This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON

279 0091 ZA

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences, the Diplomas in Economics and Social Sciences and Access Route for External Students

Financial Reporting

Wednesday, 18 May 2011 : 2.30pm to 5.45pm

Candidates should answer FOUR of the following SEVEN questions. All questions carry equal marks. Workings should be submitted for all questions requiring calculations. Any necessary assumptions introduced in answering a question are to be stated. Extracts from compound interest tables are given after the final question on this paper. 8-column accounting paper is provided at the end of this question paper. If used, it must be detached and fastened securely inside the answer book. A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book.

University of London 2011 UL11/0081

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1.

The statements of financial position (balance sheets) for Ear Ltd, Mouth Ltd and Nose Ltd as at 31 December 2010 are given as follows: Statements of Financial Position as at 31 December 2010 Ear Ltd Non-current asset (land) Investment Inventories Trade Receivables Dividend receivable from group companies Inter-company loans receivable from Mouth Ltd Inter-company loans receivable from Nose Ltd Cash 860,000 380,000 140,000 8,000 12,000 90,000 30,000 130,000 1,650,000 60,000 390,000 30,000 440,000 40,000 30,000 50,000 60,000 Mouth Ltd 260,000 Nose Ltd 300,000

Share capital (1 nominal value) Retained profits Revaluation reserve Trade payables Inter-company loans payable to Ear Ltd Dividend payable

600,000 260,000

100,000 210,000

200,000 160,000 30,000

730,000

30,000 40,000

10,000 20,000 20,000

60,000

10,000

1,650,000

390,000

440,000

Ear Ltd acquired 70% of Mouth Ltd for 290,000 on 1 January 2006 when Mouth Ltds share capital and reserves stood at 190,000. At this date the fair value of Mouth Ltd's non-current assets was 280,000 but they were recorded at their historical cost of 260,000. Mouth Ltd has not incorporated this revaluation in its books. Ear Ltd acquired 25% of Nose Ltd for 70,000 on 1 January 2007. At this date the fair value of Nose Ltd's non-current assets was 300,000 and Nose Ltd incorporated this revaluation into its accounts. The share capital and reserves on 1 January 2007 of Nose Ltd, including the revaluation reserve, stood at 250,000.

Question continues on following page

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No changes to the share capital of Mouth Ltd and Nose Ltd have occurred since their acquisition by Ear Ltd. At the year end, all group companies declare a dividend of 10p per share. These dividends have been accounted for correctly. Ear Ltd's inventory figure includes 10,000 of inventory which had been bought from Mouth Ltd. Mouth Ltd had paid 2,000 for these goods. Ear Ltds inventory figure also includes 15,000 of inventory which has been bought from Nose Ltd. Nose Ltd had paid 5,000 for these goods. Goodwill is to be capitalised. Impairment of 50,000 is seen against the value of the goodwill of Mouth Ltd in 2010. Required (a) Define a subsidiary and an associate company. Outline the differences in how such companies are accounted for. (6 marks) Prepare the consolidated statement of financial position for Ear Ltd as at 31 December 2010. (19 marks)

(b)

2.

Company M owns a manufacturing plant that cost 750,000 on 1 January 2009. The plant has a useful economic life of five years from this date and it is used to manufactures a product called the spike. There is no second hand market for the plant except as scrap and it is estimated that at the end of its useful life, or at any other time, it will cost 30,000 net of scrap proceeds, to dismantle and remove it. Annual operating costs are 300,000. The plant requires an overhaul costing 22,500 during the third year of its life. It produces a constant annual output, all of which can be sold, with an annual selling value of 600,000. During February 2010, a new model of the plant used to manufacture the spike is brought out. The directors of the company now intend to replace the existing spike plant with the new plant at the end of the existing plants life. The new plant costs 825,000 and has a six year useful life at the end of which its scrap value is expected to be 15,000. It incurs constant annual operating costs of 270,000 and produces a constant annual output, all of which can be sold, with a selling value 22,500 per annum higher than the output of the existing plant. When the new plant is installed for the first time the company will incur one off costs of 37,500 adapting the building housing the new plant. Any replacement plant together with the cost of adapting the building would be paid for at the time of replacement. All other cashflows occur at the end of the years concerned. The companys cost of capital is 10% per annum. Required (a) Define deprival value and discuss the strengths and limitations of deprival value as the basis of asset valuation in corporate financial reports (12 marks) Calculate the deprival value of the companys spike making plant as at 31 December 2010. (13 marks)

(b)

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3.

Bear Ltd started trading on 1 January 2010. The income statement and the statement of financial position for the first year of trading are given below: Income statement for 2010 Sales Cost of sales: Opening inventories Purchases Closing inventories Gross profit Depreciation Other expenses Net profit Statement of Financial Position as at 31 December 2010 Non-current assets plant and machinery Inventories Other net current assets Net assets Share capital (1 shares) Retained earnings Share capital and reserves The price change indices for the year were identified as follows: RPI Plant and machinery 100 120 130 150 Inventories (stock) 100 135 140 145 1,296,000 1,350,000

75,000 900,000 (90,000) (885,000) 465,000 (42,000) (150,000) 273,000

90,000 387,000 1,773,000 1,500,000 273,000 1,773,000

1 January 2010 30 June 2010 30 November 2010 31 December 2010

100 110 115 120

Closing inventory was acquired on 30 November 2010. All non-current assets and opening inventory were acquired on the first day of trading. Sales and purchases accrue evenly throughout the year. Question continues on following page

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Required (a) (b) What are fully stabilised current value financial statements? Discuss the advantages and limitations of fully stabilised current value financial statements. (7 marks) Prepare an income statement for Bear Ltd for the year ended 31 December 2010 and a statement of financial position for Bear Ltd as at 31 December 2010 using current value (replacement cost) accounting and using the financial capital maintenance concept. Base depreciation on the year-end value of non-current assets. (9 marks) Calculate the real realised and the real unrealised holding gains and losses on inventory and non-current assets that would appear in a set of fully stabilised current value accounts stabilised in pounds () as at 31 December 2010. Where would these items be recorded in the financial statements for 2010? (9 marks)

(c)

4.

Rhymes Ltd enters into two lease transactions in 2010 as follows: (1) An asset, asset A, which could be purchased outright for 102,004 is instead leased for three years. The useful economic life of the asset is three years and at the end of this time, the asset will have no residual value. Rhymes Ltd is responsible for all maintenance and repairs and for all insurance costs for asset A. The lease for asset A provides for halfyearly payments in advance of 20,000, the first payment being made on 1 January 2010. An asset, asset B, which could be purchased outright for 120,000 is leased for three years for annual payments of 30,000 per annum payable in advance. The useful economic life of asset B is eight years. At the end of the three years, Rhymes Ltd intends to return the asset. Rhymes Ltd is not responsible for maintaining and insuring asset B.

(2)

Required (a) (b) What are operating and finance leases? How should they be accounted for? (10 marks) Show how asset A and asset B would be accounted for by Rhymes Ltd in 2010 and 2011. (15 marks)

5.

Answer all parts of this question. (a) XYZ plc is considering whether to (i) issue share capital of 200,000 (1 nominal value shares) or (ii) issue 100,000 (1 nominal value shares) and raise 100,000 from a long term loan with an interest rate of 15% per annum. The future is uncertain and if XYZ plc has a good year, profit before interest and tax will be 100,000 but if it has a poor year, profit before interest and tax will be 20,000. Calculate profit after tax and earnings per share in both scenarios and comment on your results. Assume the tax rate is 35%. (8 marks) Identify and discuss the factors that influence the determination of the functional currency of an overseas subsidiary? (5 marks)

(b)

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(c)

A company entered into a construction contract with the following information: Date commenced Expected completion date Final contract price Costs to 31 December 2010 Value of work certified to 31 December 2010 Progress payments invoiced to 31 December 2010 Estimated costs to completion Required Show how the construction contract would be accounted for in the financial statements for the year ended 31 December 2010. (7 marks) 1 January2010 31 December 2011 4,000,000 1,200,000 1,240,000 220,000 1,000,000

(d)

Identify and discuss the differences to the financial statements if a company used the last in first out (LIFO) method for valuing inventory instead of the first in first out (FIFO) method for valuing inventory in times of rising prices? (5 marks)

6.

Either (a) What are non-current tangible assets and investment properties? Discuss the differences in the accounting treatment of non-current tangible assets and investment properties and discuss how the different accounting treatments affect the financial statements.

Or (b) Why do we need a conceptual framework? Discuss the advantages and limitations of conceptual frameworks.

7.

Either (a) Set out the definitions of well offness and measures of income suggested by Sir John Hicks and evaluate their usefulness, implications and limitations for financial reporting.

Or (b) Critically appraise both the traditional and economic arguments for and against accounting regulation.

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Compound interest factors over n periods at rate i per period. Table 1: Present value factors To determine the present value of a single payment of 1 received n periods from the present at a constant discount rate of x% per period

Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

5% 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 0.5847 0.5568 0.5303 0.5051 0.4810 0.4581 0.4363 0.4155 0.3957 0.3769

6% 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651 0.6274 0.5919 0.5584 0.5268 0.4970 0.4688 0.4423 0.4173 0.3936 0.3714 0.3503 0.3305 0.3118

7% 0.9346 0.8734 0.8163 0.7629 0.7130 0.6663 0.6227 0.5820 0.5439 0.5083 0.4751 0.4440 0.4150 0.3878 0.3624 0.3387 0.3166 0.2959 0.2765 0.2584

8% 0.9259 0.8573 0.7938 0.7350 0.6806 0.6302 0.5835 0.5403 0.5002 0.4632 0.4289 0.3971 0.3677 0.3405 0.3152 0.2919 0.2703 0.2502 0.2317 0.2145

9% 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963 0.5470 0.5019 0.4604 0.4224 0.3875 0.3555 0.3262 0.2992 0.2745 0.2519 0.2311 0.2120 0.1945 0.1784

10% 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 0.2633 0.2394 0.2176 0.1978 0.1799 0.1635 0.1486

12% 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 0.4523 0.4039 0.3606 0.3220 0.2875 0.2567 0.2292 0.2046 0.1827 0.1631 0.1456 0.1300 0.1161 0.1037

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Table 2: Cumulative present value factors (annuity factors) The table gives the present value of n annual payments of 1 received for the next n years with a constant discount rate of x% per year. For example, with a discount rate of 8% and with six annual payments of 1 the present value is 4.6229 Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 5% 0.9524 1.8594 2.7232 3.5460 4.3295 5.0757 5.7864 6.4632 7.1078 7.7217 8.3064 8.8633 9.3936 9.8986 10.3797 10.8378 11.2741 11.6896 12.0853 12.4622 6% 0.9434 1.8334 2.6730 3.4651 4.2124 4.9173 5.5824 6.2098 6.8017 7.3601 7.8869 8.3838 8.8527 9.2950 9.7122 10.1059 10.4773 10.8276 11.1581 11.4699 7% 0.9346 1.8080 2.6243 3.3872 4.1002 4.7665 5.3893 5.9713 6.5152 7.0236 7.4987 7.9427 8.3577 8.7455 9.1079 9.4466 9.7632 10.0591 10.3356 10.5940 8% 0.9259 1.7833 2.5771 3.3121 3.9927 4.6229 5.2064 5.7466 6.2469 6.7101 7.1390 7.5361 7.9038 8.2442 8.5595 8.8514 9.1216 9.3719 9.6036 9.8181 9% 0.9174 1.7591 2.5313 3.2397 3.8897 4.4859 5.0330 5.5348 5.9952 6.4177 6.8052 7.1607 7.4869 7.7862 8.0607 8.3126 8.5436 8.7556 8.9501 9.1285 10% 0.9091 1.7355 2.4869 3.1699 3.7908 4.3553 4.8684 5.3349 5.7590 6.1446 6.4951 6.8137 7.1034 7.3667 7.6061 7.8237 8.0216 8.2014 8.3649 8.5136 12% 0.8929 1.6901 2.4018 3.0373 3.6048 4.1114 4.5638 4.9676 5.3282 5.6502 5.9377 6.1944 6.4235 6.6282 6.8109 6.9740 7.1196 7.2497 7.3658 7.4694

END OF PAPER

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