years on a straight line basis. At 30 September 2012 the
property was revalued to CDF 3,500 million. Depreciation has been charged for the year
but the revaluation has not been taken into account in the preparation of financial
statements as at 30 September 2012.

8. Relevant exchange rates are as follows:

Date Exchange rate

CDF to ZMK1
1 October 2010 CDF0.5
30 September 2011 CDF0.71
30 July 2012 CDF0.45
30 September 2012 CDF0.63
Average rate for year ended 30 September 2012 CDF0.65

2
Required:

(a) As outlined in IAS 21 Effects of changes in foreign exchange rates explain the
accounting treatment of exchange differences arising on:

(i) foreign transactions and; (3 marks)

(ii) translation of a foreign entity’s results and financial position (3 marks)

(b) Prepare the consolidated statement of comprehensive income for the Lusaka Group
for the year ended 30 September 2012 and the consolidated statement of financial
position as at that date. (34 marks)

(Total 40 marks)

SECTION B

Attempt any three (3) questions in this section.

QUESTION TWO

(a) IAS 36 Impairment of Assets provides guidance on identifying, measuring and

recognising impairment losses.

Required:

(i) Briefly describe any twocircumstances which may indicate that an impairment
loss relating to an asset has occurred. (2 marks)

(ii) Briefly explain how IAS 36 deals with the recognition and measurement of the
impairment of assets. (4 marks)

(b) Nakondeplc, a listed entity, has a machinery whose carrying valueat 30 September
2012 was K2,900m. The machine appeared to have suffered a loss in value because
the inventory produced by the machine was being sold below its cost and this
occurrence had affected the value of the productive machinery. The net selling price
of the machine is estimated at K1,200m. The anticipated net cash inflows from the
machine is now K1,000m per annum for the next three years. A market discount rate
of 10% per annum is to be used in any present value computations.

Required:

Describe how Nakonde should treat the above asset in its financial statements for the
year ended 30 September 2012. (4marks)

(c) Nakonde owned a building on which it raised finance. Nakonde sold the building for
K5,000 m to a finance company on 1 October 2011 when the carrying amount was
K3,500 m. The same building was leased back from the finance company for a period
of 20 years, which was felt to be equivalent to the majority of the asset’s economic
life. The lease rentals for the period are K4,410m payable annually in arrears. The

3
 interest rate implicit in the lease is 7%. The present value of the minimum lease
payments is the same as the sale proceeds.

Required:

Describe how Nakonde should treat the above transaction in its financial statements
for the year ended 30 September 2012. (5 marks)

(d) Nakonde has an overseas subsidiary which has made a loss (adjusted for tax
purposes and appropriately translated into Kwacha) of K1,500m for the year ended
30 September 2012. Local tax legislation allows this loss to be relieved for tax
purposes only against future profits of the same trade. Nakonde has no other
subsidiaries in the same tax jurisdiction as this subsidiary. The loss is primarily due to
a reduction in revenue caused by a reduction in demand for the product that the
subsidiary produces. There is little indication that demand will be restored to its
former levels in the foreseeable future.

Nakondehas recognised a deferred tax asset of K600 million in the draft financial
statements, being the future tax consequences of the temporary difference of K1500
million, measured at the local tax rate of 40%.

Required:

Discuss the validity of the accounting treatment adopted by Nakonde based on

relevant International Financial Reporting Standards.You should clearly state what
adjustment if any is needed in Nakonde’s financial statements. (5 marks)

(Total 20 marks)

4
QUESTION THREE

Zambia Hotels Plc expanded its operations in anticipation of the increased demand to be
caused by a major football event, the African Cup of Nations. The company now owns a
chain of hotels through which it provides three basic services: restaurant facilities,
accommodation and leisure facilities. You have been provided with extracts of the financial
statements of the company from its recent annual report below:

Statement of financial position

K’m
Assets
Non-current assets at book value 4,989
Current assets
Inventories and receivables 1,143
Bank balance 384
1,527
Total Assets 6,516

Equity and Liabilities

Equity
Share capital 2,400
Retained Earnings 3,117
5,517
Non-current liabilities
Long-term borrowing 420
Current liabilities 579
Total equity and liabilities 6,516

Statement of comprehensive income

K'm K'm
Revenue 3,084
Less: Cost of Sales 2,052
Administration expenses 330
Distribution costs 303
Interest charged 42 (2,727)
Net profit 357

5
The following breakdown provides the company’s results into three divisions and head
office:
Restaurant Hotels Leisure Head office
K'm K'm K'm K'm
Revenue 1,524 456 1,104 -
Cost of Sales 948 243 861 -
Administrative expenses 129 42 114 45
Distribution costs 192 36 75 -
Interest charged 30 - - 12
Non-current assets at book value 2,670 996 1,092 231
Inventories and receivables 690 252 201 -
Bank balance 219 45 84 36
Payables 198 120 168 93
Long-term borrowings 300 - - 120

Required:

(a) Outline the nature of segmental reports and explain the reasons for presenting such
information in the published accounts. (4 marks)

(b) Prepare a segmental statement for Zambia Hotels Plc complying, so far as the
information permits, with the provisions of IFRS 8 ‘Operating Segments’, so as to show
for each segment and the business as a whole:

 Revenue
 Profit
 Net Assets. (6 marks)

(c) Examine the relative performance of the operating divisions of Zambia Hotels Plc. The
examination should be based on the following accounting ratios:

(i) Operating profit percentage;

(ii) Net Asset Turnover;
(iii) Return on net assets. (6 marks)

(d) Discuss the potential limitations of operating segment analysis as a tool for comparing
different entities (4 marks)
(Total 20 marks)

6
QUESTION FOUR

(a) In accounting, it is often argued that a measurement system based on current values
is superior to one based on historical cost and that accounting practice should
develop by greater utilisation of current values. Current value accounting can utilise
replacement cost accounting and net realisable value techniques, which use entry
and exit values respectively. If general inflation is a problem, it is possible to
eliminate the effect by producing a “real terms” measure of total gains and losses,
where a current value system of accounting is adjusted for the effects of changes in
General Purchasing Power (GPP).
Required:

Describe the problems associated with replacement cost accounting and net
realisable value accounting techniques. (6 marks)

(b) ZamSafari Ltd set up a subsidiary, ZimSafari Ltd in Zimbabwe on 1 January 2010.
The currency of Zimbabwe is Zimbabwe Dollar (ZWD). The investment by ZamSafari
Ltd was ZWD5,000 million. ZimSafari Ltd invested all the initial capital in a hotel
complex and this complex is effectively the company’s sole asset. ZimSafari Ltd does
not depreciate the hotel complex.

The exchange rates between Zambian Kwacha (ZMK) and Zimbabwe Dollar (ZWD)
were as follows:

Date Exchange rate

ZWD to ZMK1
1 January 2010 25
31 December 2012 220

The retail price index in Zimbabwe was 100 on 1 January 2010 and 1,000 on 31
December 2012.

Required:

(i) Discuss the effects that hyper-inflation can have on the usefulness of financial
statements, and explain how entities with subsidiaries that are located in
hyper-inflationary economies should reflect this fact in their consolidated
financial statements. (6 marks)

(ii) Compute the carrying value of the hotel complex in the consolidated financial
statements of ZamSafari Ltd as at 31 December 2012

(a) Assuming the economy of Zimbabwe is not a hyper-inflationary economy;

(b) Assuming the economy of Zimbabwe is a hyper-inflationary economy,
and critically evaluate the results you have obtained. (8 marks)
(Total 20 marks)

7
QUESTION FIVE

Zambia has largely been dependent on copper ever since mining started in the 1920s.
Copper still contributes more than 70% of the country’s total exports.

In the recent past, there has been increased transparency in the revenues that the
extractive industries pay to the government. The Zambia Extractive Industries Transparency
Initiative (ZEITI) has been instrumental in promoting this transparency.

Whilst there is an increase in the transparency of government revenues from the extractive
industries, different stakeholder groups have argued that the social and environmental
aspects of the mining companies are not disclosed (if disclosed, very minimal). Given the
nature of operations of the extractive industries, their social and environmental aspects
cannot be ignored. However, the disclosure requirements of these aspects remain largely
voluntary.

Required:

(a) Discuss why there has been an increasing commitment by companies to engage and
disclose their corporate social responsibility policies and practices (8 marks)

(b) Discuss the arguments for the regulation of corporate social responsibility practices,
especially in developing countries like Zambia. (6 marks)

(c) Explain how international financial institutions are providing an incentive for the
extractive industries to effectively manage their social and environmental risk.
(3 marks)

(d) Explain the role of the Zambia Institute of Chartered Accountants (ZICA) in promoting
social and environmental reporting in Zambia. (3 marks)

(Total 20 marks)

END OF PAPER

8
 PRESENT VALUE TABLE

Present value of 1, i.e.

1  r n
Where r = discount rate
n = number of periods until payment
Discount rate (r)
Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 1
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826 2
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751 3
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683 4
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621 5

6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564 6
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513 7
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467 8
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424 9
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386 10

11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350 11
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319 12
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290 13
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263 14
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239 15

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 1
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 2
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 3
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482 4
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402 5

6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 6
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 7
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233 8
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194 9
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 10

11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 11
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112 12
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093 13
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078 14
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065 15

9
 ANNUITY TABLE
1 - 1  r  -n

Present value of an annuity of 1, i.e. r

Where r = discount rate
n = number of periods
Discount rate (r)
Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 1
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736 2
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487 3
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170 4
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791 5

6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355 6
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868 7
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335 8
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759 9
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145 10

11 10.37 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495 11
12 11.26 10.58 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814 12
13 12.13 11.35 10.63 9.986 9.394 8.853 8.358 7.904 7.487 7.103 13
14 13.00 12.11 11.30 10.56 9.899 9.295 8.745 8.244 7.786 7.367 14
15 13.87 12.85 11.94 11.12 10.38 9.712 9.108 8.559 8.061 7.606 15

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 1
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528 2
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106 3
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589 4
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991 5

6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326 6
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605 7
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837 8
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031 9
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192 10

11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327 11
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439 12
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533 13
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611 14
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675 15

10
ADVANCED FINANCIAL REPORTING

MODEL ANSWERS

11
Important note:

The model answers may be considerably longer and more detailed than would be expected
from any candidate in the examination. They should therefore be used as a guide to the
form, style and technical standard (but not in length) of answers that candidates should aim
to achieve.

However, these answers , particularly the discursive answers, may not include all valid
points mentioned by a candidate. Credit should be given to candidates mentioning other
relevant points.

SOLUTION ONE

Exchange differences on foreign currency transactions

A foreign currency transaction is a transaction that is denominated or requires settlement in

a foreign currency, e.g. an entity buys or sells goods or services whose price is denominated
in a foreign currency or borrows or lends funds when the amounts payable or receivable are
denominated in a foreign currency. A foreign currency transaction shall be initially
recorded in the functional currency, by applying to the foreign currency amount the spot
exchange rate between the functional currency and the foreign currency at the date of the
transaction.

Exchange differences arising on the settlement of monetary items or on translating

monetary items at different rates from those when they were initially recognised are
recognised in profit or loss in the period in which they arise.

If a gain or loss on a non-monetary item is recognised in other comprehensive income, any

exchange component of that gain or loss should also be recognised in other comprehensive
income. Conversely, when a gain or loss on a non-monetary item is recognised in profit
or loss, any exchange component of that gain or loss shall be recognised in profit or loss.

Exchange differences on foreign operations

IAS 21 states that the results and financial position of a foreign entity should be translated
into a different presentation currency using the following procedures:

(a) assets and liabilities in the statement of financial position presented should be
translated at the closing rate at the date of that statement of financial position;

(b) income and expenses in profit or loss and other comprehensive income statement of
comprehensive income or separate income should be translated at exchange rates at
the average rate.

All resulting exchange differences should be recognised as a separate component of equity

in other comprehensive income (i.e. in reserves), until the disposal of the foreign
operation when they are transferred to the profit or loss as part of the gain or loss on
disposal.

12
Lusaka Group
Consolidated statement of financial position as at 30 September 2012

Assets: K'm
Non-current assets

Property, plant and equipment (24,500+22,222 + 2387 W6) 49,109

Goodwill (w4) 2,222

Investment in Associate (Solwezi)(w8) 3,270

54,601

Current assets (9,500+12,238) 21,738

Total assets 76,339

Equity and Liabilities:

Share capital 7,000

Reserves(w7) 46,429

Revaluation surplus 2,387

55,816

Non-controlling interest (w9) 5,190

Current liabilities (7,000+8,333) 15,333

Total equity and liabilities 76,339

13
Lusaka Group
Consolidated statement of comprehensive income for the year ended 30 Sept
2012
K' m

Revenue (16,100+11,846) 27,946

Cost of sales and operating expenses (12,950+8615) (21,565)

Exchange gain (w3) 123

Share of profit of Associate(Solwezi) (w11) 310

Profit before tax 6,814

Income tax (700+808) (1,508)

Profit for the year 5,306

Other comprehensive income:

Gains on property revaluations (2,387(w5)+700+646) 3,733

Share of other comprehensive income of
Associate(w11) 98

Exchange differences on foreign operations (w5) 2,812

Total comprehensive income 11,949

Profit Attributable to:

Owners of the parent 4,797

Non- controlling interests (w10) 509

5,306
Total comprehensive income attributable to:

Owners of the parent 10,749

Non - controlling interests (w10) 1,200

11,949

14
Workings

1) Group Structure

Kinshasa Ltd is a subsidiary as Lusaka Ltd owns 80% in it. However, Kinshasa has a
different functional currency to Lusaka, so must be translated into ZMK and then
consolidated.

Solwezi is an associate as Lusaka Ltd owns 40% of the company. Solwezi has the
same functional currency as Lusaka Ltd, so no translation. It will be equity
accounted.

Lusaka Ltd

80% 40%

Kinshasa Ltd Solwezi Ltd

2) Intra group loan

CDF'm
Original loan value at 30 Sep 2012 (1,000m x 0.71) 710
Loan value at 30 Sep 2012 (K1,000m x0.63) 630
Foreign exchange gain 80

Adjustment in Kinshasa's books

DEBIT Loan CDF 80
CREDIT Profit or loss CDF 80

The intra group loan will cancel out on consolidation

3) Translation of Kinshansa’s financial statements

Statement of comprehensive income

Kinshasa
CDF’m Rate K'm

Revenue 7,700 0.65 11,846

Cost of sales and operating expenses (5,600) 0.65 (8,615)

Exchange gain (w1) 80 0.65 123

Profit before tax 2,180 3,354

Income tax (525) 0.65 (808)

Profit for the year 1,655 2,546

15
Other comprehensive income:
Revaluation of property, plant and equipment 420 0.65 646

Total comprehensive income 2,075 3,192

Statement of financial position

Kinshasa
CDF’m Rate K'm
Assets:
Non-current assets
Property, plant and equipment 14,000 0.63 22,222

14,000 22,222
Current assets 7,710 0.63 12,238
Total assets 21,710 34,460

Equity and Liabilities:

Share capital 3,500 0.5 7,000
Pre-acquisition Reserves 6,300 0.5 12,600
Post-acquisition reserves (5950+80(w1)) 6,030 Bal. fig 5,527
15,830 25,127

Current liabilities 5,250 0.63 8,333

Non-current liabilities (710-80 (w1)) 630 0.63 1,000

Total equity and liabilities 21,710 34,460

4) Goodwill
CDF'm CDF'm Rate ZMK
Consideration transferred 9,100 0.5 18,200
Non-controlling interest (at Fair Value) 2,100 0.5 4,200

Fair value of net assets acquired

Share capital 3,500
Reserves 6,300
(9,800) 0.5 (19,600)

Goodwill at 1 October 2010 1,400 0.5 2,800

Foreign exchange loss (balancing figure) 828

Goodwill at 1 October 2011 1,400 0.71 1,972

Foreign exchange gain (balancing figure) 250

Goodwill at 1 October 2012 1,400 0.63 2,222

16
Exchange difference arising in the year

K'm
On translation of net assets

Closing net assets @ closing rate (from translated SoFP w2) 25,127

Opening net assets @ opening rate((CDF15,830-CDF2,075)/0.71) (19,373)

5,754

Less: Total comprehensive income as translated (W2) (3,192)

Exchange gain on translation of net assets 2,562

Exchange gain on goodwill (W3) 250

Total foreign exchange gains (to OCI) 2,812

5) Revaluation of foreign property( Lusaka’s books)

CDF'm Rate K'm
Original cost at 30 Sept 2011 2,500 0.71 3,521
Depreciation(3,521/10yrs) (352)
3,169
Revaluation surplus (balancing figure) 2,387
Revalued amount at 30 Sept 2012 3,500 0.63 5,556
To record the revaluation surplus therefore:

DEBIT Property plant and equipment K2,387

CREDIT Revaluation surplus (OCI) K2,387

6) Reserves

K'm
Lusaka's retained reserves per question 42,350
Share of Kinshasa's post acquisition reserves(80% x 5,527 (W2)) 4,422
Share of Solwezi's post acquisition reserves(40% x (5,250-2,450)) 1,120
Impairment of Solwezi (1,000)
Group share of net exchange loss on retranslation of goodwill
(80% x (828-250)(W3)) (462)
46,429

17
7) Investement in Associate (Solwezi)
K'm
Cost
3,150

Group share of post acquisition retained reserves(40% x (5,250-2,450)) 1,120

Impairment of Solwezi (1,000)
3,270

8) Non-controlling interest (consolidated statement of financial position)

K'm
Non-controlling interest at acquisition 4,200
Non-controlling share of post-acquisition reserves (20% x 5,527 (W2)) 1,105
Non-controlling share of net exchange loss on
retranslation of goodwill (20% x (828-250) (W3)) (116)
5,189

9) Non-controlling interest (consolidated statement of comprehensive income)

K'm
NCI share of profit (20% x K2,546m (w2)) 509

NCI share of TCI

Share of profit (as above) 509

Share of revaluation surplus (20% x K646m(w2)) 129

Share of exchange differences (20% x K2,811m(w4)) 562
1,200

10) Group share of associate’s (Solwezi’s) profit and other comprehensive income)

Share of profit K'm

Group share of Solwezi’s profit (40% x K1,400m ) 560
Less impairment loss for the year (250)
310

Group share of solwezi’s OCI

Share of revaluation surplus (40% x 245) 98

18
SOLUTION TWO

(a)(i) Circumstances indicating possible impairment

In identifying whether an impairment of an asset may have occurred an enterprise

should consider the following indications:

 there has been a significant decrease in the market value of the asset in excess of
the normal process of depreciation
 there has been a significant adverse change in either the business or the market in
which the asset is involved. This will include changes in the technological, economic
or legal environment in which the enterprise operates
 there has been a significant adverse change in the manner in which the asset has
been used
 evidence is available that indicates that the economic performance of the asset will
be worse than expected
 the asset has suffered considerable physical change, obsolescence or physical
damage
 there has been an accumulation of costs significantly in excess of those originally
expected in the acquisition or construction of an asset so that it may affect
profitability
 the management is committed to a significant reorganization programme
 where an asset is valued in terms of value in use and the actual cash flows are less
than the estimated cash flows before discounting
 market interest rates or other market rates of return on investments have increased
during the period and those increases are likely to decrease materially the asset’s
recoverable amount

(ii) Recognition and measurement of Impairment of Assets

IAS 36 Impairment of Assets says that if there is an indication of impairment, then

a review must be undertaken to confirm this fact and establish the extent of the
impairment. An asset should not be valued at an amount greater than its cost or
recoverable amount in a historical cost system. The recoverable amount is defined
as the higher of fair value less costs to sell and value in use (net present value of
future cash flows). The above rule applies, also, to assets which have been
revalued to replacement cost. The required approach is to compare the carrying
value of the asset with its fair value less costs to sell or value in use. If either the
fair value less costs to sell or value in use exceeds the carrying value then no write
down is necessary and there is no need to estimate the other amount. If the
recoverable amount is lower than the carrying value, the asset is impaired and the
carrying amount of the asset should be reduced to its recoverable amount.
Impairments should be calculated on a pre-tax basis and any tax consequences
picked up under IAS 12 (revised) Income Taxes.

The reduction is deemed to be an impairment loss and should be recognised as an

expense immediately in the income statement. Sometimes it may not be possible to
determine fair value less costs to sell and in this case the recoverable amount may
be taken as its value in use. If there is no reason to believe that the asset’s value in
19
 use materially exceeds its fair value less costs to sell, the asset’s recoverable
amount is its fair value less costs to sell. This often will be the case where the asset
is held for disposal and the sale is imminent.

If it is not possible to estimate the recoverable amount of an asset individually, the

recoverable amount of the asset’s cash generating unit should be determined.
Where an asset does not generate independent cash flows, value in use can only
be determined for the asset’s cash generating unit. An impairment loss for a cash
generating unit should only be recognised where its recoverable amount is less
than the carrying amounts of the items in that unit. Any impairment loss for a cash
generating unit should be allocated first to goodwill, then to other assets on a pro
rata basis. Any specific impairment of assets should be dealt with initially. The
discount rate to be used should be a pre-tax market determined rate that reflects
current assessments of the time value of money and risks specific to the asset.

An impairment loss relating to a revalued asset is treated as a revaluation decrease

and therefore charged to revaluation account. Where the impairment loss is greater
than the carrying amount of the asset, a liability should only be recognised where it
is required by other International Standards. After recognition of an impairment
loss, the depreciation charge should be adjusted to allocate the revised carrying
amount (less residual value) systematically over its remaining life. An enterprise
should review the statement of financial position to assess whether a recognised
impairment loss still exists or has decreased. Any reversal of an impairment loss
should be recognised in the income statement.

(b) Impairment of machinery

Nakonde will have to undertake an impairment review because of the effect of the
inventory losses. The recoverable amount is the higher of an asset’s fair value less
costs to sell and its value in use. The fair value less costs to sell of the asset is
K1,200m. The value in use is K1,000 discounted at 10% for three years i.e. K2,486
approx. Thus the recoverable amount would be deemed to be K2,486m. Nakonde
would therefore write down the asset to its value in use and recognise the loss of
K414 m (K2,486 – K2,900m) in profit or loss.

(c) Sale and lease back

A lease is classified as a finance lease if it transfers substantially the entire risks and
rewards incident to ownership. All other leases are classified as operating leases.
Classification is made at the inception of the lease. Whether a lease is a finance
lease or an operating lease depends on the substance of the transaction rather
than the form. Situations that would normally lead to a lease being classified as a
finance lease include the following:

– the lease transfers ownership of the asset to the lessee by the end of the lease
term;
– the lessee has the option to purchase the asset at a price which is expected to be
sufficiently lower than fair value at the date the option becomes exercisable that, at
the inception of the lease, it is reasonably certain that the option will be exercised;
– the lease term is for the major part of the economic life of the asset, even if title is
not transferred;
20
– at the inception of the lease, the present value of the minimum lease payments
amounts to at least substantially all of the fair value of the leased asset;
– the lease assets are of a specialised nature such that only the lessee can use them
without major modifications being made.

In this case the lease back of the building is for the major part of the building’s
economic life and the present value of the minimum lease payments amounts to all
of the fair value of the leased asset. Therefore the lease should be recorded as a
finance lease. The building is derecognised at its carrying amount and then
reinstated at its fair value with any disposal gain, in this instance K1,500 million
(K5,000m – K3,500m) being deferred over the new lease term. The building is
depreciated over the shorter of the lease term and useful economic life, so 20
years. Finance lease accounting results in a liability being created, finance charge
accruing at the implicit rate within the lease, in this case 7%, and the payment
reducing the lease liability in arriving at the year-end balance. The associated
double entry for the lease is as follows:

K’m
Sale of building
Dr cash 5,000
Cr building 3,500
Cr deferred income 1,500

Leased asset and liability

Dr asset – finance lease 5,000
Cr finance lease creditor 5,000

Deferred income release

Dr deferred income 75
Cr profit or loss 75

Depreciation of asset
Dr depreciation 250
Cr assets under finance lease 250

Rentals paid
Dr interest 350
Drfinance lease creditor 91
Cr cash
441

21
(d) IAS 12 is clear on the circumstances in which a deferred tax asset can be recognised
as a result of unused tax losses. A deferred tax asset should only be recognised to the
extent that it is probable that future taxable profit will be available against which the
unused tax losses can be utilised.

We are told in the question that there is little indication that demand will pick up in the
foreseeable future, so we cannot say it is probable that future profits will be available.

No deferred tax asset should be recognised in respect of the taxable loss. The journal
adjustment necessary will be:

DR Income tax expense in profit or loss K600 m

CR Deferred tax non-current liability K600m

Being the writing off of the asset wrongly established in the deferred tax provision. It
should be written off as part of the tax charge for the year.

SOLUTION THREE

(a) Nature of Segmental Reporting

The majority of listed and other large companies derive their revenues and profits
from a number of sources (or segments). This has implications for investment strategy
of the entity as different segments require different amounts of investments to
support their activities. Conventionally produced statements of financial position and
statements of comprehensive income capture financial position and financial
performance in a single column of figures.
Segmental reporting provides a more detailed breakdown of key numbers from the
financial statements. Such a breakdown potentially allows a user to:

 Appreciate the results and financial position more thoroughly by permitting a better
understanding of past performance and a better assessment of future prospects.
 Be aware of the impact that changes in significant components of a business may
have on the business as a whole.
 Be more aware of the balance between the different operations and be able to
assess the quality of the entity’s reports earning, the specific risks to which the
company is subject and the areas where long term growth may be expected.

(b) Assuming that the management receives relevant information about the three
components referred to in the question then the segments report would look like
this.

Restaurant Hotels Leisure Other Total

K'm K'm K'm K'm K'm
Revenue 1,524 456 1,104 - 3,084
Interest expense (30) - - (12) (42)
Profit (W1) 225 135 54 (57) 357
Reportable segment assets (W2) 3,579 1,293 1,377 267 6,516
Reportable segment liabilities (W3) (498) (120) (168) (213) (999)
22
 Workings

1) Reportable segment profit

Restaurant Hotels Leisure Other Total
K'm K'm K'm K'm K'm
Revenue 1,524 456 1,104 - 3,084
Cost of Sales (948) (243) (861) - (2,052)
Administrative expense (129) (42) (114) (45) (330)
Distribution costs (192) (36) (75) - (303)
Interest expense (30) - - (12) (42)
Profit 225 135 54 (57) 357

2) Reportable segment assets

Restaurant Hotels Leisure Other Total
K'm K'm K'm K'm K'm
Non-current assets 2,670 996 1,092 231 4,989
Inventories and receivables 690 252 201 - 1,143
Bank balances 219 45 84 36 384
Reportable segment assets 3,579 1,293 1,377 267 6,516

3) Reportable segment liabilities

Restaurant Hotels Leisure Other Total
K'm K'm K'm K'm K'm
Payables 198 120 168 93 579
Long-term borrowings 300 - - 120 420
Reportable segment liabilities 498 120 168 213 999

(c) It is clear from the ratios below that the leisure sector is underperforming
compared with the other two sectors. Hotels are performing best, when measured
by the returns on net assets ratio. It is notable that the profit margins of the three
sectors differ significantly. This additional information illustrates the value segment
reports can add compared with overall figures.

Restaurants Hotels Leisure

Operating profit 225 135 54
Revenue 1,524 456 1,104
Operating profit % 15% 30% 5%

Revenue 1,524 456 1,104

Net assets 3,081 1,173 1,209
Net asset turnover 0.5 times 0.4 times 0.9 times

Operating profit 225 135 54

Net assets 3,081 1,173 1,209
Return on Net assets 7.3% 12% 4%

23
 d) Limitations of operating segment analysis as a tool for comparing different entities
The main limitations of operating segment analysis when comparing different
entities relates to the comparability of the information. IFRS 8 gives companies
freedom to define segments based on how information is prepared for review by
the chief operating decision maker. Different companies operating in similar
business sectors could split results in different ways. There is also freedom in terms
of how smaller segments could be aggregated together if they are individually
below the 10% thresholds.

SOLUTION FOUR

(a) There are several problems associated with replacement cost accounting and net
realizable value accounting. These are outlined below:

Disadvantages of replacement cost accounting

i. The indices used to value assets can be unreliable or inappropriate.

ii. The asset values used may relate to new types of assets (not those currently in
use) and hence the statement of financial position values may not reflect the
technology actually in use.
iii. Replacement cost accounting does not take into account changes in general
price levels nor gains or losses arising from holding monetary liabilities or
assets.
iv. The term ‘replacement cost’ is imprecise, it could mean the cost of an
equivalent asset for example.

Disadvantages of net realizable value accounting

i. it is only relevant if the asset is expected to be sold in an active market. Net

realizable values may not be readily available for specialist items with no
alternative uses.
ii. Net realizable values have little relevance if the asset is expected to continue to
be used by an entity.
iii. There is a real problem in valuing intangible assets such as goodwill and also
liabilities.
iv. If a firm is not a going concern, additional liabilities may emerge which can be
difficult to value such as closure costs. Should liabilities be included at
contractual amounts or the amounts required to settle the liabilities?
v. The use of the net realizable value method implies that a business may not be
a going concern, this can give an unfortunate appearance for an entity’s
financial statement.
vi. Net realizable value does not account for general price level changes.

(b) (i) The effects of hyperinflation on the financial statements

Hyperinflation can reduce the usefulness of financial statements in the following ways:

(i) The amounts at which assets are stated in the statement of financial position
are unlikely to reflect their current values.

24
(ii) The level of profit for the year may be misleading. Income appears to increase
rapidly, while expenses such as depreciation may be based on out of date costs
and are artificially low.
(iii) It is therefore difficult to make any meaningful assessment of an entity’s
performance as assets are understated and profits are overstated

These are general disadvantages of basing financial statements on historic cost and
they affect most entities. However, where there is hyperinflation these problems are
exacerbated. In addition, where an entity’s financial statements are translated into
ZMK, for instance, hyperinflation often gives rise to significant exchange differences
which may absorb reserves.

How hyperinflation should be dealt with in the financial statements

IAS 29 does not provide a definition of hyperinflation. However, it does include

guidance as to characteristics of an economic environment of a country in which
hyperinflation may be present. These include, but are not limited to, the following:

(i) The general population prefers to keep its wealth in non monetary assets or in
a relatively stable foreign currency
(ii) Interest rates, wages and prices are linked to a price index
(iii) The cumulative inflation rate over three years is approaching, or exceeds,
100%.
IAS 29 states that the financial statements of an entity that reports in the
currency of a hyperinflationary economy should be restated in terms of the
measuring unit current at the reporting date. This involves remeasuring assets
and liabilities by applying a general price index. The gain or loss on the net
monetary position is included in net income and separately disclosed. The fact
that the financial statements have been restated should also be disclosed,
together with details of the index used.
IAS 21 “The effects of changes in foreign exchange rates” states that where
there is hyperinflation, the financial statements of a foreign operation should
be restated in accordance with the requirement of IAS 29 before they are
translated into the currency of the reporting entity. In this way, users are made
aware of the hyperinflation on the results and net assets of the entity.

(b) (ii) Carrying value of hotel complex at 31 December 2012

(a) Assuming the economy of Zimbabwe is not a hyperinflationary economy

The closing rate is used. This produces a value of:

ZWD5,000 million ÷ 220 = K22.73m

Use of the closing rate without adjustments produces an amount based

on the original cost. Because the exchange rate has increased from 25
to 220 over the life of the complex, there is a cumulative exchange loss
of K177.27m (ZWD5,000 million ÷ 25 – 22,727,273). The hotel complex

25
 appears to be worth much less at 31 December 2012 than when it was
first acquired.

(b) Assuming the economy of Zimbabwe is a hyperinflationary economy

Before the cost of the hotel complex is translated into Zambian Kwacha,
it is restated using the retail price index. This produces a value of:

ZWD5,000 million x 1000/100÷220 =K227.27m.

This method adjusts the value of the complex to reflect the effect of ten-
fold inflation over the two year period. In this way the disappearing
assets’ problem is overcome. In fact the asset now appears to be worth
more than when it was first acquired.

SOLUTION FIVE

(a) Why companies engage in Corporate Social Responsibility (CSR) or the increasing
commitment to CSR

1. Shows the commitment of businesses to contribute to sustainable economic

development. For developing countries, this is desired greatly.

2. Key mechanisms by which corporations are demonstrating accountability and

transparency for their social, environmental and ethical policies and
performance to stakeholders

i. Corporate accountability, corporate governance and risk management

involves three elements
(a) Transparency
(b) Responsiveness and
(c) Compliance

3. Through effective stakeholder engagement, stakeholders’ reasonable

expectations of the industry could be established.

4. Consistent with wealth maximisation motives of companies

i. it provides a proactive approach to effective management in a global

economy
ii. is a key ingredient to building, sustaining, and continually refining
stakeholder engagement;
iii. helps to strengthen partnerships and build trust as it is a demonstration of
transparency and open dialogue about performance, priorities and future
sustainability plans;
iv. helps evaluate potentially damaging developments before they develop
into unwelcome surprises;
v. helps sharpen management’s ability to assess the organization’s
contribution to natural, human, and social capital and;
vi. may reduce volatility and uncertainty in share price for publicly traded
enterprises, as well as reducing the cost of capital.
26
 5. Necessary for profitability through integration of CSR into company operation,
because the number of socially responsible investment funds have grown, and
investors’ social and environmental information needs have become material.
i. build sales,
ii. develop the workforce, boost enthusiasm and innovation,
iii. enhance trust in an enterprise and
iv. increase a company’s reputation and standing

(b) The arguments for the regulation of CSR practices, especially in developing countries
 current state of distrust between society and enterprises, corporate claims of
good behaviour are met with suspicion – reporting on CSR builds trust
 movement from ‘trust me’ to ‘show me’
 Governments have to take overall responsibility for ensuring that conduct
failures - whether market or non-market failures - are regulated appropriately
 Voluntary initiatives e.g. Global Reporting Initiative and Institute of Social and
Ethical Accountability Standards (Accountability) standards, have limitations. It is
at their limits that government regulation should come in.
 Not legally binding
 Raise serious questions for increased competitiveness, when not unilaterally
enforced at the national and local levels.
 The voluntary initiatives are only credible if effective legal safeguards are put in
place to ensure companies respect minimum internationally agreed social,
human and environmental rights within their spheres of influence, wherever they
operate.
 can contribute to a number of public policy objectives, such as “greater respect
for human rights, environmental protection and core labour standards
 government action has the benefit of rationalizing market forces by creating a
“level playing field”.
 it spreads costs across the breadth of society,
 provides a formal and public means of recourse when standards are not met
 creates an environment in which other initiatives can be tried and can
succeed, and should avoid the lowering of standards.
 different parties (e.g. corporations, pressure group, local community,
government) cannot agree on what ‘social responsibility’ really means and how
any resulting accountability might be discharged

(c) How international financial institutions are providing incentives for the extractive
industries to manage their social and environmental performance.

The financial institutions provide incentives for social and environmental risk
management in the extractive industry through project financing. Project finance is
often used to fund the development and construction of major infrastructure and
industrial projects.

Financial institutions have signed up to voluntary initiatives, e.g. the equator

principles (EPs). The EPs are a credit risk management framework for determining,
assessing and managing environmental and social risk in project finance transactions.
The Equator Principles Financial Institutions (EPFIs) commit to not providing loans to

27
 projects where the borrower will not or is unable to comply with their respective
social and environmental policies and procedures that implement the EPs.

The EPs, based on the International Finance Corporation Performance Standards on

social and environmental sustainability and on the World Bank Group Environmental,
Health, and Safety Guidelines (EHS Guidelines), are intended to serve as a common
baseline and framework for the implementation by each adopting institution of its
own internal social and environmental policies, procedures and standards related to
its project financing activities.

(d) The role of ZICA in promoting social and environmental reporting in Zambia
 Formulation, implementation of accounting standards that cover social and
environmental reporting
 Playing an advisory role to the government in best practices in CSR reporting
 Through partnering and/or dialogue with companies in promoting CSR reporting
 Through education of CSR related issues
 Through promotion of awareness by holding public discussion forums.

END OF SOLUTIONS

28