FAC4861/102/0/2020

NFA4861/102/0/2020
ZFA4861/102/0/2020

Tutorial letter 102/0/2020

ADVANCED FINANCIAL ACCOUNTING I

FAC4861/NFA4861/ZFA4861

Year Module

Department of Financial Governance

IMPORTANT INFORMATION:

This tutorial letter contains important information

about your module.
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INDEX Page

Due date 3

Prescribed method of study 3

Suggested working programme 4

Learning unit 0 Introduction to myUnisa 5

1 General 10

2 The Conceptual Framework for financial reporting 18

3 Presentation of financial statements 24

4 Inventories 41

5 Income taxes 55

6 Accounting policies, changes in accounting estimates and errors 88

Self assessment questions and suggested solutions 101

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DUE DATE
TEST 1 ON TUTORIAL 102: 10 MARCH 2020

TEST 1 REMARK DEADLINE: 6 MAY 2020

PERSONNEL AND CONTACT DETAILS

Personnel Telephone
Number
Lecturers
Mr M Masia (Course leader) 012 429-6145
Ms Y Abed 012 429-4713
Mr A Baloyi 012 484-1017
Ms L Letho 012 429-2288
Mr H Meyer 012 429-4722
Ms K Mohajane 012 429-4688
Ms A Uys 012 429-4750

Please send all e-mail queries to: [email protected]

PRESCRIBED METHOD OF STUDY

1. Please read the prescribed study material for every learning unit thoroughly before you study the
additional information in section A of every learning unit.

2. Do the other questions (section B) in the learning unit and make sure you understand the principles
contained in the questions.

3. Consider whether you have achieved the specific outcomes of the learning unit.

4. After completion of all the learning units - attempt the self-assessment questions to test whether you
have mastered the contents of this tutorial letter.

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SUGGESTED WORKING PROGRAMME

JANUARY / FEBRUARY 2020
WEDNESDAY THURSDAY FRIDAY SATURDAY SUNDAY MONDAY TUESDAY
29 30 31 1 2 3 4
The Inventories Income Income Accounting Self Self
Conceptual taxes Taxes policies, assessment assessment
Framework change in questions questions
accounting
Presentation estimates
of financial and errors
statements

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LEARNING UNIT 0 – INTRODUCTION TO myUNISA

INTRODUCTION

This learning unit will assist you in understanding the various functions available on
myUnisa and also in obtaining your myUnisa login details as well as creating your myLife
e-mail account.

OBJECTIVES/OUTCOMES

After you have studied this learning unit, you should be able to do the following:

1. Claim your myUnisa login details

2. Create your myLife e-mail account

3. Use the myUnisa tools and understand the functioning thereof

PRESCRIBED STUDY MATERIAL

myUnisa login

Once you have registered and have your myUnisa login details, you will have access to
all the modules which you have registered for.
In order to join the online learning environment, you will need to claim your myUnisa
login details by following the instructions at the following link:
https://my.unisa.ac.za/portal.

myUnisa

FIGURE 1: myUnisa portal

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myLife e-mail account

When claiming your myUnisa login details, you will also be creating your myLife e-mail
account. Your myLife e-mail account will be the only e-mail account recognised by Unisa
for official correspondence with you from the University. You may redirect your myLife
e-mails to another more preferred e-mail account which you have access to. However,
the myLife account will remain the official e-mail address for you on record at Unisa. The
management of this e-mail account is solely your responsibility.

Should you experience any difficulty with the above, you are welcome to ask for
assistance at:

• [email protected]
• [email protected]

What is myUnisa?

myUnisa was created to serve as a digital classroom and study space where you can
engage with your studies, your lecturer and your fellow students. myUnisa makes it
possible for you to use a digital device like a laptop, a tablet or even a smart cellphone
to receive instructions and guidance, to obtain access to sources and resources, to
listen to podcasts or view screencasts and to interact with your lecturers as well as other
students.

The myUnisa platform should be reserved strictly for Unisa academic (teaching and
learning) purposes. Advertising and or any other breach as outlined in the Student
Disciplinary Code may lead to disciplinary action.

On this site, you will find the following material:

• electronic copy of this document under Additional Resources as well as all your
tutorial letters under Official Study Material
• module-specific learning materials under Learning Units as also contained in this
document

How does myUnisa work?

• In this brief overview, we refer to those functions of myUnisa that you may
encounter and may need on a regular basis. On the left-hand side of your myUnisa
module page, you will find a number of options as indicated below. These options
are known as “buttons” because one can click on each of them in order to select
and open the “tool” that the button represents. These buttons start with Home,
Assignments and so forth from the top down.

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FIGURE 2: myUnisa toolbar

myUnisa tools

When you click on the myUnisa tools, there may, or may not be, a definition of the tool
at the top of the page that is opened. For example, the Discussion Forums tool is
defined while the Additional Resources tool, for instance, is not defined.

Each myUnisa tool has its own function and is treated very briefly below. You can open
only one tool at a time and will have to learn how to move from one tool to the other and
how to move from one option within a tool to another option within the same tool.
Moving around in myUnisa is known as “navigating”.

The myUnisa page of certain modules may include a longer list of tools than others. The
activation of tools depends on how the responsible lecturer and other role players
envisaged the flow of information and how they intended you to be exposed to the
learning experience. The supposed absence of a tool on a module page is therefore not
an indication that myUnisa is not working as it should.

The following is a brief overview of the myUnisa tools for this module, how some of
them are related to one another and how they will be useful to you:

Home

Here you will find a welcome message (refer to page 3 of this document) from your
lecturers, which includes important contact details you may find valuable during the
course of the year.

The Home tool also contains a calendar where important events have been indicated
by a red-coloured block on the specific date, for example test and exam dates. Once
you have clicked on these blocks, additional information will appear at the bottom of the
calendar, indicating the event.

Lastly, a summary of any announcement made (refer to the Announcements tool

below) will appear on the Home tool for at least ten days.

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Assignment info

Here you will be able to view your assignment (test) results.

Announcements

During the year, lecturers will place announcements on myUnisa to communicate

important and relevant information to students, such as study school venue
confirmation, new screencasts that have been uploaded to myUnisa, and so forth.
It is crucial that you have registered yourself correctly on myUnisa, since you will then
receive an e-mail notification every time your lecturer posts a new announcement.
Always check the list of previous announcements to ensure that you have not missed
any important notices.

Once you have selected this tool, click on the relevant announcement subject to view
the full details of the announcement.

Official Study Material

All tutorial letters for this module are uploaded here in PDF format. Once you have
selected this tool, please follow the instructions at the top of this page to download a
document to your personal computer or mobile device. You may also select to print the
document.

Previous exam papers are also made available on this tool. Please note that course
curriculums are regularly updated and therefore past examination papers may be
outdated. Using past examination papers as study material is done at your own risk.
Your lecturer will not provide you with the solutions to these exam papers since
previous exam papers are only updated and made available in Tutorial Letter 107 (as
case studies) later in the year.

Additional Resources

Additional resources such as tests, study school slides, additional comments on tutorial
letters and so on that can contribute to your understanding of module contents will be
uploaded here. A notification will be sent to students via e-mail to notify students when
an upload has been made to this tool. Investigate this tool after you have registered for
the module as well as regularly during the course of the year. Also view your Unisa e-
mail account regularly for any notifications.

Schedule

This function presents you with a daily, weekly, monthly or yearly calendar in which
important events are indicated on their due dates. Be aware that events mentioned
under Announcements may perhaps not have been included under the Schedule tool.
You may also select to view a list of all important events.

Discussion Forums

This is a valuable and safe space where you can interact with fellow students about
topics relating to the module that you have enrolled for. Either the lecturer or you can
create a discussion about a topic.

Once you have selected this tool, you can either create a new forum or you can select
an existing forum by clicking on the forum name. Under each forum name you can
either create a new topic or select an existing topic.

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Remember, online discussion forums are not the same as e-mail messages, or a letter
to the lecturer, or a chat room. Therefore, the myUnisa discussion forums must not be
used for personal messages to your lecturers or to one another.

Netiquette

“Netiquette” is simply “net etiquette”. This refers to the way in which you should
behave when you communicate on myUnisa and more specifically, on discussion
forums. Netiquette outlines simple, polite online discussion behaviours that
participants in an online discussion expect from one another.

Online discussions in module discussion forums are perhaps more formal than other
public discussion forums. It helps to remember that in an online class, discussion
forums are used instead of the face-to-face discussions or paper-based
correspondence that you may be used to. We require you to behave online in the
same manner which you would if you were physically sitting in a classroom with your
lecturer or e-tutor and all your classmates.

It is also important to understand that an online discussion in a university environment

is more formal than a text message (SMS). Text messaging uses abbreviations such
as “How R U?”. This abbreviated language is not appropriate in an online discussion
forum. You have to use full words and complete sentences.

Prescribed books

Contains the official Unisa Booksellers as well as the prescribed books for the year.

Please note: Although the most recent SAICA Handbook is prescribed and
recommended, any previous version may be taken into test and exam venues (refer to
the open book policy in tutorial letter 301).

Learning Units

The Learning Units tool contains all the learning units of which the syllabus for this
module comprises of.

Screencasts and/or other information might also be uploaded under Additional Learning
Activities.

ADDITIONAL LEARNING ACTIVITIES

You might find it helpful to access the following links relating to studying online:

• my Studies @ Unisa (1) (2:58)

• my Studies @ Unisa (2): What does it mean to be an ODEL student at Unisa? (1:12)
• Get connected before you start to register on myUnisa (6:10)

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LEARNING UNIT 1 – GENERAL

A. SAICA’S PRINCIPLE OF EXAMINATION LEVELS

Throughout the study material, we will refer you to the following principles of examination levels:

1. Issues that are at a core level:

An issue is at core level if:

• It is based on a significant conceptual underpinning/foundation of current financial
accounting (i.e. based on identification, recognition, measurement and presentation and
disclosure of elements); or
• It is prevalent (i.e. issues and industries that would be commonly encountered in practice
in the course of an entry-level Chartered Accountant’s work). Here, the emphasis is on
issues that are of a more general nature.

At core level an entry-level Chartered Accountant must be able to identify the underlying
problem, perform complex calculations and answer integrated questions relating to core level
issues.

2. Issues that are at an awareness level:

Awareness means that the issue is not core but it is important for an entry-level Chartered
Accountant to know about the issue. It is important for them to be able to identify that it is an
issue that potentially has significant accounting implications and requires additional or
specialist IFRS knowledge.

They would need to be able to identify and describe what the accounting issue is and read up
on it futher. Students would also be expected to perform basic processing of the transaction
when the numbers are given (e.g. obtained from an expert).

A good example might be borrowing costs i.e. students should be able to do the journal to
capitalise any qualifying borrowing costs to Property, Plant and Equipment when the borrowing
cost amount has been supplied.

3. Issues that are excluded:

The following standards are excluded from the syllabus:

• IFRS 1 First-time Adoption of International Financial Reporting Standards

• IFRS 4 Insurance contracts
• IFRS 6 Exploration for and Evaluation of Mineral Resources
• IFRS 8 Operating Segments
• IFRS 14 Regulatory Deferral Accounts
• IAS 20 Government Grants
• IAS 26 Accounting and Reporting by Retirement Benefit Plans
• IAS 29 Financial Reporting in Hyperinflationary Economics
• IAS 33 Earnings per Share
• IAS 34 Interim Financial Reporting
• IAS 41 Agriculture

Please note the scope of all standards is at an awareness level, even if the standard is
excluded. Exclusions within any standard will be specifically identified in your study material.

The treatment of any Interpetation Note will follow the principle of examination level of the related
standard.

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B. A STUDENT’S GUIDE TO SUCCESS

To all our FAC students

We prepared a guide for the FAC students who are embarking on their CTA studies. The guide
contains general information for the FAC module and highlights important information you should
take note of.

The following are important aspects of your studies:

- Attitude
- How to use the study material
- The importance of tests
- myUnisa
- Contacting your lecturer

ATTITUDE
A positive attitude is the key to your success!!!

A positive attitude includes:

Self-learning Ownership Self-confidence

A CTA student takes A CTA student has an attitude A CTA student attempts
responsibility for his/her of responsibility for his/her own his/her tests and exams with
own learning experience. progress, planning and self-confidence based on
challenges. his/her consistent effort and
commitment throughout the
Commitment Consistency year.

A CTA student prioritises A CTA student works

his/her studies by setting a consistently through the year
study program and keeping and does not leave his/her
to the program even when studies for a last minute crash
faced with other pressures course.
or commitments.

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How to use the study material (tutorial letters)

Step 1: Familiarise yourself with the relevant IFRS in the learning unit.
Use SECTION A in the learning unit to guide you through the IFRS.

Step 2: Study the relevant chapter in the TEXT BOOK.

WORK SMART: spend more time on issues that you find difficult and less time on easy
principles!

Step 3: Do the questions in SECTION B of the learning unit.

HINT: Don’t rush through these questions. Take your time and ensure you understand
the principles before proceeding to the next learning unit.

Step 4: After completing the learning units proceed to the SELF ASSESSMENT QUESTIONS.
Do the questions within the given time (simulate exam conditions).
Mark your solution.
Identify areas that you found difficult. Address these issues immediately by referring
back to the relevant learning unit, text book or by contacting the lecturers.

Use the SUGGESTED WORKING PROGRAM at the

beginning of each tutorial letter to plan your studies for
the week

The importance of tests

In order to obtain exam admission a student requires a minimum year mark of 40% based
on the student’s best three tests.

There are 4 tests during the year Don’t miss a test!

(refer TUT 101 for the test dates). There are no supplementary or sick tests.

Tests provide you with the opportunity to:

- Apply your knowledge

- Integrate your knowledge
- Revise important concepts
- Identify areas that need attention
- Build self-confidence
- Important: Work through the suggested solution.

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myUnisa

View myUnisa regularly. Important announcements are issued on the

website.

The tests and their solutions, as well as Tutorial letters and important resources are
comments from the markers are posted after available on the website.
the tests.

Remember the CTA support website:

http://sites.google.com/site/ctasupport

How to contact your lecturer

Use the FAC mailbox: [email protected]

Contact your lecturer telephonically; or

Contact the College of Accounting Sciences (CAS) at:

[email protected].

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C. EXAM TECHNIQUE – COMMENTS

1. Overall comments

Confirm your venue on myUnisa

You have to be seated 15 minutes before the reading
and in TUT 302.
time starts. No student will be allowed after the reading
Any changes to your venue need
time has started.
to be done well in advance.

Write the correct Do not write in pencil or red

module code and pen.
student number on Only use blue or black ink.
the script to avoid that
your script might get lost!
Ensure to write the CORRECT
module.
REMARKS
Indicate where your test
should be remarked. No marks will be awarded if the
Your mark can decrease incorrect module was written.
with a remark. (E.g. writing FAC4863 instead of
FAC4861)

Read your TUT101 and all the TUT300’s thoroughly!

2. Examination technique

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Examination technique remains the key distinguishing factor between students who
PASS and those who FAIL.

PRACTICE
your exam technique by answering the additional questions in each tutorial letter as
well as the questions in Tutorial Letter 106 under test or exam conditions.

2.1 Time management

Students are advised to utilise their time wisely and allocate time for
each question based on the number of marks out of which the
question counts.

Students should be aware of the tendency to spend too much time

on the first question attempted and too little time on the last – rather
return to any incomplete answered questions after attempting all
other questions.

2.2 Answering what was required

Marks can only be awarded for answers that were required.

E.g. if disclosure was required, no marks will be awarded for

calculations that were not used in the required disclosure.

2.3 Open-book examination

Unisa follows the limited open-book policy as prescribed by SAICA.

Please refer to tutorial letter 301 for the open-book policy.
Students are also advised to familiarise themselves with the Unisa
exam rules prior to writing the examination.

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2.4 Communication skills

2.4.1 Answer what has been required

Many students do not address what has been required, for example,
students only provide calculations where disclosure (notes to the
financial statements) or presentation (financial statement/(s)) were
required. Kindly note that if a student has only showed calculations
and has not addressed what has been required, no marks can be
awarded for the calculations.

2.4.2 Presentation mark are awarded

Students also need to bear in mind that this is a professional

qualification and presentation marks are awarded in the tests and
exams:

• Logical flow and conclusion/layout: Marks are awarded in theory

questions for the systematic flow of a logical argument and
conclusion (where applicable). Use bullet points and write to
the point.
• Presentation and layout: Marks are awarded for disclosure and
presentation as required by the International Financial
Reporting Standards (IFRS).

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2.4.3 Write neatly

Students need to write neatly and structure their answers.

No writing in pencil will be marked.

A marker will not be able to allocate marks if it is not possible to

read a student’s handwriting.

Only abbreviations used in the tutorial letters will be accepted.

2.4.4 Reference calculations

It is essential that students supply and reference detailed
calculations to support the figures in their answers.

Students need to ensure that their calculations are properly and

neatly cross-referenced to the final solution. Ensure that the
answer to your calculation is the amount that has been transferred
to the solution. If a different amount is used in your solution, your
calculation can not be marked.

Remember we mark from your solution to the calculations!

2.4.5 Theory questions

Marks are awarded for applying the theory to the content of the
question. No marks are awarded for writing the theory from the
Accounting Standards.
Write neatly, use bullet points where possible and ensure to obtain
the presentation marks!

2.4.6 Journal entries

Students need to indicate Dr and Cr on top of the columns where

the amounts are written. Students also need to indicate whether the
statement of profit or loss (P/L), other comprehensive income (OCI)
or the statement of financial position (SFP) are debited or credited.
Also note whether the required section requires dates and journal
narrations.

IF REQUIRED

Dr Cr
31 December 20.17
J1 Deferred tax expense (P/L) [C1] 14 000 ALWAYS
Deferred tax (SFP) 14 000 REMEMBER
Provide deferred tax for the current
financial year

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LEARNING UNIT 2 – THE CONCEPTUAL FRAMEWORK FOR FINANCIAL

REPORTING

INTRODUCTION

The Conceptual Framework for financial reporting (Conceptual Framework) describes the
objective of, and the concepts for, general purpose financial reporting. The Conceptual
Framework is not a standard. Nothing in the Conceptual Framework overrides any
Standard or any requirement in a Standard.

OBJECTIVES/OUTCOMES

After you have studied this learning unit, you should be able to do the following:

1. Discuss the objectives, usefulness and limitation of general purpose financial

reporting.

2. Define and discuss the qualitative characteristics of useful information.

3. Discuss the information financial statements provides.

4. Define the elements of financial statements.

5. Describe the recognition criteria of the elements of financial statements.

6. Determine when to derognise of all or part of a recognised asset or liability from an

entity's statement of financial position.

7. Applying measurements basis to elements of financial statements.

8. Consider the nature of the information that the measurement basis will produce.

9. Factors to consider when selecting a measurement basis.

10. Discuss presentation and disclosure objectives and principles.

11. Application of classification.

12. Describe the concepts of capital maintenance and the determination of profit.

PRESCRIBED STUDY MATERIAL

The following must be studied before you attempt the questions in this learning unit:

1. The Conceptual Framework for Financial Reporting.

2. Chapter on the Conceptual Framework in Descriptive Accounting, 21st edition.

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THE REST OF LEARNING UNIT 2 IS BASED ON THE ASSUMPTION THAT YOU

HAVE ALREADY STUDIED THE RELEVANT CHAPTERS IN THE PRESCRIBED
STUDY MATERIAL.

SECTION A – SAICA’S PRINCIPLES OF EXAMINATION

The principle of examination for Conceptual Framework is at core level.

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SECTION B - ADDITIONAL QUESTIONS

QUESTION 2.1 (20 marks)

You are employed by Expert Ltd (Expert). Expert provides accounting and tax consulting services to
various clients. The International Accounting Standards Board (Board) issued the revised
Conceptual Framework for Financial Reporting (Conceptual Framework), a comprehensive set of
concepts for financial reporting in March 20.18. Your portfolio includes the following two allocated
clients who have approached you regarding the recognition of assets and liabilities in terms of the
revised Conceptual Framework.

Client 1: Mogale Ltd

On 13 June 20.16, Mogala Ltd (Mogala) purchased a holographic touch screen patent from
Innovation Ltd (Innovation) at a cost of R250 million. This patent will give Mogala access to all the
patents internationally and locally for the design and manufacture of holographic touch screens. Only
Mogala can utilise the patent to design and manufacture the holographic touch screens. This will
result in Mogala selling the first holographic touch screen smartphones and it will ensure that Mogala
is the only designer and manufacturer of such smartphones.

Mogala will manufacture all the other components of the smartphones and it will assemble the
holographic touch screen smartphones and it is estimated that 90 million holographic touch screen
smartphones will sell within the next financial year at a satisfactory profit margin.

Client 2: Sea Homes Ltd

Sea Homes Ltd (Sea Homes) is a new real estate agency that specialise in selling beach front
holiday homes for the upper middle class market. Sea Homes is operating in the South Coast of
Kwazulu-Natal region of South Africa. As part of its expansion strategy, a decision has been taken
by the directors of the company to open a new office in the North Coast of Kwazulu-Natal region.

Sea Homes paid R40 000 to Umhlanga News to advertise holday homes for sale in the newspaper
to appear during January 20.18. This amount was paid on 15 December 20.18.

REQUIRED
Marks

Discuss, in terms of The Conceptual Framework for Financial Reporting 2018, whether the 18
patent (refer to client 1) and payment to Umhlanga News (refer to client 2) may be
recognised as an asset in the financial statements of Mogala Ltd and Sea Homes Ltd for
the year ended 31 December 20.18.

Communications skills: logical argument 2

Please note:

• Ignore any normal income tax implications.

• Ignore Value Added Taxation (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 2.1 – Suggested solution

Discuss, in terms of The Conceptual Framework for Financial Reporting 2018, whether the
patent (refer to client 1) and the payment client 2) may be recognised as an asset.

An item can only be recognised if it meets the definition of an asset (Conceptual

Framework 5.6) and only if recognition of the asset provide users of financial statements
with information that is useful (Conceptual Framework 5.6 – 5.7).

An asset is a present economic resource contolled by an entity as a result of past events

(Conceptual Framework 4.3).

An economic resource is a right that has the potential to produce economic benefits
(Conceptual Framework 4.4).

MONGALE LTD - Client 1

Definition of an asset

Right

Mogala puchased the patent and has a right to use the patent (intellectual property) to
design and manufacture holographic touch screens (Conceptual Framework 4.7 (ii)). (1)

Potential to produce economic benefits

The right to design and manufacture holographic touch screens has the potential to produce
ecenomic benefits since the holographic touch screens produced will be sold to generate
revenue which rise an asset (either cash or a trade receivable) which is an economic benefit
(Conceptual Framework 4.16 (d)). (2)

Control

The patent can only be used by Mongala, therefore, it has the ability to direct the use of the
right to manufacture holographic touch screens by using the patent (Conceptual
Framework 4.20). (1)

Mongala will obtain all the revene from the sale of the holographic touch screens
(Conceptual Framework 4.20). (1)

The patent can only be used by Mongala, it has the presents ability to prevent other entities
from directing the use of the patent in the production of touch screens
(Conceptual Framework 4.20). (1)

All revenue from the sale of holostic tough screens will be legally in the name of Mongala,
therefor, Mongala has the present ability to prevent others from obtaining the revenue ftom
the touch scrren sales (Conceptual Framework 4.20). (1)

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Past event

The past event is the acquisition of the holographic touch screen patent by Mogala from
Innovation Ltd that gives Mongala the the right to use the patent to manufacture touch
screens. (1)

Recognition criteria

Relevant information

The patent was acquired at a cost, therefore, no uncertainity that the patent exists
(Conceptual Framework 5.12 (a)). (1)

The probability of the inflow of future economic benefits is not low as the he analysis of the
current customer base and target customers; forecast that 90 million holographic touch
screens smartphones will sell in the first year, at a satisfactory profit (Conceptual
Framework 5.12 (a)). (1)

Faithful representation

The holographic touch screen patent was acquired by Mongala at a cost of R250 million,
therefor, no measurement uncertainity associated with the patent (Conceptual
Framework 5.18). (1)

Conclusion

The patent will be recognised as an asset in terms of the Conceptual Framework for
Financial Reporting in the financial statements for the year ended 28 February 20.17. (1)
Total (12)
Maximum (10)
Communication skills: logical argument and clarity (1)

SEA HOMES LTD - Client 2

Definition of an asset

Right

There is a right, in the form of a right for the adverts to apperar in the news paper in the
following financial year (Conceptual Framework 4.7 (ii)). (1)

Potential to produce economic benefits

The right has the potential to produce economic benefits, in the form of both cash inflows,
through potential cliens being attracted to the homes being advertised for sale and in the
form of reduced future cash inflows since the cash payment for the newspaper adverts
have already been made (a prepayment) (Conceptual Framework 4.16 (d)). (2)

Control

The control arises through the underlying contract with the newspaper (Conceptual
Framework 4.20) (1)

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Past event

The past event is the prepayment of cash for the advertising on 15 December 20.18, before
the reporting period. (1)

Recognition criteria

Relevant information

There is no uncertainty about the existence of the payment to Umhlanga News.

The probability of the inflow of economic benefits are not low. Refer to discussion of the two
potential economic benefits below.

Faithful representation

The relevant information right has two potential economic benefits:

• The potential to produce economic benefits through cash inflows from the future sales
of homes has such a high level of measurement uncertainty (i.e. we cannot quantify the
number or value of the sales that will occur as a direct result of the newspaper advert)
that, if we were to recognise such a benefit, we would not achieve faithful
representation (Conceptual Framework 5.18). (2)

Faithful representation

• However, the second potential economic benefit identified, being the reduced future
cash outflow (i.e. reduced advertising cash outflows), has no measurement uncertainty
at all (we know the amount that has been prepaid) and thus faithful representation is not
adversely affected and the benefit may be recognised (Conceptual Framework 5.18). (2)

Conclusion

The payment will be recognised as an asset in terms of the Conceptual Framework for
Financial Reporting in the financial statements for the year ended 28 February 20.17. (1)
Total (10)
Maximum (8)
Comminication skills: Logical argument and clarity (1)

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LEARNING UNIT 3 – PRESENTATION OF FINANCIAL STATEMENTS

INTRODUCTION

The objective of this Standard is to provide guidelines for the structure and content of
general purpose financial statements, as well as to explain certain underlying principles.

OBJECTIVES/OUTCOMES

After you have studied this learning unit, you should be able to do the following:

1. Identify the objective and scope of IAS 1 Presentation of financial statements.

2. Identify under which circumstances the standard should be applied.

3. Discuss the objective of financial statements.

4. Specify the components of financial statements.

5. Specify and discuss the overall considerations with the preparation of financial
statements.

6. Prepare financial statements in accordance with the requirements in IAS 1

Presentation of Financial Statements.

7. Disclose relevant information as required by IAS 1 Presentation of Financial

Statements.

PRESCRIBED STUDY MATERIAL

The following must be studied before you attempt the questions in this learning unit:

1. IAS 1 Presentation of financial statements.

2. Chapter on presentation of financial statements in Descriptive Accounting,

21th edition.

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THE REST OF LEARNING UNIT 3 IS BASED ON THE ASSUMPTION THAT YOU

HAVE ALREADY STUDIED THE RELEVANT CHAPTERS IN THE PRESCRIBED
STUDY MATERIAL.

SECTION A – SAICA’S PRINCIPLES OF EXAMINATION

The principle of examination of IAS 1 is at core level, to the extent that is supports the presentation
and disclosure relating to transactions or topics included in the syllabus.

SECTION B – ADDITIONAL QUESTIONS

QUESTION 3.1 (33 marks)

The following information relates to the Rock Ltd Group for the year ended 31 December 20.11:

1. Consolidated revenue amounted to R2 311 200 for the year. The costs to deliver these goods
to clients amounted to R22 100. There is no credit risk associated with the customers of
Rock Ltd Group.

2. Inventories consisted of the following at 31 December 20.11 and 31 December 20.10:

31 December 31 December
20.11 20.10
R R

Raw materials 23 000 21 500

Consumables 5 000 4 200
Work-in-progress 35 600 28 900
Finished goods 31 200 25 600
94 800 80 200

3. Raw materials amounting to R920 200 and consumables amounting to R18 900 were
purchased during the year.

4. The following salaries were paid during the 20.11 year: R

Factory workers 67 800

Sales agents 84 200
Administrative personnel 93 800

5. Stationery amounting to R11 000 were used by the administrative personnel during the 20.11
year, while advertising costs amounted to R14 800.

6. Depreciation provided for the 20.11 year is as follows: R

Plant 54 300
Delivery vehicles 26 700
Office buildings 8 200

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In terms of the Income Tax Act, the South African Revenue Services (SARS) does not grant
an income tax capital allowance on the office buildings. Depreciation on plant and delivery
vehicles did not give rise to any temporary difference for capital gains tax purposes.

7. During the 20.11 year dividends amounting to R7 000 were received on unlisted investments,
while share of profit from associates amounted to R150 000.

8. Interest paid on the bank overdraft amounted to R33 300 for 20.11.

9. Rock Ltd was paid for the use of their trademark for six months during the 20.11 year at R500
per month.

10. Donations (not deductible for tax purposes) amounting to R6 000 were made to various charity
organisations during the 20.11 year.

11. The non-controlling shareholders’ interests in the subsidiaries’ profit for the 20.11 year
amounted to R45 100.

12. The normal income tax rate is 28%. You may assume that there are no other temporary
differences except those that are evident from the question.

REQUIRED
Marks
(a) Prepare the consolidated statement of profit or loss and other comprehensive income 19
of the Rock Ltd Group for the year ended 31 December 20.11. Expenses should be
classified according to their function. All notes to the statement of profit or loss and
other comprehensive income, excluding accounting policy notes, should be supplied.

(b) Prepare the consolidated statement of profit or loss and other comprehensive income 14
of the Rock Ltd Group for the year ended 31 December 20.11. Expenses should the
classified by their nature. Only the note relating to profit before tax should be
supplied.

Please note:

• Comparative figures are not required.

• Ignore any Value-Added Taxation (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 3.1 - Suggested solution

(a) Classification of expenses by function

ROCK LTD GROUP

CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 31 DECEMBER 20.11
Note R
Revenue 2 311 200 (½)
Cost of sales [C1] (1 046 600) (3)
Gross profit 1 264 600
Other income [(500 x 6) + 7 000] 10 000 (1½)
Distribution costs [C2] (147 800) (2)
Administrative expenses [C3] (113 000) (1½)
Other expenses (6 000) (½)
Finance costs (33 300) (½)
Share of profit of associates 150 000 (½)
Profit before tax 2 1 124 500
Income tax expense [C4] 3 (274 876) (½)
PROFIT FOR THE YEAR 849 624

Profit attributable to:

- Owners of the parent (balancing figure) 804 524 (½)
- Non-controlling interests (given) 45 100 (½)
849 624

COMMENT

1. Note that the allocation of costs between the different functions is in some instances
subjective. (It could, for instance, be debated that advertisement costs represents
administrative or other costs rather than distribution costs.) Consequently IAS 1.103
states that cost of sales should be disclosed separately from other costs as a
minimum requirement. In this question it would therefore be acceptable to combine
distribution costs, administrative expenses and other expenses in one line-item (i.e.
other expenses). Cost of sales must however be shown separately.

2. Also note that the line-item other income, includes both operating income and invest-
ment income.

3. Furthermore, note that should a question state that dividends have been received by
the company, it may be assumed that the dividends were received net of Dividend
Tax. This is due to the fact that dividends tax is a withholding tax which will be paid
on the shareholder’s behalf by the company paying the dividends therefore resulting
in the shareholder receiving the dividend amount net of Dividends Tax.

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ROCK LTD GROUP

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.11

2. Profit before tax

The following items are included in profit before tax: R

Income
Dividends received – unlisted (IAS 18.35(b)(v)) 7 000 (½)

Expenses
Depreciation on property, plant and equipment
(54 300 + 26 700 + 8 200) (IAS 16.75(a); IAS 1.104) 89 200 (½)
Donations (IAS 1.112(c)) 6 000 (½)
Employee benefit expense (67 800 + 84 200 + 93 800) (IAS 1.104) 245 800 (½)

COMMENT

Note that IAS 1.104 requires that when expenses are classified by function, total
depreciation, amortisation and employee benefit expenses should be disclosed in a note.

3. Income tax expense

Major components of tax expense R

SA normal tax
Current tax
- Current year [C4] 274 876 (3)

Tax rate reconciliation

Accounting profit 1 124 500

Tax at 28% 314 860 (½)
Tax effect of non-deductible/non-taxable items:
- Depreciation on office buildings (8 200 x 28%) 2 296 (½)
- Donations (6 000 x 28%) 1 680 (½)
- Dividends received (7 000 x 28%) (1 960) (½)
- Share of profit of associates (150 000 x 28%) (42 000) (½)
Income tax expense 274 876
Total (19)

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(b) Classification of expenses by nature

ROCK LTD GROUP

CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 31 DECEMBER 20.11
Note R
Revenue 2 311 200 (½)
Other income [(500 x 6) + 7 000] 10 000 (1)
Changes in inventories of finished goods
and work in progress [C5] 12 300 (1½)
Raw materials and consumables used [C6] (936 800) (3)
Employee benefit expense (67 800 + 84 200 + 93 800) (245 800) (1½)
Depreciation and amortisation expense
(54 300 + 26 700 + 8 200) (89 200) (1½)
Other expenses [C7] (53 900) (2)
Finance costs (33 300) (½)
Share of profit of associates 150 000 (½)
Profit before tax 2 1 124 500
Income tax expense [C4] 3 (274 876) (½)
PROFIT FOR THE YEAR 849 624

Profit attributable to:

- Owners of the parent (balancing figure) 804 524 (½)
- Non-controlling interests (given) 45 100 (½)
849 624

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.11

2. Profit before tax

The following items are included in profit before tax:

Income
Dividends received – unlisted (IAS 18.35(b)(v)) 7 000 (½)
Total (14)

CALCULATIONS

C1. Cost of sales

Opening inventories 80 200 [½]

Production costs
Salaries: factory workers 67 800 [½]
Raw materials purchased 920 200 [½]
Consumables purchased 18 900 [½]
Depreciation: plant 54 300 [½]
Closing inventories (94 800) [½]
1 046 600
[3]

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C2. Distribution costs

Salaries: sales agents 84 200 [½]

Depreciation: delivery vehicles 26 700 [½]
Delivery costs 22 100 [½]
Advertising costs 14 800 [½]
147 800
[2]

C3. Administrative expenses

Salaries: administrative personnel 93 800 [½]

Depreciation: office buildings 8 200 [½]
Stationery 11 000 [½]
113 000
[1½]

C4. Taxation

Profit before tax 1 124 500 [½]

Non-taxable/non-deductible differences:
- Depreciation on office building 8 200 [½]
- Donations 6 000 [½]
- Dividends received (7 000) [½]
- Share of profit of associates (150 000) [½]
Taxable profit 981 700
Current tax at 28% 274 876 [½]
[3]

C5. Change in inventory levels

Opening inventories (28 900 + 25 600) (54 500) [½]

Closing inventories (35 600 + 31 200) 66 800 [½]
Increase in inventories results in an increase in profit 12 300 [½]
[1½]

C6. Raw materials and consumables

Opening inventories (21 500 + 4 200) 25 700 [1]

Purchased (920 200 + 18 900) 939 100 [1]
Closing inventories (23 000 + 5 000) (28 000) [1]
Consumed during the year 936 800
[3]

C7. Other operating expenses

Stationery utilised 11 000 [½]

Delivery costs 22 100 [½]
Advertising costs 14 800 [½]
Donations 6 000 [½]
53 900
[2]

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QUESTION 3.2 (20 marks)

Vintage Ltd

Vintage Ltd specialises in the purchase of wine from wine regions around the world. The company
acquires superior wine from boutique farms, some of which they will store to age before it is sold to
customers.

For the financial year ended 30 June 20.13, the company’s inventory consisted of the following:

(a) Aged wines

Description Years to Aging Market

Cost
mature completed value
R R
Cabernet Sauvignon 4 – 20 years 30% 800 000 1 600 000
Pinot Noir 2 – 8 years 60% 750 000 1 750 000
Merlot 2 – 10 years 0% 350 000 680 000
Chardonnay 2 – 6 years 50% 454 000 660 000
2 354 000 4 690 000

(b) Wines available for sale at date of purchase

Vintage Ltd has a variety of wines with little to no aging potential. These wines are immediately
available for sale and usually sell within a year from the time they have been purchased.

Market
Description Cost
value
R R
Variety of white wines 500 000 630 000
Rosé and blush wines 450 000 575 000
950 000 1 205 000

(c) Investment wines

Mr Vin Tage, owner of Vintage Ltd, has a valued appreciation for exceptional wines and travels
the world in order to obtain prized wines for Vintage Ltd’s collection of investment wines.
These wines are considered by some to be Veblen goods; Veblen goods are goods for which
the demand increases, rather than decreases, when the price thereof rises.

Market
Description Cost
value
R R
Bordeaux 900 000 1 800 000
Burgundy 250 000 700 000
Vintage port 1 000 000 2 100 000
2 150 000 4 600 000

Mr Tage is known for his prestigious collection of investment wines which has been collected
over numerous years. It is only a rare few customers who have been able to purchase any of
these wines from Vintage Ltd.

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REQUIRED
Marks
(a) Disclose the above items in the statement of financial position of Vintage Ltd for the 6
year ended 30 June 20.13.

Communication skills: presentation and layout 2

(b) For each line-item disclosed in terms of (a) above, discuss the following:

i. The reason the item was classified as current or non-current. 4

ii. The disclosure of the line item itself. 6

Communication skills: logical flow and conclusion 2

Please note:

• Comparative figures are not required.

• Notes to the financial statements are not required.
• Ignore any Value-Added Taxation (VAT) implications.
• Ignore any normal income tax implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 3.2 - Suggested solution

(a) VINTAGE LTD

STATEMENT OF FINANCIAL POSITION FOR THE YEAR ENDED 30 JUNE 20.13

Notes 20.13
R’000
ASSETS
Non-current assets
Investment wines 2 4 600 [1]

Current assets
Inventory [C1] 3
- Twelve month operating cycle 1 867 [3]
- Operating cycle more than twelve months 1 437 [2]
Total assets 7 904
Total (6)
Communication skills: presentation and layout (2)

(b) Discussion

i. Current versus Non-Current:

Non-current

Investment wines are classified as non-current since these wines are purchased for their
investment value and not to be sold within the normal operating cycle of the company. (1)

Current

Vintage Ltd has more than one operating cycle:

• An operating cycle of twelve months for wines which are ready to be sold as soon
as they have been purchased, and
• an operating cycle which exceeds twelve months, for the wines which need to
mature before they are sold. (1)

According to IAS1.66 (a) an entity classifies an asset as current when it expects to

realise the asset, or intends to sell or consume it, in its normal operating cycle. Note E7
to this paragraph indicates that the wording “operating cycle” should be read in both the
singular and the plural and that it is the nature of inventories in relation to the operating
cycle that is relevant to classification (current versus non-current). (1)

Although Vintage Ltd has more than one operating cycle, the company will disclose
inventory sold within their normal operating cycles as current items. (1)

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ii. Disclosure of items:

Investment wines

IAS 1.57(b) indicates that the descriptions used in the statement of financial position may
be amended according to the nature of the entity and its transactions, to provide
information that is relevant to an understanding of the entity’s financial position. (1)

Although the company specialises in wines, wine as an investment may not be a familiar
investment to the majority of users of the financial statements and hence the description
of this line item is amended to provide information relevant to the operations of the entity.
(1)

COMMENT

Additional information will be provided in the notes to the financial statements.

If Vintage Ltd was also the owner of other investments, then the company would have
separately disclosed the investment in wines on the face of the statement of financial
position, due to its nature and size in accordance with IAS1.57 (a) (refer below).

Inventory

If inventory of different operating cycles were held, and it was material to readers’
understanding of an entity’s financial position, then the general requirement of
IAS 1.57(a) requires disclosure of further information. (1)

IAS 1.57(a) indicates that line items are included in the statement of financial position if
the size, nature or function of an item or aggregation of similar items is such that
separate presentation is relevant to an understanding of the entity’s financial position. (1)

It is not customary for wine traders to sell wine only after it has matured. Thus the nature
of this inventory is worth disclosing to the users of the financial statements. The aged
wines also forms a material part of the inventory balance, which is why its size also
determines separate disclosure in the statement of financial position. (1)

In addition, IAS 1.65 indicates that the expected dates of realisation of assets and
liabilities are useful information in assessing the liquidity and solvency of an entity. Thus
an entity will disclose the amount of inventories that are expected to be recovered more
than twelve months after the reporting period. (1)
Total (10)
Communication skills: layout and conclusion (2)

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CALCULATIONS

C1. Inventory

Twelve month operating cycle

Description Aging completed Cost Total

R
Cabernet Sauvignon 30% 800 000 240 000 [½]
Pinot Noir 60% 750 000 450 000 [½]
Merlot 0% 350 000 - [½]
Chardonnay 50% 454 000 227 000 [½]
2 354 000 917 000

Variety of white wines 500 000 [½]

Rose and blush wines 450 000 [½]
1 867 000

Operating cycle more than twelve months

Description Aging completed Cost Total

R
Cabernet Sauvignon 100% - 30% 800 000 560 000 [½]
Pinot Noir 100% - 60% 750 000 300 000 [½]
Merlot 100% - 0% 350 000 350 000 [½]
Chardonnay 100% - 50% 454 000 227 000 [½]
2 354 000 1 437 000

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SECTION C – ADDITIONAL INFORMATION

1. Components of other comprehensive income (IAS 1.7) include:

IAS/ Re-classified to
Component IFRS Description profit or loss

(a) Changes in the reva- IAS Property, plant May not be reclassified to profit
luation surplus. 16.39 and equipment and loss.

(b) Remeasurements of de- IAS Employee May not be reclassified to profit

fined benefit plans. 19.57(d) benefits and loss.

(c) Gains and losses arising IAS The effects of May be reclassified to profit and
from translating the finan- 21.32/37/ changes in loss.
cial statements of a 38.-.49 foreign exchange (IAS32.32 and 48)
foreign operation. rates

(d) Gains and losses from IFRS Financial May not be reclassified to profit
investments in equity 9.5.7.5 instruments and loss.
instruments measured at (IFRS 9B5.7.1)
fair value through other
comprehensive income in
accordance with para-
graph 5.7.5 of IFRS 9.

(e) Gains and losses on IFRS Financial May be reclassified to profit and
financial assets mea- 9.4.1.2A instruments loss.
sured at fair value (IFRS 9B5.7.1A)
through other compre- May not be reclassified to profit
hensive income. and loss.
(IFRS 9B5.7.1)

(f) The effective portion of IFRS Financial Non-financial item (e.g. inventory):
gains and losses on 9.5.7.5 instruments • May not be reclassified to profit
hedging instruments in a and loss.
cash flow hedge. (IFRS 9.6.5.11(d))
Financial item (e.g. loans):
• May be reclassified to profit and
loss.
(IFRS 9.6.5.11(d))

(g) For particular liabilities IFRS Financial May not be reclassified to profit
designated as at fair 9.5.7.7 instruments and loss.
value through profit or (IFRS 9B.5.7.9)
loss, the amount of the
change in fair value that
is attributable to changes
in the liability’s credit risk.

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2. Disclosure requirements according to IAS 1

In addition to the disclosure requirements of other IFRSs, IAS 1 may also require additional
disclosure which includes the following:

Information to be presented either in the Statement of Financial Position or in the Notes:

IAS 1 Description

1.77 Further sub classifications of the line items presented, classified in a manner
appropriate to the entity’s operations
1.78 (a) Items of property, plant and equipment are disaggregated into classes in
accordance with IAS16
(b) Receivables are disaggregated into amounts receivable from:
• trade customers
• related parties
• prepayments
• other amounts
(c) Inventories are disaggregated into classifications such as:
• merchandise
• production supplies
• materials
• work in process
• finished goods
(d) Provisions are disaggregated into provisions for:
• employee benefits and
• other items
(e) Equity capital and reserves are disaggregated into various classes, such as:
• paid-in capital
• share premium and reserves

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Information to be presented either in the Statement of Financial Position, Statement of

Changes in Equity or in the Notes:

IAS 1 Description
1.79 For each class of share capital:
1.79 (a) (i) number of authorised shares
(ii) number of shares issued and fully paid, and issued but not fully paid
(iii) par value per share, or that the shares have no par value
(iv) reconciliation at beginning and end of the period of the number of shares
outstanding
(v) the rights, preferences and restrictions attaching to that class including
restrictions on the distribution of dividends and the repayment of capital
(vi) shares in the entity held by the entity or by its subsidiaries or associates
(vii) shares reserved for issue under options and contracts for the sale of shares,
including terms and amounts
COMMENT

According to the new South African Companies Act, shares do not have a par
value; hence there will also not be any share premium.
1.79 (b) a description of the nature and purpose of each reserve within equity
• Revaluation reserve
• Translation reserve
• Fair value adjustment reserve
• Cash flow hedge reserve
• Share-based payment reserve
1.80 An entity without share capital, shall disclose information equivalent to that
required by par 79(a), showing changes during the period in each category of
equity interest, and the rights, preferences and restrictions attaching to each
category of equity interest
1.80A If an entity has reclassified
(a) A puttable financial instrument classified as an equity instrument or
(b) An instrument that imposes on the entity an obligation to deliver to another party a
pro rata share of the net assets of the entity only on liquidation and is classified as
an equity instrument
Between financial liabilities and equity, it shall disclose the amount reclassified
into and out of each category (financial liabilities or equity), and timing and reason
for that reclassification

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Information to be presented in the Statement of Profit or Loss and other Comprehensive

Income or in the Notes:

IAS 1 Description

1.97 When items of income or expense are material, an entity shall disclose their
nature and amount separately
1.98 Circumstances which will lead to separate disclosure include the following:
(a) Write down of inventories to net realisable value and reversals of such write-
downs
(b) Write down of property, plant and equipment to recoverable amount and reversals
of such write downs
(c) Restructurings of activities of an entity and reversals of any provisions for cost of
restructuring
(d) Disposals of items of property, plant and equipment
(e) Disposals of investments
(f) Discontinued operations
(g) Litigation settlements
(h) Other reversals of provisions
1.104 An entity classifying expenses by function shall disclose additional information on
the nature of expenses, including:
• Depreciation
• Amortisation expense
• Employee benefit expense

Information to be presented in the Statement of Changes in Equity or in the Notes:

IAS 1 Description

1.106A For each component of equity an entity shall present an analysis of other
comprehensive income by item
1.107 An entity shall present the amount of dividends recognised as distributions to
owners during the period, and the related amount of dividends per share

Information to be presented in the Notes:

IAS 1 Description

112 The notes shall:

(a)Present information about the basis of preparation of financial statements and
accounting policies used
(b) Disclose the information required by IFRSs that is not presented elsewhere in the
financial statements, and
(c) Provide information that is not presented elsewhere in the financial statements,
but is relevant to an understanding of any of them
Disclosure of accounting policies:
117 An entity shall disclose in the summary of significant accounting policies:
(a) The measurement basis used in preparing the financial statements
(b) Other accounting policies used that are relevant to an understanding of the
financial statements
122 The judgement that management has made in the process of applying the entity’s
accounting policies and that have the most significant effect on the amounts
recognised in the financial statements

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IAS 1 Description
Source of estimation uncertainty
125 An entity shall disclose information about the assumptions it makes about the
future and other major sources of estimation uncertainty at the end of the
reporting period, that have a significant risk of resulting in a material adjustment to
the carrying amounts of assets and liabilities within the next financial year. Notes
should include details of their:
• Nature, and
• Carrying amount as at the end of the reporting period
Capital
134 An entity shall disclose information that enables users of its financial statements
to evaluate the entity’s objectives, policies and processes for managing capital.
Other disclosures
137 (a) Amount of dividends proposed or declared before the financial statements were
authorised for issue but not recognised as distribution to owners during the period,
and the related amount per share; and
(b) The amount of any cumulative preference dividends not recognised
138 Disclose the following if not disclosed elsewhere in information published with the
financial statements:
(a) The domicile (the place at which the entity is registered) and legal form of the
entity, its country of incorporation and the address of its registered office (or
principle place of business, if different)
(b) Description of the nature of the entity’s operations and its principal activities
(c) The name of the parent and the ultimate parent of the group, and
(d) If it is a limited life entity, information regarding the length of its life

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LEARNING UNIT 4 – INVENTORIES

INTRODUCTION

Inventory usually comprises a major component of an entity’s current assets. It’s initial
and subsequent recognition, measurement and disclosure can have a substantial impact
on the presentation of the financial position and results of operations of an entity. The
Standard therefore lay down requirements for:

- the determination of the carrying amount of inventory; and

- the presentation of useful and understandable information in respect of inventory in
the financial statements.

OBJECTIVES/OUTCOMES

After you have studied this learning unit, you should be able to do the following:

1. Determine the amount of cost in respect of inventories to be recognised as an asset

and the amount carried forward until the related revenues are recognised.

2. Determine the cost of sales recognised in the statement of profit or loss and other
comprehensive income.

3. Determine any write down to net realisable value and any reversal of the write-
down.

4. Use the different cost allocation techniques and cost formulas to assign costs to
inventories.

5. Disclose all information in respect of inventory in the financial statements.

PRESCRIBED STUDY MATERIAL

The following must be studied before you attempt the questions in this learning unit:

1. IAS 2 Inventories.

2. Chapter on inventories in Descriptive Accounting, 21st edition.

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THE REST OF LEARNING UNIT 4 IS BASED ON THE ASSUMPTION THAT YOU

HAVE ALREADY STUDIED THE RELEVANT CHAPTERS IN THE PRESCRIBED
STUDY MATERIAL.

SECTION A – SAICA’S PRINCIPLES OF EXAMINATION

The principle of examination for IAS 2 is at core level.

SECTION B – ADDITIONAL EXAMPLES AND QUESTIONS

EXAMPLES

EXAMPLE 1

Company A purchased inventory from Company B on 1 February 20.12 at a cost of R5 000 000 and
took delivery of the goods on 28 February 20.12. Company B agreed to defer settlement of the
purchase price to 31 October 20.12, which is 6 months beyond normal settlement terms of two
months from delivery date. Company B took a market related interest rate at 14% per annum,
monthly compounded, into consideration in determining the cost price of the inventory for
Company A. Company A has a 31 December year end. Company A settled the purchase price on
31 October 20.12.

REQUIRED
Marks
(a) Discuss whether IAS 2.18 is applicable in this situation. 6

(b) Calculate the cost price of the inventory and the financing element, if any, that should 2
be recognised in the books of Company A, in terms of IAS 2.18.

(c) Provide the journal entries to account for the inventory transaction. Narrations are 8
required.

(d) How would the journal entries in (c) change if Company A has a 30 September year 6
end.

EXAMPLE 1 - Suggested solution

(a) IAS 2.18 states that inventory may be purchased on deferred settlement terms, and that the
financing element contained in the agreement is then recognised as interest over the financing
period. (1)

Deferred settlement terms:

Company A purchased inventory on 1 February 20.12 and took delivery of the goods on
28 February 20.12. Normal credit terms is payment two months after delivery date, ie.
30 April 20.12. (1)

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Company B however agreed to a 31 October 20.12 settlement date, which is six months
beyond normal credit terms. (1)

This constitutes deferred (8 months) settlement terms. (1)

Financing element

Company B took an interest rate of 14% per annum, monthly compounded, into consideration
to determine the purchase price of the inventory for Company A. (1)

There is a financing element contained in the agreement. (1)

IAS 2.18 is therefore applicable to this transaction. (1)

Total (7)
Maximum (6)

(b) Calculation of cost price and financing element R

Cash price 5 000 000

Interest [C1] (443 090)
Cash price equivalent 4 556 910 (2)

(c) Journal entries

Dr Cr
R R
1 February 20.12
J1 Inventory (SFP) [(b)] 4 556 910 (1)
Deferred interest (SFP) [C1] 443 090 (1)
Trade payables - Company B (SFP) 5 000 000 (½)
Purchase of inventory on deferred credit terms (½)
31 October 20.12
J2 Finance charges (P/L) [C2] 443 090 (1)
Deferred interest (SFP) 443 090 (1)
Recognition of financing element over financing period (½)
J3 Trade payables - Company B (SFP) 5 000 000 (1)
Bank (SFP) 5 000 000 (1)
Settlement of creditor (½)
Total (8)

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(d) Journal entries if Company A has a 30 September year end

Dr Cr
R R
1 February 20.12
No change (1)
30 September 20.12- Year end
J1 Finance charges (P/L) [C3] 385 429 (1)
Deferred interest (SFP) 385 429 (1)
Recognition of financing element over financing period (½)
31 October 20.12
J2 Finance charges (443 090 [C2] – 385 429 [C3]) (P/L) 57 661 (1)
Deferred interest (SFP) 57 661 (1)
Recognition of financing element over financing period (½)
Settlement of creditor - no change
Total (6)

CALCULATIONS

C1. SHARP EL-733A SHARP EL-738 HPB11

1. 5 000 000 FV 1. 1 2nd F 1/Y (1 P/Y) 1. 1 2nd F (1 P/Y)
2. 14/12 I 2. 5 000 000 FV 2. 5 000 000 FV
3. 8 N 3. 14/12 I/YR 2. 14/12 I/YR
4. COMP PV  R4 556 910 4. 8 N 3. 8 N
5. COMP PV  R4 556 910 4. PV  R4 556 910

C2. SHARP EL-733A SHARP EL-738 HPB11

1. 1 P1/P2 1. AMRT 1 ENT 1. 1 INPUT 8
2. 8 P1/P2  8 ENT 2. 2nd F FV (AMORT)
3. ACC, ACC = 443 089,71 2.  443 089,71 3. 443 089,71

C3. SHARP EL-733A SHARP EL-738 HPB11

1. 1 P1/P2 1. AMRT 1 ENT 1. 1 INPUT 7
2. 7 P1/P2  7 ENT 2 2nd F FV (AMORT)
3. ACC, ACC = 385 429,08 2.  385 429,08 3. 385 429,08

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QUESTIONS

QUESTION 4.1 (37 marks)

Motoro Ltd, a motor vehicle manufacturer and dealer, is in the process of preparing its financial
statements for the year ended 31 December 20.12.

The following extract was taken from the trial balance at 31 December 20.12:

R’000

Sales 1 800 000

Purchases – raw materials (components) 300 000
Purchases – second-hand vehicles 32 360
Labour costs – hourly paid employees
Factory staff 360 000
Administration and selling staff 100 000
Salaries and commissions
Factory staff 140 000
Administrative and sales staff 285 000
Depreciation 159 000
Interest paid 128 000
Dividends received 49 000
Other expenses 121 000
Retained earnings at 31 December 20.11 320 000

Manufacturing process

The normal capacity of the factory is 10 000 motor vehicles per year. As a result of significant labour
stayaways during the second half of the year, actual production for the year was 80% of normal
production levels. The company has a “no work no pay” policy for employees paid at hourly rates.
Staff members were paid salaries on a monthly basis did not take part in the stayaways.

Inventories at 31 December 20.11 20.12

R’000 R’000

Raw materials, at cost 15 000 24 500

Work in progress, at cost 80 000 See note 1

Note 1: The company values spare parts, raw materials and work in progress on a FIFO basis.

The cost of work in progress at 31 December 20.12 has not yet been calculated. Detailed production
records indicate that only 24% of this year’s allocated production expenditure and material used (you
may assume that there were no raw material spillages which incurred during the year), relate to
motor vehicles that were still under production at the year end. The demand for the product is so
high that all manufactured vehicles are sold as soon as the production process is completed.

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Dealerships

The following information relates to second-hand vehicles traded:

Purchase
Motor price Estimated selling price
vehicle Date of (excluding at year end
number purchase VAT) Date of sale (excluding VAT)
20.11 20.12
R’000 R’000
216 30/10/20.11 80 - 70 80
217 30/04/20.11 110 30/06/20.12 130 -
218 30/11/20.11 160 - 180 170
219 – 425 During 20.12 32 000 During 20.12 - -
426 30/06/20.12 155 - - 170
427 25/11/20.12 205 - - 250

The only second-hand motor vehicle inventories on hand at 31 December 20.11 were vehicle
numbers 216, 217 and 218.

Sales staff earns a commission of 10% of the selling price.

Accounts receivable

The debtors listing reflected accounts receivable of R125 million at 31 December 20.11 and
R226 million at 31 December 20.12. The allowance for credit losses was R11 million at
31 December 20.11 and R21 million at 31 December 20.12. In terms of the Income Tax Act
section 11(j) the South African Revenue Services (SARS) grants a doubtful debt allowance
amounting to 25% of the company’s provision. Bad debts of R1 million were written off during the
year ended 31 December 20.12. No bad debts were written off during the 20.11 year.

These costs are included in other expenses.

Property, plant and equipment

The asset clerk has finalised schedules relating to the carrying amounts and tax bases of property,
plant and equipment. The information has been summarised as follows:

Plant and Office Distribution

machinery equipment vehicles Total
R’000 R’000 R’000 R’000
Carrying amount
31 December 20.11 550 000 3 000 40 000 593 000
31 December 20.12 700 000 2 000 42 000 744 000
Depreciation for 20.12 150 000 1 000 8 000 159 000

Tax base
31 December 20.11 450 000 3 000 40 000 493 000
31 December 20.12 550 000 2 000 42 000 594 000
Capital deductions for 20.12 200 000 1 000 8 000 209 000

Depreciation is written off on the straight-line basis over the useful life of the assets. Distribution
vehicles are used to transport manufactured inventory to customers.

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Additional information

There are no temporary differences other than those arising from the information presented above.
The normal income tax rate is 28%. Ignore any Value-Added Taxation (VAT) implications.

REQUIRED
Marks
(a) Prepare the journal entries to recognise the cost of sales for the year ended 21
31 December 20.12.

Please note:
• Journal narrations are not required.

(b) Calculate the deferred tax balance for Motoro Ltd as at 31 December 20.12. 4

Please note:
• Deferred tax should be calculated by using the statement of financial position
method.

(c) Prepare the statement of profit or loss and other comprehensive income of 12
Motoro Ltd for the year ended 31 December 20.12.

Please note:

• Comparative figures are not required.

• Round off all amounts to the nearest Rand.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 4.1 - Suggested solution

(a)
Dr Cr
R’000 R’000

J1 Cost of sales (P/L) 982 360 (½)

Purchases - raw materials (P/L) 300 000 (½)
Labour costs - factory staff (P/L) 360 000 (½)
Salaries - factory staff (P/L) 140 000 (½)
Depreciation - plant and machinery (P/L) 150 000 (½)
Purchases - second hand vehicles (P/L) 32 360 (½)
Transfer of purchases to cost of sales
J2 Cost of sales (P/L) 95 333 (½)
Inventory - raw materials (SFP) 15 000 (½)
Inventory - work-in-progress (SFP) 80 000 (½)
Inventory - second hand vehicles [C1] (SFP) 333 (2½)
Transfer of opening inventory to cost of sales
J3 Inventory - raw materials (SFP) 24 500 (½)
Cost of sales (P/L) 24 500 (½)
Recognising raw materials at year end
J4 Inventory – work-in-progress [C2] (SFP) 211 800 (6)
Cost of sales (P/L) 211 800 (½)
Recognising work-in-progress at year end
J5 Inventory - second hand vehicles [C3] (SFP) 583 (2)
Cost of sales (P/L) 583 (½)
Recognising the closing balance of second hand vehicles
on hand
J6 Cost of sales 9 (½)
Inventory second-hand vehicles: no 218 (160 – 153) 7 (1)
no 426 (155 – 153) 2 (1)
Write-down of inventory to NRV
J7 Inventory second-hand vehicles no 216 (63 – 72) 9 (1)
Cost of sales 9 (½)
Reversal of inventory writedown
Total (21)

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(b) Deferred taxation

Deferred
Tem- tax at 28%
Carrying Tax porary assets/
amount base difference (liability)
R’000 R’000 R’000 R’000
20.11
Allowance account for credit losses (11 000) (2 750)a (8 250) 2 310 (1)
Plant and machinery 550 000 450 000 100 000 (28 000) (1)
Deferred tax liability 91 750 (25 690)

20.12
Allowance account for credit losses (21 000) (5 250)a (15 750) 4 410 (1)
Plant and machinery 700 000 550 000 150 000 (42 000) (1)
Deferred tax liability 134 250 (37 590)
Total (4)
a
20.12: (21 000 x 25%) = 5 250
20.11: (11 000 x 25%) = 2 750

COMMENT

The carrying amount and tax base of the combined property, plant and equipment
account may also be used instead of only the plant and machinery. The temporary
difference will however be the same, since the carrying amounts and tax bases for the
other two asset categories are equal.

(c) MOTORO LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE

YEAR ENDED 31 DECEMBER 20.12

R’000
Revenue 1 800 000 (½)
Cost of sales (982 360 + 95 333 – 24 500 – 211 800 – 583 + 9 - 9) (840 810) (3)
Gross profit 959 190
Other income 49 000
Other expenses (121 000 + 9 000* + 100 000 + 285 000)) (515 000) (1)
Finance cost (128 000) (½)
Profit before tax 365 190
Income tax expense [C4] (88 533) (7)
PROFIT FOR THE YEAR 276 657
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 276 657
Total (12)
* (1 000 + 8 000 depreciation on office equipment and distribution vehicles)

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CALCULATIONS

C1. Opening inventory – second-hand vehicles

(Lower of cost or NRV)

Carrying
Cost NRV amount
20.11 20.11
R’000 R’000 R’000

216 80 63* 63 [1]

217 110 117# 110 [1]
218 160 162@ 160 [½]
333
[2½]

* (70 – (10% x 70))

#
(130 – (10% x 130))
@
(180 – (10% x 180))

C2. Work-in-progress

R’000
Material (15 000 + 300 000 - 24 500) x 24% 69 720 [3]
Labour cost (360 000 x 24%) 86 400 [1]
Salaries (140 000 x 80% x 24%) 26 880 [1]
Depreciation (150 000 x 80% x 24%) 28 800 [1]
211 800
[6]

C3. Closing inventory = second-hand vehicles

Carrying
Cost NRV amount
20.12 20.12
R’000 R’000 R’000

216 63 72* 72 [½]

218 160 153# 153 [½]
426 155 153# 153 [½]
427 205 225@ 205 [½]
583
[2]

* (80 000 – (10% x 80 000))

#
(170 000 – (10% x 170 000))
@
(250 000 – (10% x 250 000))

COMMENT

The reversal of the write down to net realisable value on second-hand vehicle 216 is
limited to the original cost of R80 000.

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C4. Tax calculation

Profit before tax 365 190

Dividends received (49 000) [1]
Taxable temporary differences (91 750 – 134 250) (refer (b)) (42 500) [4]
Taxable income 273 690

Current taxation (273 690 x 28%) 76 633 [1]

Deferred taxation (37 590 – 25 690) (refer (b)) 11 900 [1]
88 533
[7]

C5. Closing balances (Alternative calculation)

Raw Finished
Description materials WIP products Second-hand vehicles
R’000 R’000 R’000 R’000
Opening balances 15 000 80 000 - [C1] 333 000
216 63 000
217 110 000
218 160 000
Purchases 300 000 32 360 000
Overheads
Fixed
Salaries
(140 000 x 80%) 112 000
Depreciation
(150 000 x 80%) 120 000
Variable 360 000
To WIP (balancing) (290 500) 290 500
To finished products
(balancing) (750 700) 750 700
Vehicles written off to
net realisable value (9)
Reversal of vehicle
inventory writedown 9
Sold (750 700) 217 (110 000)
219-425 (32 000 000)
Closing Balances 24 500 211 800 - 583 000
Given [C2] Given [C3]

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QUESTION 4.2 (22 marks)

The accountant of one of your clients approached you with the following questions regarding
inventory to be included in the financial statements for the year ended 31 December 20.12.

(a) During the 20.12 financial year the company was approached by a customer to manufacture a
product for a specific purpose. As this product was completely different from the products
produced by the company at this stage, it was necessary to appoint a consultant to design the
product.

The consultant’s fees amounted to R350 000. This is a once-off order and at year end the
product was 40% complete at a production cost of R8 000 000. The accountant wants to know
whether he can include the R350 000 in the carrying amount of inventory at year end.

(b) From the beginning of the current year the company manufactures product A. The normal
production level are 200 000 units per annum and variable costs are R1,50 per unit. The fixed
production overhead cost for the year was R500 000 and was debited to “fixed overhead
control account”. The variable overhead costs were debited to the “variable overhead control
account”. The actual production was 170 000 of which 150 000 units were sold. The
accountant requests you to prepare the journal entries to account for inventory and cost of
sales.

(c) With reference to (b) the accountant also ask that you show the journal entries requested in (b)
if the actual production was 220 000 units.

(d) Included in inventory at year end are raw materials which were delivered by air-freight. The
cost of delivery was R300 000 more than the normal delivery cost but had to be incurred to
avoid a halt in production. The accountant wants to know whether this R300 000 can be
included in the cost of inventory.

(e) At year end an amount of R55 000 was written off as a result of net realisable value being less
than cost. The accountant wants to know how this R55 000 should be accounted for in the
20.12 financial statements.

REQUIRED
Marks
Answer all of the accountant’s questions and provide reasons for your answers as well as 22
calculations (if applicable).

Please note:

• Journal narrations are not required.

• Ignore any normal income tax implications.
• Ignore any Value-Added Taxation (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 4.2 - Suggested solution

(a) Yes the R350 000 can be added to the R8 000 000 production cost. In terms of IAS 2.15 other
cost of inventories to the extent that they are incurred in bringing the inventories to their
present location and condition must be included in the cost of inventory. The cost of designing
products for specific customers is cited as an example of such non-production overheads.
Therefore it can be added to the cost of inventory at year end. (3)

(b) Journal entries

Dr Cr
R R
J1 Inventories (170/200 x 500 000) (SFP) 425 000 (1)
Cost of sales (30/200 x 500 000) (P/L) 75 000 (1)
Fixed overhead control account (SFP) 500 000 (1)
Allocation of fixed production overheads
J2 Inventory (170 000 x R1,50) (SFP) 255 000 (1)
Variable overhead control account (SFP) 255 000 (1)
Allocation of variable costs
J3 Cost of sales [150/170 x (425 000 + 255 000)/1] (P/L) 600 000 (1½)
Inventory (SFP) 600 000 (1)
Transfer cost of inventory sold to cost of sales

Alternative journals

Dr Cr
R R
J1 Cost of sales (P/L) 500 000 (1)
Fixed overhead control account (SFP)) 500 000 (1)
Allocation of fixed production overheads to cost of sales
J2 Cost of sales (P/L) (170 000 x R1,50) 255 000 (1)
Variable overhead control account (SFP) 255 000 (1)
Allocation of fixed production overheads to cost of sales
J3 Inventory (SFP)
(20/170 x [(170/200 x 500 000) + 255 000] 80 000 (2½)
Cost of sales (P/L) 80 000 (1)
Transfer closing balance to inventory

COMMENT

In this question the entity uses control accounts to allocate all production costs until it is
known where these overhead costs will be allocated to (capitalised or expensed).

The alternative journals indicate the allocation of all costs to cost of sales, where after
only the closing inventory balance is transferred to inventory.

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(c) Journal entries

Dr Cr
R R
J1 Inventory ((500 000 ÷ 220 000) x 220 000) (SFP) 500 000 (1)
Fixed overhead control account (SFP) 500 000 (1)
Allocation of fixed production overhead costs
J2 Inventory (220 000 x R1,50) (SFP) 330 000 (1)
Variable control account (SFP) 330 000 (1)
Allocation of variable costs
J3 Cost of sales [150/220 x (500 000 + 330 000)] (P/L) 565 909 (1½)
Inventories (SFP) 565 909 (1)
Transfer of inventories sold to cost of sales

(d) The R300 000 additional cost is excessive and may not be included in inventory. In this
instance the test of net realisable value, needs to be considered specifically (IAS 2.16(a)). (2)

(e) In terms of par 34 of IAS 2 any write-down of inventories to net realisable value shall be
recognised as an expense in the period the write-down occurs, and IAS 2 par 36 (e) requires
that the amount of such a write-down should be disclosed. Furthermore the carrying amount of
the inventory, which is carried at fair value less cost to sell must be disclosed separately
(IAS 2.36(c)). (3)
Total (22)

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LEARNING UNIT 5 – INCOME TAXES

INTRODUCTION

Taxation represents an unavoidable expense for most entities. Apart from various
income taxes that include all domestic and foreign taxes, it is also necessary to account
for deferred taxation. Deferred tax represents tax that will be paid/saved in future periods
when the carrying amounts of the assets/liabilities are recovered/settled.

OBJECTIVES/OUTCOMES

After you have studied this learning unit, you should be able to do the following:

1. Identify the objective of IAS 12 and be able to apply IAS 12.

2. Understand and apply the following definitions:

(a) Tax base of assets and liabilities;

(b) Taxable and deductible temporary differences; and
(c) Deferred tax assets and liabilities.

3. Understand and calculate current tax.

4. Understand and calculate deferred tax by:

(a) Calculating the tax base of assets and liabilities,

(b) Calculating the temporary differences for each asset and liability, and
(c) Calculating the movements in temporary differences and deferred tax.

5. Understand and calculate the implications of tax losses (recognised and

unrecognised) on current and deferred tax.

6. Calculate and recognise the income tax line in the statement of profit or loss and
other comprehensive income.

7. Disclose the income tax expense in the notes to the statement of profit or loss and
other comprehensive income.

8. Calculate and recognise all tax balances for the statement of financial position, for
example the deferred tax balance and tax payable.

9. Disclose income tax and deferred tax in the notes to the financial statement.

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PRESCRIBED STUDY MATERIAL

The following must be studied before you attempt the questions in this learning unit:

1. IAS 12 Income Taxes.

2. FRG 1 Substantively enacted tax rates and tax laws.

3. The following document is excluded:

• SIC 25 Income taxes – Changes in the tax status of an entity or its

shareholders.

4. Chapter on income taxes in Descriptive Accounting, 21st edition.

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THE REST OF LEARNING UNIT 5 IS BASED ON THE ASSUMPTION THAT YOU

HAVE ALREADY STUDIED THE RELEVANT CHAPTERS IN THE PRESCRIBED
STUDY MATERIAL.

SECTION A – SAICA’S PRINCIPLES OF EXAMINATION

The principle of examination of IAS 12 is at core level to the extent that is supports transactions or
topics included in both the financial accounting and tax syllabus, or when students are given the tax
treatment.

The following paragraphs in IAS 12 are excluded from the syllabus:

• Paragraphs 38 to 45 relating to group temporary differences;

• Paragraphs 52A and B;
• Paragraph 68 relating to equity-settled share-based payments; and
• Disclosures required by paragraphs 82A to 88.

The principal of examination of FRG1 is at core level.

SECTION B – ADDITIONAL EXAMPLES AND QUESTIONS

EXAMPLES

The purpose of this series of examples is to assist you in understanding deferred tax and how it fits
together with current tax in the calculation of income tax.

Examples 1 - 5 relate to Deasy Ltd which has a 31 December financial year end. The normal income
tax rate is 28% and the inclusion rate for capital gains tax (CGT) is 80%.

EXAMPLE 1A – Income tax

The accounting profit before tax for the financial year ended 31 December 20.12 is R500 000.
Included in the accounting profit before tax are dividends received of R10 000 that are not taxable
and a penalty of R15 000 that is not deductible for tax purposes.

CALCULATIONS

C1. Current tax 20.12

Profit before tax 500 000

Non-taxable/non-deductible items:
Dividends not taxable (10 000)
Penalty not deductible 15 000
Taxable profit 505 000
Tax at 28% (505 000 x 28%) 141 400a

a
The current tax of R141 400 is income tax payable to the South African Revenue Services
(SARS) in respect of the taxable profit for the year ended 31 December 20.12.

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DISCLOSURE

The income tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12
will be as follows:

DEASY LTD
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.12

3. Income tax expense 20.12

R
Major components of tax expense

SA normal tax
Current tax
-Current year [C1] 141 400
141 400

Tax rate reconciliation

Accounting profit 500 000
Tax @ 28% 140 000
Tax effect of non-taxable/non-deductible items:
- Dividends not taxable (10 000 x 28%) (2 800)
- Penalty not deductible (15 000 x 28%) 4 200
Income tax expense 141 400

THE PURPOSE OF A TAX RATE RECONCILIATION

Profit before tax of R500 000 in the statement of profit or loss and other comprehensive
income multiplied with 28% is R140 000. Why is the income tax expense R141 400
and not R140 000?

The reasons are as follows:

• Included in profit before tax are dividends received that were not taxable, and
• Included in profit before tax is a penalty paid that was not deductible for tax
purposes.

The reasons above are the reconciling items in the tax rate reconciliation, which
provides additional information to users of the financial statements as to how the profit
before tax figure and the tax expense figures are reconciled.

EXAMPLE 1B – Income tax and prior year underprovision

The same information applies as in Example 1A. Deasy Ltd raised a provision for current tax
payable of R121 000 for the financial year ended 31 December 20.11. The final assessment issued
by the SARS on 30 April 20.12 (relating to the financial year ended 31 December 20.11), reflected
income tax payable of R126 000. Deasy Ltd accepted the assessment issued by the SARS as
correct.

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UNDERPROVISION RELATING TO THE PRIOR YEAR

The current tax payable that was calculated by Deasy Ltd for the financial year ended
31 December 20.11 was R121 000. The final assessment issued by the SARS reflected
income tax payable of R126 000. As a result, current tax in the prior year financial
statements was underprovided for with R5 000 (R126 000 – R121 000). This additional
R5 000 will increase the current tax in the current year and must be paid to the SARS.
The underprovision will be accounted for as follows:
Dr Cr
R R
Income tax expense (current tax) (P/L) 5 000
Other payables: SARS (SFP) 5 000

The underprovision relating to the prior year will be disclosed in the income tax expense
note as an increase in current tax.

Taking into account the underprovision, the income tax note to the financial statements of Deasy Ltd
for the year ended 31 December 20.12 will be as follows:

DEASY LTD
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.12

3. Income tax expense 20.12

R
Major components of tax expense

SA normal tax
Current tax
-Current year [C1] 141 400
-Underprovision for prior year (126 000 - 121 000) 5 000
146 400
Tax rate reconciliation
Accounting profit 500 000
Tax @ 28% 140 000
Tax effect of non-taxable items/non-deductible items:
- Dividends not taxable (10 000 x 28%) (2 800)
- Penalty not deductible (15 000 x 28%) 4 200
Underprovision for current tax for prior year (126 000 - 121 000) 5 000a
Income tax expense 146 400

a
Note that the amount of the underprovision in the tax rate reconciliation is not multiplied with
28% as it already represents 28%.

UNDERPROVISION IN THE TAX RATE RECONCILIATION

The taxable profit of 20.11 (not 20.12) gave rise to the R5 000 current tax. As a result,
the underprovision will be a reconciling item in the tax rate reconciliation.

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EXAMPLE 1C – Income tax and prior year overprovision

The same information applies as in Example 1A. Deasy Ltd raised a provision for current tax
payable of R128 000 for the financial year ended 31 December 20.11. The final assessment issued
by the SARS on 30 April 20.12 for the financial year ended 31 December 20.11, reflected income tax
payable amounting to R122 000. Deasy Ltd accepted the assessment issued by the SARS as
correct.

OVERPROVISION RELATING TO THE PRIOR YEAR

The current tax payable that was calculated by Deasy Ltd for the financial year ended
31 December 20.11 was R128 000. The final assessment issued by the SARS reflected
income tax payable of R122 000. As a result, current tax in the prior year financial
statements was overprovided for with R6 000 (R128 000 – R122 000). The SARS will
use this R6 000 overprovision to decrease the current tax in the current year. This
overprovision will be accounted for as follows:
Dr Cr
R R
Other payables: SARS (SFP) 6 000
Income tax expense (current tax) (P/L) 6 000

The overprovision relating to the prior year will be disclosed in the income tax expense
note as a decrease in current tax.

Taking into account the overprovision, the income tax note to the financial statements of Deasy Ltd
for the year ended 31 December 20.12 will be as follows:

DEASY LTD
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12

3. Income tax expense 20.12

R
Major components of tax expense

SA normal tax
Current tax
-Current year [C1] 141 400
-Overprovision for prior year (122 000 - 128 000) (6 000)
135 400

Tax rate reconciliation

Accounting profit 500 000
Tax @ 28% 140 000
Tax effect of non-taxable/non-deductible items:
- Dividends not taxable (10 000 x 28%) (2 800)
- Penalty not deductible (15 000 x 28%) 4 200
Overprovision for current tax for prior year (122 000 - 128 000) (6 000)
Income tax expense 135 400

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INTRODUCTION TO EXAMPLES 2 - 4

Deferred tax arises due to the difference in treatment of items from an accounting and income tax
perspective. Deferred tax is an accounting entry to account for future tax payments or tax savings
that arise due to these different treatments. Deferred tax is thus tax that Deasy Ltd will pay in the
future to the SARS or a future tax saving due to these differing treatments. The future tax
consequences are provided for by recognising a deferred tax liability (for future tax payable) or a
deferred tax asset (for a future tax saving).

EXAMPLE 2 – Temporary differences

The accounting profit before tax was R500 000 for each of the financial years ended
31 December 20.12, 20.13, 20.14 and 20.15. Included in the accounting profit before tax for each
year are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not
deductible for tax purposes.

Deasy Ltd acquired a new machine on 1 January 20.12 for R300 000 which is depreciated over four
years on the straight-line basis (the residual value is Rnil). The depreciation has been included in the
accounting profit before tax. In terms of the Income Tax Act, the South African Revenue Services
(SARS) grants a section 12C allowance of 40% in the first year and 20% per year for the subsequent
three years, which is not apportioned for part of a year.

The deferred tax balance as at 31 December 20.11 was Rnil.

ACCOUNTING POLICY VERSUS THE INCOME TAX ACT

The total cost of the machine of R300 000 is going to be deducted over time for
accounting purposes (through depreciation) and for tax purposes (through the
section 12C allowance). For the year ended 31 December 20.12, for accounting
purposes, depreciation amounts to R75 000 (R300 000/4 years) while for tax purposes,
the tax deduction amounts to R120 000 (R300 000 x 40%).

Even though the depreciation and tax deduction are not the same for the years ended
31 December 20.12, 31 December 20.13 and 31 December 20.14 by
31 December 20.15 the full cost of the machine of R300 000 will be written off for both
accounting and tax purposes.

Temporary differences will therefore exist during the course of the four year period,
which will result in deferred tax at the end of each year, except at the end of the 20.15
year.

CALCULATIONS

C1. Current tax

20.12 20.13 20.14 20.15

Profit before tax (given) 500 000 500 000 500 000 500 000
Non-taxable/non-deductible items:
Dividends not taxable (10 000) (10 000) (10 000) (10 000)
Fine not deductible 15 000 15 000 15 000 15 000
Taxable profit before temporary differences* 505 000 505 000 505 000 505 000
Movement in temporary differences [C2] (45 000) 15 000 15 000 15 000
Taxable profit 460 000 520 000 520 000 520 000
Tax at 28% 128 800 145 600 145 600 145 600

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MOVEMENT IN TEMPORARY DIFFERENCES

* The current tax calculation above can be performed up to the line “Taxable profit
before temporary differences”. It is then necessary to first perform the deferred tax
calculation using the “statement of financial position method” below [C2] in order to
calculate the movement in temporary differences.

Temporary differences are defined in IAS 12.5. The tax base of an asset is defined
as the amount that will be deductible for tax purposes in future (IAS 12.7). If the
economic benefits that flow from an asset are not taxable, then the tax base of the
asset will be equal to the carrying amount of the asset.

C2. Deferred tax

Deferred
Carrying Tax Temporary tax at 28%
amount base difference asset/
(liability)
31 December 20.11 (given) - - - -

31 December 20.12
Machinery 225 0001 180 0005 45 0009 (12 600)12

Movement in temporary difference (taxable) (45 000 - 0) 45 00010 (12 600)

31 December 20.13
Machinery 150 0002 120 0006 30 000 (8 400)12

Movement in temporary difference (reversal of taxable)

(30 000 - 45 000) (15 000)11 4 200

31 December 20.14
Machinery 75 0003 60 0007 15 000 (4 200)12

Movement in temporary difference (reversal of taxable)

(15 000 - 30 000) (15 000) 4 200

31 December 20.15
Machinery -4 -8 - -

Movement in temporary difference (reversal of taxable)

(0 - 15 000) (15 000) 4 200

1
20.12: 300 000 – (300 000 / 4) = 225 000
2
20.13: 225 000 – (300 000 / 4) = 150 000
3
20.14: 150 000 – (300 000 / 4) = 75 000
4
20.15: 75 000 – (300 000 /4) = 0
5
20.12: 300 000 – (300 000 x 40%) = 180 000
6
20.13: 180 000 – (300 000 x 20%) = 120 000
7
20.14: 120 000 – (300 000 x 20%) = 60 000

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8
20.15: 60 000 – (300 000 x 20%) = 0
9
On 31 December 20.12, the carrying amount of R225 000 is greater than the tax base of
R180 000 which gives rise to a taxable temporary difference of R45 000. Why is it taxable? It
is taxable because for tax purposes R45 000 more has been deducted than for accounting
purposes. In future, for tax purposes, there will be R45 000 less to deduct than for accounting
purposes and this will cause an increase in taxable profit and the current tax expense in the
future.
10
This movement in temporary differences from Rnil to R45 000 is taxable as it will increase
future taxable profit. The impact of the R45 000 is as follows on the income tax expense:
• Current tax: This movement of R45 000 must be deducted from taxable profit in the
current year as it is only taxable in the future.
• Deferred tax: It gives rise to an increase in the deferred tax balance from Rnil (as at
31 December 20.11) to a deferred tax liability of R12 600 (as at 31 December 20.12).
11
The movement in the temporary differences of R15 000 (R30 000 – R45 000) is a partial
reversal of the taxable temporary difference of R45 000 that arose on 31 December 20.12.
The impact of the R15 000 is as follows on the income tax expense:
• Current tax: This movement of R15 000 must be added to the taxable profit in the
current year as it is taxable in the current year.
• Deferred tax: It gives rise to a decrease in the deferred tax liability from R12 600 (as at
31 December 20.12) to a deferred tax liability of R8 400 (as at 31 December 20.13).
12
These amounts will be the balance of the deferred tax asset/(liability) in the statement of
financial position for the years ended 31 December 20.12, 20.13 and 20.14 respectively.

The journals to account for the current tax and deferred tax for all 4 years are as follows:

Dr Cr
31 December 20.12 R R
Income tax expense (current tax) (P/L) [C1] 128 800
Other payables: SARS (SFP) 128 800
Recognise provision for current tax
Income tax expense (deferred tax) (P/L) [C2] 12 600
Deferred tax (SFP) 12 600
Recognise deferred tax liability
31 December 20.13 – 31 December 20.15
Income tax expense (current tax) (P/L) [C1] 145 600
Other payables: SARS (SFP) 145 600
Recognise provision for current tax
Deferred tax (SFP) [C2] 4 200
Income tax expense (deferred tax) (P/L) 4 200
Recognise decrease in deferred tax liability

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The T-accounts reflecting the above journals relating to deferred tax are as follows from 20.12 until
20.15:

Dr Cr
Deferred tax (SFP)
20.11 Opening balance -
20.12 Balance c/f 12 600 20.12 Income tax expense (P/L) 12 600
12 600 12 600
20.13 Balance b/f 12 600
20.13 Income tax expense (P/L) 4 200
20.13 Balance c/f 8 400
12 600 12 600
20.14 Balance b/f 8 400
20.14 Income tax expense (P/L) 4 200
20.14 Balance c/f 4 200
8 400 8 400
20.15 Balance b/f 4 200
20.15 Income tax expense (P/L) 4 200
20.15 Balance c/f -
4 200 4 200
20.16 Balance b/f -

Dr Cr
Income tax expense (deferred tax) (P/L)
20.12 Deferred tax (SFP) 12 600

20.13 Deferred tax (SFP) 4 200

20.14 Deferred tax (SFP) 4 200

20.15 Deferred tax (SFP) 4 200

It is clear from the T-accounts above that in 20.12 the increase in the deferred tax liability increases
the total income tax expense in P/L as the “income tax expense (deferred tax)” account is debited.
From 20.13 to 20.15, the decrease in the deferred tax liability decreases the total income tax
expense in P/L as the “income tax expense (deferred tax)” account is credited.

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DISCLOSURE

The income tax note and deferred tax note in the financial statements of Deasy Ltd for the financial
years ended 31 December 20.12, 20.13, 20.14 and 20.15 will be as follows:

DEASY LTD
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 TO 31 DECEMBER 20.15

3. Income tax expense

Major components of tax expense
20.12 20.13 20.14 20.15
R R R R
SA normal tax
Current tax
-Current year [C1] 128 800 145 600 145 600 145 600
Deferred tax
-Movement in temporary differences*
[C2] 12 600 (4 200) (4,200) (4 200)
141 400 141 400 141 400 141 400
Tax rate reconciliation
Accounting profit 500 000 500 000 500 000 500 000
Tax @ 28% 140 000 140 000 140 000 140 000
Tax effect of non-taxable/non-deductible
items:
- Dividends not taxable (10 000 x 28%) (2 800) (2 800) (2 800) (2 800)
- Penalty not deductible (15 000 x 28%) 4 200 4 200 4 200 4 200
Income tax expense 141 400 141 400 141 400 141 400

10. Deferred tax

Analysis of temporary differences:
Property, plant and equipment
-Accelerated deductions for tax
purposes [C2] 12 600 8 400 4 200 -
Deferred tax liability 12 600 8 400 4 200 -

* Please note that the temporary differences are NOT reconciling items in the tax rate
reconciliation as the temporary differences are accounted for when deferred tax is raised.

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THE TWO FUNCTIONS OF THE MOVEMENT IN TEMPORARY DIFFERENCES

With reference to the financial year ended 31 December 20.12, the movement in
temporary differences of R45 000 (taxable) has two functions:

1. It is deducted from the taxable profit on 31 December 20.12 in the current tax
calculation, AND
2. It gives rise to an increase in the deferred tax liability of R12 600 on
31 December 20.12 (R45 000 x 28%) which increases the income tax expense in
P/L as follows:
Dr Cr
Income tax expense (deferred tax) (P/L) 12 600
Deferred tax (SFP) 12 600

The deferred tax expense of R12 600 has the effect of increasing the total income tax
expense (income and deferred tax combined) from R128 800 to R141 400 which is the
same as the income tax expense in Example 1A where no temporary differences
existed (refer to the income tax note in Example 1A above).

This principle therefore illustrates the essence and purpose of deferred tax, being to
“bridge the gap” between accounting and taxation treatments, consequently resulting in
the total combined income tax expense only being impacted by “permanent differences”
(i.e. items that will never be taxable or never be tax deductible).

DEFERRED TAX CALCULATIONS

When doing a deferred tax calculation using the “statement of financial position method” which is
required by IAS 12, it is very important to correctly apply the definitions of a tax base in IAS 12.7 –
.11. It is suggested that you memorise these definitions so that you can apply them without
constantly referring to IAS 12.

You can also memorise the following for purposes of determining whether a temporary difference of
an item is taxable or deductible:

ASSET (for example Machinery):

Carrying amount > tax base taxable temporary difference deferred tax liability
Carrying amount < tax base deductible temporary difference deferred tax asset

LIABILITY (for example Revenue received in advance):

Carrying amount > tax base deductible temporary difference deferred tax asset
Carrying amount < tax base taxable temporary difference deferred tax liability

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CALCULATING THE MOVEMENT IN TEMPORARY DIFFERENCES

You should understand the following in order to determine whether the total movement in
temporary differences (from one year to the next year) is taxable or deductible:

Deferred tax liability:

Increase in deferred tax liability is an increase in taxable temporary differences
• movement in temporary differences is deducted in current tax calculation, and
• increase income tax expense (deferred tax) (P/L) as follows:
Dr Income tax expense (deferred tax) (P/L)
Cr Deferred tax liability (SFP)
Decrease in deferred tax liability is a decrease in taxable temporary differences
• movement in temporary differences is added to current tax calculation, and
• decrease income tax expense (deferred tax) (P/L) as follows:
Dr Deferred tax liability (SFP)
Cr Income tax expense (deferred tax) (P/L)
Deferred tax asset:
Increase in deferred tax asset is an increase in deductible temporary differences
• movement in temporary differences is added to current tax calculation, and
• decrease income tax expense (deferred tax) (P/L) as follows:
Dr Deferred tax asset (SFP)
Cr Income tax expense (deferred tax) (P/L)
Decrease in deferred tax asset is a decrease in deductible temporary differences
• movement in temporary differences is deducted in current tax calculation, and
• increase income tax expense (deferred tax) (P/L) as follows:
Dr Income tax expense (deferred tax) (P/L)
Cr Deferred tax asset (SFP)

EXAMPLE 3 – Land measured using the revaluation model in IAS 16

The accounting profit before tax for the year ended 31 December 20.12 is R500 000. Included in the
accounting profit before tax are dividends received of R10 000 that are not taxable and a penalty of
R15 000 that is not deductible for tax purposes. Prepaid expenses on 31 December 20.11 amounted
to R40 000 and R30 000 on 31 December 20.12. Both these prepaid expense balances were tax
deductible in the years in which the expenses were incurred, in accordance with section 23H of the
Income Tax Act.

Deasy Ltd acquired land in Midrand for R1 000 000 on 1 January 20.11 and plans to construct a
factory thereon. For the financial year ended 31 December 20.11, the land was measured using the
cost model of IAS 16. In 20.12 Deasy Ltd changed its accounting policy to the revaluation model in
IAS 16. The land was revalued to R1 200 000 on 31 December 20.12. The revaluation surplus
before taxation amounted to R200 000. The deferred tax relating to the revaluation surplus
amounted to R44 800.

The deferred tax balance as at 31 December 20.10 was Rnil. There were no temporary differences
on 31 December 20.11 or on 31 December 20.12, other than those arising from the information
provided above.

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CALCULATIONS

C1. Current tax 20.12

Profit before tax 500 000

Non-taxable/non-deductible items:
Dividends received not taxable (10 000)
Fine not deductible 15 000
Taxable profit before temporary differences 505 000
Movement in temporary differences (reversal of taxable) [C2] 10 0001
Taxable profit 515 000
Tax at 28% 144 200

Deferred
Temporary
tax at
Carrying difference
C2. Deferred tax Tax base 28%
amount at 100% or
asset/
80%
(liability)

31 December 20.11
Prepaid expenses 40 000 -1 40 000 (11 200)
Land in Midrand 1 000 000 1 000 0002 -2 -
Deferred tax liability 40 000 (11 200)
31 December 20.12
Prepaid expenses 30 000 -1 30 000 (8 400)
Land in Midrand (through OCI)
(200 000 x 80%) 1 200 000 1 000 000 160 0003 (44 800)3
Net deferred tax liability 190 000 (53 200)
Movement in temporary differences (through P/L) (10 000)4 2 800
Movement in temporary differences (through OCI) 160 000 (44 800)

1
Section 23H of the Income Tax Act limits the tax deductibility of prepaid expenses, however,
since these expenses fall within the R100 000 exclusion provided in section 23H, the total
expense will be tax deductible in the financial year in which the expense was incurred. The tax
base of these prepaid expenses (i.e. the amount that is tax deductible in future) is Rnil, since
the expenses have been deducted for tax purposes, even though they have been capitalised
to be expensed at a later stage for accounting purposes.
2
Land at cost model:
Kindly refer to IAS12.BC6 which contains the following –
Recognition of depreciation implies that the carrying amount of a depreciable asset is expected
to be recovered through use to the extent of its depreciable amount, and through sale at its
residual value. Consistently with this, the carrying amount of a non-depreciable asset, such as
land having an unlimited life, will be recovered only through sale. In other words, because the
asset is not depreciated, no part of its carrying amount is expected to be recovered (ie
consumed) through use.
Therefore the tax base would then be equal to the base cost for CGT purposes, as this amount
will be allowed as a deduction against the proceeds from the sale when calculating the capital
gain on disposal.

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3
In accordance with IAS 12.47, deferred tax assets and liabilities shall be measured at the tax
rates that are expected to apply to the period when the asset is realised or the liability is
settled. The deferred tax on the temporary difference on revalued land is therefore raised at
the CGT inclusion rate of 80% which is thereafter taxed at 28%.
4
The movement in temporary differences excludes items that do not affect P/L. As a result, the
revaluation of the land (which affects OCI) is not included in the movement in temporary
differences disclosed in the income tax expense note. Note that the movement in temporary
differences of R10 000 is a reversal of the taxable temporary difference related to prepaid
expenses from R40 000 to R30 000 which is added to the taxable profit. It has the same effect
as a deductible temporary difference.

DISCLOSURE

The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year
ended 31 December 20.12 will be as follows:

DEASY LTD
NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.12

3. Income tax expense 20.12

R
Major components of tax expense
SA normal tax
Current tax
-Current year [C1] 144 200
Deferred tax
-Movement in temporary differences [C2] (10 000 x 28%) (2 800)
141 400

Tax rate reconciliation

Accounting profit 500 000
Tax @ 28% 140 000
Tax effect of non-taxable/non-deductible items:
- Dividends received not taxable (10 000 x 28%) (2 800)
- Penalty not deductible (15 000 x 28%) 4 200
Income tax expense 141 400

10. Deferred tax

Analysis of temporary differences:

Property, plant and equipment
-Revaluation, net of related depreciation 44 8001
Prepaid expenses 8 400
Deferred tax liability 53 200

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1
The total deferred tax (regardless of whether it is recognised in P/L, OCI or directly in equity)
must be disclosed in the deferred tax note, since this total balance has to reconcile back to the
total deferred tax liability balance on the face of the statement of financial position.

ITEMS RECOGNISED IN P/L, OCI AND DIRECTLY IN EQUITY

Current tax calculations:

A company can do three separate current tax calculations:

1. For items recognised in P/L,

2. For items recognised in OCI, and
3. For items recognised directly in equity.

The aggregate of these three current tax calculations will be the total income tax that
must be paid to (or received from) the South African Revenue Services (SARS) for the
current financial year.

Deferred tax calculations:

A company can do one deferred tax calculation, but need to split the movement in the
temporary differences between P/L, OCI and directly in equity. Deferred tax will have no
impact on amounts payable to (or received from) the SARS, since deferred tax only
represents “future taxation” implications, should be related assets or liabilities be
realised.

Income tax expense (which includes current tax and deferred tax) is disclosed as
follows:

1. The income tax expense for items recognised in P/L is disclosed in the income tax
expense note.
2. The income tax expense for items recognised in OCI is disclosed either on the face
of the statement of OCI or in an income tax expense note for items recognised in
OCI (IAS 1.91 and IAS 12.81(0)).
3. The income tax expense for items recognised in directly in equity is disclosed as an
aggregate amount (IAS 12.81(a)) which can be added as a disclosure at the end of
the income tax note or a separate note for income tax expense for items
recognised directly in equity. Two examples of items that are recognised directly in
equity are listed in IAS 12.62A.

EXAMPLE 4 – Deferred tax on items carried at fair value through profit or loss

The accounting profit before tax for the year ended 31 December 20.12 is R500 000. Included in the
accounting profit before tax are dividends received of R10 000 that are not taxable and a penalty of
R15 000 that is not deductible for tax purposes.

On 1 January 20.11 Deasy Ltd acquired shares in Cappy Ltd as a long-term investment. The shares
are carried in terms of IFRS 9 at fair value through profit or loss. The shares were acquired for
R800 000 and transaction costs were R20 000. The fair value of the shares was R920 000 on
31 December 20.11 and R990 000 on 31 December 20.12. Assume that the investment in shares is
subject to Capital Gains Tax (CGT) and that transaction costs are included in base cost of the
shares for CGT purposes.

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Deasy Ltd acquired new machinery on 1 January 20.12 for R300 000 which is depreciated over four
years on the straight-line basis (the residual value is Rnil). The depreciation has been included in the
accounting profit before tax. In terms of the Income Tax Act, the South African Revenue Services
(SARS) allows a section 12C allowance of 40% in the first year and 20% per year for the subsequent
three years, this allowance is not apportioned for part of a year.

The deferred tax balance as at 31 December 20.10 was Rnil. There were no temporary differences
on 31 December 20.11 or on 31 December 20.12, other than those that are apparent from the
information provided above.

CALCULATIONS

C1. Current tax 20.12

Profit before tax 500 000

Non-taxable/non-deductible items:
Dividends received not taxable (10 000)
Fine not deductible 15 000
Fair value adjustment on investment not taxable (20%) (14 000)1
Taxable profit before temporary differences 491 000
Movement in temporary differences (taxable in future) [C2] (101 000)
Taxable profit 390 000
Tax at 28% 109 200

1
The fair value adjustment on the investment in shares on 31 December 20.12 is R70 000
(R990 000 – R920 000) and is included in P/L. 80% of this fair value adjustment will be subject
to CGT in the future when the shares are sold. The balance of 20% will never be taxable and is
therefore a non-taxable item in the tax rate reconciliation.

Temporary Deferred
Carrying Tax difference tax at 28%
C2. Deferred tax
amount base at 100% or asset/
80% (liability)

31 December 20.11
Investment in shares (100 000 x 80%) 920 000 820 000 80 000 (22 400)
Deferred tax liability 86 000 (22 400)
31 December 20.12
Investment in shares (170 000 x 80%) 990 000 820 000 136 000 (38 080)
Machinery 225 000 180 000 45 000 (12 600)
Deferred tax liability 181 000 (50 680)

Movement in temporary differences (through P/L) (taxable)

(181 000 – 80 000); (50 680 – 22 400) 101 000 (28 280)

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DISCLOSURE

DEASY LTD
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12
3. Income tax expense 20.12
R
Major components of tax expense

SA normal tax
Current tax
-Current year [C1] 109 200
Deferred tax
-Movement in temporary differences [C2] 28 280
137 480
Tax rate reconciliation
Accounting profit 500 000
Tax @ 28% 140 000
Tax effect of non-taxable/non-deductible items:
- Dividends received not taxable (10 000 x 28%) (2 800)
- Penalty not deductible (15 000 x 28%) 4 200
- Fair value adjustment on shares not taxable (70 000 x 20% x 28%) (3 920)
Income tax expense 137 480

10. Deferred tax

Analysis of temporary differences:
Property, plant and equipment
-Accelerated deductions for tax purposes [C2] 12 600
Investment in equity shares at fair value through P/L [C2] 38 080
Deferred tax liability 50 680

TAX RATE RECONCILIATION

Please take note that only 20% of the fair value adjustment is a reconciling item in the tax
rate reconciliation, since this portion of the fair value adjustment is a permanent
difference which is not compensated for as part of the movement in temporary
differences.

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QUESTIONS

QUESTION 5.1 (26 marks)

The following information was extracted from the books and records of April Ltd for the year ended
29 February 20.12:

1. The deferred tax liability as at 28 February 20.11 was made up as follows:

R

Property, plant and equipment (accelerated deductions for tax purposes) (271 150) Cr
Contract liability (revenue received in advance) 13 340 Dr
(257 810) Cr

2. Profit before tax for the year ended 29 February 20.12 amounted to R735 000 and included,
inter alia, the following items:
R

Foreign income (not taxable in South Africa as tax is payable on this

income at 35% in the foreign country) 132 000
Dividends received (not taxable) 175 000
Profit on sale of land (capital gain for tax purposes) 210 000
Fines and donations (not tax deductible) 700
Legal fees
- Not tax deductible 900
- Tax deductible 1 100
Depreciation on vehicles 150 000

3. The profit on sale of land relates to land that was sold during the 20.12 financial year. The land
was measured using the cost model.

4. The carrying amount of the remaining property, plant and equipment as at 29 February 20.12
was R2 550 000 and the tax base was R1 360 000. Property, plant and equipment does not
include any other land (except as referred to in paragraph 3 above) or any assets which are
being recovered through sale.

5. The contract liability (revenue received in advance account) in the trial balance reflected a
credit balance of R62 000 on 29 February 20.12.

6. The creditor account for the South African Revenue Services (SARS) (relating to income tax)
in the accounting records of April Ltd as at 29 February 20.12 was made up as follows:

Dr/(Cr)
R

Balance at 1 March 20.11 (provision in respect of 20.11 tax assessment) (31 000)
Payments actually made in final settlement of 20.11 tax assessment
(no interest or penalties were charged) 29 500
Provisional tax payments made in respect of 20.12 38 000
36 500

7. The foreign tax payable account in the trial balance had a credit balance of R46 200 at
28 February 20.12. This amount of tax relates to the foreign income received of R132 000 in
the financial year ended 29 February 20.12. No foreign tax was paid over during the financial
year.

MJM
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Additional information

1. No objection was made by April Ltd in respect of the 20.11 tax assessment. April Ltd has no
unused capital losses or unused tax losses carried forward from prior years.

2. The Minister of Finance announced in March 20.11 that the tax rate decreased from 29% to
28% for financial years that started on or after 1 March 20.11. The inclusion rate for capital
gains tax is 80%.

REQUIRED
Marks
(a) Present the abovementioned information in the statement of profit or loss and other 4
comprehensive income (commencing from the profit before tax line) and in the
statement of financial position of April Ltd for the year ended 28 February 20.12.

Please note:
• Only present tax related account balances in the statement of financial position
of April Ltd for the year ended 28 February 20.12.

(b) Disclose the notes to the financial statements of April Ltd for the year ended 28 22
February 20.12 as required by IAS 12 Income taxes.

Please note:

• The movement in temporary differences in the current tax calculation must be

calculated using the statement of financial position method.
• Comparative figures are not required.
• Round off all amounts to the nearest Rand.
• Ignore any Value-Added Taxation (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

COMMENTS ON INFORMATION GIVEN IN THE QUESTION

• The provision in respect of the 20.11 assessment of R31 000 in point 6 relates to
the current tax calculation that has been done for the financial year ended
28 February 20.11.
• The payments actually made in the final settlement of the 20.11 assessment of
R29 500 represent the income tax for 20.11 per the assessment issued by the
SARS.
• Point 1 in the additional information states that April Ltd did not object to the 20.11
assessment that was issued by the SARS which means that the correct amount
payable to the SARS was R29 500 and not R31 000. The current tax for 20.11
was therefore overprovided for with R1 500 (31 000 – 29 500).

MJM
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QUESTION 5.1 - Suggested solution

(a) APRIL LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE

YEAR ENDED 28 FEBRUARY 20.12
20.12
Notes R

Profit before tax 735 000 (1)

Income tax expense 3 (144 338) (1)
PROFIT FOR THE YEAR 590 662 (1)
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 590 662

APRIL LTD

STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.12

20.12
Notes R
EQUITY AND LIABILITIES
Non-current liabilities
Deferred tax 10 315 840 (½)

Current liabilities
Other payables:
SARS and tax payable in foreign country (3 608 + 46 200) 49 808 (½)
Total (4)

OFFSETTING OF CURRENT TAX ASSETS AND LIABILITIES

Tax receivable and tax payable may only be set off against one another if there is a legal
enforceable right to set off the recognised amounts (IAS 12.71-.72). The tax payable on
the foreign income is payable to the tax authority of the foreign country and not to the
SARS. As a result the assessment issued by the SARS is separate from the tax payable
in the foreign country and thus these two amounts cannot be set off against each other. If
the SARS account had a debit balance at year end, then the two accounts would not
have been allowed to be set off against each other. However, as the balances are both
credit balances, they may be grouped together as part of other payables.

MJM
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(b) APRIL LTD

NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 28 FEBRUARY 20.12

3. Income tax expense

Major components of tax expense

20.12
R
SA normal tax
Current tax 40 108
- Current year [C1] 41 608 (5)
- Overprovision in prior year (31 000 - 29 500) (1 500) (1)
Deferred tax 58 030
- Movement in temporary differences [C2] (239 000 x 28%) 66 920 (3)
- Change in tax rate [C2] (8 890) (1)

SA normal tax 98 138

Foreign tax (132 000 x 35%) 46 200 (1)
144 338

Tax rate reconciliation

Accounting profit 735 000 (½)

Tax at 28% 205 800 (½)
Tax effect of non-taxable/non-deductible items:
- Dividends received not taxable (175 000 x 28%) (49 000) (1)
- Capital gain on sale of land not taxable (210 000 x 20% x 28%) (11 760) (1)
- Fines and donations not deductible (700 x 28%) 196 (1)
- Legal fees not deductible (900 x 28%) 252 (1)
Change in tax rate [C2] (8 890) (1)
Effect of different tax rate on foreign income (132 000 x (35% - 28%)) 9 240 (1½)
Overprovision of current tax in prior year (31 000 – 29 500) (1 500) (½)
Income tax expense 144 338

The income tax rate has been decreased from 29% to 28% by the Minister on Finance in
March 20.11 for financial years starting on or after 1 March 20.11. (IAS 12.81(d)) (1)

FOREIGN TAX IN THE TAX RATE RECONCILIATION

The foreign income is included in the accounting profit of R735 000. The foreign income
is taxed at 35% (46 200 / 132 000) while tax is paid in South Africa at 28%. This
additional 7% represents a reconciling item in the tax rate reconciliation.

10. Deferred tax

Analysis of temporary differences:

Property, plant and equipment
- Accelerated deductions for tax purposes [C2] 333 200 (1)
Revenue received in advance [C2] (17 360) (1)
Net deferred tax liability 315 840
Total (22)

MJM
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CALCULATIONS

C1. Current tax

Profit before tax (given) 735 000 [½]

Non-deductible/non-taxable items:a
- Dividends received not taxable (175 000) [½]
- Fines and donations not deductible 700 [½]
- Legal fees not deductible 900 [½]
- Foreign income not taxable in SA (132 000)b [½]
- Portion of capital gain that is not taxable: (210 000 x 20%) (42 000) [1]
Taxable profit before temporary differences 387 600
Movement in temporary differences (taxable) [C2] (see comment below) (239 000) [1]
Taxable profit for the year 148 600
Tax at 28% 41 608 [½]
[5]
a
Note that no separate adjustment as a non-deductible item is necessary for depreciation,
as the movement in temporary differences of R239 000 already includes the effect of
adding back depreciation and deducting the income tax capital allowances.
b
The foreign income should be deducted from profit before tax as it is not taxable in South
Africa. The tax that was paid in the foreign country will be shown separately in the
income tax expense note and because it was taxed at 35% and not 28%, it will cause a
reconciling item in the tax rate reconciliation for the difference of 7%.

MOVEMENT IN TEMPORARY DIFFERENCES

A taxable temporary difference will only be taxable in future and will result in a tax
liability payable to the SARS in future. In the current year, this taxable temporary
difference is not taxable and must be deducted from the taxable profit.

A deductible temporary difference will only be deductible in future and will result in a
tax saving in future. In the current year, this deductible temporary difference is not
deductible and must be added to the taxable profit.

MJM
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C2. Deferred tax

Deferred
Carrying Temporary tax
Tax base
amount difference asset/
(liability)
28 February 20.11 29%

Property, plant and equipment ? ? 935 000 a (271 150) [½]

Contract liability (revenue [½]
received in advance) (46 000) -c (46 000)b 13 340
Net deferred tax liability at 29% 889 000 (257 810)
Change in tax rate (889 000 x 1%) or (257 810 x 1/ 29) 8 890 [1]
Net deferred tax liability at 28% (248 920)

29 February 20.12 28%

Property, plant and equipment 2 550 000 1 360 000 1 190 000 (333 200) [1]
Contract liability (revenue
received in advance) (62 000) -d (62 000) 17 360 [1]
Net deferred tax liability 1 128 000 (315 840)

Movement in temporary differences (taxable)

(1 128 000 – 889 000); (315 840 – 248 920) 239 000e (66 920)
[4]
a
271 150 (given) / 29% = 935 000
b
13 340 (given) / 29% = 46 000
c
The tax base of revenue received in advance is the carrying amount minus amounts
NOT taxable in future (46 000 – 46 000 = 0). The revenue received in advance is taxed
in the financial year ended 29 February 20.11 and will not be taxable again in future.
d
62 000 – 62 000 = 0 (refer to note c)
e
The deferred tax liability increases for the year ended 29 February 20.12 which means
that the movement in temporary differences is taxable.

C3. Creditor account for the SARS

The overprovision of R1 500 is corrected by passing the following journal:

Dr Cr
R R
Other payables: SARS (SFP) 1 500
Income tax expense (current tax) (P/L) 1 500

The current tax for the year is then accounted for by passing the following journal:

Dr Cr
R R
Income tax expense (current tax) (P/L) [C1] 41 608
Other payables: SARS (SFP) 41 608

The balance of the creditor account for the SARS on 29 February 20.12 is as calculated as
follows:
R36 500 (dr) (given) + 1 500 (dr) – 41 608 (cr) = R3 608 (cr).
The R3 608 is a credit balance (amount payable to the SARS) which means it is a current
liability and not a current asset.

MJM
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QUESTION 5.2 (25 marks)

The accounting profit before tax for Super Ltd for the year ended 31 December 20.12 is R450 000.
Included in the accounting profit before tax are dividends received of R10 000 that are not taxable
and a penalty of R15 000 that is not deductible for tax purposes. On 31 December 20.11 prepaid
expenses amounted to R60 000 and the unused tax loss was R550 000. Prepaid expenses were tax
deductible in the 20.11 year in accordance with section 23H of the Income Tax Act. The
South African Revenue Services (SARS) assessment also reflects an assessed tax loss of R550 000
for the 20.11 financial year.

Super Ltd acquired new machinery on 1 January 20.12 for R300 000 which is depreciated over four
years on the straight-line basis (the residual value is Rnil). The depreciation has been included in the
accounting profit before tax. The SARS grants a section 12C allowance of 40% in the first year and
20% per year for the subsequent three years, which is not apportioned for part of a year.

There are no temporary differences other than those that are apparent from the information
provided. The normal income tax rate is 28%.

REQUIRED
Marks
Prepare the income tax expense note and deferred tax notes of Super Ltd for the financial
year ended 31 December 20.12 for the following three scenarios:

Scenario 1 14
Future taxable profits are probable for both financial years ending 31 December 20.11 and
20.12 as the budget for 20.13 reflects new contracts that will increase the taxable profit in
the future with R1 000 000.

Scenario 2 6
Assume that future taxable profits were probable as at 31 December 20.11 but when re-
evaluated as at 31 December 20.12, they are not.

Scenario 3 5
Future taxable profits were not probable as at 31 December 20.11 but are probable as at
31 December 20.12 as the budget for 20.13 reflects new contracts that will increase the
taxable profit in the future with R1 000 000.

Please note:

• The movement in temporary differences in the current tax calculation must be

calculated using the statement of financial position method.
• Comparative figures are not required.
• Ignore any Value-Added Taxation (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

ASSESSED TAX LOSS VERSUS UNUSED TAX LOSS

Please note that an unused tax loss that has been assessed by the SARS for the prior
year is referred to as an assessed tax loss.

The tax loss calculated as part of the current tax calculation has not yet been assessed
by the SARS and will be referred to as an unused tax loss.

The difference between the assessed tax loss calculated by the SARS and the unused
tax loss calculated by the company will result in an overprovision or underprovision of
income tax that will be corrected in the following financial year.

MJM
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QUESTION 5.2 – Suggested solution

SUPER LTD
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12

Scenario 1 Scenario 2 Scenario 3

3. Income tax expense 20.12 20.12 20.12
R R R
Major components of tax expense

SA normal tax
Current tax
-Current year [C1] - (3½) - -
Deferred tax
-Movement in temporary differences [C2] [C3] [C4] (4 200) (4) (4 200) (4 200)
-Recognition of unused tax loss not previously
b
recognised - - (137 200) (1)
C2 C3 c
-Unused tax loss utilised 131 600 (1) 141 400 (2) 131 600 (1)
127 400 137 200 (9 800)

Tax rate reconciliation

Accounting profit 450 000 (½) 450 000 450 000
Tax @ 28% 126 000 (½) 126 000 126 000
Tax effect of non-taxable/non-deductible items:
-Dividends received not taxable (10 000 x 28%) (2 800) (1) (2 800) (2 800)
-Penalty not deductible (15 000 x 28%) 4 200 (1) 4 200 4 200
a
Unused tax loss not recognised - 9 800 (1) -
Unused tax loss utilised that was not previously
b
recognised - - (137 200) (1)
Income tax expense 127 400 137 200 (9 800)

10. Deferred tax

Analysis of temporary differences:

Property, plant and equipment
C2 C3 C4
-Accelerated deductions for tax purposes (12 600) (½) (12 600) (12 600)
C2 C3 C4
Unused tax loss for normal tax 22 400 (½) 12 600 (½) 22 400 (½)
C2 C3 C4
Net deferred tax asset / (liability) 9 800 (½) - (½) 9 800 (½)
(13) (4) (4)

Additional disclosure in the deferred tax calculation

Scenario 1:
The company has an unused tax loss for which a deferred tax asset has been recognised because the
budget for 20.13 reflects new contracts that will increase the taxable profit in future. The deferred tax asset
recognised is presented in the analysis of temporary differences above. (IAS 12.82) (1)

Scenario 2:
The company has an unused tax loss in the current year for which no deferred tax asset has been
recognised due to uncertainty regarding the probability of future taxable profits. The unrecognised unused (1)
tax loss is as follows:
Unused tax loss for which no deferred tax asset has been recognised
(80 000 - 45 000) (IAS 12.81(e)) 35 000 (1)

Scenario 3:
The company has an unused tax loss for which a deferred tax asset has been recognised because the
budget for 20.13 reflects new contracts that will increase the taxable profit in future. The deferred tax asset
recognised is presented in the analysis of temporary differences above. (IAS 12.82) (1)
Total (25)
a (80 000 - 45 000)[C3] x 28% = 9 800
b (550 000 – 60 000)[C4] x 28% = 137 200
c (550 000 – 80 000)[C4] x 28% = 131 600

MJM
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ADDITIONAL DISCLOSURE REQUIRED FOR DEFERRED TAX ASSET

Please take note of the additional disclosure required by IAS 12 for each of the three
Scenarios that have been provided above.

TAX RATE RECONCILIATION

Scenario 2
As at 31 December 20.12, a deferred tax asset can only be raised for R45 000 of the
R80 000 unused tax loss, since future taxable profits are not probable. The remaining
balance of R35 000 that is not recognised at all gives rise to a reconciling item in the
tax rate reconciliation. Refer to C3.

Scenario 3
Only R60 000 of the unused tax loss of R550 000 can be recognised as at
31 December 20.11. The unused tax loss of R490 000 (R550 000 – R60 000) was not
recognised at all as at 31 December 20.11 because future taxable profits were not
probable). The unrecognised portion of R490 000 will be reflected as a reconciling item in
the 20.11 tax rate reconciliation.

The unrecognised unused tax loss of R490 000 must now be recognised in order to
reflect the true movement in the unused tax balance from R490 000 to R80 000 and not
from R60 000 to R80 000 as reflected in C4. This unrecognised unused tax loss that is
now recognised will be a reconciling item in the tax rate reconciliation.

CALCULATIONS

C1. Current tax (Current tax is the same for Scenarios 1,2 and 3)

Profit before tax 450 000

Non-taxable/non-deductible items:
Dividends received not taxable (given) (10 000)
Fine not deductible (given) 15 000
Taxable profit before temporary differences 455 000
Movement in temporary differences (deductible) [C2] [C3] [C4] 15 000
Taxable profit before unused tax loss 470 000
Unused tax loss of prior year (given) (550 000)
Cumulative unused tax loss as at 31 December 20.12 (80 000)
Tax at 28% -

UNUSED TAX LOSS OF PRIOR YEAR

It is important to note that for purposes of the current tax calculation, the SARS does not
consider whether or not Super Ltd recognised the unused tax loss for deferred tax
purposes. Therefore, even though the entire unused tax loss was not recognised for
deferred tax purposes (accounting purposes), the SARS will allow Super Ltd’s full
unused tax loss of R550 000 as a deduction against taxable profits in the current tax
calculation. The R80 000 remaining usused tax loss will be carried forward and may be
deducted from future taxable profit.

MJM
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Temporary Deferred tax

Carrying difference at 28% asset/
C2. Deferred tax (Scenario 1) amount Tax base at 100% (liability)

31 December 20.11
Prepaid expenses 60 000 - 60 000 (16 800) [1]
60 000 (16 800)
Unused tax loss - 550 000 (550 000) 154 000 [1]
Deferred tax asset (490 000) 137 200

31 December 20.12
Machinery 225 0002 180 0002 45 000 (12 600) [1]
45 000 (12 600)
Unused tax loss - 80 000 (80 000) 22 400 [1]
Net deferred tax asset (35 000) 9 800
Movement in temporary differences (excluding tax
loss) (deductible)
(45 000 – 60 000); (16 800 – 12 600) (15 000) 4 200
Movement in unused tax loss (reversal of deductible)
((80 000) - (550 000)); (154 000 – 22 400) 470 000 (131 600) [1]
Total movement in temporary differences
((45 000 - (550 000)); (9 800 – 137 200) 455 000 (127 400)
[5]

1
300 000 – (300 000/4) = 225 000
2
300 000 – (300 000 x 40%) = 180 000

RECOGNITION OF A DEFERRED TAX ASSET (IAS 12.34-35)

In order to recognise a deferred tax asset for an unused tax loss which can be used to
decrease taxable profit in future, the normal recognition criteria for an asset as per the
Conceptual Framework must be met. IAS 12.34-35 states that if it is not probable that
future taxable profits will be available against which the unused tax loss can be utilised,
the deferred tax asset recognised must be limited to the extent that future taxable profits
are probable.

On 31 December 20.11 and 20.12 future taxable profits are probable against which the
unused tax loss can be utilised. As a result the full unused tax loss can be recognised as
a deferred tax asset. The unused tax loss can be seen as an asset as it will reduce
future taxable profit and income tax expense. The tax base is greater than the carrying
amount which gives rise to a deductible temporary difference and a deferred tax
asset.

MJM
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Temporary Deferred tax

Carrying difference at 28% asset/
C3. Deferred tax (Scenario 2) amount Tax base at 100% (liability)

31 December 20.11
Prepaid expenses 60 000 - 60 000 (16 800)
60 000 (16 800)
Unused tax loss - 550 000 (550 000) 154 000
Deferred tax asset (490 000) 137 200

31 December 20.12
Machinery 225 0001 180 0002 45 000 (12 600)
45 000 (12 600)
Unused tax loss - 80 000 (45 000) 12 600 [1]
Net deferred tax asset - -
Movement in temporary differences (excluding tax
loss) (deductible)
(45 000 – 60 000); (16 800 – 12 600) (15 000) 4 200
Movement in unused tax loss (reversal of deductible)
((45 000) - (550 000)); (154 000 – 12 600) 505 000 (141 400) [1]
Total movement in temporary differences
((0) - (490 000)); (0 – 137 200) 490 000 (137 200)
[2]

1
300 000 – (300 000/4) = 225 000
2
300 000 – (300 000 x 40%) = 180 000

LIMITATION OF DEFERRED TAX ASSET ON 31 DECEMBER 20.12

As at 31 December 20.12, future taxable profits are not probable which means that the
future utilisation of the unused tax loss must be limited. The taxable temporary difference
of R45 000 relating to the machinery represents future taxable profits. In terms of
IAS 12.35, the deferred tax asset on the unused tax loss of R80 000 must be limited to
the extent that Super Ltd expects future taxable profits. Super Ltd has taxable temporary
differences which will be taxable in future, and as a result, the unused tax loss that can
be recognised is limited to R45 000. The net deferred tax balance is therefore Rnil for the
year ended 31 December 20.12.

MJM
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Temporary Deferred tax

Carrying difference at 28% asset/
C4. Deferred tax (Scenario 3) amount Tax base at 100% (liability)

31 December 20.11
Prepaid expenses 60 000 - 60 000 (16 800)
60 000 (16 800)
Unused tax loss - 550 000 (60 000) 16 800
Deferred tax asset - -

31 December 20.12
Machinery 225 0001 180 0002 45 000 (12 600)
45 000 (12 600)
Unused tax loss - 80 000 (80 000) 22 400 [1]
Net deferred tax asset (35 000) 9 800
Movement in temporary differences (excluding tax
loss) (deductible)
(45 000 – 60 000); (16 800 – 12 600) (15 000) 4 200
Movement in unused tax loss (reversal of deductible)
((80 000) - (60 000)); (22 400 – 16 800) (20 000) *5 600 [1]
Total movement in temporary differences
((35 000) - 0); (0 – (9 800)) (35 000) 9 800
[2]

1
300 000 – (300 000/4) = 225 000
2
300 000 – (300 000 x 40%) = 180 000

LIMITATION OF UNUSED TAX LOSS ON 31 DECEMBER 20.11

As at 31 December 20.11, future taxable profits were not probable. The taxable
temporary difference of R60 000 relating to the prepaid expenses represents future
taxable profits. In terms of IAS 12.35, the deferred tax asset on the unused tax loss of
R550 000 must be limited to the extent that future taxable profits are probable, and as a
result, the unused tax loss that can be recognised is limited to R60 000. The net deferred
tax balance on 31 December 20.11 is therefore Rnil.

As at 31 December 20.12 the unused tax loss of R80 000 is not limited as future taxable
profits are probable and the full R80 000 is recognised as a deferred tax asset.

MOVEMENT IN UNUSED TAX LOSS

* Please note that the movement in the unused tax loss disclosed above as part of the
income tax expense note reconciles to the total movement in the unused tax loss
calculated in C4:

Unused tax loss not previously recognised

(154 000 – 16 800) [C2] OR (550 000 – 60 000) x 28% (137 200)
Unused tax loss utilised (550 000 – 80 000) x 28% 131 600
Total movement per deferred tax calculation 5 600

MJM
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QUESTION 5.3 (24 marks)

1. The balance of the deferred tax account of Spring Ltd was R2 240 (credit) on 1 January 20.10.

2. The unused tax loss as at 31 December 20.10 is R12 000. There was no unused tax loss as at
31 December 20.9.

3. The net temporary differences are as follows at the end of the respective years:

31 December 20.10: R11 000 (taxable)

31 December 20.11: R9 000 (taxable)
31 December 20.12: R9 000 (taxable)

All temporary differences are subject to the normal income tax rate of 28%, with no capital gains
tax (CGT) implications.

4. Profit before tax for the year ended 31 December 20.11 amounted to R7 000 while the accounting
loss before tax for the year ended 31 December 20.10 amouned to R9 000. All items included in
the profit/(loss) before tax for both years are taxable or deductible for tax purposes.

5. As at 31 December 20.10 there were doubts as to whether Spring Ltd would generate future
taxable profits. As from 31 December 20.11 it is probable that Spring Ltd will generate future
taxable income for the next three years in excess of R13 000 per year.

REQUIRED
Marks
(a) Calculate the deferred tax balance on 31 December 20.10. 2

(b) Calculate the taxable profit for the year ended 31 December 20.11 before utilisation of 2
the unused tax loss.

(c) Calculate the cumulative tax loss on 31 December 20.11. 2

(d) Calculate the deferred tax balance on 31 December 20.11. 2

(e) Calculate the current tax for the year ended 31 December 20.12. Assume that the 4
profit before tax for the year ended 31 December 20.12 amounted to R10 000.

(f) Calculate the deferred tax balance on 31 December 20.12. 1

(g) Prepare the income tax expense note for Spring Ltd for the financial year ended
31 December 20.10, 20.11 and 20.12. 11

Please note:

• The movement in temporary differences in the current tax calculation must be

calculated using the statement of financial position method.
• Ignore any Value-Added Tax (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

MJM
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QUESTION 5.3 - Suggested solution

(a) Deferred tax Deferred

Carrying Tax Temporary tax at 28%
amount base differences asset/
(liability)
R R R R
31 December 20.10
Taxable temporary differences
(given) ? ? 11 000 (3 080) (1)
Unused tax loss
(12 000 limited to 11 000) - 12 000 (11 000) 3 080 (1)
Deferred tax balance -
Total (2)

LIMITATION OF UNUSED TAX LOSS

On 31 December 20.10 the total tax loss amounted to R12 000. As there is uncertainty
regarding future taxable profits, the deferred tax asset created in respect of this tax loss is
limited to the taxable temporary differences (R11 000). As a result the deferred tax balance
on the statement of financial position is Rnil (consisting of an asset of R3 080 in respect of
the unused tax loss and a liability of R3 080 in respect of the taxable differences). The
unused tax loss still amounts to R12 000 (which will be deductible from future taxable
income), of which R11 000 is recognised and R1 000 is unrecognised.

(b) Taxable profit for the year ended 31 December 20.11 before utilisation of unused
tax loss
R

Profit before tax (given) 7 000 (½)

Movement in temporary differences (11 000 – 9 000) (reversal of taxable) 2 000 (1)
Taxable profit before unused tax loss 9 000 (½)
Total (2)
(c) Cumulative tax loss as at 31 December 20.11
Unused tax loss of prior year (given) (12 000) (1)
Cumulative unused tax loss as at 31 December 20.11 (3 000) (1)
Total (2)

(d) Deferred tax Deferred

Carrying Tax Temporary tax at 28%
amount base differences asset/
(liability)
R R R R
31 December 20.11
Taxable temporary differences
(given) ? ? 9 000 (2 520) (1)
Unused tax loss - 3 000(c) (3 000)(c) 840 (1)
Deferred tax liability (1 680)
Total (2)

(e) Current tax for the year ended 31 December 20.12 R

Profit before tax 10 000 (½)
Movement in temporary differences (9 000 – 9 000) - (1)
Taxable profit before unused tax loss 10 000
Unused tax loss of prior year (c) (3 000) (1)
Taxable profit after utilisation of unused tax loss 7 000 (½)

Current tax at 28% 1 960 (1)

Total (4)

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(f) Deferred tax

Deferred
tax at
Carrying Tax Temporary
28%
amount base differences
asset/
(liability)
R R R R
31 December 20.12
Taxable temporary differences (given) ? ? 9 000 (2 520) (1)
Unused tax loss - - - -
Deferred tax liability (2 520)

(g) SUPER LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.10, 20.11 and 20.12

4. Income tax expense 20.12 20.11 20.10

R R R
Major components of tax expense

SA normal tax
C7
Current tax 1 960 - - (1)
Deferred tax 840 1 680 (2 240)
C8 C4 C1
- Movement in temporary differences - (560) 840 (3)
C2
- Recognition of unused tax loss - - (3 080) (1)
C5
- Recognition of unused tax loss not previously recognised - (280) - (1)
C9 C6
- Unused tax loss utilised 840 2 520 - (2)

2 800 1 680 (2 240)

Tax rate reconciliation

Accounting profit/(loss) 10 000 7 000 (9 000) (½)

Tax at 28% 2 800 1 960 (2 520) (½)
C3
Unused tax loss not recognised - - 280 (1)
C5
Unused tax loss utilised that was not previously recognised - (280) - (1)
Income tax expense 2 800 1 680 (2 240)
Total (11)
C1
Taxable temporary differences on 31 December 20.10 11 000
Taxable temporary differences on 31 December 20.9 8 000 (2 240 / 28%)
Movement in temporary differences (taxable) 3 000
Increase in deferred tax liability (3 000 x 28%) 840 (credit deferred tax, debit P/L)
C2
11 000 x 28% = 3 080 (refer to (a))
C3
12 000 (unused tax loss) minus 11 000 (unused tax loss recognised) = 1 000 unrecognised
unused tax loss x 28% = 280
C4
9 000 taxable temporary difference for 20.11 – 11 000 taxable temporary difference for 20.10 =
2 000 x 28% = 560 (Decrease in deferred tax liability, therefore debit deferred tax and credit P/L)
C5
1 000 unrecognised unused tax loss [C3] x 28% = 280
C6
Unused tax loss at 31 December 20.11 of 3 000 (refer to (c)) minus the unused tax loss at
31 December 20.10 of 12 000 = 9 000 tax loss utilised x 28% = 2 520
C7
Refer to (e)
C8
9 000 taxable temporary difference for 20.12 – 9 000 taxable temporary difference for 20.11 = 0
C9
Unused tax loss at 31 December 20.12 of nil minus unused tax loss on 31 December 20.11 of
3 000 = 3 000 tax loss utilised x 28% = 840

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LEARNING UNIT 6 – ACCOUNTING POLICY, CHANGES IN ACCOUNTING

ESTIMATES AND ERRORS

INTRODUCTION

The purpose of this standard is to prescribe criteria for the selection of an accounting
policy, as well as for the accounting treatment and disclosure of changes in accounting
policies, changes in accounting estimates and correction of prior period errors, to ensure
consistent preparation and presentation of financial statements. The standard enhances
the comparability of the entity’s financial statements with previous periods, as well as with
financial statements of other entities.

OBJECTIVES/OUTCOMES

After you have studied this learning unit, you should be able to do the following:

1. Identify the objective of IAS 8 and be able to apply IAS 8.

2. Provide guidance on the choice of an accounting policy regarding specific

transactions.

3. Identify, account for and disclose a change in accounting policy.

4. Identify, account for and disclose changes in accounting estimates.

5. Identify, account for and disclose errors.

PRESCRIBED STUDY MATERIAL

The following must be studied before you attempt the questions in this learning unit:

1. IAS 8 Accounting policies, changes in accounting estimates and errors.

2. Chapter on accounting policies, changes in accounting estimates and errors in

Descriptive Accounting, 21st edition.

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THE REST OF LEARNING UNIT 6 IS BASED ON THE ASSUMPTION THAT YOU

HAVE ALREADY STUDIED THE RELEVANT CHAPTERS IN THE PRESCRIBED
STUDY MATERIAL.

SECTION A – SAICA’S PRINCIPLE OF EXAMINATION

The principle of examination of IAS 8 is at core level.

SECTION B – ADDITIONAL QUESTION

QUESTION 6.1 (50 marks)

The accounting profit before tax of Trueblue Ltd for the financial year ended 28 February 20.11 was
R600 000 (R500 000 for the financial year ended 28 February 20.10).

The following information relating to Trueblue Ltd is presented to you for the year ended
28 February 20.11:

1. Inventory amounting to R95 000 were destroyed and written off due to a flood during the year. An
amount of R60 000 was received from the insurance company as compensation for the inventory
that was destroyed. The two amounts are included in the accounting profit before tax for the year
ended 28 February 20.11. Assume that these amounts are material.

2. The directors of the company decided to change the accounting policy in respect of the valuation
of inventory, since the new policy will ensure a more reliable value of inventory. Previously
inventory was valued according to the weighted average method, but it should now be valued
according to the first-in-first-out method. This change in accounting policy has not been accounted
for as yet.

The value of inventory at 28 February, based on the two methods of valuation, was as follows:

20.11 20.10 20.9 20.8

R R R R

First-in-first-out method 460 000 420 000 395 000 380 000
Weighted average method 420 000 395 000 382 000 375 000

The South African Revenue Service (SARS will not re-open the previous years’ assessments, but
will accept the new policy in respect of the current year for tax purposes.

3. During the current year the bookkeeper established that a material error had been made in the
published financial statements for the year ended 28 February 20.10. New manufacturing
equipment amounting to R25 000 that was acquired on 1 September 20.9 was incorrectly
recorded as administration expenses. The company depreciates such equipment at 20% per
annum according to the straight-line method, apportioned for part of a year. This error has not
been corrected.

The accountant immediately informed the SARS of the error and the SARS agreed to re-open
the 20.10 assessment in order to correct this error. In accordance with the Income Tax Act, the
SARS grants a section 12C allowance on the equipment of 40% in the first year and 20% in the
second, third and fourth years, which is not apportioned for part of a year.

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4. Trueblue Ltd acquired a fleet of delivery vehicles on 1 March 20.9 for R500 000. The fleet has
been depreciated over three years on the straight-line method, apportioned for part of a year. The
fleet has a residual value of R140 000. The depreciation for the year ended 28 February 20.11
was correctly recorded.

On 28 February 20.11 (after depreciation was recorded), management extended the maintenance
contract of the fleet to 28 February 20.13 and management estimated the remaining useful life of
the fleet on 28 February 20.11 to be two years. This change has not been accounted for as yet.

The SARS grants a section 11(e) wear-and-tear allowance on the cost less the residual value of
the fleet of delivery vehcles over four years, which is apportioned for part of a year.

5. The income tax rate is 28% and was not adjusted for the past five years. There are no temporary
differences other than those that are apparent from the question. The deferred tax liability on
28 February 20.9 was R3 500. All the temporary differences included in the deferred tax balance
of R3 500 are subject to a tax rate of 28% with no capital gains tax (CGT) implications.

6. The retained earnings balance on 1 March 20.9 was R800 000.

7. The company had 500 000 issued ordinary shares since incorporation.

REQUIRED
Marks
(a) Prepare an extract of the statement of profit or loss and other comprehensive income
for Trueblue Ltd for the year ended 28 February 20.11 by starting with the profit before 19
tax figure.

(b) Prepare extract from statement of changes in equity for Trueblue Ltd for the year 3
ended 28 February 20.11 (only the retained earnings column is required).

(c) Disclose the following notes in the financial statements of Trueblue Ltd for the year
ended 28 February 20.11:
8
- Profit before tax 12
- Change in accounting policy 8
- Prior period error

Please note:

• The movement in temporary differences in the current tax calculation must be

calculated using the statement of financial position method.
• Round off all amounts to the nearest Rand.
• Ignovre any Value-Added Tax (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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COMMENTS ON INFORMATION GIVEN IN THE QUESTION

• The change in accounting policy must be applied retrospectively which means the
information must be adjusted for:
- the current year ended 28 February 20.11,
- the previous year ended 28 February 20.10, and
- the opening balance for the previous year (1 March 20.9).
• The valuations of inventories provided for 20.8 should not be used.
• The error regarding the equipment that was incorrectly expensed should be
corrected in the financial year where the error occurred, being the previous financial
year. The error will also affect the current year since depreciation on the equipment
must still be recognised.
• The change in the useful life of the fleet is a change in accounting estimate. The
change in accounting estimate must be applied prospectively to the current and
future periods. The change in the accounting estimate in the current year must be
done at the beginning of the current year, i.e. 1 March 20.10 (refer note 3).

EXAM TECHNIQUE

If comparative figures are not specifically excluded in the required, comparative figures
are required.

In this question the statement of financial position is not required. If it was required, three
statements of financial position will need to be prepared as required by IAS 1.40A.

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QUESTION 6.1 - Suggested solution

(a) TRUEBLUE LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE

YEAR ENDED 28 FEBRUARY 20.11

20.11 20.10
R R

Profit before tax [C4] 650 000 534 500 (6)

Income tax expense [C5] (182 000) (149 660) (12½)
PROFIT FOR THE YEAR 468 000 384 840 (½)
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 468 000 384 840
Total (19)

(b) TRUEBLUE LTD

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.11

Retained
earnings
R

Balance as at 1 March 20.9 800 000 (½)

Change in accounting policy [C1] 9 360 (1)
Restated balance 809 360
Total comprehensive income for the year
- Profit for the year (restated) 384 840 (½)
Balance at 28 February 20.10 1 194 200 (½)
Total comprehensive income for the year
- Profit for the year 468 000 (½)
Balance at 28 February 20.11 1 662 200
Total (3)

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(c) TRUEBLUE LTD

NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.11
1. Profit before tax
The following items are included in profit before tax:
20.11 20.10
R R
Income
Compensation received from insurance company for
inventory damaged in flood (IAS 2.36 and IAS 1.98) 60 000 - (1)

Expenses
Write-off of inventory as a result of flood (IAS 2.36 and
1.98) 95 000 - (1)
Depreciation on property, plant and equipment (IAS 1.104)
- Equipment [C2] 5 000 2 500 (1)
- Fleet of delivery vehicles [C3.1] 80 000 120 000 (2½)

Included in depreciation for 20.11 is a change in estimate (decrease in

depreciation) of R40 000 arising from the remaining useful life of the fleet of
delivery vehicles that was changed from one year to two years on
28 February 20.11, with effect from 1 March 20.10. This change will result in an
increase in depreciation in future periods amounting to R40 000 [C3.2].
(IAS 8.39). (2½)
Total (8)

2. Change in accounting policy

The company changed its accounting policy during the year in respect of the valuation of
inventory from the weighted average method to the first-in-first-out method. This change
was effected to ensure fairer presentation of the valuation of inventory. The opening
balance of retained earnings at the beginning of 20.10 was adjusted while the
comparative amounts were restated accordingly. The effect of the change in accounting
policy on the results for 20.10 and 20.11 is as follows: (2½)

1 March
20.11 20.10 20.9
R R R

Decrease in cost of sales [C1] 15 000 12 000 (1½)

Increase in income tax expense [C1] (4 200)2 (3 360)1 (1½)
Increase in profit [C1] 10 800 8 640

Increase in inventory [C1] 40 000 25 000 13 000 (2)

Increase in deferred tax liability [C1] [C6] - (7 000) (3 640) (1½)
Increase in tax payable [C1] (11 200) - (1)
Increase in equity [C1] 28 800 18 000 9 360

Adjustment against retained earnings on

1 March 20.9 (IAS 8.29(d)) 9 360 (1)

Increase in earnings per share (IAS 8.29(c))

(10 800 / 500 000) (8 640 / 500 000) 0,02 0,02 (1)
Total (12)

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INCREASE IN INCOME TAX EXPENSE AS A RESULT OF CHANGE IN ACCOUNTING

POLICY
1
The R3 360 is a movement in the deferred tax balance relating to inventory from
R3 640 to R7 000 [C6], since the SARS indicated that they will only accept the new
accounting policy from the current year, even though the new policy has been
applied retrospectively for accounting purposes.
2
The income tax expense line includes the current tax and movement in deferred tax
relating to the change in accounting policy. The R4 200 (R15 000 x 28%) can also
be proven as follows:

Current tax on change in accounting policy for the year ended 28 February 20.11:

Increase in taxable profit R15 000

Movement in temporary differences on inventory [C6]
(reversal of taxable temporary difference) R25 000
Taxable profit R40 000

Income tax (current tax at 28%) (R40 000 x 28%) R11 200
Income tax (deferred tax) (7 000 - 0) [C6]
(debit deferred tax liability and credit P/L) (R 7 000)
Income tax expense R 4 200

3. Prior period error

The error relates to a correction in respect of equipment that was incorrectly

recorded as administrative expenses in the 20.10 financial year. The
comparative amounts were restated. The effect of the correction of the error on
the 20.10 results is as follows: (2)

1 March
20.10 20.9
R
R
Decrease in other expenses [C3] (25 000 - 2 500) 22 500 (1)
Increase in income tax expense (22 500 x 28%) (6 300)1 (½)
Increase in profit for the year 16 200 (½)
Increase in property, plant and equipment
(25 000 - 2 500) [C2] 22 500 (1)
Increase in deferred tax liability (2 100) (½)
Increase in tax payable ((22 500 - 7 500) x 28%) (4 200) (1)
Increase in equity 16 200 (½)
Adjustment against retained earnings on 1 March 20.9
(IAS 8.49(c)) - (1)
Total (8)

EFFECT OF ERROR IN CURRENT YEAR

Note that the effect of the error in the current year is not disclosed, since it is corrected in
the current year before the financial statements are published.

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INCREASE IN INCOME TAX EXPENSE AS A RESULT OF PRIOR PERIOD ERROR

1
The income tax expense line includes the current tax and movement in deferred tax
relating to the prior period error. The R6 300 (R22 500 x 28%) can also be proven
as follows:

Current tax on error for the year ended 28 February 20.10:

Increase in taxable profit R22 500

Movement in temporary difference on equipment [C6]
(7 500 - 0) (taxable temporary difference) (R 7 500)
Taxable profit R15 000

Income tax expense (current tax at 28%) (R15 000 x 28%) R 4 200
Income tax expense (deferred tax) (2 100 - 0) [C6]
(debit P/L and credit deferred tax liability) R 2 100
Income tax expense R 6 300

CALCULATIONS

C1. Change in accounting policy (inventory)

20.9 P/L 20.10 P/L 20.11

First-in-first-out (New) 395 000 420 000 460 000
Weighted average (Old) (382 000) (395 000) (420 000)
13 0001 12 0003 25 0002 15 000 40 000 [2½]
Tax at 28% (3 640) (3 360) (7 000) (4 200) (11 200) [2½]
9 360 8 640 18 000 10 800 28 800
[5]
1
On 28 February 20.9, as a result of the change in accounting policy, the closing
inventory increased with R13 000. Since closing inventory is deducted from cost
of sales, the R13 000 decreases costs of sales which will increase gross profit
and profit before tax.
2
On 28 February 20.10, the closing inventory increased with R25 000 which also
decreases cost of sales.
3
The P/L for the year ended 28 February 20.10 is affected by opening inventory
that increased with R13 000 (which increases cost of sales) and closing inventory
that increased with R25 000 (which decreases cost of sales). The net effect on
P/L for the year ended 28 February 20.10 is a net decrease in cost of sales which
is an increase in profit before tax of R12 000:

Dr (Cr)

Cost of sales (12 000)

Opening inventory 13 000
Purchases xx
Closing inventory (25 000)

The same principle applies to the changes made to the inventory

balance for the 20.11 financial year.

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JOURNALS TO EXPLAIN CHANGE IN ACCOUNTING POLICY (not required)

The journals to account for the change in accounting policy are not required, but are
provided for learning purposes only.

1 March 20.9 Dr Cr
J1 Inventory (SFP) 13 000
Retained earnings (SCE) 9 360
Deferred tax (SFP) 3 640
Change in accounting policy in opening retained earnings of
prior year
28 February 20.10
J2 Inventory (SFP) 12 000
Cost of sales (P/L) 12 000
Increase in closing inventory in prior year
J3 Income tax expense (deferred tax) (P/L) 3 360
Deferred tax (SFP) 3 360
Recognise deferred tax on increase in closing inventory
28 February 20.11
J4 Inventory (SFP) 15 000
Cost of sales (P/L) 15 000
Increase in closing inventory in current year
The deferred tax and current tax consequences on the change in accounting
policy for the current year are included in the tax journals that are provided in C6
for learning purposes.

C2. Prior period error

Equipment
Acquistion on 1 September 20.9 25 000
Depreciation for year ended 28 February 20.10 (25 000 x 20% x 6/12) (2 500) [1]
Carrying amount of equipment on 28 February 20.10 22 500
Depreciation for year ended 28 February 20.11 (25 000 x 20%) (5 000) [1]
Carrying amount of equipment on 28 February 20.11 17 500 [2]

JOURNALS TO EXPLAIN PRIOR PERIOD ERROR (not required)

Even though the journals are not required in this question, if you are unsure of the
effects of an error, it can be of great assistance to do the journals as part of your
calculations.

Correcting journals on 28 February 20.10 Dr Cr

J1 Equipment (SFP) 25 000
Other expenses (P/L) 25 000
Reclassification of equipment from other expenses
J2 Depreciation (P/L) 2 500
Accumulated depreciation (SFP) 2 500
Recognise depreciation on the equipment for prior year

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Dr Cr
J3 Income tax expense (current tax) (P/L)
(22 500 – 7 500 taxable temporary difference) x 28%) [C6] 4 200
Other payables: SARS (SFP) 4 200
Current tax payable for operating costs incorrectly deducted
J4 Income tax expense (deferred tax) (P/L) (7 500 x 28%) [C6] 2 100
Deferred tax (SFP) 2 100
Recognise a deferred tax liability on the equipment
Correcting journal on 28 February 20.11
J3 Depreciation (P/L) 5 000
Accumulated depreciation (SFP) 5 000
Recognise depreciation on the equipment for current year

The correction in the current year (J3) is corrected before the financial statements
are published and therefore not disclosed in the note.

The deferred tax and current tax consequences for the current year are included
in the tax journals that are provided in C6 for learning purposes.

C3.1 Change in accounting estimate

After Before
change in change in
estimate estimate
Fleet of vehicles acquired on 1 March 20.9 500 000 500 000
Depreciation for year ended 28 February 20.10
(500 000 - 140 000)/3 (120 000) (120 000) [1]
Carrying amount on 28 February 20.10 (1 March
20.10) 380 000 380 000
Depreciation for year ended 28 February 20.11
(380 000 - 140 000)/3 (80 000)1 (120 000) [1]
Carrying amount on 28 February 20.11 300 000 260 000
Depreciation for year ended 28 February 20.12
(380 000 - 140 000)/3 (80 000) (120 000)
Carrying amount on 28 February 20.12 220 000 140 000
Depreciation for year ended 28 February 20.12
(380 000 - 140 000)/3 (80 000) -
Carrying amount on 28 February 20.13 140 000 140 000
1
On 28 February 20.11 the new remaining useful life was two years. That
means that on 1 March 20.10 three years remained.

C3.2 Effect of change in estimate on future depreciation

Future depreciation on 28 February 20.11 (after change in estimate)

(80 000 for 20.12 + 80 000 for 20.13) 160 000 [½]
Future depreciation on 28 February 20.11 (before change in estimate) 120 000 [½]
Increase in future depreciation 40 000
[3]

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C4. Profit before tax

20.11 20.10
Accounting profit (given) 600 000 500 000 [1]
Decrease in cost of sales as a result of the increase in closing
inventory (change in accounting policy) [C1] 15 000 12 000 [1]
Prior period error: add back other expenses - 25 000 [1]
Prior period error: deduct depreciation [C2] (5 000) (2 500) [2]
Change in estimate: decrease in depreciation
(R120 000 - R80 000) [C3.1] 40 000 - [1]
650 000 534 500
[6]

C5. Current tax

Profit before tax [C4] 650 000 534 500 [1]

Movement in temporary differences (taxable) [C6] (20 000) (12 000)
Taxable profit 630 000 522 500

Income tax expense (current tax) at 28% (debit P/L) 176 400 146 300 [1]
Income tax expense (deferred tax) (debit P/L) [C6] 5 600 3 360 [1]
Total income tax expense 182 000 149 660
[3]

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C6. Deferred tax

Deferred
tax at
Carrying Temporary
Tax base 28%
amount difference
asset/
(liability)
28 February 20.9
Balance (given) 12 500 (3 500) [½]
Inventory [C1] 395 000 382 000 13 000 (3 640) [1]
Deferred tax liability 25 500 (7 140)

28 February 20.10
Inventory [C1] 420 000 395 000 25 000 (7 000) [1]
Equipment [C2] 22 500 15 0001 7 500 (2 100) [1]
Fleet of delivery vehicles [C3.1] 380 000 375 0002 5 000 (1 400) [1]
Deferred tax liability 37 500 (10 500)

Movement in temporary differences (taxable) 12 000 (3 360) [1]

28 February 20.11
Inventory [C1] 460 000 460 000 - - [1]
Equipment [C2] 17 500 10 0003 7 500 (2 100) [1]
Fleet of delivery vehicles [C3.1] 300 000 250 0004 50 000 (14 000) [1]
Deferred tax liability 57 500 (16 100)

Movement in temporary differences (taxable) 20 000 (5 600) [1]

[9½]
1
25 000 - (25 000 x 40%) = 15 000 [28]
2
500 000 - (500 000/4) = 375 000
3
25 000 - (25 000 x 40%) - (25 000 x 20%) = 10 000
4
500 000 - (500 000/4) - (500 000/4) = 250 000

TAX JOURNALS (not required)

The tax journals for the finanicial year ended 28 February 20.11 are provided for
learning purposes only.
Dr Cr
R R
28 February 20.11
J1 Income tax expense (current tax) (P/L) [C5] 176 400
Other payables: SARS (SFP) 176 400
Provide for current tax for the current year
J2 Income tax expense (deferred tax) (P/L) [C6] 5 600
Deferred tax (SFP) 5 600
Recognise increase in the deferred tax liability

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SECTION C – ADDITIONAL INFORMATION

1. IAS 1: Statements of financial position

According to IAS 1.40A-B an entity shall present three statements of financial position if an
accounting policy is applied retrospectively, or if the entity makes retrospective restatements or
reclassifications.

Examples when three statements of financial position are required:

• Retrospective change in accounting policy for valuation of inventory (e.g. weighted

average to first-in-first-out);
• Errors in prior periods;
• Reclassification adjustments of amounts previously recognised in other comprehensive
income to profit or loss;
• Reclassification adjustments on disposal of a foreign operation, derecognition of
available-for-sale financial assets and when a hedged forecast transaction affects profit
or loss (IAS 1.95); or
• Other retrospective changes in accordance with IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors.

If financial statements are thus presented for the year ended 31 December 20.12 and the
accounting policy for valuation of inventory was changed retrospectively, statements of
financial position will have to be presented on 1 January 20.11, 31 December 20.11 and
31 December 20.12 (if the information is available).

Other than the disclosure required by IAS 1.41-44 and IAS 8, IAS 1.40C states that the
entity need not present the related notes to the opening statement of financial position as at
the beginning of the preceding period.

2. Propective application of change in estimate

IAS 8.38 – Prospective recognition of the effect of a change in an accounting estimate means
that the change is applied to transactions, other events and conditions from the date of the
change in estimate.

IAS 16.51 The residual value and the useful life of an asset shall be reviewed at least at each
financial year-end and, if expectations differ from previous estimates, the change(s) shall be
accounted for as a change in an accounting estimate in accordance with IAS 8 Accounting
policies, Changes in Accounting Estimates and Errors.

According to IAS8.38 a change in estimate is accounted for from the date of the change in
estimate. However, since the residual value and the useful life of assets can be re-estimated
during the year (refer to IAS16.51 above), a change in estimate with regard to the residual
value or useful life of an asset will be accounted for from the beginning of the financial year
in which the change in estimate occurred.

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SELF ASSESSMENT QUESTIONS AND SUGGESTED SOLUTIONS

COMMENT

SAICA is advancing the assessment of students’ ability to critically evaluate information

provided in case study-format questions and, combined with a sound knowledge of
International Financial Reporting Standards (IFRS), requires of students to mostly supply
their solution in a discussion format.

With reference to the above SAICA changes, students need to note that tests and exams
will now require solutions mostly in a discussion format (theory). In the past, only 25% of
a test or exam paper required a discussion format solution. Going forward, test and
exams will require 50% or more of the solution to be in a discussion format.

Question Question name Source Marks Topics covered Page

1 Aluminium Ltd FAC4861 40 Journals: 102
Test 1/2019 • Income tax
Disclosure:
• Accounting policies and
estimates
Theory:
• Inventory
2 Uber-Accountants FAC4861 40 Disclosure: 109
Test 1/2018 • Income tax
• Inventory
Discussion:
• Presentation of financial
statements
3 Burger Queen Ltd FAC4861 34 Journals: 119
Test 1/2017 • Income tax
Theory:
• Conceptual framework
Disclosure:
• Inventory
4 Avicenne Ltd FAC4861 38 Disclosure: 129
Test 1/2016 • Income tax
Theory:
• Accounting policies and
estimates
5 Boring Ltd FAC4861 31 Disclosure and theory: 138
Test 1/2015 • Income tax
6 Sourtree Ltd FAC4861 40 Presentation: 144
Test 1/2014 • Statement of profit or loss
and of the comprehensive
income
• Income tax
• Accounting error
Disclosure:
• Income tax
• Prior period error
Deco Art Ltd Calculations:
• Inventory

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QUESTION 1 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

THE QUESTION CONSISTS OF TWO SEPARATE PARTS.

PART I 20 marks

IGNORE VALUE ADDED TAX (VAT).

Aluminium Ltd (Aluminium) is a manufacturing company who operates in South Africa and is listed
on the Johannesburg Stock Exchange. The company is a leading supplier of aluminium frames.

You are the financial accountant who is in the process of finalising the financial statements for the
year ended 28 February 20.19 before they were authorised for issue on the 15 April 20.19.

The following information was presented to you:

1. Aluminium frame order received

On 1 February 20.19 Aluminium entered into a contract with a customer to deliver
500 aluminium frames to the customer on 15 March 20.19. The contract requires the customer
to pay a consideration of R500 000 in advance to Aluminium on 1 February 20.19. The
customer paid the consideration and the accountant recognised the amount of R500 000
correctly as a contract liability in the statement of financial position for the year ended
28 February 20.19 in terms of IFRS 15 Revenue from Contracts with Customers.

2. Land
Aluminium acquired land in Port Elizabeth for R1 100 000 on 1 March 20.18 (which is equal to
the land’s base cost for capital gains tax (CGT) purposes). Management was planning to
construct a new factory building on this land band construction was due to start in
1 March 20.19. It is the policy of the company to subsequently measure land by using the
revaluation model in accordance with IAS 16 Property, Plant and Equipment. On
28 February 20.19 the land was revalued to R1 500 000.

3. Manufacturing plant and machinery

Manufacturing plant and machinery are accounted for in terms of the cost model according to
IAS 16 Property, Plant and Equipment and are depreciated over their useful lives on the
straight-line method after consideration of any residual value. The manufacturing plant and 10
machines were acquired on 1 June 20.15 and were made available for use on 1 July 20.15.
The manufacturing plant and the 10 machines have residual values of R500 000 and
R400 000 respectively.

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The following is the disclosure note in the draft financial statements of Aluminium with regard
to its manufacturing plant and machinery for the year ended 28 February 20.19:

Plant Machinery
R R

Carrying amount at the beginning of the year 3 800 000 3 040 000
Cost 5 000 000 4 000 000
Accumulated depreciation (1 200 000) (960 000)

Depreciation (450 000) (360 000)

Disposal - (268 000)
Carrying amount at the end of the year 3 350 000 2 412 000

After the draft financial statements for the year ended 28 February 20.19 had been prepared,
the directors of Aluminium re-estimated the residual value of manufacturing plant to be
R460 000. The residual value of the machinery and the useful life of both plant and machinery
remained unchanged. The financial accountant did not account for the change in the residual
value since he was of opinion that it will only affect the financial statements for the year ended
28 February 20.20.

One machine was disposed of on 28 February 20.19 and has been correctly accounted for.

The South African Revenue Service (SARS) grants an allowance on plant and machinery in
accordance with section 12C of the Income Tax Act on a 40:20:20:20 basis, which is not
apportioned for part of a year.

4. Security
On 1 January 20.18 Aluminium entered into a contract with Yoga Security Company for
security services. The contract fee is payable annually in advance and renews each year on
1 January. The payment on 1 January 20.19 amounted to R120 000 (1 January 20.18:
R90 000). Both these amounts have been correctly accounted for in the 20.18 and 20.19
financial years. The SARS has indicated that these security service payments will be
deductible for income tax purposes when actually incurred in accordance with section 23H of
the Income Tax Act.

5. SARS 20.18 assessment and 20.19 taxable income

The SARS assessment for 20.18 reflects an assessed tax loss of R1 810 550. During 20.18
Aluminium was of the opinion that future taxable profits will not be available against which the
unused tax loss can be utilised. The financial accountant correctly calculated the taxable
income for 20.19 at R33 844 641, before utilising the assessed loss.

6. Other information
The income tax rate is 28% and has remained unchanged for the past 10 years. The inclusion
rate for capital gains tax is 80%.

PART II 20 marks

IGNORE VAT.

You are the newly appointed financial manager of ABC Accountants. The senior partner approached
you with regard to the following outstanding matters.

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Client 1: Print-Sure Ltd

Print-Sure Ltd (Print-Sure) supplies both printing services as well as stationery supplies. The
company has a 31 December financial year end. The directors of Print-Sure services as well as
decided to change the accounting policy regarding the valuation of the company’s inventory on
31 December 20.18. The previously used weighted average cost formula, will be replaced with the
first-in-first-out cost formula, since it will result in more relevant and reliable presentation of the value
of inventory.

On 31 December the value of inventory, based on the two methods of valuation, was as follows:

20.18 20.17 20.16 20.15

R R R R

First-in-first-out cost formula 345 000 310 000 265 000 240 000
Weighted average cost formula (old) 301 000 279 000 244 000 220 000

The South African Revenue Service (SARS) will not re-open the previous years’ assessments, but
will accept the new policy in respect of the current year for tax purposes.

No adjustments have been performed to account for the above changes.

Client 2: Juice-House Ltd

Juice-House Ltd (JH) is listed on the Johannesburg Stock Exchange with a 31 December financial
year end. The company imports two types of juices, Yum-Juice and Just-Refresh and sells it to
customers in South Africa. The following information relates to the financial year ended on
31 December 20.18.

Yum-Juice
Yum-Juice is a popular brand and JH is the only company that supplies Yum-Juice to customers in
South Africa. During December 20.18, a competitor commenced with the selling of Best-Juice, a
famous juice brand imported from Italy. Best-Juice contains more vitamins and nutritional value and
soon became a public favourite. This lead to a decline in the market for Yum-Juice and on
31 December 20.18, the selling price of Yum-Juice was estimated to be R41 per litre. The selling
costs of Yum-Juice is negligible.

On 31 December 20.18 JH had 4 320 litres of Yum-Juice on hand, which was accounted for at its
cost price amounting to R43 per litre.

During the year, JH entered into contract with Cool Ltd to supply 1 500 litres of Yum-Juice at R42 per
litre on 5 March 20.19. At year end, Cool Ltd confirmed that the company is still committed to the
contract despite the decline in the market.

The financial director of JH was uncertain of the accounting of the inventory balance of Yum-Juice
for the financial year ended 31 December 20.19, and approached ABC Accountants for advice.

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REQUIRED

YOU NOW HAVE 60 MINUTES TO ANSWER THIS QUESTION

Marks

PART I

Prepare the journal entry to account for the movement in the deffered tax balance in the 20
financial records of Aluminium Ltd for the year ended 28 February 20.19.

Please note:
• Journal narrations are not required.
• The movement in temporary differences must be calculated by using the statement of
financial position method.

PART II

(a) Prepare the change in accounting policy note to the financial statements of 12
Print-Sure Ltd for the financial year ended 31 December 20.18 according to IAS 8
Accounting Policies, Changes in Accounting Estimate and Errors.

Communication skills: presentation and layout 2

Please note:
• Disclosure relating to the adjustments for basic and diluted earnings per share
are not required.

(b) Write an email, addressed to the financial director of Juice-House Ltd to discuss, 5
with reasons and supporting calculations, the correct inventory closing balance of
Yum-Juice for the year ended 31 December 20.18 according to IAS 2 Inventories.

Communication skills: logical flow and argument 1

Please note:
• Assume all amounts to be material except where stated otherwise.
• Round off all amounts to the nearest Rand.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 1 – Suggested solution

PART I

Journals for the year ended 28 February 20.19

Dr Cr
R R

Tax expense - deferred (P/L) 574 576 (17)

Tax expense - deferred (OCI) 89 600 (1½)
Deferred Tax (SFP) 664 176 (1½)
Deferred tax movement for the current financial year
Total (20)

CALCULATIONS

Deferred tax
Deferred
Temporary
tax asset
Carrying difference
Tax base at 28%
amount at 100% or
Asset/
80%
(liability)
R R R R
28 February 20.18
a
Plant 3 800 000 1 000 000 2 800 000 (784 000) [1½]
b
Machinery 3 040 000 800 000 2 240 000 (627 200) [1½]
c
Prepaid expense 75 000 - 75 000 (21 000) [1½]
Unutilised tax loss - 1 810 510 (1 810 510) 506 943 [1]
Deferred tax liability 3 304 490 (925 257)
[5½]
a
5 000 000 x 20% = 1 000 000
b
4 000 000 x 20% = 800 000
c
90 000 x 10/12 = 75 000

28 February 20.19
f d
Plant 3 344 545 - 3 344 545 (936 473) [4½]
e
Machinery 2 412 000 - 2 412 000 (675 360) [1½]
Contract liability (500 000) - (500 000) 140 000 [1½]
g
Prepaid expenses 100 000 - 100 000 (28 000) [1]
Utilised tax loss
(1 810 550 - 1 810 550) - - - - [½]
Land (at 80%) 1 500 000 1 100 000 320 000 (89 600) [1½]
Deferred tax liability 5 676 545 (1 589 433)
[10½]

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Movement in deferred tax

Total movement
(1 589 433 – 925 257) 664 176 [1]
Movement through OCI (89 600) [1]
Movement through P/L 574 576 [½]

d
1 000 000 – (5 000 000 x 20%) = 0
e
800 000 – (4 000 000 x 20%) = 0
f
(5 000 000 – 500 000)/450 000 = 10 years
(3 800 000 – 460 000)/88 (120 – 8 – 12 – 12)
x 12 = 455 455
3 800 000 – 455 455 = 3 344 545
g
120 000 x 10/12 = 100 000

PART II

(a) PRINT-SURE LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.18

1. Change in accounting policy

The company changed its accounting policy during the current financial year in respect of the
valuation of inventory from the weighted average cost formula to the first-in-first-out cost
formula.

This change was effected to ensure more relevant and reliable presentation.

The opening balance of retained earnings at the beginning of 20.17 was adjusted while the
comparative figures were restated accordingly. (2)

The effect of the change in accounting policy is as follows:

20.18 20.17 1 Jan 20.17

R R R
Decrease in cost of sales [C1] 13 000 10 000 (4)
Increase in income tax expense (3 640) (2 800) (1)
Increase in profit 9 360 7 200 (½)

Increase in inventory [C1] 44 000 31 000 21 000 (1½)

Increase in deferred tax liability - (8 680) (5 880) (1)
Increase in current tax payable (12 320) - (½)
Increase in equity 31 680 22 320 15 120 (½)
Adjustment against retained earnings on
1 January 20.17 (IAS 8.29(d)) 15 120 (1)
(12)
Communication skills: presentation and layout (2)

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CALCULATIONS

C1. Change in accounting policy (inventory)

20.18 P/L 20.17 P/L 20.16

First-in-first-out (New) 345 000 310 000 265 000 [1½]
Weighted average (Old) (301 000) (279 000) (244 000) [1½]
44 000 13 000 31 000 10 000 21 000 [2½]
Tax at 28% (12 320) (3 640) (8 680) (2 800) (5 880)
31 680 9 360 22 320 7 200 15 120
[5½]

(b) To: Financial Director (Juice-House Ltd)

From: Financial Manager
Date: 12 March 20.19
Subject: Inventory balance of Yum-Juice at 31 December 20.18

Dear Financial director

Kindly refer below with regard to the accounting of the inventory closing balance of
Yum-Juice for the year ended 31 December 20.18.

Inventory has to be valued at the lower of its cost (4 320 x R43 = R185 760) and its
net realisable value, which is the amount that Juice-House Ltd expects to obtain from
the sale of the Yum-Juice, in the ordinary course of business (IAS 2.9). (1)

Since the selling price of Yum-Juice declined to below its cost price (due to the
introduction of the Best-Juice brand in the market) the cost of the Yum-Juice inventory
will not be fully recoverable (IAS 2.28). (1)

Inventory cannot be carried in excess of the amount expected to be realised from the
sale or use thereof. Yum-Juice inventory should therefore be written down to its net
realisable value (IAS 2.28). (1)

The net realisable value of Yum-Juice will be calculated as follows:

The contract with Cool Ltd satisfies a firm sales contract and therefore the net
realisable value of 1 500 litres is based on the contract price of R42 (IAS 2.31). (1)

The remaining 2 820 (4 320 – 1 500) litres of juice will be measured by using the net
realisable value of R41 (selling costs are negligible). (2)

The net realisable value of Yum-Juice inventory will therefore be calculated as follows:
1 500 x R42 = R 63 000 (½)
2 820 x R41 = R115 620 (½)
= R178 620

Yours sincerely

Financial Manager
Total (8)
Maximum (5)
Communication skills: logical flow and argument (1)

MJM
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QUESTION 2 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

IGNORE ANY VAT IMPLICATIONS

You are the audit clerk at Uber-Accountants and need to finalise the following queries with regard to
the below three clients for the financial year ended 31 December 20.17.

Client 1: Catinho Ltd (Catinho) 19 marks

Catinho is a company operating in the manufacturing and maintenance industry. Catinho is listed on
the Johannesburg Stock Exchange and has a 31 December 20.17 financial year end.

You are the financial accountant of Catinho and the financial manager presented you with an extract
of the preliminary statement of profit or loss and other comprehensive income for the financial year
ended 31 December 20.17.

CATINHO LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR
ENDED 31 DECEMBER 20.17

20.17
R

Revenue 9 180 000

Cost of sales (2 570 400)
Gross profit 6 609 600
Other income 312 500
Operating expenses (3 178 000)
Finance cost (312 900)
Profit before tax 3 431 200
Income tax expense ???
PROFIT FOR THE YEAR ???

Additional information

1. Included in other income is a dividend received from a South African company amounting to
R62 500. This dividend is exempt from normal tax in terms of section 10(1)(k) of the Income
Tax Act.

2. Catinho acquired land for future development at a purchase price of R1 700 000 on
31 March 20.16 (which is equal to the land's base cost for capital gains tax purposes). During
the current financial year Cathino sold the land for R1 870 000. Land is measured according to
the cost model in terms of IAS 16 Property, Plant and Equipment. The accounting profit on the
sale of land amounting to R170 000 is included in other income. The South African Revenue
Services (SARS) confirmed that the sale of land will be subject to capital gains tax.

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3. Catinho received foreign income amounting to R70 000 (after deduction of R10 000 foreign
tax). This amount is included in other income and is not subject to income tax in South Africa.

4. Included in operating expenses is depreciation on plant and equipment amounting to

R876 000. The tax allowance on the plant and equipment amounted to R900 000. The carrying
amount of the plant and equipment on 31 December 20.17 amounted to R3 168 000 while the
tax base was R2 500 000.

5. The SARS issued an additional 20.15 assessment on 15 August 20.17 to include an additional
amount of R15 000 payable (which includes interest amounting to R4 500) which relates to an
expense which Cathino claimed during the tax year ending 31 December 20.15 and was not
allowed as a deduction by SARS. The amount payable in terms of the additional assessment
was not recorded in the financial statements for the year ended 31 December 20.17.

6. There are no temporary differences other than those that are apparent from the information in
the question.

7. The only non-taxable and non-deductible items included in the accounting profit or loss are
those that are apparent from the information provided.

8. The normal income tax rate is 28% and the capital gains tax inclusion rate is 80%.

9. You may assume that all amounts are material.

Client 2: D’Lux Ltd (D’Lux) 10 marks

D’Lux is one of the largest paint manufacturers in South Africa. The company has a 31 December
financial year end and is listed on the Johannesburg Stock Exchange.

The previous year’s financial statements indicated a closing balance for raw materials of R4 200 000
(carried at cost) and for finished products of R5 251 000 (carried at cost). There are no work-in-
progress at financial year end.

A normal spillage, amounting to R0,25 per litre of paint produced, occurs with the packaging of the
paint.

Other information relating to the year ended 31 December 20.17:

Raw material purchases for the current financial year (before any discount) 5 766 134
D’Lux received a 3% discount on the above purchases for settling their accounts in time.

Delivery cost: 350 000

• Raw materials received 230 000
• Finished products delivered to customers 120 000

Depreciation 900 000

• Property, plant and equipment: Manufacturing 750 000
• Property, plant and equipment: Other 150 000

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Normal capacity: 600 000 litres of paint per annum

Actual production: 450 000 litres for the current financial year
Other variable cost R3,5 per litre
Actual spillage at the end of the production process R0,30 per litre

The inventory count at the financial year end indicated the following:
• R700 000 worth of raw materials were identified as substandard and will be sold at R175 000;
• the closing balance for raw materials amounted to R6 498 150; and
• 40% of the finished products manufactured in the current financial year were the only finished
products on hand at the financial year end.

Client 3: Manyonga Ltd (Manyonga) 11 marks

The financial manager, Mr Samaai, prepared the statement of financial position of Manyonga as at
31 December 20.17 and sent you a copy for a final review. You have assisted Mr Samaai with the
previous year's financial statements and he awaits your feedback to finalise the financial statements
for the year ended 31 December 20.17 before he sends it to the chief financial officer for approval.
Mr Samaai provided you with notes regarding the matters that he is unsure of.

MANYONGA LTD

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.17

Notes 20.17
R’000
ASSETS
Non-current assets
Property,plant and equipment 37 500
Intangible assets 3 500
Inventories 1 5 200
46 200
Current assets
Inventories 20 200
Trade receivables 20 500
Other current assets 500
Cash and cash equivalents 3 500
44 700
Total assets 90 000

EQUITY AND LIABILITIES

Equity attributable to the owners of the parents
Share capital 15 200
Retained earnings 30 000
Other components of equity 1 500
Total equity 46 700

Non-current liabilities
Long-term borrowings 2 24 600
Total non-current liabilities 24 600

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Notes 20.17
R’000
Current liabilities
Trade and other liabilities 2 300
Allowance for credit losses 3 1 500
Short-term borrowings 4 2 500
Current tax payable 10 500
Deferred tax 2 800
Total current liabilities 19 600
Total liabilities 44 200
Total equity and liabilities 90 900

Notes

1. Manyonga has various types of inventory with different operating cycles. Manyonga acquired
Inventory A amounting to R5 200 000 on 1 December 20.17. Inventory A has to undergo
various processes before it will be ready to sell to a customer. Manyonga intends to sell the
Inventory A in February 20.19. The normal operating cycle of this type of inventory is
16 months.

2. Long-term borrowings of R24 600 000 represent a loan from Africa Bank. The interest rate
charged by Africa Bank is market related. The loan is repayable over 10 years. The loan
instalments of R4 500 000 each are payable on 31 December of each year. The instalment on
31 December 20.18 consisted of R1 860 000 interest and a capital re-payment of R2 640 000.

3. Manyonga uses the simplified approach in accordance with IFRS 9 Financial Instruments
when determining the expected credit losses for trade receivables. The R1 500 000 allowance
for credit losses is the lifetime expected credit losses of the trade receivables.

4. On 1 April 20.17 Manyonga obtained a short-term loan from Smart Bank amounting to
R2 500 000. The loan and interest is repayable on 31 March 20.18, however the terms of the
agreement stipulate that Manyonga has the discretion to extend the loan's due date to
31 December 20.19 at an additional fee of R50 000. The applicable interest rate for the
extended period will be renegotiated. Mr Samaai indicated that the chief financial officer has
instructed him to start with the negotiation of the new interest rate for the extended loan period
with Smart Bank since Manyonga intends to extend the loan.

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REQUIRED

YOU NOW HAVE 60 MINUTES TO ANSWER THIS QUESTION

Marks

(a) Prepare the income tax note to the financial statements of Cathino Ltd for the year 18
ended 31 December 20.17 as required by IAS 12.79, 80 and 81(c)(i) Income Taxes
(refer to Client 1).

Please note:
• Comparative figures are not required.
• The movement in temporary differences in the current tax calculation has to be
calculated by using the statement of financial position method.

Communication skills: presentation and layout 1

(b) Disclose the inventory in the inventory note to the financial statements of D’Lux Ltd 9
for the year ended 31 December 20.17 (refer to Client 2).

Please note:
• Comparative figures are not required.
• Narrative information is not required.

Communication skills: presentation and layout 1

(c) Discuss the presentation and classification issues in terms of IAS 1 Presentation of 10
Financial Statements relating to the statement of financial position of Manyonga Ltd
as at 31 December 20.17 (refer to Client 3).

Please note:
• Your feedback should include any incorrect presentation and classification and
the suggested corrections of the errors noted.
• Your answer should include calculations.

Communication skills: logical argument 1

Please note:

• Round off all amounts to the nearest Rand.

• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 2 - Suggested solution

(a) CATINHO LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.17

11. Income tax expense

Major components of tax expenses

R
SA normal tax
Current tax 917 896
- Current year 907 396 (7)
- Under provision for prior years (15 000 - 4 500) 10 500 (1)
Deferred tax
- Movement in temporary differences 6 720 (4)
924 616
Foreign Tax 10 000 (1)
934 616
Tax rate reconciliation
Accounting profit 3 436 700 (½)
Taxation at 28% 962 276 (½)
Tax effect of non-deductible/non-taxable items:
- Dividends received (62 500 x 28%) (17 500) (½)
- Interest paid not deductible (R4 500 x 28%) 1 260 (½)
- Accounting profit on land not taxable (170 000 x 20% x 28%) (9 520) (1)
Difference in tax rate on foreign income (10 000 - (80 000 x 28%)) (12 400) (1)
Under provision of current tax relating to prior periods (15 000 - 4 500) 10 500 (1)
934 616
Total (18)
Communication skills: presentation and layout (1)

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CALCULATIONS

C1. Deferred tax

Deferred
Temporary
tax
Carrying Tax difference
28%
amount base at 100% or
asset/
80%
(liability)

31 December 20.16
Land 1 700 000 1 700 000 - - [1]
Plant (3 168 000 + 876 000)
(2 500 000 + 900 000) 4 044 000 3 400 000 644 000 (180 320) [1]
644 000 (180 320)
31 December 20.17
Land - - - -
Plant 3 168 000 2 500 000 668 000 (187 040) [1]
Movement in temporary differences
through P/L (668 000 - 644 000) 24 000 (6 720) [1]

C2. Profit before tax adjusted

Profit before tax 3 431 200 [½]

Foreign tax 10 000 [½]
Interest payable to SARS (4 500) [1]
3 436 700

C3. Current tax calculation

Profit before tax [C1] 3 436 700 [2]

Non-taxable/Non-deductible items:
- Dividends received not taxable (62 500) [½]
- Interest paid not deductible 4 500 [½]
- Accounting profit on land not taxable (170 000 x 20%) (34 000) [1]
- Foreign income (70 000 + 10 000) (80 000) [1]
Movement in temporary differences (24 000) [½]
Taxable profit before tax loss 3 240 700 [1]
Tax at 28% 907 396 [½]
[7]

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(b) D’LUX LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.17

5. Inventory

20.17
R

Raw materials [given] 6 498 150 (½)

Finished products [C1] 2 046 000 (8½)
8 544 150
Total (9)
Communication skills: presentation and layout (1)

CALCULATIONS

C1. Finished products

Raw Work-in- Finished

materials process products

Opening balance 4 200 000 - 5 251 000 (1)

Transferred from 3 000 000 5 115 000
Purchases 5 766 134 (½)
Less: Discount at 3% (172 984) (½)
Delivery costs (R350 000 – R120 000) 230 000 (½)
Depreciation
(450’L/600’L x (R900 000 – R150 000)) 562 500 (1½)
Abnormal spillage
(450 000L x (R0,30 - R0,25)) (22 500) (1½)
Write-down to nett realisable value
(R700 000 – R175 000) (525 000) (1)
Variable cost (450 000L x R3,5) 1 575 000 (1)
Closing balance
(Given) (6 498 150) (½)
(R5 115 000 x 40%) (2 046 000) (½)
Transferred to 3 000 000 5 115 000 8 320 000

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(c) Manyonga Ltd

Comparative information
According to IAS 1.38 an entity shall present comparative information in respect of the
preceding period for all amounts reported in the current period's financial statements.

IAS 1.38A stipulates that a minimum of two statements of financial position shall be
presented.

Manyonga Ltd needs to present comparative information in respect of the preceding

financial period ended 31 December 2016, this will also ensure there is a minimum of
two statements of financial position presented. (2)

Casting error
The total assets should equal the total equity and liabilities in the statement of financial
position. There is a casting error and the total assets should be R90 900 000. (1)

Inventory
In terms of IAS 1.66(a) an entity shall classify an asset as current when it expects to
realise/sell the asset in its normal operating cycle.

According to IAS 1.68 an operating cycle of an entity is the time between the
acquisition of assets for processing and their realisation in cash.

The normal operating cycle of Inventory A is 16 months. The inventory was acquired
on 1 December 20.17 and Manyonga intends to sell the inventory in February 20.19.
The period between the acquisition and the realisation of the inventory into cash is
within the normal operating cycle of this type of inventory. (2)

Therefore, the R5 200 000 must be classified as current assets. (1)

Long-term borrowings
IAS 1.61 stipulates that an entity shall disclose the amount expected to be settled after
more than twelve months for each liability line item that combines amounts expected
to be settled no more than twelve months after reporting period and more than twelve
months after reporting period.

Therefore the amount that is included in the R24 600 000 long-term borrowings that
will be settled on or before 31 December 20.18 must be shown as the current portion
of long-term borrowing and classified as current liabilities. (1)

The capital re-payment amount of R2 640 000 must be disclosed as current liabilities
and the amount of R21 960 000 (R24 600 000 – R2 640 000) as non-current liabilities. (1)

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Offsetting
In terms of IAS 1.32 and .33 an entity shall not offset assets and liabilities and should
report both assets and liabilities separately.

According to IAS 1.33 measuring assets net of valuation allowance is not offsetting.

Therefore, the classification of the allowance for credit losses under current liabilities is
not correct and should be offset against the trade receivables of R20 500 000. (1)

The final trade receivables presented in the statement of financial position should be
R19 000 000 (R20 500 000 – R1 500 000). (1)

Short-term borrowings
In terms of IAS 1.73 if an entity expects and has the discretion to roll over an
obligation for at least 12 months after the reporting period under an existing loan
facility, it classifies the obligation as non-current even if it would otherwise be due
within a shorter period.

According to the terms of the loan agreement Manyonga Ltd has the discretion to roll
over the loan from Smart Bank and Manyonga Ltd expects that the entity will roll over
the loan as they already started negotiating with Smart Bank. (1)

The loan of R2 500 000 should be classified as non-current liabilities since the rollover
of the loan to 31 December 20.19 is more than 12 months after the reporting period of
31 December 20.17. (1)

Deferred tax
According to IAS 1.56 when an entity presents current and non-current liabilities as
separate classifications in its statement of financial position, deferred tax liabilities
shall not be classified as current liabilities.

Therefore, the deferred tax balance of R2 800 000 is incorrectly classified as current
liabilities and should be classified as part of non-current liabilities. (1)
Total (13)
Maximum (10)
Communication skills: logical argument (1)

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QUESTION 3 34 marks

YOU HAVE 13 MINUTES TO READ THIS QUESTION

THIS QUESTION CONSISTS OF TWO SEPARATE PARTS THAT ARE NOT RELATED TO EACH
OTHER.

PART I

Burger Queen Ltd (Burger Queen) is a company that conducts business in the restaurant industry
and is listed on the JSE Limited. The company has a 30 June financial year end.

You are the newly recruited financial accountant and the financial manager has assigned you the
responsibility of preparing the annual financial statements of Burger Queen for the year ended
30 June 20.16. The financial manager provided you with the following information:

Notes

1. Land

Burger Queen purchased land on 1 July 20.15 at a cost of R3 906 000 for the future
development of a new restaurant. The base cost of the land in terms of Paragraph 20 of the
Eighth Schedule of the Income Tax Act is equal to the purchase price of the land. It is the
policy of the company to subsequently measure land by using the cost model in accordance
with IAS 16 Property, Plant and Equipment. However, residents in the vicinity objected to the
construction of a Burger Queen restaurant in their neighbourhood. This resulted in the board of
directors agreeing to sell the land. The land was sold on 15 March 20.16 at an accounting loss
of R360 000. The South African Revenue Service (SARS) has confirmed that the sale of the
land will be subject to capital gains tax (CGT) despite the fact that the land was purchased and
sold in the same financial year.

2. Fleet of delivery vehicles

During the 20.14 financial year the executive management of Burger Queen saw an
opportunity in the food delivery market, which lead Burger Queen to purchase a fleet of 11
delivery vehicles on 1 July 20.15 at a cost of R159 000 each. Each delivery vehicle in the fleet
has a residual value of R44 500. It is the accounting policy of the company to subsequently
measure delivery vehicles by using the cost model in accordance with IAS 16 Property, Plant
and Equipment.

The fleet of delivery vehicles is depreciated over five years by using the straight-line method.
In terms of the Interpretation Note No. 47 of the Income Tax Act, the SARS grants a section
11(e) wear-and-tear allowance on the cost less residual value of the vehicles over four years,
which is apportioned for part of a year.

3. Prepaid fleet vehicle insurance premiums

The monthly vehicle fleet insurance premium is R9 900 per month. Burger Queen paid seven
months insurance in advance on 31 May 20.16. In accordance with section 23H of the Income
Tax Act, the SARS allowed the prepaid insurance premiums as a tax deduction in the 20.16
financial year.

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4. Trade receivables

Trade receivables amounted to R350 000 and the allowance account for credit losses
amounted to R180 500 on 30 June 20.16. The movement in the allowance account is included
in other operating expenses. In accordance with section 11(j) of the Income Tax Act, the SARS
allows 25% of the loss allowance on the trade receivables account as a deduction for income
tax purposes.

5. Tax

A deferred tax liability amounting to R187 917 was recognised in the financial statements for
the year ended 30 June 20.15.

No provision has been made for the current and deferred tax relating to the financial year
ended 30 June 20.16.

An extract of the income tax payable to the SARS in the general ledger for the financial years
ended 30 June 20.15 and 30 June 20.16 were as follows:

Income tax payable

31 Dec 20.14 Provisional payment 700 000 01 Jul 20.14 Opening balance -
30 Jun 20.14 Provisional payment 776 182 30 Jun 20.14 Income tax provision
for 20.15 1 476 182
1 476 182 1 476 182
31 Dec 20.14 Final payment: 01 Jul 20.15 Opening balance -
20.15 assessment 122 018

6. Profit before tax

Profit before tax for the year ended 30 June 20.16 amounted to R13 620 000.

The following items have been included in profit before tax:

6.1 Dividend income received of R96 000, these dividends are not taxable.

6.2 On 16 January 20.16 the Competition Commission fined Burger Queen for food price
fixing. The penalty imposed on Burger Queen by the Competition Commission amounted
to R900 000. The penalty was immediately payable by Burger Queen. This penalty is not
deductible for tax purposes.

6.3 Research and development costs of R65 600 were incurred in order to develop rounder
burger patties in the financial year ended 20.16. The research and development costs
have been correctly expensed in the accounting records. In accordance with section 11D
of the Income Tax Act, the SARS allows a deduction of 150% of the full expense
incurred, in the year that the expense was incurred.

6.4 Burger Queen received R1 500 000 revenue from a franchisee in Bulgaria for the year
ended 30 June 20.16. The amount was subject to foreign tax of 10%, and is therefore not
taxable in South Africa. The foreign tax will only be paid during the 20.17 financial year.

6.5 Burger Queen received royalties amounting to R3 000 000 from a franchisee in
South Africa on 1 June 20.16. Burger Queen will recognise the royalty income during the
30 June 20.17 financial year when the performance obligation has been satisfied.

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Additional information

1. All the above information was correctly accounted for in the financial statements of
Burger Queen, except where it has been indicated otherwise.

2. There were no non-taxable or non-deductible items included in the accounting profit for the
financial years ended 30 June 20.15 and 30 June 20.16, except for those that are apparent
from the information provided.

3. Management is of the opinion that future capital gains are probable, against which any unused
capital losses can be utilised.

4. Assume a normal income tax rate of 28% and a CGT inclusion rate of 80%.

PART II

You are the audit manager on the audit of Pesticide Ltd (Pesticide), an entity listed on the
JSE Limited. The accountant prepared and presented all the notes relating to the inventory of
Pesticide for the financial year ended 28 February 20.17 to you. The entity elected to present its
financial statements by function.

PESTICIDE LTD

NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.17

1. Accounting policy

Inventory

Inventories comprising finished goods are valued at the lower of cost and net realisable value.
The cost is calculated using the weighted average cost formula. Write-downs to the net
realisable value and inventory losses are recognised in the profit or loss in the reporting period
in which the write-downs or losses occur.

13. Inventory
20.17 20.16
R R

Closing balance of inventories 21 395 000 19 060 000

Inventories held at net realisable value amounted to R1 035 000 (20.16: R1 250 000).

The above notes are the only notes regarding the inventory that the accountant has prepared.
You noted that, according to IAS 2 Inventories, the disclosure was incomplete and referred to
the working papers for additional information relating to Pesticide’s inventory:

20.17 20.16
R R
Inventories
Raw materials and consumables 5 330 000 4 560 000
Work in progress 12 345 000 11 650 000
Finished products 3 720 000 2 850 000
21 395 000 19 060 000

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Finished product Insecto became obsolete towards the end of the 20.17 financial year. The
South African market initially favoured its predecessor GreenBug. GreenBug became obsolete
in 20.16 after the release of Insecto, which was more effective. R1 885 000 was expensed in
the year ended 29 February 20.16 to write GreenBug off to its net realisable value amounting
to R1 250 000. GreenBug was the only inventory carried at its net realisable value for the
financial year ended 29 February 20.16.

In 20.17 research indicated that GreenBug contains less hazardous elements than Insecto. A
media release based on the recent research listed the toxicity levels of the products on the
market. The market reacted accordingly and the products containing the more hazardous
elements became the least in demand. Consequently the South African demand for GreenBug
increased towards the end of the 20.17 financial year and the write-down to its net realisable
value in the 20.16 financial year was reversed in the 20.17 financial year.

The media release caught Pesticide by surprise. The company had a high volume of Insecto
finished products on hand at the 20.17 financial year end. There were no raw materials or
work-in-progress for this product on hand at the end of the 20.17 financial year.

Pesticide estimated the net realisable value of Insecto for the 20.17 financial year at
R3 100 000, which is a decrease of R518 000 in the inventory’s previous carrying amount. The
estimate was based on a similar product from PestGo Ltd (PestGo), a competitor of Pesticide.
PestGo performed market research to determine the effect that the media release had on their
product. PestGo’s product contains less hazardous elements than Insecto. Pesticide adjusted
the estimate that PestGo used to value its inventory to their net realisable value, with a 5%
increase. Management was of the opinion that a lower estimate will unnecessarily result in a
weaker impression of the entity’s asset value.

Due to the losses incurred relating to the Insecto product, Pesticide had to obtain additional
funding to manufacture additional GreenBug products and also develop an enhanced
GreenBugPro, which will be more effective than its predecessor. Pesticide had to pledge
inventory amounting to R1 850 000 as security for the loan they obtained from Secure Bank at
the end of the 20.17 financial year.

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REQUIRED

YOU NOW HAVE 51 MINUTES TO ANSWER THIS QUESTION

Marks

PART I

(a) Prepare all the journal entries with regards to current and deferred taxation for 21
Burger Queen Ltd for the year ended 30 June 20.16 in terms of IAS 12
Income Taxes.

Please note:
• Journal narrations are not required.
3
(b) Prepare the deferred tax note to the financial statements of Burger Queen Ltd for the
year ended 30 June 20.16.
1
Communication skills: presentation and layout

Please note:
• Comparative figures are not required.

Please note:

• Round off all amounts to the nearest Rand.

• The movement in temporary differences in the current tax calculation must be
calculated using the statement of financial position method.
• Ignore any Value Added Taxation (VAT) implications.
• Your answer must comply with the International Financial Reporting Standards
(IFRS).

MJM
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Marks

PART II

Correctly disclose the inventory to the notes of the financial statements of Pesticide Ltd for 8
the year ended 28 February 20.17, by assuming that:

• The cost of inventories recognised as an expense and included in cost of sales

amounted to R15 945 000 (2016: R13 775 000).
• To correct the write down to the net realisable value for the 20.17 financial year, the
net realisable value of the product Insecto was decreased with R1 050 000 on the
financial reporting date ended 28 February 20.17.

Please note:
• The accounting policy note is not required.

Communication skills: presentation and layout 1

Please note:

• Ignore any Value Added Tax implications.

• Ignore any Income Tax implications.
• Your answer must comply with the International Financial Reporting Standards
(IFRS).

MJM
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QUESTION 3 - Suggested solution

PART I

(a) JOURNAL ENTRIES

Dr Cr
R R

J1 Income tax expense (current tax) (P/L) [C2] 4 023 911 (16½)
Other payables: SARS (SFP) [C2] 4 023 911 (½)
Recognition of the current tax provision
J2 Deferred tax (SFP) [C1] 1 112 197 (1)
Income tax expense (deferred tax) (P/L) [C1] 1 112 197 (½)
Recognition of a deferred tax asset
J3 Income tax expense (foreign tax) (P/L) 150 000 (1½)
Other payables: Foreign tax authority (SFP) 150 000 (1)
Recognition of foreign tax provision
(1 500 000 x 10%)
Total (21)

(b) BURGER QUEEN LTD

NOTES FOR THE YEAR ENDED 30 JUNE 2016

10. Deferred tax

20.16
R
Analysis of temporary differences:
Property, plant and equipment
- Accelerated deductions for tax purposes [C1] (17 633) (1)
Allowance for credit losses [C1] 37 905 (½)
Prepaid expenses [C1] (16 632) (½)
Contract liability [C1] 840 000 (½)
Unused capital loss for capital gains tax [C1] 80 640 (½)
Net deferred tax asset 924 280
Total (3)
Communication skills: presentation and layout (1)

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CALCULATIONS

C1. Deferred tax

Deferred
Temporary
tax
Carrying Tax base difference
asset/
amount at 100% or
(liability)
80%
28%

30 June 20.15
Opening balance (given) 671 132 (187 917) [½]
Deferred tax liability 671 132 (187 917)

30 June 20.16
(a) (b)
Vehicles 1 497 100 1 434 125 62 975 (17 633) [2½]
Trade receivables 169 500 304 875 (135 375) 37 905
Gross amount 350 000 350 000 - - [½]
(c)
Allowance for credit losses (180 500) (45 125) (135 375) 37 905 [1½]
Contract liability (3 000 000) - (3 000 000) 840 000 [1]
Prepaid expenses
(9 900 x 6) 59 400 - 59 400 (16 632) [1]
(3 013 000) 843 640
Unused capital loss (sale of
land) (360 000 x 80%) - 360 000 (288 000) 80 640 [1½]
Net deferred tax asset (3 301 000) 924 280

Movement in temporary differences (excluding unused

capital loss) (deductible) (3 013 000 + 671 132) (3 684 132) 1 031 557 [1]
Movement in unused capital loss (deductible)
((288 000) - 0) (288 000) 80 640 [½]
Total movement in temporary differences (3 972 132) 1 112 197
[10]
(a)
Cost at 30 June 20.16 (159 000 x 11) 1 749 000
Depreciation at 30 June 20.16 ([159 000 – 44 500] x 11) / 5 (251 900)
Carrying amount at 30 June 20.16 1 497 100

(b)
Cost at 30 June 20.16 (159 000 x 11) 1 749 000
Wear-and-tear allowance at 30 June 20.16
([159 000 – 44 500] x 11) / 4 (314 875)
Tax base at 30 June 20.16 1 434 125

(c)
180 500 (given) x 25% (section 11(j)) = 45 125

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C2. Current tax

Profit before tax 13 620 000 [½]

Income received in advance (3 000 000) [½]
Adjusted profit before tax 10 620 000
Additional tax deduction:
Research and development costs (65 600 x 50%) (32 800) [1]
Non-taxable/non-deductible items:
Revenue not taxable in South Africa (1 500 000) [½]
Dividends received not taxable (96 000) [½]
Penalty not deductible 900 000 [½]
Capital loss not deductible (360 000 x 20%) 72 000 [1]
Taxable profit before temporary differences 9 963 200
Movement in temporary differences (deductible) [C1] 3 684 132 [7½]
Movement in unused capital loss (deductible) [C1] 288 000 [2½]
Taxable profit 13 935 332

Income tax expense (current tax) (13 935 332 x 28%) 3 901 893 [1]
Current tax: under provision for prior year 122 018 [½]
Total current tax 4 023 911
[16]

PART II

Inventory note

PESTICIDE LTD

NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.17

13. Inventory

20.17 20.16
R R (½)
Inventories
Raw materials and consumables 5 330 000 4 560 000 (½)
Work in progress 12 345 000 11 650 000 (½)
Finished products (3 720 000 – 1 050 000) 2 670 000 2 850 000 (1)
20 345 000 19 060 000 (½)

The cost of inventories recognised as an expense and included in cost of sales amounted to
R15 945 000 (20.16: R13 775 000). (½)

Inventories held at net realisable value amounted to R2 050 000 a (20.16: R1 250 000). The
write-down of inventories amounted to R1 568 000b (20.16: R1 885 000). Inventories that were
written off to their net realisable value in the previous financial year were reintroduced to the
marked in 20.17 due to the health benefits of the product being superior to that of its
contending product. Therefore the write-down of the inventories in the 20.16 financial year
amounting to R1 885 000 was reversed in the current financial year. (3½)

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The net realisable value was determined by estimating the selling value at which the entity will
realise the inventory in the ordinary course of business, excluding the estimated costs of
completion and cost necessary to make the sale. The estimate was based on assumptions
made from information obtained from competitor prices, which had to be adjusted for the
differences in the products. These selling prices are volatile and determined by marked
conditions. (½)

Inventories amounting to R1 850 000 were pledged as security for a loan with Secure Bank
(refer note 23). (½)
Total (8)
Communication skills: presentation and layout (1)
a
R3 100 000 – R1 050 000 = R2 050 000
b
R518 000 + R1 050 000 = R1 568 000

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QUESTION 4 38 marks

YOU HAVE 14 MINUTES TO READ THIS QUESTION

THIS QUESTION CONSISTS OF TWO SEPARATE PARTS THAT ARE NOT RELATED TO EACH
OTHER.

PART A

Avicenna Ltd (Avicenna), a company that manufactures essential oils, is listed on the JSE Limited.
The company is named after an Arabian alchemist and physician known as Avicenna, who lived 980
- 1037 AD and the first person to perfect steam distillation.

The financial manager prepared the following draft trial balance for the year ended
29 February 20.16:

Dr Cr
Notes R R

Property, plant and equipment 1 8 168 750

Goodwill 2 800 000
Inventory 1 805 000
Trade and other receivables 2 240 000
Cash and cash equivalents 2 925 295
Share capital 9 500 000
Retained earnings (1 March 20.15) 3 783 795
Revaluation surplus 700 000
Profit before tax 3 500 250
Foreign tax expense 3 135 000
Dividends paid 4 600 000
Deferred tax (1 March 20.15 – at 28%) 5 140 000
Short-term liabilities 6 2 050 000
16 674 045 16 674 045

Notes

1. Owned property, plant and equipment

Avicenna measures all property, plant and equipment according to the cost model (except land
which is measured according to the revaluation model). All depreciable assets are depreciated
according to the straight-line method over their useful lives. The South African Revenue
Services (SARS) allows the following deductions:

• Manufacturing buildings: According to section 13(1)(b) an 5% annual allowance is

granted on this building and any improvements thereto, not apportioned for a part of the
year.
• Manufacturing plant: According to section 12C an annual allowance is granted over four
years at the following rates 40%:20%:20%:20%, not apportioned for a part of the year.

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An analysis of assets is as follows:

Cost/
Accumulative Carrying
Notes Revalued
depreciation amount
amount
R R R

Land (Property B) (a) 2 500 000 - 2 500 000

Manufacturing:
- Building (b) 2 350 000 431 250 1 918 750
- Plant (c) 7 500 000 3 750 000 3 750 000
Balance at 29 February 20.16 12 350 000 4 181 250 8 168 750

(a) Land: Avicenna sold land (Property A) during the current financial year ended
29 February 20.16 at a loss of R75 000 which is also a capital loss for tax purposes. No
revaluation has been performed on Property A since its acquisition.
Property B (land), which was acquired for R1 800 000, was revalued for the first time to
its fair value on 29 February 20.16. The revaluation surplus before taxation amounted to
R700 000. The deferred tax relating to the revaluation surplus amounted to R156 800.
The property is situated in a fast expanding industrial park of which the property value is
expected to escalate in future years. Future capital gains on Property B are therefore
probable.
(b) Manufacturing building: Construction of the original manufacturing building commenced
in November 20.7 and the building was occupied by Avicenna on 1 September 20.8. On
1 December 20.14 the company capitalised improvements amounting to R750 000 to the
manufacturing building. These improvements qualify for a tax deduction under
section 13(1)(b). The manufacturing building and any improvements thereto are
depreciated over 30 years on a straight-line basis.
(c) Manufacturing plant: Avicenna elected to depreciate the plant according to the SARS’ tax
deductions rates specified for wear and tear allowances, since it reflects the manner in
which the plant’s future economic benefits are expected to be consumed by Avicenna.
There were no other movements in the carrying amount of the manufacturing plant, other
than the depreciation which has been correctly provided for in the accounting records.

2. Goodwill

Goodwill arose on the acquisition of the assets and liabilities of two businesses on
1 March 20.13. One of the businesses was not as profitable as initially expected, hence an
impairment loss on goodwill of R125 000 was recognised in terms of IAS 36 Impairment of
assets in the financial statements of Avicenna for the 20.16 financial year. The SARS does not
allow any tax deductions on an impairment loss recognised on goodwill.

3. Profit before tax

Profit before tax includes the following:

(a) Profit of a foreign branch of Avicenna amounting to R750 000, which is not taxable in
South Africa. Tax amounting to R135 000 was paid on this profit to the taxation
authorities in the foreign country during the financial year ended 29 February 20.16.
(b) Dividends received from local companies amounting to R85 000.

The tax expense for the financial year ended 29 February 20.16 has not yet been calculated or
provided for.

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4. Dividends paid

Avicenna declared a dividend amounting to R600 000 on 31 August 20.15. All shareholders
are South African companies; hence no dividends tax was withheld.

5. Deferred tax

On 1 March 20.15 the taxable temporary differences amounted to R500 000. This included an
assessed tax loss of R950 000. You may assume that the deferred tax calculation for the
financial year ended 28 February 20.15 was calculated correctly and that future taxable profits
were probable on that date.

6. Liabilities

On 29 February 20.16 the liabilities of Avicenna consisted of the following:

Notes Short-
term
R

Trade payables 1 300 000

Other payables (a) 750 000
2 050 000

(a) Included in other payables is a leave pay accrual of R72 000. The SARS only allows a
tax deduction when the leave is actually paid to employees.

Additional information

• A tax rate of 28% applies for both the years ended 29 February 20.16 and 28 February 20.15.
The inclusion rate for capital gains tax is 80% and VAT is charged at 15%.
• You may assume that all items have been correctly accounted for in the draft trial balance,
unless the information indicates otherwise. The only non-taxable or non-deductible items
included in profit or loss are those items that are apparent in the question.
• You may assume that all amounts are material.

PART B

Mr CFO is the chief financial officer of Company Ltd. Not only does Mr CFO direct financial
operations, he also creates company policies and financial goals to ensure profitability and continued
growth.

Mr CFO approached you for advice regarding the correct accounting treatment of the following items
which are material to Company Ltd’s financial statements for the year ended
29 February 20.16:

(a) In order to simplify their deferred tax calculation, Mr CFO decided to change the depreciation
method of Company Ltd’s manufacturing buildings to be in line with the wear and tear
allowances granted by the SARS.

There is no indication of any change to the initial estimation of the periodic use of the buildings,
therefore the initial depreciation method remains to provide relevant information and faithfully
represents the utilisation of this asset.

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(b) Prior to the financial year 20.16 the accountant of Company Ltd did not include the
depreciation of machinery used in the production process to the cost of inventory. Mr CFO
indicated that the exclusion thereof did not faithfully represent the inventory cost incurred from
the beginning of the 20.16 financial year, the fixed overhead cost includes the depreciation of
machinery that is used in the production process.

Mr CFO, is uncertain of the recognition of the above items. In his request for your assistance he was
of opinion that both the above items ((a) and (b)) should be accounted for as a change in accounting
policy and quoted IAS 8.35 in support of his argument. IAS 8.35 reads as follows:

“A change in the measurement basis applied is a change in an accounting policy, and is not a
change in an accounting estimate. When it is difficult to distinguish a change in accounting policy
from a change in an accounting estimate, the change is treated as a change in an accounting
estimate.”

MJM
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REQUIRED

YOU NOW HAVE 57 MINUTES TO ANSWER THIS QUESTION

Marks
PART A

(a) Calculate the following for Avicenna Ltd for the financial year ended
29 February 20.16:

(i) The deferred tax movements in: 13

• Profit or loss
• Other comprehensive income
• Unused capital loss
• Unused tax loss
(ii) The current tax. 6

Please note:
• The movement in temporary differences in the current tax calculation has to be
calculated by using the statement of financial position method.

(b) Prepare the income tax expense note to the financial statements of Avicenna Ltd for 7
the financial year ended 29 February 20.16.

Please note:
• Reference adequately to your calculations in (a).
• The tax expense reconciliation should be done in accordance with
IAS 12.81(c)(i).

Communication skills: presentation and layout 1

PART B

Write a memorandum, addressed to Mr CFO, to advise him on the correct accounting 10

treatment in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors of the two items in question for the year ended 29 February 20.16.

Please note:
• Ignore disclosure requirements.
• Ignore taxation.

Communication skills: logical argument 1

Please note:

• Comparative figures are not required.

• Your answer must comply with International Financial Reporting Standards (IFRS).

MJM
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QUESTION 4 - Suggested solution

(a) AVICENNA LTD

(i) Deferred tax movements

Carrying Temporary Deferred
amount Tax base differences taxation
Asset/
100%/80% (Liability)
R R R R

20.15
Temporary differences
1 March 20.15 (given) 500 000 (140 000) (½)
Unused tax loss (added
back) 950 000 950 000 (266 000)
1 450 000 (406 000)
Unused tax loss 950 000 (950 000) 266 000
Net deferred tax liability 500 000 (140 000)

20.16
Land
- Cost 1 800 000 1 800 000 - - (1)
- Revaluation 700 0001 - 560 000 (156 800) (1½)
Manufacturing building 1 918 750 1 635 000 283 750 (79 450) (½)
- Cost 960 0002 (1)
- Improvements 675 0003 (1)
Manufacturing plant
- Owned 3 750 000 3 750 000 - -
Leave pay (72 000 ) - (72 000) 20 160 (1)
771 750 (216 090)
Unused Capital loss 75 000 (60 000) 16 800 (1)
Net deferred tax liability 711 750 (199 290)

Movement (P/L) (1 238 250) 346 710 (½)

- 20.16 temporary differences before capital loss 771 750 (½)
- 20.16 temporary difference through OCI (560 000) (½)
- 20.15 temporary differences before unused tax loss
(500 000 + 950 000) (1 450 000) (1)
Movement (OCI) 560 000 (156 800) (1)
Movement in unused tax
loss (reversal of deductable) 950 000 (266 000) (1)
Movement in unused capital
loss (deductable) (60 000) 16 800 (1)
211 750 (59 290)
Total (13)

1. R2 500 000 – R1 800 000 = R700 000 [1]

2. R1 600 000 [(R2 350 000 – R750 000) x (20 - 8)/20] = R960 000 [1]
3. R750 000 x (20 - 2)/20 = R675 000 [1]

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(ii) Tax calculation

R

Profit before tax (given) 500 250 (½)

Non-taxable/-Non-deductable items:
- Capital loss not deductable (75 000 x 20%) 15 000 (1)
- Impairment of goodwill not deductable 125 000 (½)
- Foreign income not taxable in RSA (750 000) (½)
- Dividends received not taxable (85 000) (½)
Taxable profit before the movement in temporary difference (194 750)
Movement in taxable temporary difference 1 238 250 (½)
Unused capital loss created 60 000 (½)
Taxable profit before tax loss 1 103 500
Unused tax loss of prior year (950 000) (1)
Taxable profit 153 500
Current tax at 28% 42 980 (1)
Total (6)

(b) AVICENNA LTD

NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 29 FEBRUARY 20.16

15. Income tax expense

20.16
Major component of tax expense R
SA Normal Taxation
Current tax
- Current tax 42 980 (½)
Deferred taxation (97 510)
- Movement in temporary differences (346 710) (½)
- Unused tax loss utilised 266 000 (½)
- Unused capital loss created (16 800) (½)
Foreign tax 135 000 (1)
80 470
Tax expense reconciliation
Accounting profit 500 250 (½)
Tax at 28% 140 070 (½)
Tax effect of non-taxable/non-deductable items:
- Dividends received (85 000 x 28%) (23 800) (½)
- Capital loss on sale of land not deductable (75 000 x 20% x 28%) 4 200 (1)
- Impairment of goodwill not deductable (125 000 x 28%) 35 000 (½)
- Effect of different tax rate on foreign income
[(750 000 x 28%) - 135 000] (75 000) (1)
80 470
Total (7)
Communication skills: presentation and layout (1)

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PART B

MEMORANDUM

TO: Mr CFO
FROM: Student X
DATE: 15 March 20.16
RE: Advice requested regarding items in question

Dear Mr CFO,

Herewith kindly receive my advice regarding the items which you have mentioned:

(a) Proposed change to the depreciation method of the manufacturing building of

Company Ltd:

A change to the depreciation method of an asset can’t be recognised as a change in accounting

policy for the following reasons: (½)

• The change is not required by a Standard or an Interpretation (IAS 8.14).

• The change does not result in more reliable and relevant information about the effects of
transactions, events or conditions on the entity’s financial position, performance or cash flows
(IAS 18.14). (1)

A change to the depreciation method arises when the estimates, which have been taken into
account to determine the initial depreciation method, are revised (IAS 8.32). (½)

According to IAS 8.34, if any of these estimates need to be revised due to changes which has
occurred in the circumstances on which the estimates were based or as a result of new
information or more experience, the change is accounted for as a change in estimate. (2)

However since there are no indication that there has been any change to the estimates which
were used to determine the initial depreciation method and the current depreciation method
remains to provide relevant information and faithfully represents the utilisation of the asset,
Company Ltd will not be able to recognise this change as a change in estimate. (2)

I therefore advise the depreciation method for Company Ltd’s manufacturing buildings to remain
unchanged. (1)

(b) Change in fixed overhead per unit:

IAS 2.10 indicates that the cost of inventories will comprise all costs of purchase, conversion and
other costs incurred in bringing the inventories to its present location and condition. (½)

IAS 2.12 further indicates that fixed overheads include indirect costs of production that remain
relatively constant regardless of the volume of production, such as depreciation and maintenance
of factory buildings and equipment. (½)

It will therefore be incorrect not to include the depreciation of machinery in the cost of
inventory, since this cost was incurred to bring the inventories to their present condition. (1)

The change is therefore not a change in accounting policy, but a correction of a prior period (1)
error.

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According to IAS 8.42 an entity shall correct material prior period errors retrospectively in the first
set of financial statements authorised for issue after the discovery of the error, hence the inclusion
of depreciation as a fixed overhead only from the beginning of the year will be incorrect.
Company Ltd should correct the retrospectively for the earliest prior period presented
(IAS 8.42(b)), except if it is impracticable (IAS 8.43). (2)

It will be practicable for Company Ltd to determine the depreciation of prior periods which was
incorrectly not capitalised to inventory, since depreciation has been disclosed in the prior period
financial statements. (1)

Therefore according to IAS 8.42 (b) the opening balances of the assets, liabilities and equity
for the earliest prior period presented need to be restated. (1)

You are welcome to contact me should you have any further queries in this regard.

Yours sincerely,
Student X
Student X
Total (14)
Maximum (10)
Communication skills (1)

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QUESTION 5 31 marks

YOU HAVE 12 MINUTES TO READ THIS QUESTION

Boring Ltd (Boring) is an events company that organises birthday parties and similar functions for
children under the age of 14 years at their one hectare property in Waterkloof.

You are the financial manager responsible for the finalisation of the financial statements of Boring for
the financial year ended 31 December 20.14. The following are notes that you took during your
review of the company.

Operations

1. Boring was wildly successful in the first year of trading. However on 2 February 20.13 another
events company, Excitement Ltd (Excitement) opened a similar business next door to Boring.
Excitement affected Borings’ revenue to such an extent, that a loss before tax of R120 500
was recorded for the year ended 31 December 20.13.

2. In December 20.13 Boring reviewed their business model and as a result decided to employ a
larger supervising staff and to apply stricter safety control measures. They were confident that
these measures would result in Boring returning to profitability. This proved to be the case
since Boring made a profit before tax of R681 000 for the year ended 31 December 20.14.

Revenue

1. Boring usually requires a 50% deposit for a customer in order to confirm a booking. It was,
however. decided that management will waive this policy for the 20.14 financial year by not
requiring this deposit from customers. This decision was made to match the terms offered by
Excitement to its customers.

2. The company received deposits to the value of R165 000 in December 20.13 for parties that
were held in the 20.14 financial year. No expenses with regards to these parties were incurred
at the end of the 20.13 financial year. The deposits held by Boring do not contain a significant
financing component.

3. Boring was contracted by a luxury hotel in a foreign country to organise a birthday party for a
well-known teen singer on 1 August 20.13. This singer specifically requested the services of
Boring due to him being hyper-allergic to various food substances. On 2 October 20.13 Boring
invoiced the hotel R80 000 for organising this birthday party. This amount was subjected to
foreign withholding tax of 30% and is therefore not taxable in South Africa.

Property, plant and equipment

1. Boring owns the land on which their jungle gyms are erected on. The land was purchased for
an amount of R1 200 000 in September 20.11. Boring measures land according to the
revaluation model. The base cost of the land in terms of paragraph 20 of the Eigth Schedule of
the Income Tax Act is equal to the purchase price of the land. On 15 December 20.14 the
property was revalued for the first time by an independent valuator to the amount of
R1 450 000. Boring rents a hall on an adjacent property in which its functions are held. The

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monthly rental for the hall is R25 000 per month. Boring paid three month’s rental in advance
on 30 November 20.14. In accordance with section 23H of the Income Tax Act, the
South Africa Revenue Services (SARS) allowed all three payments as tax deductions for the
20.14 year.

2. Boring depreciates its jungle gyms over 10 years using the straight line method. The jungle
gyms were purchased on 2 January 20.12 at a cost of R660 000 (the residual value is Rnil).
The SARS has granted Boring a special tax directive whereby the jungle gyms may be written
off over a five year period for income tax purposes (not apportioned for part of a year). The
estimated useful life of the jungle gyms changed in January 20.14 and as a result depreciation
to the amount of R170 971 was recognised for 20.14 financial year.

Lawsuit

During the 20.13 year the company erected an advertising banner outside the rented property which
stated the following “Excitement is dangerous. Going Boring is safe”. Excitement sued Boring for an
amount of R200 000 since the phrase is considered defamatory. On 30 November 20.13 Boring
obtained a legal opinion which indicated that the claim will be successful and that an amount of
R150 000 will most likely be payable. The accountant misunderstood the legal report and treated the
success for the claim against Boring, for accounting purposes in the 20.13 financial statements, as
being remote. In July 20.14 the accountant became aware of his error. This error has not been
corrected by the accountant.

It was agreed on 10 October 20.14 to settle the claim with Excitement out of court. The first
settlement payment of R75 000 was payable in November 20.14 and the second payment of
R75 000 is payable in January 20.15. Boring timeously paid the first payment. These payments are
tax deductible once they have been paid to the plaintiff.

Taxation

1. On 5 May 20.13 Boring received their 20.12 tax assessment from the SARS. This assessment
indicated that the income tax payable for the year ended 31 December 20.12 amounted to
R153 715. The current tax expense for the 2012 financial year, as disclosed in the 20.12
financial statements, amounted to R118 215. The 20.12 tax assessment indicates that Boring
was fined R15 000 for the underestimation off their prior year tax and also had to pay interest
of R6 250.

2. On 31 December 20.12 Boring had a deductible temporary difference in terms of IAS 12

Income taxes of R142 650.

3. There are no temporary differences other than those that are apparent from the question.

Additional information

1. All the above information was accounted for correctly in the financial statements of Boring,
except where it has been indicated otherwise.

2. The normal income tax rate is 28% and the capital gains tax inclusion rate is 80%.

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REQUIRED

YOU NOW HAVE 47 MINUTES TO ANSWER THIS QUESTION

Marks
Disclose the income tax expense note and deferred tax note to the financial statements of 29
Boring Ltd for the year ended 31 December 20.14.

Please note:
• Comparatives figures are required.
• The movement in temporary differences in the current tax calculation has to be
calculated by using the statement of financial position approach.
• The tax rate reconciliation should be done in accordance with IAS 12.81(c)(i)

Communication skills: presentation and layout 2

Please note:

• Round off all amounts to the nearest Rand.

• Ignore any Value-Added Tax (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 5 – Suggested solution

BORING LTD

NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.14

3. Income tax expense

20.14 20.13
R R
Major components of tax expense:
SA normal tax
Current tax 39 500 35 500
- Current year [C1] 39 500 - (5)
- Underprovision for prior year (153 715 -118 215) - 35 500 (1)
Deferred tax 151 180 (92 190)
- Movement in temporary differences [C2] 70 288 (11 298) (11)
- Unused tax loss created [C2] - (80 892) (1)
- Unused tax loss utilised [C2] 80 892 - (½)
SA normal tax 190 680 (56 690)
Foreign tax (80 000 x 30%) - 24 000 (1)
190 680 (32 690)

Tax rate reconciliation

Accounting profit /(loss) 681 000 (270 500) (1)
Tax @ 28% 190 680 (75 740) (1)
Tax effect of non-taxable / non – deductible items: - 7 550
- Fine (15 000 x 28%) - 4 200 (½)
- Interest (6 250 x 28%) - 1 750 (½)
- Effect of different tax rate in foreign income
(80 000 x (30% - 28%) - 1 600 (1)
Underprovision for current tax for prior year - 35 500 (½)
Income tax expense 190 680 (32 690)

20. Deferred tax

Analysis of temporary differences:
Property, plant and equipment
- Accelerated deductions for tax purposes [C2] 26 048 36 960 (1)
- Revaluation [C2] 56 000 - (1½)
Provision (legal claim) [C2] (21 000) (42 000) (1)
Income received in advance [C2] - (46 200) (½)
Prepaid expenses [C2] 14 000 - (½)
Unused tax loss for normal tax - (80 892) (½)
Net deferred tax liability/(asset) 75 048 (132 132)
Total (29)
Communication skills: presentation and layout (2)

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CALCULATIONS

C1. Current tax 20.14 20.13

Profit/(loss) before tax (given) 681 000 (120 500) [1]

Prior year error (provision for legal claim) - (150 000) [½]
Adjusted profit before tax 681 000 (270 500)
Non-taxable/non-deductible items: - (58 750)
- Fine not deductible - 15 000 [½]
- SARS interest not deductible - 6 250 [½]
- Foreign income not taxable in SA - (80 000) [½]
Taxable profit before temporary differences 681 000 (329 250)
Movement in temporary differences (taxable/deductible) [C2] (251 029) 40 350 [1]
Taxable profit before unused tax loss / Unused tax loss 429 971 (288 900)
Unused tax loss (288 900) [½]
Taxable profit for the year 141 071
Tax at 28% 39 500 [½]
[5]

COMMENT

Even though the information in the question did not state whether Boring will have
adequate, probable future taxable profits in order to recognize the deferred tax asset, this
conclusion is automatically reached when the question provides the profit before tax
figure of R681 000 for the 20.14 year. This given profit before tax figure exceeds the
unused tax loss calculated for the 20.13 year and therefore it can be assumed that a
deferred tax asset may be recognised for the 20.13 year.

C2. Calculation of deferred tax

20.13
Deferred
Temporary tax
Carrying difference asset/
Tax base
amount @ 100% or (liability)
80% @ 28%

Land (80%) 1 200 000 1 200 000 - [½]

Equipment 528 0001 396 0002 132 000 (36 960) [2½]
Provision (Legal claim) (150 000) - (150 000) 42 000 [1]
Revenue received in advance (165 000) - (165 000) 46 200 [1]
(183 000) 51 240
Unused tax loss - 288 900 (288 900) 80 892 [1]
Deferred tax asset (471 900) 132 132

Movement in temporary differences: (329 250) 92 190

Movement in profit or loss (183 000 – 142 650 (given)) (40 350) 11 298 [1]
Movement in unused tax loss (288 900) 80 892

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20.14
Temporary Deferred
Carrying difference tax asset/
Tax base
amount @ 100% or (liability)
80% @ 28%

Equipment 357 0293 264 0004 93 029 (26 048) [1½]

Provision (Legal claim) 75 000 - (75 000) 21 000 [1]
Prepaid rent 50 0005 - 50 000 (14 000) [1½]
68 029 (19 048)
Land (80%) 1 450 000 1 200 000 200 000 (56 000) [1½]
Deferred tax liability 268 029 (75 048)

Movement in temporary differences: 739 929 (207 180)

Movement in profit or loss (183 000 + 68 029) 251 029 (70 288) [1]
Movement through OCI 200 000 (56 000)
Movement in unused tax loss 288 900 (80 892) [½]
[14]
1
660 000 x (10 – 2) / 10
2
660 000 x (5 – 2) / 5
3
528 000 – 170 971
4
660 000 x 2/5
5
2 x 25 000

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QUESTION 6 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

THIS QUESTION CONSISTS OF TWO INDEPENDENT PARTS

PART A 30 marks

Sourtree Ltd conducts business in the retail industry and is listed on the JSE Limited. The company’s
year end is 28 February.

You are responsible for the preparation of the financial statements of Sourtree Ltd for the year ended
28 February 20.14. The following information is available for the 20.14 financial year:

SOURTREE LTD

TRIAL BALANCE FOR THE YEAR ENDED 28 FEBRUARY 20.14

Dr Cr
Notes R R

Share capital (1 000 000 ordinary shares) 350 000

Retained income 9 829 860
Trade payables 1 690 000
Revenue 1 16 308 000
Dividends received 140 000
Rental received 220 000
Cost of sales 11 000 000
Operating expenses (including depreciation) 3 120 500
Donations (not deductible for tax purposes) 60 000
Interest paid 66 500
Loss on sale of land 5 200 000
Penalties 2 1 398 500
Dividends paid 3 210 000
Deferred tax asset (1 March 20.13) 3 122 360
Trade and other receivables 4 2 405 600
Land at cost 5 3 663 000
Office buildings at carrying amount 5 2 442 000
Plant and machinery at carrying amount 5 945 000
Cash and cash equivalents 2 044 000
Prepaid insurance premium (deductible for tax purposes –
section 23H) 88 900
Inventory 771 500
28 537 860 28 537 860

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Additional information

1. Accounting error

On 31 January 20.13 Sourtree Ltd received an amount of R575 000 (Value-Added Tax (VAT)
included) from a customer for services that were only rendered during June 20.13. The
accountant recognised the R575 000 as revenue in January 20.13 and did not allocate the
VAT of 15% to the VAT output account. As a result the R575 000 was included in revenue for
the financial year ended 28 February 20.13. For tax purposes, the R575 000 was taxed in the
financial year ended 28 February 20.13. The South African Revenue Service (SARS) indicated
that they will re-open the 20.13 assessment to correct the amount of VAT that was incorrectly
included in taxable profit. The figures in the trial balance have not yet been adjusted to account
for the correction of the accounting error (the error is regarded as material).

Assume that Sourtree Ltd is a registered VAT vendor and that the R575 000 received was for
rendering taxable services. Ignore the implications of any penalties and/or interest on the late
payment of VAT.

2. Penalties

On 26 July 20.13 the Competition Commission fined Sourtree Ltd for retail price fixing. The
Competition Commission imposed a penalty of R1 398 500 on Sourtree Ltd because of the
existence of a vertical agreement between Sourtree Ltd and Rosehip Ltd for setting retail
prices. The penalty was immediately payable. This penalty is not deductible for income tax
purposes.

3. Deferred tax asset

The net deferred tax asset of R122 360 as at 28 February 20.13 consisted of the following:

Dr/(Cr)
R
Property plant and equipment (143 661)
Allowance for credit losses 67 221
Unused tax loss 198 800
Net deferred tax asset 122 360

All the temporary differences that gave rise to the net deferred tax asset of R122 360 were
taxed at 28%. The final tax assessment issued by the SARS for the financial year ended
28 February 20.13 reflected an assessed tax loss of R710 000 which was accepted by
Sourtree Ltd.

On 28 February 20.13 the management of Sourtree Ltd was of the opinion that future taxable
profits and future capital gains were probable as the budget for the coming financial year
showed a sharp increase in profits as a result of a new contract obtained by Sourtree Ltd. This
opinion of management remained unchanged for the financial year ended 28 February 20.14.

The current tax expense for the year ended 28 February 20.14 was correctly calculated at
R529 074 (after taking into account all the additional information provided). Deferred tax for the
year ended 28 February 20.14 has not yet been calculated or provided for.

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The normal income tax rate is 28% and the inclusion rate for capital gains tax is 80% for the
years ended 28 February 20.13 and 28 February 20.14. As all the shareholders of Sourtree
Ltd are South African companies, no Dividends Tax was withheld from the cash dividend paid
of R210 000.

4. Trade and other receivables

Trade and other receivables were made up as follows on 28 February 20.14:

R
Trade receivables 2 595 300
Loss allowance on trade receivables (410 600)
Other receivables 220 900
Balance at year end 2 405 600

The SARS has on a consistent basis granted an annual doubtful debt provision allowance of
25% of the amount provided for financial reporting purposes in terms of section 11(j) of the
Income Tax Act.

5. Property, plant and machinery

On 13 March 20.13 Sourtree Ltd purchased land for the future development of a new plant.
Due to the worldwide economic crisis and a decline in the property market during the second
half of 20.13, the directors agreed to sell the land as soon as possible. The land was sold on
12 December 20.13 at a loss of R200 000 (excluding VAT) which is a capital loss for tax
purposes.

Sourtree Ltd depreciates the office buildings at R165 500 per annum, while the SARS permits
no deduction on the buildings.

The tax base of the plant and machinery on 28 February 20.14 is R546 000.

PART B 10 marks

Deco Art Ltd (“Deco”) is a proudly South African company that manufactures high quality melamine
dinner sets, mainly for use in caravans. The financial year end is 31 December 20.13. Deco
measures raw materials and work-in-progress (WIP) on a first-in-first-out (FIFO) basis. The following
information pertains to their manufacturing process:

Raw materials

Raw materials on hand on 31 December 20.12 (at cost) (6 062 kg) R1 145 635
Raw materials on hand on 31 December 20.13 ?
Raw materials purchased during the year 8 500 kg

The following costs relating to the purchasing of raw materials were incurred during the current
financial year:
R
Purchase price 1 705 459
Transport costs 45 000
Handling costs 29 000
Storage costs (not part of production process) 55 000
Administrative expenses (general bookkeeping expenses) 45 167
1 879 626

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Deco purchased the raw materials from Arty Ltd on 1 February 2013. Arty Ltd has a normal credit
cycle of three months. Per agreement, Deco will settle the amount of R1 705 459 due to Arty Ltd on
30 September 20.13. As the settlement will only take place in September, the effect of discounting is
material.

The inventory count at year end indicated that only 8% of the total raw materials purchased during
the year was on hand at 31 December 20.13.

The normal raw material wastage is 3%, which takes place at the beginning of the production
process.

Work in progress
R
Work in progress on hand on 31 December 20.12 (at cost) 231 260

The cost of work in progress at 31 December 20.13 has not yet been calculated. Detailed production
records indicate that 5% of this year’s allocated production expenditure and raw materials used,
relates to dinner sets that were still in production at year end. The demand for the product is so high
that all manufactured dinner sets are sold as soon as the production process is completed.

Overhead costs

The following overheads occurred during the year ended 31 December 20.13:
R
Variable production overheads 963 450
Fixed production overheads 950 500

Labour

The following information is available for the year ended 31 December 20.13:

Direct labour R8,20 per hour

Productive hours 133 600 hours
Normal idle hours 3 400 hours

Additional information

• A fair discount rate for Deco is 9% per annum, compounded monthly.

• Normal capacity equals 18 000 units per year. Due to an exceptional high production output
20 500 units were produced for the year ended 31 December 20.13.

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REQUIRED

YOU NOW HAVE 60 MINUTES TO ANSWER THIS QUESTION

Marks
PART A

(a) Prepare the statement of profit or loss and other comprehensive income of 6
Sourtree Ltd for the year ended 28 February 20.14 (income and expenditure should
be presented in terms of their function).

Communication skills: presentation and layout 1

(b) Prepare the following notes to the financial statements of Sourtree Ltd for the
financial year ended 28 February 20.14:

• Income tax expense in terms of IAS 12.79-12.80 and 12.81(c)(i) 13

• Prior period error 8

Communication skills: presentation and layout 2

Please note:

• The presentation of earnings per share is not required.

• Comparative figures are not required.
• Round off all calculated amounts to the nearest Rand.
• Your answer must comply with International Financial Reporting Standards (IFRS).

PART B

Calculate the Rand amount of the work-in-progress that Deco Art Ltd must transfer to 10
finished products for the year ended 31 December 20.13.

Please note:

• Round off all calculated amounts to the nearest Rand.

• Ignore any normal income tax implications.
• Ignore any Value-Added Tax (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 6 - Suggested solution

PART A
(a) SOURTREE LTD
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 28 FEBRUARY 20.14
Note R
Revenue (16 308 000 + (575 000 x 100/115)) 16 808 000 (1½)
Cost of sales (11 000 000) (½)
Gross profit 5 808 000
Other income (140 000 + 220 000) 360 000 (1)
Other expenses (3 120 500 + 60 000 + 200 000 + 1 398 500) (4 779 000) (2)
Finance cost (66 500) (½)
Profit before tax 1 322 500
Income tax expense (797 020) (½)
3
PROFIT FOR THE YEAR 525 480
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 525 480
Total (6)
Communication skills: presentation and layout (1)

(b) SOURTREE LTD

NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.14
3. Income tax expense
Major components of tax expense.
2014
R
SA normal tax
Current tax
- Current year (given) 529 074 (1)
Deferred tax 267 946
- Movement in temporary differences (taxable) [C1] 113 946 (6)
- Unused tax loss utilised [C1] 198 800 (1)
- Unused capital loss created [C1] (44 8006) (1)
SA normal tax 797 020

Tax reconciliation

Accounting profit 1 322 500 (½)

Tax at 28% 370 300 (½)
Tax effect of non-deductible/non-taxable items:
- Dividends not taxable (140 000 x 28%) (39 200) (½)
- Donations not deductible (60 000 x 28%) 16 800 (½)
- Capital loss on sale of land not deductible
(200 000 x 20% x 28%) 11 200 (1)
- Depreciation on office buildings not deductible 46 340 (½)
(165 500 x 28%)
- Penalties not deductible (1 398 500 x 28%) 391 580 (½)
Income tax expense 797 020
Total (13)

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4. Prior period error

Revenue received in advance during the 20.13 financial year was incorrectly recognised as
revenue in the financial year ended 28 February 20.13 instead of in the financial year ended
28 February 20.14. The amount recognised erroneously included the Value-Added Tax (VAT)
that was charged on the amount received. The comparative amounts for the financial year
ended 28 February 20.14 were restated. The effect of the restatement on the financial
statements is summarised below:
(2)

20.13
R
Decrease in revenue (575 000) (1)
Decrease in income tax expense (575 000 x 28%) 161 000 (1)
Decrease in profit (414 000)

Increase in contract liability (revenue received in advance

(575 000 x 100/115) (500 000) (1)
Increase in VAT payable (575 000 x 15/115) or (575 000 – 500 000) (75 000) (1)
Increase in deferred tax asset (500 000 x 28%) 140 000 (1)
Decrease in current tax payable (75 000 x 28%) 21 000 (1)
Decrease in equity (414 000)
Total (8)
Communication skills: presentation and layout (2)

CALCULATIONS

C1. Deferred tax

Deferred
Temporary
tax at
Carrying Tax difference
28%
amount base at 100% or
asset/
80%
(liability)
28 February 20.13
Plant and machinery ? ? 513 0751 (143 661)
Loss allowance on trade
receivables - - (240 075) 67 221
Contract liability( revenue
received in advance) (500 000) - (500 000) 140 000 [1]
(227 000) 63 560
Unused tax loss - 710 000 (710 000) 198 800
Net deferred tax asset (937 000) 262 360

Alternative calculation
28 February 20.13
Deferred tax 20.13 273 000 (76 440)
Contract liability( revenue
received in advance) (500 000) (500 000) 140 000 [1]
(227 000) 63 560
Unused tax loss 710 000 (710 000) 198 800
(937 000) 262 360
1
143 661 (given) / 28% = 513 075

MJM
 151 FAC4861/102
NFA4861/102
ZFA4861/102

Deferred
Temporary
tax at
Carrying Tax difference
28%
amount base at 100% or
asset/
80%
(liability)
28 February 20.14
Plant and machinery 945 000 546 000 399 000 (111 720) [1]
Loss allowance on trade
receivables (410 600) (102 650)1 (307 950) 86 226 [1½]
Prepaid insurance premium 88 900 - 88 900 (24 892) [1]
179 950 (50 386)
Unused capital loss (sale of land) - 200 000 (160 000)2 44 800 [1½]
19 950 (5 586)
[5]
Movement in temporary differences (excluding unused tax
loss and unused capital loss) (taxable)
(179 950 – 227 000) 406 950 113 946 [1]
Movement in unused tax loss (reversal of deductible) 710 000 198 800 [1]
Movement in unused capital loss (deductible) (160 000) (44 800)
Total movement in temporary differences 956 950 267 946
1
410 600 x 25% = 102 650
2
200 000 x 80% = 160 000

PART B

Work in Progress transferred to finished products

R
Raw material
- Opening balance at 1 January 20.13 1 145 635 (1)
- Purchases (1 606 500 [C1] + 45 000 + 29 000) 1 680 500 (3)
- Closing balance (1 680 500 x 8%) (134 440) (1)
Transferred to WIP 2 691 695

Work in progress
- Opening balance at 1 January 20.13 231 260 (1)
- Movement / Additions 5 729 045
- Raw material 2 691 695 (½)
- Direct labour ((133 600 + 3 400) x 8,20) 1 123 400 (1)
- Fixed production overheads 950 500 (1)
- Variable production overheads 963 450 (½)
- Closing balance (5 729 045 x 5%) (286 452) (1)
Transferred to finished products 5 673 853
Total (10)

CALCULATIONS

PART B
C1. Purchase price
N = 8
I = 9%/12 [2]
FV = R1 705 459
PV = ? R1 606 500

MJM