S T U D Y PAPER F7 FINANCIAL REPORTING (INTERNATIONAL) In this new syllabus first edition approved by ACCA • We discuss the best strategies for studying for ACCA exams • We highlight the most important elements in the syllabus and the key skills you will need • We signpost how each chapter links to the syllabus and the study guide • We provide lots of exam focus points demonstrating what the examiner will want you to • We emphasise key points in regular fast forward summaries • We test your knowledge of what you've studied in quick quizzes • We examine your understanding in our exam question bank • We reference all the important topics in our full index BPP's i-Learn and i-Pass products also support this paper FOR EXAMS IN DECEMBER 2009 AND JUNE 2010 T E X T First edition 2007 Third edition June 2009 ISBN 9780 7517 6370 (Previous ISBN 9870 7517 4729 4) British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Published by BPP Learning Media Ltd BPP House, Aldine Place London W12 8AA All our 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 BPP Learning Media Ltd www.bpp.com/learningmedia Printed in the United Kingdom We are grateful to the Association of Chartered Certified Accountants for permission to reproduce past examination questions The suggested solutions in the exam answer bank have been prepared by BPP Learning Media Ltd, unless otherwise stated Your learning materials, published by BPP Learning Media Ltd, are printed on paper sourced from sustainable, managed forests © BPP Learning Media Ltd 2009 ii Contents Page Introduction How the BPP ACCA-approved Study Text can help you pass (v) Studying F7 (vii) The exam paper (viii) 10 11 12 13 14 15 16 17 18 19 20 21 22 23 The conceptual framework The regulatory framework 21 Presentation of published financial statements 35 Non-current assets 59 Intangible assets 89 Impairment of assets 101 Reporting financial performance 111 Introduction to groups 123 The consolidated statement of financial position 135 The consolidated income statement 175 Accounting for associates 187 Inventories and construction contracts 201 Provisions, contingent liabilities and contingent assets 219 Financial assets and liabilities 231 The legal versus the commercial view of accounting 245 Leasing 263 Accounting for taxation 271 Earnings per share 289 Analysing and interpreting financial statements 303 Limitations of financial statements and interpretation techniques 329 Statements of cash flows 337 Alternative models and practices 355 Specialised, not-for-profit and public sector entities 365 Exam question bank 375 Exam answer bank 401 Index 447 Review form and free prize draw iii A note about copyright Dear Customer What does the little © mean and why does it matter? 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But the e-products are sold on a single user licence basis: we not supply ‘unlock’ codes to people who have bought them second-hand And what about outside the UK? BPP Learning Media strives to make our materials available at prices students can afford by local printing arrangements, pricing policies and partnerships which are clearly listed on our website A tiny minority ignore this and indulge in criminal activity by illegally photocopying our material or supporting organisations that If they act illegally and unethically in one area, can you really trust them? iv How the BPP ACCA-approved Study Text can help you pass your exams – AND help you with your Practical Experience Requirement! NEW FEATURE – the PER alert! Before you can qualify as an ACCA member, you not only have to pass all your exams but also fulfil a three year practical experience requirement (PER) To help you to recognise areas of the syllabus that you might be able to apply in the workplace to achieve different performance objectives, we have introduced the ‘PER alert’ feature You will find this feature throughout the Study Text to remind you that what you are learning to pass your ACCA exams is equally useful to the fulfilment of the PER requirement Tackling studying Studying can be a daunting prospect, particularly when you have lots of other commitments The different features of the text, the purposes of which are explained fully on the Chapter features page, will help you whilst studying and improve your chances of exam success Developing exam awareness Our Texts are completely focused on helping you pass your exam Our advice on Studying F7 outlines the content of the paper, the necessary skills the examiner expects you to demonstrate and any brought forward knowledge you are expected to have Exam focus points are included within the chapters to highlight when and how specific topics were examined, or how they might be examined in the future Using the Syllabus and Study Guide You can find the syllabus, Study Guide and other useful resources for F7 on the ACCA web site: www.accaglobal.com/students/study_exams/qualifications/acca_choose/acca/professional/fr/ The Study Text covers all aspects of the syllabus to ensure you are as fully prepared for the exam as possible Testing what you can Testing yourself helps you develop the skills you need to pass the exam and also confirms that you can recall what you have learnt We include Questions – lots of them - both within chapters and in the Exam Question Bank, as well as Quick Quizzes at the end of each chapter to test your knowledge of the chapter content Introduction v Chapter features Each chapter contains a number of helpful features to guide you through each topic Topic list Topic list Syllabus reference Tells you what you will be studying in this chapter and the relevant section numbers, together the ACCA syllabus references Introduction Puts the chapter content in the context of the syllabus as a whole Study Guide Links the chapter content with ACCA guidance Exam Guide Highlights how examinable the chapter content is likely to be and the ways in which it could be examined Knowledge brought forward from earlier studies What you are assumed to know from previous studies/exams FAST FORWARD Summarises the content of main chapter headings, allowing you to preview and review each section easily Examples Demonstrate how to apply key knowledge and techniques Key terms Definitions of important concepts that can often earn you easy marks in exams Exam focus points Tell you when and how specific topics were examined, or how they may be examined in the future Formula to learn Formulae that are not given in the exam but which have to be learnt This is a new feature that gives you a useful indication of syllabus areas that closely relate to performance objectives in your Practical Experience Requirement (PER) vi Introduction Question Give you essential practice of techniques covered in the chapter Case Study Provide real world examples of theories and techniques Chapter Roundup A full list of the Fast Forwards included in the chapter, providing an easy source of review Quick Quiz A quick test of your knowledge of the main topics in the chapter Exam Question Bank Found at the back of the Study Text with more comprehensive chapter questions Cross referenced for easy navigation Studying F7 F7 is a demanding paper covering all the fundamentals of financial reporting It has five main sections: The conceptual framework of accounting The regulatory framework Preparation of financial statements which conform with IFRS Preparation of consolidated financial statements Analysis and interpretation of financial statements All of these areas will be tested to some degree at each sitting Sections and are the main areas of application and you must expect to have to produce consolidated and single company financial statements in your exam Some of this material you will have covered at lower level papers You should already be familiar with accounting for inventories and non-current assets and preparing simple income statements, statements of financial position and statements of cash flows You should know the basic ratios F7 takes your financial reporting knowledge and skills up to the next level New topics are consolidated financial statements, construction contracts, financial instruments and leases There is also coverage of the substance of transactions and the limitations of financial statements and ratios The examiner wants you to think about these issues If you had exemptions from lower level papers or feel that your knowledge of lower level financial reporting is not good enough, you may want to get a copy of the study text for F3 Financial Accounting and read through it, or at least have it to refer to You have a lot of new material to learn for F7 and basic financial accounting will be assumed knowledge The way to pass F7 is by practising lots of exam-level questions, which you will when you get onto revision Only by practising questions you get a feel for what you will have to in the exam Also, topics which you find hard to understand in the text will be much easier to grasp when you have encountered them in a few questions So don’t get bogged down in any area of the text Just keep going and a lot of things you find difficult will make more sense when you see how they appear in an exam question Introduction vii The exam paper The exam is a three hour paper with five compulsory questions Format of the paper Question Question Question Question Question Marks 25 25 25 15 10 100 Question will be on consolidated financial statements Question will be on single company financial statements Question is likely to be on cash flow statements or interpretation of accounts Questions and will be on other areas of the syllabus A certain number of IFRSs/IASs will be tested in questions and Others will appear in questions and The examiner has in the past used questions and to test construction contracts, deferred tax, provisions and issues relating to non-current assets viii Introduction Analysis of past papers The table below provides details of when each element of the syllabus has been examined and the question number and section in which each element appeared Further details can be found in the Exam Focus Points in the relevant chapters Covered in Text chapter Pilot Paper Dec 2007 June 2008 Dec 2008 Q4(a)(b) Q4(b) Q4(a)(b) Q5(b) Q4(a)(b) Q2 Q4(a) A CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING The need or a conceptual framework Understandability, relevance, reliability and comparability – – Framework qualitative characteristics Accounting policies, changes I accounting estimates and errors Recognition and measurement 15 The legal versus the commercial view of accounting 22 Alternative models and practices (accounting for inflation) The concept of 'faithful representation' ('true and fair view') Q4(a) Q2 Q4(b) Q4(a) A REGULATORY FRAMEWORK FOR FINANCIAL REPORTING Reasons for the existence of a regulatory framework The standard setting process 23 Specialised, not-for-profit and public sector entities 21 Statements of cash flows Tangible non-current assets – Property, plant and equipment – Investment properties – Government grants – Borrowing costs FINANCIAL STATEMENTS Intangible assets 12 Inventories and construction contracts 14 Financial assets and financial liabilities – Fair value through profit or loss – Amortised cost – Convertible debt 16 Leases 13 Provisions, contingent liabilities and contingent assets Impairment of assets – Group accounting – Other 17 Taxation – Current tax – Deferred tax Q3 Q2 Q2 Q2 Q2 Q5(a)(b) Q2, Q5 Q2 Q2, Q5 Q2 Q4(b) Q1(a) Q2 Q2 Q2 Q5 Q2, Q4(b) Q4(b) Q2, Q4 Q1(b) Q1(a) Q2 Q2 Q2 Q2 Q2 Q2 Q2 Q2 Introduction ix Payments under finance leases ∴ paid c/d > yr < yr FINANCE LEASE LIABILITIES $ 450 b/d > yr 1,300 < yr 500 Property, plant & equipment 2,250 $ 1,200 450 600 2,250 28 Elmgrove Marking scheme Marks (a) Format/presentation Cash generated from operations (½ per item) Interest paid Income taxes paid Purchase of property, plant and equipment Sale of property, plant and equipment Interest received Issue of share capital Dividend paid Property, plant and equipment note Cash and cash equivalents note 1½ 1 2½ 17 Available/Maximum (b) Memo format Identify users Ability to generate cash Ability to repay debts Helps decision making Easier to understand than the income statement Aids comparison 1 Available Maximum 440 Exam answer bank 20 1 1 25 Suggested solution (a) ELMGROVE – STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 MARCH 20X9 $m Cash flows from operating activities Profit before taxation Adjustments for Loss on disposal Depreciation Interest income Interest expense $m 109 43 (6) 17 169 53 (8) 56 270 (13) (62) Decrease in inventories (123 – 176) Increase in trade receivables (95 – 87) Increase in trade payables (126 – 70) Cash generated from operations Interest paid (W2) Income taxes paid (W3) Net cash from operating activities 195 Cash flows from investing activities Purchase of property, plant and equipment (W1) Proceeds from sale of property, plant and equipment (28 – 6) Interest received (165) 22 (137) Net cash used in investing activities Cash flows from financing activities Proceeds from issuance of share capital (W4) Dividend paid Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of the period Cash and cash equivalents at end of the period 60 (32) 28 86 94 Workings Property, plant and equipment additions Balance b/d (NBV) ∴ Additions PROPERTY, PLANT AND EQUIPMENT $m 264 Revaluation surplus Depreciation Disposal Balance c/d (NBV) 165 429 $m 31 43 28 327 429 Interest paid Paid Balance c/d INTEREST PAYABLE $m Balance b/d 13 Income statement 20 $m 17 20 Exam answer bank 441 Income taxes paid Paid Balance c/d INCOME TAXES PAYABLE $m Balance b/d 62 Income statement 39 101 Issue of shares Issue of shares Share capital (plus premium) 31/3/X9 Share capital 31/3/X8 Increase Debentures converted into shares Shares issued for cash $m 54 47 101 $m 230 120 110 (50) 60 IAS requires that investing and financing activities that not require the use of cash, such as converting debt to equity, should be excluded from the statement of cash flows (b) MEMO To: From: Date: Memorandum to the directors of Elmgrove AN Accountant 1.4.20X9 Subject: Major benefits to the users of financial statements from the publication of statements of cash flows The users of financial statements can basically be divided into the following groups (i) (ii) (iii) (iv) Shareholders Management Creditors and lenders Employers The needs of these groups are not identical and hence not all benefits listed below will be applicable to all users Benefits 442 Exam answer bank (i) Statements of cash flows direct attention to the survival of the entity which depends on its ability to generate cash (ii) Statements of cash flows indicate the ability of an entity to repay its debts (iii) They give information which can be used in the decision making and stewardship process (iv) They are more easily understood than income statements that depend on accounting conventions and concepts (v) Statements of cash flows give a better means of comparison between different companies 29 CPP and CCA Tutorial note It is unlikely that a detailed computation will be asked for, but you must have an understanding of the principles of CPP and CCA, the differences between them and the ways in which they try to improve on HCA (a) In accounting, the value of income and capital is measured in terms of money In simple terms, profit is the difference between the closing and opening statement of financial position values (after adjustment for new sources of funds and applications such as dividend distribution) If, because of inflation, the value of assets in the closing statement of financial position is shown at a higher monetary amount than assets in the opening statement of financial position, a profit has been made In traditional accounting, it is assumed that a monetary unit of $1 is a stable measurement; inflation removes this stability CPP accounting attempts to provide a more satisfactory method of valuing profit and capital by establishing a stable unit of monetary measurement, $1 of current purchasing power, as at the end of the accounting period under review A distinction is made between monetary items, and non-monetary items In a period of inflation, keeping a monetary asset (eg trade receivables) results in a loss of purchasing power as the value of money erodes over time Non-monetary assets, however, are assumed to maintain 'real' value over time, and these are converted into monetary units of current purchasing power as at the year end, by means of a suitable price index The equity interest in the statement of financial position can be determined as a balancing item The profit or deficit for the year in CPP terms is found by converting sales, opening and closing inventory, purchases and other expenses into year-end units of $CPP In addition, a profit on holding net monetary liabilities (or a loss on holding net monetary assets) is computed in arriving at the profit or deficit figure CPP arguably provides a more satisfactory system of accounting since transactions are expressed in terms of 'today's money' and similarly, the statement of financial position values are adjusted for inflation, so as to give users of financial information a set of figures with which they can: (i) (ii) (b) Decide whether operating profits are satisfactory (profits due to inflation are eliminated) Obtain a better appreciation of the size and 'value' of the entity's assets CPP and CCA accounting are different concepts, in that CPP accounting makes adjustments for general inflationary price changes, whereas CCA makes adjustments to allow for specific price movements (changes in the deprival value of assets) Specific price changes (in CCA) enable a company to determine whether the operating capability of a company has been maintained; it is not a restatement of price levels in terms of a common unit of money measurement The two conventions use different concepts of capital maintenance (namely operating capability with CCA, and general purchasing power with CPP) In addition CPP is based on the use of a general price index In contrast, CCA only makes use of a specific price index where it is not possible to obtain the current value of an asset by other means (eg direct valuation) (c) In CCA, holding gains represent the difference between the historical cost of an asset and its current cost If the asset is unsold, and appears in the statement of financial position of a company at current cost, there will be an 'unrealised' holding gain, which must be included in a current cost reserve When the asset is eventually sold, the profit (equal to the sale price minus the historical cost) may be divided into: (i) An operating profit which would have been made if the cost of the asset were its current value (ii) A realised holding gain which has arisen because of the appreciation in value of the asset between the date of its acquisition and the date of its sale Exam answer bank 443 444 Exam answer bank Index 445 446 Note Key Terms and their page references are given in bold Accelerated depreciation, 279 Accounting device, 277 Accounting policies, 333 Accounting standards and choice, 31 Accruals basis, Accrued expenses, 276 Accrued income, 276 Accumulated depreciation, 281 Acid test ratio, 315 Actuarial method, 267 Advantages and disadvantages of current cost accounting, 363 Advantages of cash flow accounting, 351 Analysis of cash flow statements, 350 Asset is less than its tax base, 281 Asset is realised, 283 Asset is recognised, 278 Asset turnover, 308 Basic EPS, 291 Benefits of cash flow information, 339 Bonus issue, 294 Borrowing costs, 83 Calculating ratios, 305 Capital, 358 Capital gearing ratio, 311 Capital maintenance, 358, 361 Capitalisation/bonus issue, 294 Cash, 339 Cash and cash equivalents, 339 Cash cycle, 315 Cash equivalents, 339 Cash flow ratio, 314 Cash flows, 339 Cash generating units, 104 CCA profits, 362 Change in accounting policy, 284, 334 Changes in equity, 51 Changes in the carrying amount of deferred tax assets/ liabilities, 283 Characteristics of Not-for-profit Entities, 368 Charged/credited directly to equity, 283 Charities, 369 Conceptual framework, Consignment inventory, 251 Consolidated income statement, 176 Constructive obligation, 221 Contingent liability, 226 Cost model, 81 Cost of inventories, 281 Creative accounting, 248 Current asset, 41 Current cost accounting (CCA), 361 Current IASs, 29 Current investments, 278, 281 Current liability, 41 Current purchasing power (CPP) accounting, 359 Current ratio, 315 Debt ratio, 310 Debt/equity ratio, 312 Debtors' payment period, 316 Decommissioning, 224 Deductible temporary differences, 275, 277, 280 Deferred tax assets, 274, 275, 279, 281, 282 Deferred tax liabilities, 274, 275, 278, 279, 280 Depreciation, 64, 277 Deprival value, 361 Derecognition, 66 Development costs, 277, 279 Diluted eps, 297 Dilutive potential ordinary shares, 300 Direct method, 341 Directly in equity, 283 Dividend cover, 320 Dividend per share and dividend cover, 320 Dividend yield, 321 Dividends, 257 Dividends and pre-acquisition profits, 165 Dividends paid by a subsidiary, 145 Due process, 28 Earnings per share, 290, 320 Economic value (EV), 362 Efficiency ratios, 316 Elements of financial statements, 12 Equal to its tax base, 276 Equity instrument, 290 Events occurring after the reporting period, 332 Exemption from preparing group accounts, 127 F actoring of receivables/debts, 255 Fair presentation, 17 Fair value, 203, 257 Fair value adjustments, 167 Fair value model, 80 Financial instrument, 281, 290 Financing activities, 339, 340 Index 447 Fixed production overheads, 204 Fluctuates from one year to another, 283 Framework, 256 FRS Cash flow statements, 350 FRS Reporting financial performance, 334 Full provision method advantage, 282 GAAP, Gearing ratio, 311 General price inflation, 359 Generally Accepted Accounting Practice (GAAP), 26 Going concern, 332 Goodwill, 97, 278 Goodwill and pre-acquisition profits, 146 Goodwill arising on consolidation, 145 Government assistance, 74 Government grant, 73, 281 Gross profit margin, 309 IAS Disclosure of accounting policies, 343 IAS Cash flow statements, 338 IAS 8, 112 IAS 11 Construction contracts, 207, 248 IAS 12 Income taxes, 272 IAS 16, 60 IAS 17 Leases, 247 IAS 18 Revenue, 256 IAS 2, 202 IAS 20, 73 IAS 23, 83 IAS 24 Related party disclosures, 247 IAS 27 Consolidated and separate financial statements, 124, 136 IAS 28 Investments in associates, 188 IAS 32, 233 IAS 33 EARNINGS PER SHARE, 290 IAS 36, 102 IAS 37 Provisions, contingent liabilities and contingent assets, 220 IAS 38, 90 IAS 39, 233 IAS 40, 79 IASB objectives, 23 structure, 24 IFRS Business combinations, 98, 151, 166 IFRS 3: Fair values, 169 IFRS 5, 117 Impairment loss, 107 Implications of high or low gearing, 312 Income statement, 283 Indirect method, 342 Indirect versus direct, 342 448 Index Initial recognition, 278, 281 Interest, 257 Interest cover, 313 Interest received, 279 Interest revenue, 277 Interest, royalties and dividends, 259 Internally generated goodwill, 92 International Financial Reporting Interpretations Committee (IFRIC), 30 International Public Sector Accounting Standards Board, 367 Interpretation of IASs, 30 Intra-group sales of non-current assets, 160 Intra-group trading, 156, 177 Inventories and short-term WIP, 202 Investing activities, 339, 340 Investments in associates, 126 L essees, 267 Leverage, 311 Liability, 276 Liability is recognised, 281 Liability method, 283 Liability settled, 283 Limitations of ratio analysis, 334 Liquidity, 310, 314, 315 Loan, 277 Loan payable, 276 Long-term solvency, 310 Measurement of revenue, 257 Negative goodwill, 281 Net profit margin, 309 Net realisable value, 203 Net realisable value (NRV), 281, 362 Net replacement cost (NRC), 361 Non-controlling interest, 135, 141 Not-for-profit and public sector entities, 366 Operating activities, 339, 340 Options, 299 Ordinary shares, 290 Originating timing differences, 276 P/E ratio, 321 PBIT, profit before interest and tax, 306 Permanent and temporary differences, 277 Permanent differences, 276 Potential ordinary share, 290 Prepaid expenses, 277 Preparing a cash flow statement, 345 Presentation of a ratio anaylsis report, 322 Primary profitability ratio, 308 Profit analysis, 309, 310 Profit before interest and tax, 306 Profit margin, 308 Profitability, 306 Prudence, 282 Public sector entities, 366 Purchased goodwill, 97 Quick ratio, 315 R atio analysis, 304 Recognition criteria, 280 Recover or settle the carrying amount, 274 Recoverable amount, 281 Rendering of services, 258 Reporting period, 37 Research and development (R&D) costs, 92, 281 Residual value, 69 Restructuring, 224 Retirement benefit costs, 280 Return on capital employed (ROCE), 307 Return on equity (ROE), 308 Revaluations, 284 Revalued, 278 Revalued assets, 279 Revenue, 257 Revenue recognition, 255 Reviewed at each balance sheet date, 283 Rights issue, 294 Royalties, 257 Sale and leaseback transactions, 253 Sale and repurchase agreements, 252 Sale of goods, 257 Sale of goods revenue, 277 Secondary ratios, 308 Share split/reverse share split, 294 Short-term solvency, 314 Specific price inflation, 359 Standards Advisory Council, 24 Statement of comprehensive income, 35, 42 Statement of financial activities, 369 Statement of financial position, 35, 38 Stock turnover period, 317 Structure of the IASB, 24 Sufficient future taxable profits, 282 Tax assets and liabilities, 287 Tax base, 275, 277 Tax expense, 287 Tax payments, 278 Taxable profit, 276 Taxable temporary differences, 275, 277, 278, 282 Taxation, 284 Temporary differences, 275, 277, 279 Temporary tax differences, 281 The consolidated statement of financial position, 135 Timing differences, 278, 280, 283 True and fair view, 26 U nrealised profit, 156 Users and their information needs, Value to the business (deprival value, 361 Variable production overheads, 204 Warranties, 223 Warrants or options, 290 Working capital, 41 Index 449 450 Index Notes Notes Review Form & Free Prize Draw – Paper F7 Financial Reporting (International) (6/09) All original review forms from the entire BPP range, completed with genuine comments, will be entered into one of two draws on 31 January 2010 and 31 July 2010 The names on the first four forms picked out on each occasion will be sent a 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Studying F7 F7 is a demanding paper covering all the fundamentals of financial reporting It has five main sections: The conceptual framework of accounting The regulatory framework Preparation of financial. .. conceptual framework ⏐ F7 Financial reporting Key term A reporting entity is an entity for which there are users who rely on the financial statements as their major source of financial information