Exam 3 November 2012, answers PDF

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SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012 SOLUTION 1 (a) (i) The bottling plant is qualifying asset and the borrowing cost has to be capitalized as part of the initial cost to recognize. The capitalization rate is the WAC, calculated as follows: Weighted average cost m x 0) (GHC6 m x GHC8 m Bor...

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SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

SOLUTION 1 (a) (i)

The bottling plant is qualifying asset and the borrowing cost has to be capitalized as part of the initial cost to recognize. The capitalization rate is the WAC, calculated as follows: Weighted average cost = [(GHC2 m x 0.2) + (GHC6 m x 0.24)] GHC8 m = GHC400,000 + GHC1,440,000 GHC8,000,000 = 23% Borrowing costs to be capitalized

=

=

23% of 600,000 of 9/12 103,500 23% of 1,000,000 of 6/12 115,000 23% of 200,000 0/12 GHC218,500

The asset will therefore be recognized initially as Capital outlay 1,800,000 Capitalized borrowing cost 218,500 2,018,500 (ii)

The instrument is a compound financial instrument which should be presented separately as a liability and as an equity. Thus: Year

Cash Flow GHC 2011 60,000 2012 1,060,000 Total liability component Total Proceeds (10,000 x GHC100) Equity component

Discount Factor 1/1.08 1/1.082

Present Value GHC 55,556 908,779 964,335 1,000,000 33,665

Subsequently, the annual interest expense recognized in income statement should be calculated by reference to the interest rate used in the initial measurement of the liability component (i.e 8%) Continuing from above, the liability component would be accounted for as follows in 2011 and 2012. Year 2011 2012

Balance at 1/1 964,335 91,482

Interest expense @ 8% 77,147 78,518

Interest paid @ 6% (60,000) (60,000)

Balance at 31 December 981,482 1,000,000 Page 1 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

Income Statement Interest expense

(iii)

2011 77,147

2012 78,518

Statement of financial position as at Equity Option to convert

2011

2012

33,665

33,665

Liability Loan Note

981,482

1,000,000 (redeemed)

The lease extends over the useful life of the building so the building element within the lease should be classified as a finance lease. The two elements should be measured by reference to the fair value of the leasehold interests, so  GHC63,000 (which is 10% of GHC630,000) is allocated to the land  GHC567,000 (the remaining 90%) is allocated to the buildings The annual rental should be allocated between:  The land: GHC5,000 (10% of GHC550,000 rental). The buildings: 90% of 630,000 should be recognized as a non-current asset and a liability, charging depreciation on the asset and adjusting the liability by GHC45,000 (90% of the GHC50,000 annual rental) and by the finance charge at 7.5% of the outstanding amount. GHC Income statement (extract) Expenses Operating lease rental 5,000 Depreciation charge (567,000/30 years) 18,900 Finance charge (W1) 39,150 

Statement of financial position as at 31 December 2010 (extract) GHC Property plant and equipment Leasehold property (cost) Depreciation

567,000 (18,900) 548,100

Non current liabilities Obligation under finance lease (W1)

516,560

Current liabilities Obligation under finance lease (W1): Capital Finance cost

5,850 39,150 Page 2 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

Working 1 Year 2010 2011 (iv)

Balance at 1/1 GHC 567,000 561,150

Lease Payment GHC (45,000) (45,000)

Bal outstanding during the year GHC

522,000 516,150

Finance Cost @ 7.5% GHC 39,150 38,711

It is necessary to estimate the value in use and compare it with the fair value less cost to sell of the plant in order to determine whether an impairment has occurred and to quantify impairment loss. Future Discount Present Year cash flows Factor Value GHC @ 15% GHC 2011 550,000 0.870 478,500 2012 500,000 0.756 378,000 2013 300,000 0.658 197,400 2014 700,000 0.572 400,400 1,454,300 Recoverable amount (the higher of value in use and fair value less cost to sell) Carrying amount (net book value) Impairment loss

(b) (1)

Balance at 31/12 GHC 561,150 554,861

GHC 1,454,300 1,800,000 345,700

Dagadu Ltd Dividend Yield Method Price per share

=

Dividend per share Appropriate Dividend Yield

Dividend per share

=

Gross Dividend No of Ordinary Shares

Gross dividend

=

300,000 = GHC0.60 500,000

Assuming a yield similar to that a comparable listed entity and discounted by 20% . = Dividend yield = GHC0.48 x 100 = 8% raised by 20% = 9.6% GHC600 :. Price per share

=

:. Value of 50,000 shares = =

GHC0.60 0.096

=

GHC6.25

GHC6.25 x 50,000 GHC312,500 Page 3 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

(2)

Earnings Yield Method Price per share = EPS

=

Current Earnings per share

Projected EPS

EPS__________________ Appropriate Earnings Yield Profit after tax less Preference Dividend No of Ordinary Shares = GHC516,000 – 60,000 500,000 = GHC0.912 = =

Average EPS

=

=

GHC663,000 – 60,000 500,000 GHC1.206 495,000 + 456,000 400,000 500,000

2

GHC1.2375 + GHC0.912 2 GHC1.075

Using appropriate earnings yield of 12%, (see workings) Current price per share = GHC0.912 0.12 = GHC7.60 :. Value of 50,000 ordinary shares = GHC7.60 x 50,000 = GHC380,000

(3)

Value based on projected earnings

= GHC 1.26 x 50,000 0.12 = GHC10.05 x 50,000 = GHC502,500

Value based on average earnings

= GHC1.075 x 50,000 0.12 = GHC447,917

Net Asset Basis

2011 GHC000 Shareholders fund 3,948 Less preference shares 600 Net assets of Ordinary Shareholders 3,348 Value per share

Valuation of 50,000 shares

GHC3,348 500 = GHC6.7 335,000

Projected GHC000 4,926 600 4,326 GHC4,326 500 GHC8.7 435,000 Page 4 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

The lowest price Mr. Kusi could receive from his co-shareholders is GHC312,500. The highest price that he could receive is GHC502,500.

SOLUTION 2 (a)

Hard ltd Consolidated Statement of Financial Position as at 30th September 2012 GHC 000 Non Current Assets Goodwill Patents Tangible Fixed Assets: Freehold Plant Investment Investment Associates Current Assets Stock Debtors (840 + 760 – 240) Bank Current Liabilities: Deferred consideration Trade creditors (1,100 + 660 – 140) Taxation (680 + 240) Overdraft

654 1,340 8,320 4,640 700 1,920 17,574 1,924 1,360 300 3,584 800 1,620 920 160 3,500 84 (400) 17,258

Net Current Assets Deferred Tax Net Assets Equity: Stated capital Capital surplus (2,000 + 0) Income surplus

NCI

GHC 000

4,000 2,000 9,838 15,838 1,420 17,258

Page 5 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

Workings (1)

(2)

(3)

Tangible Fixed assets: Freehold (5,120 + 2,800 + 400) Plant (2,840 + 1,800) Patent (500 + 840) Stocks Amount per question (1,140 + 800) Less provision for unrealized profit 40% x 40 x 280 x1 140 2

GHC000 8,320 4,640 1,340

=

GHC000 1,940 16 1,924

Net assets in Soft Ltd

Stated capital Capital surplus Income surplus Fair value adjustment (4)

= = =

At acquisition GHC000 2,000 1,000 2,400 400 5,800

Goodwill in Soft Ltd Cost of investment: Cash Deferred Cons 1,000 1.253

5,000 512 5,512

80% of net assets acquired (80% x 5,800)

4,640 872 218 654

Less impairment Goodwill at 31/9/2011 (5)

Investment in Associate Cost of Investment Add share of Post acquisition profit 40% (2,400 – 1,600)

1,600 320 1,920

Alternatively: Share of Net assets 40% x 3,600 Add Goodwill (6)

At reporting date GHC000 2,000 1,000 3,800 400 7,200

1,440 480 1,920

Elimination of current accounts Payables Income surplus (Soft) Receivables

DR 140 100

CR

240 Page 6 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

(7)

Non Controlling Interest: Share of Net Assets 20% x 7,200 Less share of management charge 20% of 100

Consolidated Income surplus Hard Ltd URP Goodwill impairment Discount unwound (800 – 512) Share of post acquisition profit Soft 80% x (3,800 – 100 – 2,400) Active

(c )

1,440 (20) 1,420 GHC 9,000 (16) (218) (288) 1,040 320 9,838

A parent need not present consolidated financial statements if and only if: i.

the parent is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements;

ii.

the parent’s debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an ov er-the-counter market, including local and regional market);

iii.

the parent did not file, nor is it in the process of filling, its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market; and

iv.

the ultimate or any intermediate parent of the parent produces consolidated financial statements available for public use that comply with International Financial Reporting Standards.

Page 7 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

SOLUTION 3 1.

Relative Position of Stakeholders in case of Liquidation GHC 000 4,000 900 2,000 2,020 660 9,580

Freehold property Plant, machinery & vehicles Patents Stocks Debtors Proceeds available on liquidation Distribution as follows: 20% Debentures Bank overdraft

3,800 2,100 5,900 3,680 420 3,260 Prorated 2,745 515 3,260

Less liquidation expense Cash available to unsecured creditors Trade creditors Accrued expenses

Recovery Ratio

2.

3.

=

3,260 3,800

3,200 600 3,800 =

85.79 = 86%

The unsecured creditors will receive GHC3,260,000 instead of GHC3,800,000. Both the Ordinary Shareholders and the Preference Shareholders will receive nothing. Computation of Maximum Loss in Cash of Reorganisation GHC000 Income surplus 7,340 Bad debts 100 Reconstruction expenses 300 Preference dividend arrears 1,134 8,874 Capital Reduction GHC000 GHC000 Ordinary shares 5,730 4,871 Preference shares 3,150 2,678 Debentures 3,800 Bank overdraft 2,100 160 Trade creditors 3,200 31 600 Accruals 1,134 1,134 Preference dividends 8,874 19,714

GHC000 859 472 3,800 2,100 3,040 569 Page 8 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

4.

Suggested Scheme: There is no one single solution 85% of the existing ordinary and preference and preference shares should be cancelled. The ordinary shareholders should take new equity shares to the tune of GHC3,000,000. The preference shareholders should subscribe to a right issue in ordinary shares to GHC1,134,000 equivalent to dividend in arrears. The debenture holders to convert GHC1 million of debentures to new ordinary shares and rate of interest raised to 22% since the debenture holders would recover their entire capital the rise in rate to 22% would be acceptable if the yield on the market of similar investment is comparable. The ordinary shareholders would lose 35% control but still would be in charge (65%) of the company. The loss of 35% is necessary to ensure that there is adequate cash to promote smooth operations.

5.

Additional information that would be needed are as follows: i.

Detailed cash flow projection for the next five years

ii.

Whether the necessary court order has been received for the reconstruction

iii.

How does the estimated profits compare with other companies in the industry and how reliable is the basis of the estimates

iv.

How adequate is the cash that is introduced by the existing stakeholders

v.

What is the number of issued shares?

SOLUTION 4 (a)

i.

Qualitative Factors

Cash Flows from Operating Activities Premix Limited shows higher operating profit than Diesel Limited. It could be that Premix Limited is able to control its cost of sales as well as administrative expenses much better than diesel Limited. However, Premix Limited records a much lower figure for depreciation than Diesel Limited. This could mean that investment in fixed assets is poor in Premix Limited. If so it may affect the capacity of Premix Limited to operate efficiently into the foreseeable future. Diesel Limited records a much higher figure for decreases in inventory than Premix Limited. A decrease in inventory means that cost of goods sold as reported in the income account exceeds purchases made during the period. If so, then Premix Limited appears to be doing better than Diesel Page 9 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

Limited. There is an increase in receivables in Premix Limited but a decrease in Diesel Limited. An increase in receivables means that revenue from credit sales exceeds collections from customers. If so, then Diesel Limited appears to be doing better by being able to collect from its customers in excess of sales made to them. In other words, previous sales made to customers are also collected. Diesel Limited records a lower figure for increases in payables than Premix Limited. An increase in payables means that accruals-based figure for purchases is greater than cash payments made to suppliers. If so, then Premix Limited appears to doing better by holding on creditor payment than Diesel Limited. On overall basis, Premix Limited does better with respect to net cash flows from operating activities. Cash Flows from Investing Activities Net cash inflow investing activities is higher in diesel Limited than in Premix Limited. Even more disturbing is the fact that Premix Limited is investing very little fixed assets. Not just that, it is also selling off significant portions of its assets it has. What can inform a business to take this line of action? While Diesel Limited is growing by investment in subsidiaries, Premix Limited does not contemplate such an interest. The combination of its failure to engage in growth strategies as well as its rapid disposal of available assets does not suggest that there is any future for Premix Limited. Cash Flows from Financing Activities Much more funds are realized from financing activities in Premix Limited than in Diesel Limited. Unfortunately, the use to which these funds were put is not easily discernible. Premix Limited did not engage in any serious investing activity, and no funds were returned to investors by way of dividend. Probably the funds raised were used to pay off an overdraft. Why would the opening cash balance be in such a huge deficit? Was an overdraft taken from a bank? To finance what. In terms of cash inflows from financing activities, diesel Limited is doing much better than Premix Limited. ii. Qualitative Factors Available Shares Premix Limited has more available shares to issue to raise in the future. However, this is no advantage over Diesel Limited because the smaller of shares can be priced at a value as will raise more funds than the bigger volume of registered shares. Infractions The failure of Premix Limited to settle to settle the quarterly advance tax payment is much more serious than failure to implement a wage agreement by Diesel Limited. Premix Limited commits an offence against the State and can be cited for criminal is conduct which can result in closure of its business. Diesel Limited can discharge a civil liability towards its employees and thereafter, continue with its business. iii. Advice to Mr. Peter Paul given the net effect of both qualitative and quantitative factors, the investment of Peter Paul will be safer in Diesel Limited than in Premix Limited.

Page 10 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

(b)

Difference Between Operating Profit & Net Cash Flow from Operating Activities i. Non-cash Expenses - some expenses such as depreciation expense reduce operating profit but do not require any cash outlay. ii. Timing Difference - revenue and expenses may be recognized in a different accounting period from the related cash flows. iii. Non-Operating Gains & Loss – net income may include gains and losses relating to investing and financing activities which are not operating activities.

(c)

Cash Flow Statement Assists in Resolving -

The company’s ability to generate positive cash flows in future periods.

-

The company’s ability to meet its obligations and to pay dividends.

-

The company’s need for external financing.

-

Causes of the change in the amount of cash and cash equivalents between the beginning and end of the accounting period.

-

Reasons for the difference between the amount of operating income and the related cash flows from operating activities.

-

Both the cash and non-cash aspects of the company’s investment and financing transactions for the period.

SOLUTION 5

(a)

Computation of Holding Gains: GHC Goodwill: Current Cost Historical Cost PPE: Current Cost Historical Cost Cost of Sales: Current Cost Historical Cost Inventory: Current Cost Historical Cost Total Holding Gain

605,000 450,000 590,000 560,000 160,000 188,500

GHC 12,500 62,500 (50,000) 155,000 30,000 (25,500) 106,500

Page 11 of 12

SOLUTION ADVANCED FINANCIAL REPORTING NOV 2012

(b)

i.

Current Cost Statement of Comprehensive Income GHC 880,000 590,000 290,000 67,000 223,000 106,500 329,500

Turnover Less: Current Cost of Sales Gross Profit Less: Selling, General & Comprehensive Income Operating Profit Add: Holding Gain Net Profit to Income Surplus ii.

Statement of Financial Position GHC Property, Plant & Equipment Goodwill Current Assets Inventory Accounts receivables Bank & Cash Current Liabilities Accounts Payables Net Assets Less: Medium Term Loan

GHC 605,000 12,500 617,500

160,000 98,500 84,000 342,500 85,500

257,000 874,500 45,000 829,500

Financed By: Stated Capital Income Surplus

(c)

500,000 329,500 829,500

i. Financial statements Restated for General Price-level Changes: This restates financial statement items into cedis that have equal purchasing power, it changes the unit of measurement, not the underlying accounting principles used to report historical cost amounts. It is cost-based. ii. Current Value Financial Statements Current cost accounting changes the basis of measurement from historical cost to current value. Changes in the specific price of items may be very different from the change in the general price level. Monetary items are stated at their current cost in the historical cost financial statements. Monetary items are cash, accounts receivables, accounts payables and loans which are not adjustable. Nonmonetary items must be adjusted t year-end to take account of the price effect. Non-monetary items are land, PPE and inventory. Page 12 of 12...