Professional Documents
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Answer the following TWO compulsory questions which relate to the Case below. Marks
will be awarded for logical argumentation and appropriate presentation of the answers.
CASE
You are the accounting manager of Profit Making Limited (“PML”), a listed company in Hong
Kong which is principally engaged in manufacturing of electronic products in Hong Kong.
All PML’s products are sold in the USA.
On 1 April 2003, PML acquired a 70% equity interest in two operating companies, SML-A
and SML-B, at a total cash consideration of HK$600 million to their previous owner. SML-A
is engaged in property trading in Hong Kong and SML-B is engaged in manufacturing
electronic products in Hong Kong. Like PML’s products, SML-B’s are sold in the USA.
The book values of the assets and liabilities of SML-A and SML-B as at 1 April 2003 were
approximately equal to the fair values at that date. As at 1 April 2003, retained earnings of
SML-A and SML-B were HK$200 million and HK$210 million respectively.
Summary information, in HK$ million unless otherwise stated, for the year ended
31 March 2004 of the PML Group and each of the operating companies is as follows:
2. Directors’ share options (in issue since 2000) allow PML’s directors to subscribe, on
1 April 2005 or after, for a total of 5 million new ordinary shares of PML at an exercise
price of $8 each.
3. The current rate of income tax for PML is 17.5%. Deferred taxation is not material for
the PML Group.
4. The average market price of PML’s ordinary shares throughout the year ended
31 March 2004 was $20.
5. During the year ended 31 March 2004, SML-A sold office premises to PML at a cost of
HK$40 million. PML sold HK$20 million goods to SML-B on 31 March 2004 at a gross
profit margin of 40% (i.e. cost of the products was HK$12 million). SML-B
purchased these products as its plant and equipment, with an estimated useful life of
10 years.
6. The 6% debenture was mainly used to finance PML’s operation. The long term bank
loan was used to finance the operation of SML-A and SML-B and PML therefore
charged the interest thereon to SML-A and SML-B accordingly.
7. The management of PML judged that the goodwill relating to the acquisition of SML-A
and SML-B on 1 April 2003 should be allocated 60% to SML-A and 40% to SML-B.
The goodwill was estimated to have a useful life of 5 years.
8. It is PML Group’s accounting policy to depreciate plant and equipment and amortise
goodwill over their estimated useful life on a straight line basis and to eliminate
intra-group profits/(losses) against the group’s profit in full.
9. The number of ordinary shares of PML in issue during the year was 60 million. There
was no change in the share capital of all the operating companies during the year
ended 31 March 2004 and no dividend was paid or declared during the year.
Could you please clarify the following points relating to PML’s draft financial summary which I
have just reviewed.
1) Some of the consolidated amounts in the financial summary for the year ended
31 March 2004 are different from the corresponding combined amounts of the
operating companies. What has caused these differences?
2) I am puzzled by the diluted EPS figure, which is lower than the basic EPS. Why do
we need to disclose this figure? How is it arrived at?
3) In your summary, you said a segment information note would be included in the
consolidated financial statements. I cannot understand why we have to disclose
segment information. We didn’t have to disclose this information in the past. Our
principal business is electronic manufacturing, not property trading and
development. Why do we need to disclose the segment information?
Best regards
Peter
Required:
(20 marks)
(10 marks)
(c) Prepare an annex to your memorandum showing the calculation of the basic
and diluted earnings per share figures for the year ended 31 March 2004.
(6 marks)
The directors of PML are considering selling the 70% interest in SML-A in the financial year
ending 31 March 2005.
Required:
(a) Explain to the directors how the intended disposal of SML-A would affect the
consolidated profit or loss of the PML for the year ending 31 March 2005.
(6 marks)
(b) To illustrate the effect, calculate the consolidated gain or loss on disposal,
assuming that:
2) SML-A’s results for the six months ended 30 September 2004 are exactly
half of its annual results in the year ended 31 March 2004, except that there
were no intra-group transactions during the six months.
(8 marks)
* * * END OF SECTION A * * *
(QUESTIONS)
Answer all of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.
A director of a Hong Kong incorporated company said ‘Our company can choose
whichever accounting policies we consider appropriate.’
If you are a certified public accountant who holds a directorship in the same company,
please comment on the above statement from the legal, professional and ethical
perspectives. Refer to appropriate legal materials or professional pronouncements
where necessary.
(10 marks)
Oriental Network Limited provides network infrastructure solutions, including (i) the sale of
network equipment and software and (ii) the provision of network infrastructure development
services, to its customers. Historically, all costs for sale of equipment were incurred upon
completion of installation work. The workload and relevant costs of the network
infrastructure development services were evenly distributed over the development period.
On 30 June 2003, the company entered into a contract with a customer in which the sale of
network equipment and the provision of related infrastructure development services were
bundled together. Based on historical data, the company estimated that the fair value of
sale of equipment accounted for 50% while provision of development services accounted for
the remaining 50% of the contract price.
Required:
Determine how the above transaction should be accounted for by Oriental Network
Limited in terms of revenue recognition for the year ended 31 December 2003. You
should give specific explanations by referring to relevant Hong Kong Accounting
Standards.
(10 marks)
James Medical Limited (“JML”), a wholly owned subsidiary of the Thomas Group, is a
“High-Tech” enterprise approved by the Technology Bureau of Xiamen. JML applied to the
Bureau for a government grant of Rmb5,000,000 in early 2002. According to the
regulations governing such grants, the grant must be used to finance purchases of
machinery from domestic manufacturers. In addition, JML must carry on its business in the
High-Tech Park for a period not less than 5 years from its date of establishment in the High
Tech Park (i.e. the Xiamen plant cannot be closed down before 31 December 2005). If JML
fails to comply with all agreed terms, it must repay the grant to the Bureau by 5 equal annual
instalments from the date on which it fails to observe the terms.
The Thomas Group had been confident since it submitted the application in early 2002 that it
would receive the grant eventually, although no formal reply was received from the Bureau
until the Bureau made the government grant of Rmb5,000,000 to JML on
31 December 2003.
The Thomas Group prepares consolidated financial statements in accordance with Hong
Kong Accounting Standards. According to the Thomas Group’s accounting policies,
machinery is depreciated over its estimated useful life of 10 years.
Required:
(a) Determine and explain when the Thomas Group should initially recognise the
government grant in its consolidated financial statements in accordance with
relevant Hong Kong Accounting Standards.
(5 marks)
(b) Identify acceptable methods of measuring and presenting the carrying amounts
of the government grant and the machinery subsequent to their initial
recognition in accordance with relevant Hong Kong Accounting Standards.
(6 marks)
(c) Calculate the carrying amounts of the government grant and the machinery in its
consolidated balance sheets as at 31 December 2002, 2003 and 2004 by each of
the acceptable method.
(7 marks)
Mr. Edward Chan is an employee of Golden Dragon Limited, a Hong Kong garment trading
company. Management of Golden Dragon Limited decided to terminate Mr. Chan’s
employment contract on 31 December 2004. The following table sets out key terms of Mr.
Chan’s employment and profile:
Age 40
Annual paid leave 10 working days per year. A maximum of 5 days untaken
annual leave can be carried forward for one calendar year
only. Paid leave is first taken out of the balance brought
forward from the previous year and then out of the current
year’s entitlement (a FIFO basis).
* Under the Hong Kong Employment Ordinance severance payment and long service payment are
determined by multiplying the number of years of service by two-thirds of the last full month of
salary. The monthly salary is subject to a cap of HK$22,500.
Required:
Identify and calculate the amount of the employee benefits in relation to Mr. Chan’s
employment that Golden Dragon Limited should recognise as an expense in its
financial statements for the year ended 31 December 2004. Explain the reasons for
recognition and the calculations in accordance with relevant Hong Kong Accounting
Standards.
(12 marks)