CAF7 financial accounting and reporting II questionbank ICAP

2015 FINANCIAL ACCOUNTING AND REPORTING II QUESTION BANK CAF-07 ICAP Question Bank P Financial accounting and reporting II Second edition published by Emile Woolf Limited Bracknell Enterprise & Innovation Hub Ocean House, 12th Floor, The Ring Bracknell, Berkshire, RG12 1AX United Kingdom Email: info@ewiglobal.com www.emilewoolf.com © Emile Woolf International, February 2015 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, without the prior permission in writing of Emile Woolf Publishing Limited, or as expressly permitted by law, or under the terms agreed with the appropriate reprographics rights organisation You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer Notice Emile Woolf International has made every effort to ensure that at the time of writing the contents of this study text are accurate, but neither Emile Woolf International nor its directors or employees shall be under any liability whatsoever for any inaccurate or misleading information this work could contain © Emile Woolf International ii The Institute of Chartered Accountants of Pakistan Certificate in Accounting and Finance Financial accounting and reporting II C Contents Page Question and Answers Index v Questions Section A Questions Answers 93 Answers Section B © Emile Woolf International iii The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II © Emile Woolf International iv The Institute of Chartered Accountants of Pakistan Certificate in Accounting and Finance Financial accounting and reporting II I Index to questions and answers Question page Answer page CHAPTER – IAS 1: PRESENTATION OF FINANCIAL STATEMENTS 2.1 LARRY 94 2.2 MINGORA IMPORTS LIMITED 95 2.3 BARRY 97 2.4 OSCAR INC 99 2.5 CLIFTON PHARMA LIMITED 101 2.6 SARHAD SUGAR LIMITED 103 2.7 BSZ LIMITED 10 105 2.8 YASIR INDUSTRIES LIMITED 12 108 2.9 SHAHEEN LIMITED 14 112 2.10 MOONLIGHT PAKISTAN LIMITED 15 114 2.11 FIGS PAKISTAN LIMITED 17 115 CHAPTER – IAS 7: STATEMENTS OF CASH FLOWS 3.1 KLEA 19 119 3.2 STANDARD INC 21 121 3.3 FALLEN 22 124 3.4 BIN QASIM MOTORS LIMITED 24 126 3.5 ITTEHAD MANUFACTURING LTD 27 129 3.6 WASEEM INDUSTRIES LIMITED 29 131 3.7 JALIB INDUSTRIES LIMITED 31 134 © Emile Woolf International v The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II Question page Answer page 3.8 APOLLO INDUSTRY LIMITED 32 136 3.9 MARVEL ENGINEERING LIMITED 34 137 CHAPTER – CONSOLIDATED ACCOUNTS: STATEMENTS OF FINANCIAL POSITION – BASIC APPROACH 4.1 HALL 36 139 4.2 HASSLE 37 140 4.3 HYMN 37 141 4.4 HANG 38 143 4.5 HASH 38 144 CHAPTER – CONSOLIDATED ACCOUNTS: STATEMENTS OF FINANCIAL POSITION - COMPLICATIONS 5.1 HAIL 39 146 5.2 HAIRY 40 148 5.3 HARD 41 150 5.4 HALE 42 152 5.5 HELLO 42 153 5.6 HASAN LIMITED 43 155 CHAPTER – CONSOLIDATED ACCOUNTS: STATEMENTS OF COMPREHENSIVE INCOME 6.1 HARRY 45 159 6.2 HORNY 46 161 6.3 HERON 47 163 6.4 HANKS 48 164 CHAPTER – PROPERTY, PLANT AND EQUIPMENT 7.1 ROONEY 50 168 7.2 EHTISHAM 51 170 7.3 CARLY 51 172 7.4 ADJUSTMENTS LIMITED 52 173 7.5 FAM 53 175 7.6 IMRAN LIMITED 54 177 7.7 HUMAYUN CHEMICALS LIMITED 55 179 7.8 FARADAY PHARMACEUTICAL LIMITED 55 180 © Emile Woolf International vi The Institute of Chartered Accountants of Pakistan Index to questions and answers Question page Answer page 7.9 SPIN INDUSTRIES LIMITED 56 182 7.10 SCIENTIFIC PHARMA LIMITED 56 183 7.11 QURESHI STEEL LIMITED 57 184 7.12 GRANITE CORPORATION 58 185 CHAPTER – IAS 38: INTANGIBLE ASSETS 8.1 FAZAL 59 186 8.2 HENRY 59 186 8.3 TOBY 60 187 8.4 BROOKLYN 60 188 8.5 ZOUQ INC 61 189 8.6 STAR-BRIGHT PHARMACEUTICAL LIMITED 62 190 8.7 RAISIN INTERNATIONAL 62 191 CHAPTER – IAS 17: LEASES 9.1 DAWOOD 64 192 9.2 FINLEY 64 192 9.3 FABIAN 64 193 9.4 XYZ INC 65 194 9.5 SNOW INC 65 197 9.6 MIRACLE TEXTILE LIMITED 66 199 9.7 SHOAIB LEASING LIMITED 66 200 9.8 NEPTUNE LIMITED 67 202 9.9 QUARTZ AUTO LIMITED 67 204 9.10 LODHI TEXTILE MILLS LIMITED 68 205 9.11 NOMAN ENGINEERING LIMITED 68 206 CHAPTER 10 – IAS 37: PROVISIONS CONTINGENT LIABILITIES AND CONTINGENT ASSETS AND IAS 10: EVENTS OCCURRING AFTER THE REPORTING DATE 10.1 BADAR 69 207 10.2 GEORGINA 69 207 10.3 EARLEY INC 70 209 10.4 ACCOUNTING TREATMENT 70 210 © Emile Woolf International vii The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II Question page Answer page 10.5 J-MART LIMITED 71 211 10.6 AKBER CHEMICALS LIMITED 72 212 10.7 QALLAT INDUSTRIES LIMITED 72 213 10.8 SKYLINE LIMITED 73 213 10.9 WALNUT LIMITED 74 214 10.10 ATTOCK TECHNOLOGIES LIMITED 75 215 CHAPTER 11 – IAS 8: ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 11.1 WONDER LIMITED 76 216 11.2 DUNCAN 77 217 11.3 MOHANI MANUFACTURING LIMITED 78 218 CHAPTER 12 – IAS 12: INCOME TAXES 12.1 FRANCESCA 79 219 12.2 SHEP (I) 79 220 12.3 SHEP (II) 80 221 12.4 SHEP (III) 81 222 12.5 SHEP (IV) 82 224 12.6 WAQAR LIMITED 82 225 12.7 SHAKIR INDUSTRIES 83 227 12.8 MARS LIMITED 84 228 12.9 BILAL ENGINEERING LIMITED 85 230 12.10 GALAXY INTERNATIONAL 85 231 12.11 APRICOT LIMITED 86 232 CHAPTER 13 – RATIO ANALYSIS 13.1 WASIM 87 233 13.2 AMIR AND MO 88 233 CHAPTER 14 – ETHICAL ISSUES IN FINANCIAL REPORTING 14.1 ETHICAL ISSUES 90 235 14.2 SINDH INDUSTRIES LTD 90 236 © Emile Woolf International viii The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II Working Carrying amount and tax base of machinery Cost b/f Accumulated depreciation b/f At 31 December 2013 Accounting depreciation (200/8 years) Tax depreciation (10% of WDV) NBV 200.0 (25.0) 175.0 (25.0) d) At 31 December 2014 Accounting depreciation (200/8 years) Tax depreciation (10% of WDV) 150.0 (25.0) 81.0 At 31 December 2015 125.0 72.9 NBV 50.0 (10.0) 40.0 (5.0) Tax base 50.0 (8.1) 40.5 (4.05) At 31 December 2014 Accounting depreciation (10%  50) Tax depreciation (10% of WDV) 35.0 (5.0) At 31 December 2015 30.0 36.45 (3.65) Movement on deferred taxation account (W2) At January Change due to change in rate (23.64  5/35) 2015 23.64 (3.38) 20.26 32.8 2014 29.57 - Change due to origination and reversal of temporary differences in the period (balancing figure) (5.47) (5.93) At December 31 14.79 23.64 Tax expense Current tax Deferred tax: Due to origination and reversal of temporary differences in the period Due to change in rate 2015 14.48 2014 13.63 - Tax expense e) 90.0 (9.0) Carrying amount and tax base of furniture and fittings Cost b/f Accumulated depreciation b/f At 31 December 2013 Accounting depreciation (10%  50) Tax depreciation (10% of WDV) c) Tax base 200.0 Tax reconciliation Accounting profit Tax rate (5.93) 5.63 7.7 2015 40.0 30% 12.0 Tax effect of untaxed gain: 30%  10.0 35%  8.0 Decrease in opening deferred tax balances due to change in rate (with rounding adjustment) Tax expense © Emile Woolf International (3.38) (5.47) (3.0) (2.8) (3.37) 5.63 226 2014 30.0 35% 10.5 7.7 The Institute of Chartered Accountants of Pakistan Answers 12.7 SHAKIR INDUSTRIES COMPUTATION OF TAX EXPENSE FOR THE YEAR ENDED DECEMBER 31, 2015 2015 Rs in million Profit before tax Add: Inadmissible expenses Accounting depreciation (Rs 1.1 million + Rs 0.7 million) Financial charges on finance lease Penalty paid to SECP Provision for gratuity 15.80 1.80 0.15 0.70 2.40 5.05 Less: Admissible expenses Tax depreciation Lease payments Payment of gratuity Borrowing cost capitalised Rs.m 1.65 0.65 1.60 2.30 6.20 Taxable profit for the year 14.65 Current tax expense @ 35% 5.13 COMPUTATION OF DEFERRED TAX EXPENSE FOR THE YEAR ENDED DECEMBER 31, 2015 Carrying amount Fixed assets – Owned Fixed assets – Leased Capital work in progress Provision for gratuity (0.7 + 2.4 – 1.6) Obligation against assets subject to finance lease Tax base Temp difference Rs.m Rs.m Rs.m 16.70 1.80 2.30 (1.50) 13.85 - 2.85 1.80 2.30 (1.50) (1.20) - Total (1.20) 4.25 Deferred tax expense @ 35% 1.49 Rs in million Deferred tax liability (Opening) 0.55 Deferred tax expense for the year (balancing figure) Deferred tax liability as at December 31, 2015 (Rs 4.25 million x 35%) 0.94 © Emile Woolf International 227 1.49 The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II 12.8 MARS LIMITED (a) Date Particulars Debit Credit Rupees 01.07.2014 01.07.2014 30.06.2015 Motor Vehicle - Cost Obligations under finance lease Capitalisation of the lease 1,600,000 1,600,000 Obligations under finance lease Bank First lease payment made in advance 480,000 Finance charges Accrued finance charges 153,451 480,000 153,451 Finance charge accrual for the year ended June 30, 2015 Working: (Rs 1,600,000  480,000)  13.701% = Rs 153,451) 30.06.2015 Depreciation Accumulated depreciation - Motor Vehicle 400,000 400,000 Depreciation charge for the year ended June 30, 2015 Working: Rs 1,600,000 ÷ = Rs 400,000 Assuming that there is no reasonable certainty about transfer of ownership at the end of lease term 30.06.2015 Tax expense (W1) 1,492,035 Tax payable 1,492,035 Recognition of tax expense for the year ended June 30, 2015) 30.06.2015 Tax expense Deferred tax (W2) Recognition of deferred tax asset W1 22,035 22,035 Tax computation Rs © Emile Woolf International Accounting profit before tax Add: Depreciation on leased assets Add: Finance charges Less: Lease payment 4,900,000 400,000 153,451 (480,000) Taxable profit 4,973,451 Tax @ 30% 1,492,035 228 The Institute of Chartered Accountants of Pakistan Answers W2 Deferred tax computation Carrying amount Taxable temporary difference Leased assets Deductible temporary difference Obligations under finance lease Accrued finance charges Tax base 1,200,000 - (1,120,000) (153,451) Net taxable temporary difference 1,200,000 (1,120,000) (153,451) (73,451) Deferred tax @ 30% (Asset) (b) Difference 22,035 Liabilities against assets subject to finance lease (W3) 2015 Rs Present value of minimum lease payments Less: Current maturity shown under current liabilities 1,120,000 (326,549) 793,451 Minimum lease payments (W3) Not later than year Later than year and not later than years (480,000 × 2) Less: future finance charges on finance lease 480,000 960,000 1,440,000 (320,000) 1,120,000 Present value of finance lease liabilities (W3) Not later than year Later than year and not later than years (371,289 + 422,162) 326,549 793,451 1,120,000 The minimum lease payment has been discounted at an interest rate of 13.701% to arrive at their present value Rentals are paid in annual instalments W3: Repayment Schedule Opening Principal Years Balance repayment Rs.m 2015 2016 2017 2018 1,600,000 1,120,000 793,451 422,162 Rs.m 480,000 326,549 371,289 422,162 Interest 13.701% Annual payment Closing Balance Rs.m Rs.m Rs.m 153,451 108,711 57,838 480,000 480,000 480,000 480,000 1,120,000 793,451 422,162 - 320,000 © Emile Woolf International 229 The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II 12.9 BILAL ENGINEERING LIMITED (a) Computation of current taxation Rs.m 50.000 10.000 Tax liability for the year (52.446 × 35%) Tax liability for prior periods (0.100 × 35%) 18.356 0.035 18.391 Deferred taxation Accounting depreciation Tax depreciation 0.096 1.000 (7.000) (0.300) (1.350) 52.446 10.000 (7.000) Financial charges on finance lease liability(1.00 – 0.3) × 13.701% Annual instalment of lease payment allowed under tax Amortization charged in accounts Amortization cost claimed in tax Excess of taxable income over accounting profit due to time differences Deferred tax credit at 35% Total tax expenses (current and deferred) (b) Rs.m Profit before tax Add: Accounting depreciation Financial charges on lease liability (1.00 – 0.3) × 13.701% Amortization of research and development cost for the year Less : Tax depreciation Annual instalment of lease payment Amortization of research and development cost (15 × 0.9/10) Current year taxable income 3.000 0.096 (0.300) (0.204) 1.000 (1.350) (0.350) 2.446 (0.856) 17.535 Bilal Engineering Limited: Notes to the financial statements for the year ended December 31, 2015 1.1 Relationship between tax expense and accounting profit 2015 Accounting profit before tax Tax on accounting profit at 35% Tax on expenses disallowed (Permanent Difference) Effective tax rate/tax charge 50.000 17.500 0.035 17.535 Rs.m (c) Journal entries © Emile Woolf International Income tax expenses Provision for taxation (Tax provision for 2015) Deferred tax asset Tax expenses – deferred (Deferred tax credit for 2015) 230 Debit Credit Rs.m Rs.m 18.391 18.391 0.856 0.856 The Institute of Chartered Accountants of Pakistan Answers 12.10 GALAXY INTERNATIONAL 28 : TAXATION 2015 2014 Rs.m Rs.m 0.84 6.95 7.79 (0.96) (0.96) 28.1 : Relationship between tax expense and accounting profit Profit/(Loss) before taxation 23.50 (1.75) Current - for the year (W – 1) Deferred (W – 2) Tax at the applicable rate of 35% Tax effect of exempt income (1.25 x 35%) W1 : Computation of Current Tax (Loss) / profit before tax as per books Add: Allowable income / Disallowed expenses Accounting depreciation Provision for gratuity Accrued expenses Less: Disallowed income / Allowable expenses Tax depreciation Interest income from SIBs (Exempt) Accrued expenses Taxable income / (loss) Tax liability (@ 35% Tax loss to be brought forward (29.05 x 35%) Tax payable W -2: Computation of Deferred Tax Timing differences (cumulative) on account of: Depreciation (2015: 30-51, 2014: 15-45) Accrued expenses Provision for gratuity Tax losses Deferred tax @ 35% Add: Opening deferred tax (dr.) Charge/(Reversal) for the year © Emile Woolf International 231 8.23 (0.44) 7.79 (0.61) (0.35) (0.96) 23.50 (1.75) 15.00 2.20 - 15.00 1.70 2.00 (6.00) (1.25) (2.00) 31.45 11.01 (10.17) 0.84 (45.00) (1.00) 21.00 (3.90) 17.10 30.00 (2.00) (1.70 ) (29.05) (2.75) 5.99 0.96 6.95 (0.96) (0.96) (29.05) - The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II 12.11 APRICOT LIMITED Taxation 2015 2014 Rs.m Rs.m Current (W1) Deferred (W2) 20.48 (1.58) 18.90 10.76 (21.35) (10.59) Relationship between tax expense and accounting profit Profit before taxation Tax at the applicable rate of 35% Less: Tax effect of exempt income 2015 60.00 21.00 (2.10) 18.90 W1: W2: Computation of Current Tax Profit before tax as per books Add: Allowable income / Disallowed expenses Accounting depreciation Tax profit on sale of fixed assets Bad debt expense 60.00 45.00 10.00 1.00 5.00 9.00 7.00 Less: Disallowed income / Allowable expenses Tax depreciation Accounting profit on sale of fixed assets Capital gain Bad debts written off (8.00) (0.50) (6.00) (3.00) (7.00) (4.00) Taxable income 58.50 50.00 Tax liability (@ 35%) 20.48 17.50 2015 2014 Rs.m Rs.m Computation of Deferred Tax Fixed assets (2014: 95-90, 2015: 82.5-80) (W2.1) Provision for bad debts (2014: 12×35%, 2015: 14×35%) 0.87 1.75 Closing balance of deferred tax Less: Opening balance (4.90) (4.03) (2.45) (4.20) (2.45) (18.90) Charge for the year (1.58) (21.35) [W2.2] W2.1 W2.2 Movement of Fixed Assets Opening balance Disposal during the year Depreciation for the year - 2015 Accounting 95.00 (2.50) (10.00) Tax 90.00 (2.00) (8.00) Closing balance 82.50 80.00 Movement of provision for bad debts Opening balance Provision for the year Write off during the year 2015 12.00 5.00 (3.00) 2014 9.00 7.00 (4.00) Closing balance 14.00 12.00 © Emile Woolf International 232 The Institute of Chartered Accountants of Pakistan Answers CHAPTER 13 – RATIO ANALYSIS 13.1 WASIM Ratios Year Gross profit % = Gross prof it x 100 Sales Net profit % = Net prof it x 100 Sales  Return on capital employed = Prof it bef ore interest and tax  405 x 100 = 19% 2,160 x 100 = 0.4%  Share capital and reserv es+ Long - term debt capital 15  x 100 = 6% Sales 2,160 Current ratio = Current assets 422 Current liabilities Quick ratio = Current assets excluding inv entory   13.2 56 x 100 = 29% x 100  = 8.8 times 246  x 100 = 2.9% Asset turnover =   53 190 Share capital and reserv es+ Long - term debt capital  x 100 = 20% 1,806 246  362 1,806 2,160  Year 422 - 106 Current liabilities Average time to collect = Trade receiv ables x 365 Sales Average time to pay = Trade pay ables x 365 Cost of purchases Inventory turnover = Inv entory x 365 Cost of sales = 1.7 times   1.2 times 254  316 x 365 2,160  198 x 365 1,755  106 x 365  1,755  Amir = 9.5 times 190 254  1,806  265 = 1.8 times 147 265 - 61  1.4 times 147  53 day s 198 x 365  1,806 = 41 day s   22 day s   40 day s 142 x 365 = 36 day s 1, 444 61 x 365 = 15 day s 1, 444 AMIR AND MO   Mo Gross profit % = Gross prof it 90,000 x 100 x 100 = 60% 150,000 Sales 490,000 x 100 = 70% 700,000 Net profit % = Net prof it x 100 Sales  © Emile Woolf International  44,895  x 100 = 30% 150,000  270,830 x 100 = 39% 700,000  233 The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II Return on capital employed = Prof it bef ore interest and tax Share capital and reserv es+ Long - term debt capital Amir 61,500 + 500 x 100 = 28.5% 207, 395 +10,000  Mo 371,000 +12,000 x 100 = 47% 565,580 + 250,000  Asset turnover =  Sales x 100 Share capital and reserv es+ Long - term debt capital Amir 150,000 = 0.7 times 207, 395 +10,000  Mo 700,000 = 0.85 times 565,580 + 250,000  Amir Mo  ratio = Current Current assets 50,000 Current liabilities 22,605 153,250 = 2.2 times = 1.3 times 117,670 Quick ratio =  Current assets excluding inv entory  50,000 - 12,000 22,605 Current liabilities Average time to collect =  Trade receiv ables x 365  = 1.7 times 37,500  150,000 153,250 - 26,250 = 1.1 times 117,670 x 365 = 91 day s  105,000 x 365 = 55 day s 700,000 Sales Average time to pay =  Trade pay ables  22,605 x 365 Cost of purchases  Inventory turnover = Inv entory © Emile Woolf International x 365 = 137 day s 60,000  117,670 x 365 = 204 day s 210,000  12,000 x 365 x 365 = 73 day s 60,000 Cost of sales    26,250 x 365 = 46 day s 210,000  234 The Institute of Chartered Accountants of Pakistan Answers CHAPTER 14 – ETHICAL ISSUES IN FINANCIAL REPORTING 14.1 ETHICAL ISSUES The range of comments made by Arif raises questions over his ethical behaviour and professional standards A chartered accountant should be unbiased when involved in preparing and reviewing financial information A chartered accountant should prepare financial statements fairly, honestly, and in accordance with relevant professional standards and must not be influenced by considerations of the impact of reported results Arif’s failings Arif appears to be influenced by the need to achieve a specified level of profit This is not appropriate and calls his integrity into question In addition Arif’s professional competence seems to be suspect His comment on not being up to date on all of the little technicalities in IFRS s suggests that he has not maintained a level of professional competence appropriate to his professional role ICAP members have a responsibility to engage in continuing professional development in order to ensure that their technical knowledge and professional skills are kept up to date Arif should seek continuing professional development activities and improve his knowledge on ethical standards Furthermore, it might be expected that as Waheed’s superior he should set an example to Waheed and guide him in his responsibilities Clearly this is not happening As a member of ICAP Arif should be aware of the ICAP code of ethics Arif should know of the danger of self-interest threats and intimidation threats to himself and to others His attempt to influence the outcome of a fellow professional by applying such a threat to that individual is very unprofessional Waheed’s ethical issues Waheed faces a self-interest threat, in that there is the possibility of a bonus provided the earnings per share figure remains the same as last year Arif has also suggested that she can influence the Board’s decision over employing him as a replacement finance director – another self-interest threat to Waheed Both of these threats must be ignored Arif’s comments imply that his application of professional responsibility is lacking This may extend into the way in which the current financial statements have been prepared Waheed must be very careful (as always) to carry out the review with all due care Waheed should first discuss his recommendations with Arif and remind his of his professional responsibilities to ensure that the accounting standards are correctly followed If the financial statements are found to contain errors or incorrect accounting treatment then they must be amended If Arif refuses to amend the draft financial statements if necessary Waheed should discuss the matter with other board members (including non- executives and the audit committee, if possible) Further action might include consulting with ICAP © Emile Woolf International 235 The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II 14.2 SINDH INDUSTRIES LTD (a) Financial reporting issues Revenue IAS 18 Revenue sets out the rules to be followed in recognising revenue The fact that the customer cannot cancel the contract is not relevant to the recognition of revenue Revenue from providing a service is recognised according to the stage of completion subject to satisfying criteria set out in IAS 18 In the absence of other information the revenue in this contract should be recognised over the life of the contract as time progresses As the contract was only signed just before the year end, none of the revenue can be recognised in 2015 The credit for the amount received should be recognised as a liability This represents the obligation that the company has to provide the service over the next two years The fact that the customer cannot cancel the contract is not relevant to the recognition of revenue If Sindh Industries failed to provide the service they would be sued for restitution Therefore the revenue can only be recognised as the service is provided New factory Borrowing costs directly attributable to construction of an asset which necessarily takes a substantial period to get ready for its intended use should be capitalised as part of the cost of that asset under IAS 23 Borrowing Costs IAS 23 states that the capitalisation of borrowing costs should commence when three conditions are all met for the first time: borrowing costs are being incurred, expenditure is being incurred and activities to prepare the asset are being undertaken Although borrowing costs were incurred throughout the year and expenditure was incurred from February 2015 (the date the land was purchased), construction only started on June 2015 Therefore this is the date on which capitalisation commences Capitalisation ceases when substantially all of the activities required to make the asset ready for use/sale have been completed, that is on 30 September 2015 (The actual date on which the factory was brought into use is irrelevant.) Therefore the period of capitalisation should be four months Where construction is financed from general borrowings, the calculation of the amount to be capitalised should be based on the weighted average cost of borrowings This is: (Rs.1,000,000 × 9.75%) + (Rs.1,750,000 × 10%) + (Rs.2,500,000 × 8%)/ (Rs.1,000,000 + Rs.1,750,000 + Rs.2,500,000) = 9% Therefore the amount capitalised should be 9% × Rs.4.5 million (land Rs.1.8 million plus construction costs Rs.2.7 million) × 4/12 = Rs.135,000 The total cost of the factory should be measured at Rs.4,635,000 (Rs.1.8 million plus Rs.2.7 million, plus Rs.135,000) The amount that has been recognised in the statement of financial position should be reduced by Rs.315,000 (Rs.450,000 – Rs.135,000) Finance costs recognised in profit or loss should be increased by Rs.315,000 Land should not be depreciated because it has an indefinite life Under IAS 16 Property, Plant and Equipment depreciation charges should start when the asset becomes available for use, from October 2015 in this case © Emile Woolf International 236 The Institute of Chartered Accountants of Pakistan Answers Depreciation of Rs.35,000 ((Rs.2.7 million, plus (Rs.135,000 × 2.7/4.5) ÷ 20) × 3/12) should be recognised in profit or loss for the year ended 31 December 2015 and the carrying amount of the asset reduced by the same amount to Rs.4.6 million Useful life of the blast furnace Depreciation of the blast furnace has been based on an estimated useful life of 20 years This is at variance with a report by a qualified expert The asset valuation specialist treats the furnace as being made up of two components, the main structure and the lining, which must be replaced at regular five yearly intervals over the life of the asset This is the approach required by IAS 16 The uncertainties inherent in business mean that many items in financial statements cannot be measured with certainty, but estimates should always be made using the most up to date and reliable information Where estimates have been prepared by professionals with relevant qualifications, then it is nearly always most appropriate to use those estimates Therefore in accordance with the valuer’s report the main structure of the furnace should be depreciated over 15 years from January 2015 and the lining should be depreciated over five years from that date The reassessment of the estimated lives of assets is a change in accounting estimate, rather than a change in accounting policy (IAS Accounting Policies, Changes in Accounting Estimates and Errors) Changes in accounting estimate should be dealt with on a prospective basis This is achieved by including the effect of the change in profit or loss in current and future periods The additional depreciation should be calculated as: Rs.000 Revised depreciation: main structure ((Rs.3.5m – Rs.1.4m)/15 years) 140 lining (Rs.1.4m/5 years) 280 420 Current depreciation (Rs.3.5m/20 years) (175) Additional depreciation 245 IAS requires the disclosure of the nature and amount of the effect of the change in the estimate of useful lives on the profit for the year (b) Revised financial statements Statement of profit or loss extract for the year ended 31 December 2015 Draft Revenue Rs.000 Profit before tax © Emile Woolf International Rs.000 2,500 (1,000) 237 Borrowing Blast costs furnace Rs.000 (315)+ (35) Revised Rs.000 Rs.000 (245) 905 The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II Statement of financial position at 31 December 2015 Draft Revenue Rs.000 Rs.000 (c) Non-current assets Property, plant and equipment Current assets Total assets 12,000 3,500 15,500 Share capital Retained earnings Equity Non-current liabilities Current liabilities Total equity and liabilities 2,000 6,000 8,000 5,000 2,500 15,500 (1,000) 500 500 Borrowing costs Rs.000 Blast furnace Rs.000 (315) + (35) (245) (315) + (35) (245) Revised Rs.000 11,405 3,500 14,905 2,000 4,405 6,405 5,500 3,000 15,905 Ethical issues It is noticeable that all the adjustments required reduce profit This and the background to the previous finance director’s resignation suggest serious problems It is not clear who actually prepared the draft financial statements If they were prepared by more junior staff in the absence of a finance director, some of the adjustments (for example, the calculation of borrowing costs to be capitalised) could be the result of genuine errors or lack of accounting knowledge However, it seems reasonably clear that the managing director has attempted to influence the treatment of the revenue and the estimated useful life of at least one significant non-current asset (Note: the directors have reviewed the useful lives of several items of plant and machinery and it is possible that other assets besides the furnace are being depreciated over unrealistically long periods.) It seems almost certain that the previous finance director resigned as a result of pressure from the managing director (and possibly from other members of the Board) to present the financial statements in a favourable light The directors intend to seek a stock market listing in the near future Therefore they have clear motives for manipulating the profit figure and also (perhaps) for making controversial decisions before the financial statements come under much greater scrutiny as a result of the listing The job title of financial controller is also significant It suggests that the role has been downgraded and that the person holding it has less authority than the rest of the Board Possible courses of action:  Discuss with the managing director the financial reporting standards that apply to the transactions and explain the implications of non-compliance If the managing director is himself a member of a professional body then it might be worth pointing out to him that he himself is bound by an ethical code  Advise him that as a Chartered Accountant you are bound by the ICAP code of ethics, and that you would not be prepared to compromise your views of the figures he has prepared for career advancement  Consider speaking to the other directors (or audit committee if there is one) and seeking their support  If all of these actions produce a negative response then it would be appropriate to consult the ICAP ethical handbook and/or the Institute  If all else fails then consider seeking alternative employment © Emile Woolf International 238 The Institute of Chartered Accountants of Pakistan Head Office-Karachi: Chartered Accountants Avenue, Clifton, Karachi-75600 Phone: (92-21) 99251636-39, UAN: 111-000-422, Fax: (92-21) 99251626, e-mail: info@icap.org.pk Regional Office-Lahore: 155-156, West Wood Colony, Thokar Niaz Baig, Raiwind Road, Lahore Phone: (92-42) 37515910-12, UAN: 111-000-422, e-mail: lahore@icap.org.pk Islamabad Office: Sector G-10/4, Mauve Area, Islamabad UAN: 111-000-422, Fax: (92-51) 9106095, e-mail: islamabad@icap.org.pk Faisalabad Office: 36-Z, Commerical Center, Near Mujahid, Hospital Madina Town, Faisalabad Phone: (92-41) 8531028, Fax: (92-41) 8503227, e-mail: faisalabad@icap.org.pk Multan Office: 3rd Floor, Parklane Tower, Officers’ Colony, Near Eid Gaah Chowk, Khanewal Road, Multan Phone: (92-61) 6510511-6510611, Fax: (92-61) 6510411, e-mail: multan@icap.org.pk Peshawar Office: House No 30, Old Jamrud Road, University Town, Peshawar Phone: (92-91) 5851648, Fax: (92-91) 5851649, e-mail: peshawar@icap.org.pk Gujranwala Office: 2nd Floor, Gujranwala Business Center, Opp Chamber of Commerce, Main G.T Road, Gujranwala Phone: (92-55) 3252710, e-mail: gujranwala@icap.org.pk Sukkur Office: Admin Block Sukkur IBA, Airport Road, Sukkur Phone: (92-71) 5806109, e-mail: sukkur@icap.org.pk Quetta Office: Civic Business Center, Hali Road, Quetta Cantt Phone: (92-81) 2865533, e-mail: quetta@icap.org.pk Mirpur AJK Office: Basic Health Unit (BHU) Building Sector D, New City Mirpur, Azad Jammu and Kashmir e-mail: mirpur@icap.org.pk 2015 FINANCIAL ACCOUNTING AND REPORTING II QUESTION BANK ... in Accounting and Finance Financial accounting and reporting II A Questions © Emile Woolf International The Institute of Chartered Accountants of Pakistan Financial accounting and reporting II. .. Woolf International ii The Institute of Chartered Accountants of Pakistan Certificate in Accounting and Finance Financial accounting and reporting II C Contents Page Question and Answers Index... Certificate in Accounting and Finance Financial accounting and reporting II I Index to questions and answers Question page Answer page CHAPTER – IAS 1: PRESENTATION OF FINANCIAL STATEMENTS 2.1