SCHOOL OF BUSINESS, ECONOMICS AND MANAGEMENT

AFIN215/ACCA F7 – FINANCIAL REPORTING, ANALYSIS & PLANNING

MID SEMESTER MOCK EXAMINATION with suggested solutions

FRIDAY, 21ST APRIL 2017

THREE HOURS FROM 09:00 TO 12:00 HOURS

Time allowed: 3 HOURS plus 5minutes reading time

Read the instruction below carefully:

1. Check that you have the correct examination paper in front of you.

2. Answer all FOUR (4) questions in the paper

3. Write down the number of questions that you have answered on the cover
of the examination answer booklet provided.

4. All questions must be answered in the answer booklet.

5. Begin answering each question on a new page.

6. Non Programmable Scientific Calculators are permitted for this

examination.

7. There shall be NO communication among students during the examination.

Any students caught doing this will be disqualified.

DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO

QUESTION ONE

a) State and explain 5 limitations in the use of ratio analysis for assessing corporate
performance.
[15marks]

b) Define Generally Accepted Accounting Principles (GAAP) and explain four

sources of GAAP in Zambia.
[10 Marks]
[Total: 25 Marks]

QUESTION TWO
(a) During the last decade, it has not been unusual for the premium paid to acquire
control of a business to be greater than the fair value of its tangible net assets. This
increase in the relative proportions of intangible assets has made the accounting
practices for them all the more important.

During the same period many companies have spent a great deal of money internally
developing new intangible assets such as software and brands. IAS 38 'Intangible
assets' was issued in September 1998 and prescribes the accounting treatment for
intangible assets.
Required
In accordance with IAS 38, discuss whether intangible assets should be recognised,
and if so how they should be initially recorded and subsequently amortised in the
following circumstances:
(i) When they are purchased separately from other assets
(ii) When they are obtained as part of acquiring the whole of a business
(iii) When they are developed internally. [10 marks]

Note. Your answer should consider goodwill separately from other intangibles.

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(b) Dexterity is a public listed company. It has been considering the accounting
treatment of its intangible assets and has asked for your opinion on how the matters
below should be treated in its financial statements for the year to 31 March 2014.

(i) On 1 October 2013 Dexterity acquired Temerity, a small company that specialises in
pharmaceutical drug research and development. The purchase consideration was by
way of a share exchange and valued at K35 million. The fair value of Temerity's net
assets was K15 million (excluding any items referred to below). Temerity owns a patent
for an established successful drug that has a remaining life of 8 years. A firm of
specialist advisors, Leadbrand, has estimated the current value of this patent to be K10
million, however the company is awaiting the outcome of clinical trials where the drug
has been tested to treat a different illness. If the trials are successful, the value of the
drug is then estimated to be K15 million. Also included in the company's statement of
financial position is K2 million for medical research that has been conducted on behalf
of a client.
[4 marks]
(ii) Dexterity has developed and patented a new drug which has been approved for
clinical use. The costs of developing the drug were K12 million. Based on early
assessments of its sales success, Leadbrand have estimated its market value at K20
million.
[3 marks]
(iii) Dexterity's manufacturing facilities have recently received a favourable inspection by
government medical scientists. As a result of this the company has been granted an
exclusive five-year licence to manufacture and distribute a new vaccine. Although the
licence had no direct cost to Dexterity, its directors feel its granting is a reflection of the
company's standing and have asked Leadbrand to value the licence. Accordingly they
have placed a value of K10 million on it.
[3 marks]
(iv) In the current accounting period, Dexterity has spent K3 million sending its staff on
specialist training courses. Whilst these courses have been expensive, they have led to
a marked improvement in production quality and staff now need less supervision. This
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in turn has led to an increase in revenue and cost reductions. The directors of Dexterity
believe these benefits will continue for at least three years and wish to treat the training
costs as an asset.
[2 marks]
(v) In December 2013, Dexterity paid K5 million for a television advertising campaign for
its products that will run for 6 months from 1 January 2014 to 30 June 2014. The
directors believe that increased sales as a result of the publicity will continue for two
years from the start of the advertisements.
[3 marks]

Required
Explain how the directors of Dexterity should treat the above items in the financial
statements for the year to 31 March 2014.

Note. The values given by Leadbrand can be taken as being reliable measurements.
You are not required to consider depreciation aspects.
[Total: 25 marks]

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QUESTION THREE
The following hypothetical list of account balances at 31 March 2011 relates to CEC
PLC, a company specialized in energy distribution and production. All amounts on the
list are in K, 000s.

Sales revenue (note a) 358,450.00

Cost of sales 185,050.00

Distribution cost 28,700.00

Administration 15,000.00

Lease rentals (note b) 20,000.00

Loan interest paid 2,000.00

Dividend paid 12,000.00

Property at cost (note c) 200,000.00

Plant and equipment at cost 154,800.00

Depreciation 1 April 2010 - Plant and equipment 34,800.00

Developmet expenditure (note d) 30,000.00

Profit on disposal of non current assets 45,000.00

Trade accounts receivable 55,000.00

Inventories: 31 March 2011 28,240.00

Cash and bank 10,660.00

Trade accounts payable 29,400.00

Taxation: over provision in year to 31 March 2010 2,200.00

Equity shares of 25 C each 150,000.00

8% loan notes (Issued in 2008) 50,000.00

Retained earnings 1 April 2010 71,600.00

741,450.00 741,450.00

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The following notes are relevant.

1. Included in sales revenue is K27 million, which relates to sales made to customers
under sale or return agreements. The expiry date for the return of these goods is 30
April 2011. CEC PLC has charged a mark-up of 20% on cost for these sales.
2. A lease rental of K20 million was paid on 1 April 2010. It is the first of five annual
payments in advance for the rental of an item of equipment that has a cash
purchase price of K80 million. The auditors have advised that this is a finance lease
and have calculated the implicit interest rate in the lease as 12% per annum. Leased
assets should be depreciated on a straight-line basis over the life of the lease.
3. On 1 April 2010 CEC PLC acquired a new property at a cost of K200 million. For the
purpose of calculating depreciation only, the asset has been separated into the
following elements.

The depreciation of the elements of the property should be calculated on a straight-

line basis. The new property replaced an existing one that was sold on the same
date for K95 million. It had cost K50 million and had a carrying value of K80 million
at the date of sale. The profit on this property has been calculated on the original
cost. It had not been depreciated on the basis that the depreciation charge would not
be material. Plant and machinery is depreciated at 20% on the reducing balance
basis.

4. The figure for development expenditure in the list of account balances represents
the amounts deferred in previous years in respect of the development of a new
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 product. Unfortunately, during the current year, the government has introduced
legislation which effectively bans this type of product. As a consequence of this the
project has been abandoned. The directors of CEC PLC are of the opinion that
writing off the development expenditure, as opposed to its previous deferment,
represents a change of accounting policy and therefore wish to treat the write off as
a prior period adjustment.

5. A provision for income tax for the year to 31 March 2011 of K15 million is required.

Required

(a) Prepare CEC PLC’s income statement for the year to 31 March 2011, along with the
changes in retained earnings from the statement of changes in equity. [15 marks]

(b) Prepare a statement of financial position as at 31 March 2011 in accordance with

International Financial Reporting Standards as far as the information permits.
[10 marks]
[Total = 25 marks]

QUESTION FOUR
a) The broad principles of accounting for property, plant and equipment involve
distinguishing between capital and revenue expenditure, measuring the cost of assets,
determining how they should be depreciated and dealing with the problems of
subsequent measurement and subsequent expenditure. IAS 16 Property, plant and
equipment has the intention of improving consistency in these areas.
Required

Explain:
(i) How the initial cost of property, plant and equipment should be measured
[4 marks]

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 (ii) The circumstances in which subsequent expenditure on those assets should be
capitalised
[3 marks]
(b) Explain IAS 16's requirements regarding the revaluation of non-current assets and
the accounting treatment of surpluses and deficits on revaluation and gains and losses
on disposal.
[8 marks]

b) Broadoak has recently purchased an item of plant from Plantco, the details of this are:

Broadoak paid for the plant (excluding the ancillary costs) within four weeks of order,
thereby obtaining an early settlement discount of 3%.

Broadoak had incorrectly specified the power loading of the original electrical cable to
be installed by the contractor. The cost of correcting this error of K6,000 is included in
the above figure of K14,000.

The plant is expected to last for 10 years. At the end of this period there will be
compulsory costs of K15,000 to dismantle the plant and K3,000 to restore the site to its
original use condition.

Required
Calculate the amount at which the plant will be measured at recognition. (Ignore
discounting.)
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 [5 marks]
Broadoak acquired a 12 year lease on a property on 1 October 2010 at a cost of
K240,000. The company policy is to revalue its properties to their market values at the
end of each year.

Accumulated amortisation is eliminated and the property is restated to the revalued

amount. Annual amortisation is calculated on the carrying values at the beginning of the
year. The market values of the property on 30 September 2011 and 2012 were
K231,000 and K175,000 respectively. The existing balance on the revaluation surplus at
1 October 2010 was K50,000. This related to some non-depreciable land whose value
had not changed significantly since 1 October 2010.
Required
Prepare extracts of the financial statements of Broadoak (including the movement on
the revaluation reserve) for the years to 30 September 2011 and 2012 in respect of the
leasehold property.
[5 marks]
[Total = 25 marks]

END OF EXAMINATION

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 AFIN215 – MOCK EXAM 21ST APRIL 2017
SUGGESTED SOLUTIONS
QUESTION ONE

a) Limitations of ratio analysis

 Ratios may be based on historical information
 Inflation may distort comparison of ratios in two different periods
 Different accounting practices can distort comparison
 Seasonal factors can also distort ratio analysis
 Some ratios are based on a point in time and care must be taken when
using these

1 Mark for each valid stated point + 2 Marks for explanation. Maximum 15 Marks

[15marks]

b) Generally Accepted Accounting Principles (GAAP) are rules from whatever

source that govern accounting.
Sources of GAAP include:
 National company law (e.g. Companies Act)
 Accountants Act and ZICA rules derived from the Act
 Securities and Exchange regulations regarding accounting
 International Accounting Standard (IAS) and International Financial
Reporting Standards (IFRS).
 Banking and Financial Services Act requirements for financial reporting for
financial institutions
2 Marks for defining GAAP + 2 Marks for explaining each point.
Maximum 10 Marks
[10 Marks]
[Total: 25 Marks]

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QUESTION TWO
(a)
(i) When they are purchased separately from other assets
 Intangible assets acquired separately are generally recognized
 Under the cost model (which is a benchmark or recommended model under
IAS38), the intangible asset is carried at its cost less amortisation and less
impairment losses. Intangible assets with: (a) finite useful life must be amortised
on a straight line basis over their useful life (usually with a nil residual value)
while (b) intangible assets with an indefinite life must not be amortised but
tested for impairment on an annual basis or more often in cases of signs of
impairment.
 In IAS 38’s revaluation model the intangible asset is revalued to a carrying
amount of fair value less subsequent amortisation and subsequent impairment
losses. Fair value must be arrived it with reference to an active market. Active
markets for many intangible assets can be rare.
(ii) When they are obtained as part of acquiring the whole of a business
 Intangible assets acquired as part of a business combination are recognised at
fair value provided that they can be valued separately from goodwill.
 If an intangible cannot be valued, then it will be subsumed into goodwill.
 Subsequent measurement would be as per description above. Note that goodwill
obtained as part of a business combination will; once recognised, be held
indefinitely, without amortisation but subject to impairment reviews.
(iii) When they are developed internally.
 As a general rule, internally generated intangible assets cannot be capitalised.
 Internally generated intangibles can however be recognised if they are acquired
as part of a business combination. For example, a brand name acquired in a
business combination is capitalised whereas an internally generated brand isn't.

3 Marks for each valid point well explained – Maximum 10 Marks

[10 Marks]

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(b)

(i) Temerity

The following assets will be recognised on acquisition:

Fair value of sundry net

assets 15
Patent at fair value 10
Research carried out for
customer 2
Goodwill (balancing figure) 8
Total consideration 35

The patent is recognised at its fair value at the date of acquisition, even if it hadn't
previously been recognised by Temerity. It will be amortised over the remaining 8 years
of its useful life with an assumed nil residual value.

The higher value of $15m can't be used because it depends on the successful outcome
of the clinical trials. The extra $5m is a contingent asset, and contingent assets are not
recognised in a business combination. (Only assets, liabilities and contingent liabilities
are recognised.)

Although research is not capitalised, this research has been carried out for a customer
and should be recognised as work-in-progress in current assets. It will be valued at the
lower of cost and net realisable value unless it meets the definition of a construction
contract.

The goodwill is capitalised at cost. It is not amortised but it will be tested for impairment
annually.

(ii) New drug

Under IAS 38 the $12m costs of developing this new drug are capitalised and then
amortised over its commercial life. (The costs of researching a new drug are never
capitalised.) Although IAS 38 permits some intangibles to be held at valuation it
specifically forbids revaluing patents, therefore the $20m valuation is irrelevant.

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(iii) Government licence
IAS 38 states that assets acquired as a result of a government grant may be capitalised
at fair value, along with a corresponding credit for the value of the grant.

Therefore Dexterity may recognise an asset and grant of $10m which are then
amortised/released over the five year life of the license. The net effect on profits and on
shareholders funds will be nil.

(iv) Training costs

Although well trained staff add value to a business IAS 38 prohibits the capitalisation of
training costs. This is because an entity has 'insufficient control over the expected future
economic benefits' arising from staff training; in other words trained staff are free to
leave and work for someone else. Training is part of the general cost of developing a
business as a whole.

(v) Advertising costs

IAS 38 Para 69 states that advertising and promotional costs should be recognised as
an expense when incurred. This is because the expected future economic benefits are
uncertain and they are beyond the control of the entity.
However, because the year-end is half way through the campaign there is a $2.5m
prepayment to be recognised as a current asset.

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QUESTION THREE
The following hypothetical financial statements
CEC PLC

10 Marks – Income statement 5 Marks Statement of changes in equity

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10 Marks – Statement of financial position

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QUESTION FOUR
a)
(i) IAS 16 states that an item of property which qualifies for recognition as an asset must
initially be measured at cost. Cost comprises the following components.
(1) Purchase price, less any trade discounts or rebates, but not settlement discounts
(2) Import duties and non-refundable purchase taxes
(3) Directly attributable costs of bringing the asset to working condition for its
intended use. These include the cost of site preparation, initial delivery and handling
costs, installation costs and professional fees. Also included is the estimated cost of
removing the asset and restoring the site, to the extent that it is recognised as a
provision under IAS 37 Provisions, contingent liabilities and contingent assets.

Certain costs will not normally be part of the cost of property, plant and equipment,
and must instead be expensed. These are administration costs, start-up costs and initial
operating losses.

In the case of self-constructed assets, the principles are the same as for acquired
assets. This may include labour costs of the entity's own employees. Abnormal costs
such as wastage and errors are excluded.

In addition to IAS 16 and IAS 37 we also need to consider IAS 20 on government grants
which states that the cost of an asset may be reduced by any such grants.

(ii) There may be subsequent expenditure on an item of property, plant or equipment,

after its purchase and recognition. Such expenditure may be added to the carrying
amount of the asset, but only when the original criteria are met. All other
subsequent expenditure is recognised as an expense as it is incurred.
The standard gives examples of the kind of improvements that would allow subsequent
expenditure to be capitalised.
(1) Modification of an item of plant to extend its useful life
(2) Upgrade of machine parts to improve the quality of output
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(3) Adoption of a new production process, leading to large reductions in operating
costs

(b)
IAS 16 allows property, plant and equipment (most commonly property) to be shown at
a revalued amount. Such revaluations are permitted under the allowed alternative
treatment rules providing that the fair value of the asset can be measured reliably.
However, revaluation, particularly of property has been open to abuse, with companies
'cherry picking' those properties whose valuation is favourable to show at valuation.

Accordingly, IAS 16 tries to bring some consistency to the practice of revaluation.

When an item of property, plant and equipment is revalued, the whole class of assets
to which it belongs should be revalued. All the items within a class should be
revalued at the same time to prevent selective revaluation of certain assets and to
avoid disclosing a mixture of costs and values from different dates in the financial
statements. Revaluations must be sufficiently regular, so that the carrying value of an
asset does not differ significantly from its market value. In addition, revaluations must
be kept up to date. Surpluses and deficits

In the case of a surplus, IAS 16 requires the increase to be recognised in other

comprehensive income and accumulated in equity under the heading of revaluation
surplus. The exception is when the increase is reversing a previous decrease
which was recognised as an expense. Then it is treated as income.

The treatment is similar for a decrease in value on revaluation. Any decrease should
be recognised as an expense, except where it offsets a previous increase taken as
a revaluation surplus. In this case the decrease will be recognised in other
comprehensive income reducing the balance on the revaluation surplus.

Any decrease greater than the previous upwards increase in value must be taken as
an expense in the income statement section of the statement of comprehensive income.

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Gains and losses on disposal
Gains or losses are the difference between the estimated net disposal proceeds and the
carrying amount of the asset. They should be recognised as income or expense in
the income statement. Any revaluation surplus standing to the credit of a disposed
asset should be transferred to retained earnings as a reserve movement.

(c) (i) Following IAS 16, not all the components of the cost of the item of plant may be
capitalised. While trade discounts may be capitalised, settlement discounts may not.
Such discounts are a revenue item and will probably be deducted from administration
costs in the income statement. Likewise, maintenance is a revenue item. There will be
a prepayment in the statement of financial position for maintenance costs relating to
subsequent years. The cost of the error in specifying the power loading is an abnormal
cost and must be charged to the income statement. The costs to be capitalised may
now be calculated as follows.

$,000 $,000

Basic list price of plant 240,000.00

Less trade discount at 12.5% on list
price (30,000.00)

210,000.00

Shipping and handling costs 2,750.00

Estimated pre-production testing 12,500.00

Site preparation costs
Electrical cable installation
(14,000 -6,000) 8,000.00

Concrete re-inforcement 4,500.00

Own labour costs 7,500.00

20,000.00
Dismantling and restoration costs (15,000 +
3,000) 18,000.00

263,250.00
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