CIMA Paper F1 Financial Reporting and Taxation Study Text Published by: Kaplan Publishing UK Unit 2 The Business Centre, Molly Millars Lane, Wokingham, Berkshire RG41 2QZ Copyright © 2015 Kaplan Financial Limited. 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 or otherwise without the prior written permission of the publisher. Acknowledgements We are grateful to the CIMA for permission to reproduce past examination questions. The answers to CIMA Exams have been prepared by Kaplan Publishing, except in the case of the CIMA November 2010 and subsequent CIMA Exam answers where the official CIMA answers have been reproduced. Notice The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. 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ISBN: 9781784153021 Printed and bound in Great Britain. ii Contents Page Chapter Fundamentals of Business Taxation Chapter Accounting for Investments in Subsidiaries and Associates 67 Chapter Consolidated Statement of Financial Position 75 Chapter Consolidated Statement of Profit or Loss and other comprehensive income 143 Chapter Associates 173 Chapter The Regulatory Environment 203 Chapter The Conceptual Framework 221 Chapter External Audit 247 Chapter Code of Ethics 265 Chapter 10 Corporate governance 279 Chapter 11 Introduction to Single Entity Accounts 301 Chapter 12 IAS 7 Statement of Cash Flows 357 Chapter 13 Noncurrent Assets 405 Chapter 14 IFRS 5 Noncurrent Assets Held for Sale and Discontinued Operations 457 Chapter 15 IAS 20 Government Grants and IAS 40 Investment Properties 485 Chapter 16 IAS 2, 8, 10, 34 and IFRS 8 503 Chapter 17 IAS 12 Income Taxes 543 Chapter 18 IAS 21 – The Effects of Changes in Foreign Exchange Rates 563 Chapter 19 IAS 19 – Employee benefits 579 Chapter 20 Shortterm finance and investments 597 Chapter 21 Working capital management 631 iii iv Chapter 22 Working capital management – accounts receivable and payable Chapter 23 Working capital management – inventory control 719 Chapter 24 Working capital management – cash control 679 743 chapter Intro Introduction v How to use the materials These official CIMA learning materials have been carefully designed to make your learning experience as easy as possible and to give you the best chances of success in your Objective Test Examination. The product range contains a number of features to help you in the study process. They include: • • • a detailed explanation of all syllabus areas; extensive ‘practical’ materials; generous question practice, together with full solutions This Study Text has been designed with the needs of home study and distance learning candidates in mind. Such students require very full coverage of the syllabus topics, and also the facility to undertake extensive question practice. However, the Study Text is also ideal for fully taught courses. The main body of the text is divided into a number of chapters, each of which is organised on the following pattern: vi • Detailed learning outcomes. These describe the knowledge expected after your studies of the chapter are complete. You should assimilate these before beginning detailed work on the chapter, so that you can appreciate where your studies are leading • Stepbystep topic coverage. This is the heart of each chapter, containing detailed explanatory text supported where appropriate by worked examples and exercises. You should work carefully through this section, ensuring that you understand the material being explained and can tackle the examples and exercises successfully. Remember that in many cases knowledge is cumulative: if you fail to digest earlier material thoroughly, you may struggle to understand later chapters • Activities. Some chapters are illustrated by more practical elements, such as comments and questions designed to stimulate discussion Question practice. The text contains three styles of question: • • – Examstyle objective test questions (OTQs) – 'Integration' questions – these test your ability to understand topics within a wider context. This is particularly important with calculations where OTQs may focus on just one element but an integration question tackles the full calculation, just as you would be expected to do in the workplace – ‘Case’ style questions – these test your ability to analyse and discuss issues in greater depth, particularly focusing on scenarios that are less clear cut than in the Objective Test Examination, and thus provide excellent practice for developing the skills needed for success in the Operational Level Case Study Examination Solutions. Avoid the temptation merely to ‘audit’ the solutions provided. It is an illusion to think that this provides the same benefits as you would gain from a serious attempt of your own. However, if you are struggling to get started on a question you should read the introductory guidance provided at the beginning of the solution, where provided, and then make your own attempt before referring back to the full solution If you work conscientiously through this Official CIMA Study Text according to the guidelines above you will be giving yourself an excellent chance of success in your Objective Test Examination. Good luck with your studies! Quality and accuracy are of the utmost importance to us so if you spot an error in any of our products, please send an email to mykaplanreporting@kaplan.com with full details, or follow the link to the feedback form in MyKaplan. Our Quality Coordinator will work with our technical team to verify the error and take action to ensure it is corrected in future editions. Icon Explanations Definition – These sections explain important areas of knowledge which must be understood and reproduced in an assessment environment Key point – Identifies topics which are key to success and are often examined. Supplementary reading – These sections will help to provide a deeper understanding of core areas. The supplementary reading is NOT optional reading. It is vital to provide you with the breadth of knowledge you will need to address the wide range of topics within your syllabus that could feature in an assessment question Reference to this text is vital when self studying Test your understanding – Following key points and definitions are exercises which give the opportunity to assess the understanding of these core areas vii Illustration – To help develop an understanding of particular topics. The illustrative examples are useful in preparing for the Test your understanding exercises. Exclamation mark – This symbol signifies a topic which can be more difficult to understand. When reviewing these areas, care should be taken Study technique Passing exams is partly a matter of intellectual ability, but however accomplished you are in that respect you can improve your chances significantly by the use of appropriate study and revision techniques. In this section we briefly outline some tips for effective study during the earlier stages of your approach to the Objective Test Examination. We also mention some techniques that you will find useful at the revision stage. Planning To begin with, formal planning is essential to get the best return from the time you spend studying. Estimate how much time in total you are going to need for each subject you are studying. Remember that you need to allow time for revision as well as for initial study of the material. With your study material before you, decide which chapters you are going to study in each week, and which weeks you will devote to revision and final question practice. Prepare a written schedule summarising the above and stick to it! It is essential to know your syllabus. As your studies progress you will become more familiar with how long it takes to cover topics in sufficient depth. Your timetable may need to be adapted to allocate enough time for the whole syllabus. Students are advised to refer to the notice of examinable legislation published regularly in CIMA’s magazine (Financial Management), the students enewsletter (Velocity) and on the CIMA website, to ensure they are uptodate. The amount of space allocated to a topic in the Study Text is not a very good guide as to how long it will take you. The syllabus weighting is the better guide as to how long you should spend on a syllabus topic. viii Tips for effective studying (1) Aim to find a quiet and undisturbed location for your study, and plan as far as possible to use the same period of time each day. Getting into a routine helps to avoid wasting time. Make sure that you have all the materials you need before you begin so as to minimise interruptions (2) Store all your materials in one place, so that you do not waste time searching for items every time you want to begin studying. If you have to pack everything away after each study period, keep your study materials in a box, or even a suitcase, which will not be disturbed until the next time (3) Limit distractions. To make the most effective use of your study periods you should be able to apply total concentration, so turn off all entertainment equipment, set your phones to message mode, and put up your ‘do not disturb’ sign (4) Your timetable will tell you which topic to study. However, before diving in and becoming engrossed in the finer points, make sure you have an overall picture of all the areas that need to be covered by the end of that session. After an hour, allow yourself a short break and move away from your Study Text. With experience, you will learn to assess the pace you need to work at. Each study session should focus on component learning outcomes – the basis for all questions (5) Work carefully through a chapter, making notes as you go. When you have covered a suitable amount of material, vary the pattern by attempting a practice question. When you have finished your attempt, make notes of any mistakes you made, or any areas that you failed to cover or covered more briefly. Be aware that all component learning outcomes will be tested in each examination (6) Make notes as you study, and discover the techniques that work best for you. Your notes may be in the form of lists, bullet points, diagrams, summaries, ‘mind maps’, or the written word, but remember that you will need to refer back to them at a later date, so they must be intelligible. If you are on a taught course, make sure you highlight any issues you would like to follow up with your lecturer (7) Organise your notes. Make sure that all your notes, calculations etc. can be effectively filed and easily retrieved later ix Objective Test Objective Test questions require you to choose or provide a response to a question whose correct answer is predetermined. The most common types of Objective Test question you will see are: • Multiple choice, where you have to choose the correct answer(s) from a list of possible answers. This could either be numbers or text • Multiple choice with more choices and answers, for example, choosing two correct answers from a list of eight possible answers. This could either be numbers or text • Single numeric entry, where you give your numeric answer, for example, profit is $10,000 • • Multiple entry, where you give several numeric answers • Matching pairs of text, for example, matching a technical term with the correct definition • Other types could be matching text with graphs and labelling graphs/diagrams True/false questions, where you state whether a statement is true or false In every chapter of this Study Text we have introduced these types of questions, but obviously we have had to label answers A, B, C etc rather than using click boxes. For convenience we have retained quite a few questions where an initial scenario leads to a number of subquestions. There will be questions of this type in the Objective Test Examination but they will rarely have more than three subquestions. Guidance re CIMA onscreen calculator As part of the CIMA Objective Test software, candidates are now provided with a calculator. This calculator is onscreen and is available for the duration of the assessment. The calculator is available in each of the Objective Test Examinations and is accessed by clicking the calculator button in the top left hand corner of the screen at any time during the assessment. All candidates must complete a 15minute tutorial before the assessment begins and will have the opportunity to familiarise themselves with the calculator and practise using it. Candidates may practise using the calculator by downloading and installing the practice exam at http://www.vue.com/athena/. The calculator can be accessed from the fourth sample question (of 12). x Fundamentals of Business Taxation 8 Summary diagram 52 chapter Test your understanding answers Test your understanding – Trading income $ 80,000 (8,000) 5,500 ––––––– 77,500 19,375 Accounting profit Less: exempt income Add back: disallowable expenses Taxable profit Tax at 25% Test your understanding – Trading income Plant and machinery Accounting depreciation Building $1,500 ($10,000 + $5,000 × 10%) Accounting depreciation $4,000 ($100,000 × 4%) Total accounting depreciation = ($1,500 + $4,000) = $5,500 Test your understanding – Trading income Plant and machinery Tax depreciation TWDV at start of year $8,000 Tax depreciation at 20% $1,600 ($10,000 × 80%) The asset had been purchased in the previous accounting period, therefore tax depreciation has already been claimed for Ye. 31/03/X1. This year's tax depreciation must be calculated on the tax written down value at the beginning of the year, i.e. $8,000. The new plant and machinery is given 100% FYA which means relief in given on the total cost in the year of purchase of $5,000. The building tax depreciation of 3% is based on cost of $100,000 = $3,000 Total tax depreciation = ($1,600 + $5,000 + $3,000) = $9,600 53 Fundamentals of Business Taxation Test your understanding – Trading income $ Accounting profit 60,000 Less exempt income (4,000) Add back disallowable expenses 4,500 Add accounting depreciation 5,500 (TYU 2) Less tax depreciation Taxable profit (9,600) (TYU 3) ––––––– 56,400 Test your understanding – Trading income $ Accounting profit 60,000 Less exempt income (4,000) Add back disallowable expenses 4,500 Add accounting depreciation 5,500 (TYU 2) Less tax depreciation Taxable profit Tax at 30% (9,600) (TYU 3) ––––––– 56,400 16,920 Test your understanding – Trading income Tax payable is: ($800,000 × 9/12 × 26%) + ($800,000 × 3/12 × 28%) = $212,000 The accounting period runs from 01/07/X0 to 30/06/X1. 9 months of the accounting period profit (01/07/X0 – 31/03/X1) is charged at 26% and 3 months of the accounting period profit (01/04/X1 – 30/06/X1) is charged at 28%. 54 chapter Test your understanding – Balancing allowances/charges Carrying amount at the date of sale = $10,000 – $2,000 = $8,000 Accounting depreciation ($10,000 × 10% × 2 years) = $2,000 Total accounting loss = (proceeds $6,000 – CA $8,000) = $2,000 Test your understanding – Balancing allowances/charges Plant and machinery Tax depreciation in year 1 $2,000 ($10,000 × 20%) TWDV at start of year 2 $8,000 ($10,000 × 80%) Tax depreciation at 20% $1,600 The total tax depreciation = $2,000 + $1,600 = $3,600. Tax written down value at the date of sale = $10,000 – $3,600 = $6,400 Total tax loss = (proceeds $6,000 – TWDV $6,400) = $400 This $400 would be classed as a balancing allowance Test your understanding – Balancing allowances/charges $ Accounting profit Add accounting loss Less tax loss (BA) Taxable profit Tax at 25% 50,000 2,000 (TYU 7) (400) (TYU 8) ––––––– 51,600 12,900 55 Fundamentals of Business Taxation Test your understanding 10 – Balancing allowances/charges $ Accounting profit 50,000 Less accounting profit (1,000) (W1) Less tax loss (BA) 2,600 (W2) ––––––– Taxable profit Tax at 25% 51,600 12,900 (W1) Carrying amount at the date of sale = $10,000 – $2,000 = $8,000 Accounting depreciation ($10,000 × 10% × 2 years) = $2,000 Total accounting profit = (proceeds $9,000 – CA $8,000) = $1,000 (W2) Tax depreciation in year 1 $2,000 ($10,000 × 20%) TWDV at start of year 2 $8,000 ($10,000 × 80%) Tax depreciation at 20% $1,600 The total tax depreciation = $2,000 + $1,600 = $3,600. Tax written down value at the date of sale = $10,000 – $3,600 = $6,400 Total tax profit = (proceeds $9,000 – TWDV $6,400) = $2,600 This $2,600 would be classed as a balancing charge 56 chapter Test your understanding 11 – Trading losses Year Trading profit/(loss) Workings 1 – 20,000 – 20,000 2 – 3 – 19,000 – 19,000 4 19,000 25,000 – 6,000 (balance of the loss) The trading loss is carried back first against the trading profit in year 1, this must be done to the maximum extent, i.e. you cannot use part of the profit for relief if all of it is needed. The balance of the loss must then be carried forward against the first available trading profit in year 3, again to the maximum extent and this means year 4 will be reduced by the remainder of the loss $6,000, i.e. ($45,000 – $20,000 – $19,000). Year 4 will therefore have trading profits of $19,000 ($25,000 – $6,000). Test your understanding 12 – Cessation losses 20X1 $ 20X2 20X3 $ $ Trading profits 100,000 50,000 – Loss relief (10,000) ––––––– (50,000) ––––––– – ––––––– 90,000 – – Revised trading profits On cessation, trading losses must be carried back on a LIFO basis, i.e. most recent trading profits are used first. When you carry back make sure you relieve the loss against the profit to the maximum possible extent in the year, you can't use part of it If the loss has been carried back as far as possible, (years dependent on the rule for that country), and still not fully relieved, then the remainder of the loss would be wasted. 57 Fundamentals of Business Taxation Test your understanding 13 – Capital taxes Sale proceeds $ 150,000 Less: cost to sell (2,000) ––––––– Net proceeds 50,000 148,000 1,500 12,000 ––––––– (63,500) ––––––– 84,500 Cost to purchase Cost to buy Enhancements Chargeable gain NB: Roof repairs are not an allowable cost for deduction, i.e. they are not a "new" capital cost or a cost to buy/sell. They are a cost to replace an existing structure. Test your understanding 14 – Capital taxes The indexation allowance would be as follows: ($50,000 + $1,500) × 30% = $15,450 12,000 × 20% = $2,400 Total allowance = $15,450 + $2,400 = $17,850 The allowance is given based on the movement in the RPI between the purchase date to the disposal date to give relief for inflation. 58 chapter Test your understanding 15 – Capital taxes Sale proceeds $ 150,000 Less: cost to sell (2,000) ––––––– Net proceeds 50,000 148,000 1,500 12,000 ––––––– (63,500) ––––––– 84,500 Cost to purchase Cost to buy Enhancements Less: Indexation allowance ($50,000 + $1,500) × 30% 12,000 × 20% (15,450) (2,400) (17,850) ––––––– Chargeable gain 66,650 Capital tax = $66,650 × 30% =$19,995 Test your understanding 16 – Loss relief Year Capital gain/(loss) Trading profit/(loss) 1 4,000 – 2 – – 3 3,000 13,000 The capital loss cannot be carried back against year 1, only carried forward against the first available capital gain. It will be used against the gain in year 3 to reduce it to $3,000 ($9,000 – $6,000). The trading loss is carried back first against year 1 to reduce the profit to nil. The remainder of the loss of $3,000 ($30,000 – $27,000) is carried forward against year 3 to reduce the profit to $13,000 ($16,000 – $3,000). 59 Fundamentals of Business Taxation Test your understanding 17 – VAT Output VAT VAT $ – 40,000 ––––––– 40,000 Sales of Paws – $120,000 × 0% Sales of Claws – $240,000 × 20/120 Input VAT Purchases $90,000 × 15% Purchases $60,000 × 15% Total VAT payable 13,500 9,000 ––––––– (22,500) ––––––– 17,500 Profit is based on net sales and purchases. Sales of Paws Sales of Claws (240,000 – 40,000) Purchases (90,000 + 60,000) Profit 60 $ 120,000 200,000 ––––––– 320,000 (150,000) ––––––– 170,000 chapter Test your understanding 18 – International taxation Net dividend received WHT 5% ($100,000 × 80%) UT – $80,000 × (62/310) Gross dividend Total foreign tax ($96,000 – $76,000) $ 76,000 4,000 ––––––– 80,000 16,000 ––––––– 96,000 20,000 Tax in UK Tax at 40% on gross dividend $96,000 38,400 Less DTR (lower of foreign and UK tax) (20,000) ––––––– Tax paid in UK 18,400 Test your understanding 19 – Transfer pricing Aston must increase its taxable profits by $7,500 ($1.50 × 5,000 units). The taxable profits must reflect the sale at market value, i.e. arms length price. 61 Fundamentals of Business Taxation Test your understanding 20 – Practice questions (1) (a) VAT (b) Employee tax deducted from salaries (c) Corporate income tax (corporation tax) (2) Tax evasion is the illegal manipulation of the tax system to avoid paying tax Tax avoidance is tax planning to arrange the affairs of the enterprise within the scope of the law to minimise the income tax liability. (3) Tax authorities may have the following powers: – Power to review and query filed returns – Power to request special reports if inadequate information has been submitted – Power to examine records of previous periods – Powers of entry and search – Power to pass on information to foreign tax authorities (4) B – Excise duties (5) Benefits in kind are noncash benefits given by the employer to an employee, often in place of cash payments (6) A – Excise duty (7) The advantages for the government are: – The tax is collected earlier than the usual selfassessment systems which collect tax after the tax year which gives a cash flow benefit – The costs of tax collection and administration are passed on to the employer who acts as a tax collector The advantage for the employee is: – 62 The tax is collected gradually over the year thus is easier to bear than a single lump sum payment chapter (8) Enterprise A Sale to B Input tax Output tax $ $ 12 VAT paid $ 12 paid by A B Purchase from B Sale to C 12 18 6 paid by B C Purchase from B Sale to D 18 28 10 paid by C Total suffered by D 28 (9) C – You need to add the excise duty of $1,000 (100 items × $10) and compute VAT on the inclusive price of $5,000 (100 items × $40 plus excise duty of $1,000). The VAT is 15% of $5,000 which results in 750. Total tax payable is $1,000 excise duty and $750 VAT = $1,750 (10) It is necessary to compute the VAT on sales (output VAT) and the VAT on purchases (input VAT): Output VAT charged on standard rated sales (800 × $30) × $4,200 17.5% = Input VAT paid (2,000 × 17.5%) ($350) ––––– VAT paid to tax authorities $3,850 The VAT can be claimed back on standardrated and zerorated supplies. The correct answer is C. (11) B (12) D – The correct answer is country in which goods are sold (13) An overseas subsidiary is an enterprise resident for tax purposes in a foreign country whose share capital is owned by an entity resident in another country (14) A – Profits of the enterprise (15) D – Loss relief (16) D – A warehouse used for storage (17) Incidence of Tax is the distribution of the tax burden – who actually pays the tax (18) D (19) A – Paid by one person with the intention of passing it on (20) Hypothecation is the extent to which a certain type of tax is entirely allocated to a certain type of expenditure 63 Fundamentals of Business Taxation Test your understanding 21 – Practice questions (1) D – International Law. (2) B – Country that has enforceable laws that apply to an enterprise (3) The three main tax bases are: assets (capital), Income and consumption (4) A – $3,000 tax on $30,000 = 10% and $7,500 tax on $60,000 = 12.5%. The tax rates increase as the income rises, hence a progressive tax (5) C – To ensure that standard rates of depreciation are used by all organisations for tax purposes (6) A – Deferral of the payment of corporate income tax on gains arising from the disposal of a business asset (7) A – All the underlying corporate income tax on the dividend distribution is passed as a credit to the shareholders (8) B – Unit tax. This is a tax based on the number or weight of items, e.g. excise duties (9) A – Power of arrest (10) Answers could be: – So that entities know when payment is required; – It enables the tax authorities to forecast their cash flows more accurately; – Provides a reference for late payment – useful for applying penalties for not paying; – To prevent entities spending tax money deducted from employees. If tax is deducted from employees at source and not paid to the tax authorities fairly quickly, there is more chance of an entity spending the amount deducted, instead of paying it to the tax authorities (11) A branch of the entity is merely an extension of the entity's business (12) Gross dividend = $90,000/90 × 100 = $100,000 Underlying tax = (Tax on profits/profits after tax) × gross dividend Underlying tax = (200,000/1,000) × 100,000 = $20,000 (13) C – Country C. An entity is considered to be resident in the country of effective management (14) Withholding tax is a tax deducted at source from a payment before it is made to the recipient. Underlying tax is the tax on the profits out of which a dividend is paid 64 chapter (15) Indexation allowance is a relief given on the disposal of capital assets. The relief is based on the movement of RPIs between the date costs were incurred on the asset and the disposal date and represents relief for inflation. The indexation allowance will reduce the amount of gain charged for tax purposes. (16) Taxable profit = $100,000 + $10,000 + $15,000 – $9,000 = $116,000 (17) Chargeable gain = $40,000 – $15,000 – $2,000 – $5,000 = $18,000 (18) Chargeable gains are created when assets are sold at a profit. They are calculated based on the difference between proceeds and allowable costs. Capital taxes represent the tax charged on the chargeable gains (19) True. Balancing charges represent the tax profit on disposal of an asset for corporate tax purposes. They are calculated on the difference between proceeds and tax written down value. The balance charge will increase the taxable profits 65 Fundamentals of Business Taxation 66 ... 5.101 4.730 4.775 4.812 4.843 4.870 F1 FINANCIAL REPORTING AND TAXATION Syllabus overview F1 covers the regulation and preparation of financial statements and how the information contained in... Accounting Standards Board • • • financial reporting including local corporate law, local and international conceptual frameworks, local and international financial reporting standards and other... accordance with international financial reporting standards F1 – B FINANCIAL ACCOUNTING AND REPORTING (45%) produce the consolidated statement of financial position and consolidated statement of comprehensive