TI Business Reporting Advanced Stage July 2013

MARK PLAN AND EXAMINERS COMMENTARY TI Business Reporting July 2013

This report includes:

A summary of the scenario and requirements for each question.

The technical and skills marks available for each part of the requirement.

A description of how skills should be demonstrated.

Detailed points for a full answer.

Examiners commentary on candidates performance.

The information set out below was that used to mark the questions. Markers were encouraged to use discretion
and to award partial marks where a point was either not explained fully or made by implication.
Question 1
Scenario
The candidate is working as an assistant to a finance director and is required to correct the work of an
inexperienced junior. The candidate is required to explain and demonstrate understanding of the financial
reporting issues by preparing journal entries and a revised statement of changes in equity and a revised
EPS calculation.
The technical issues covered in this question are the disposal of a shareholding in a subsidiary company,
share options and the acquisition of an overseas subsidiary.

Requirements
a) Explain the correct financial
reporting treatment of the
items in Exhibit 1 and
prepare journal entries for
any adjustments you
propose;

Technical
marks
12

Skills
marks
6

Skills assessed

b) Prepare a revised statement

of changes in equity for the
year ended 31 May 2013;
and

c) Calculate a draft basic (and

diluted if necessary) EPS
figure for the year ended 31
May 2013.

Available marks
Maximum marks

12

Identify and explain incorrect

accounting treatment of the
disposal of the subsidiary.
Recommend the appropriate
treatment according to IFRS.
Recommend appropriate journal
entries to correct and record the
transactions.
Assimilate adjustments and prepare
in an appropriate format for
presentation to the finance director
Assimilate and apply technical
knowledge.

12
24

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TI Business Reporting Advanced Stage July 2013

To:
Carl.McCoy@Bauhaus.com
From: Maida.Cheema@Bauhaus.com
Subject: Year-end adjustments
1: Mission Mouldings Ltd (MM)
MM should have been treated as a subsidiary once Bauhaus achieved control, which was on 1 January 2009.
Goodwill arose on consolidation, and this would have been calculated as:

Cost of investment (375,000 x 32)

NCI at acquisition (125,000 x 25)
Less: Net assets at acquisition (see working below)
Goodwill

Net assets at acquisition

Share capital (500,000 x 50p)
Reserves
Fair value adjustment
Total

000
12,000
3,125
(3,400)
11,725
000
250
2,750
400
3,400

When Bauhaus sells the 40% of MMs shares on 1 March 2013, MM becomes an associate. As such MM
should be treated as a subsidiary for the first nine months of the financial year, and revenue and costs pro-rated
for that period. Therefore MM will only contribute directly 5.4 million (7.2 million x 9/12) to profit for the year.
Tutorial note: alternative assumptions regarding the fair value adjustment at disposal are acceptable.
A gain on disposal of the shares will arise on 1 March 2013. This is calculated as
000
20,000
14,000
6,975

Sale proceeds (200,000 x 100)

Fair value of remaining shares (175,000 x 80)
Non-controlling interest at disposal (see working below)
Less: Net assets of MM at disposal (0.25m + 12.75 m + (7.2 m x 9/12))

(18,400)

Less: Goodwill (see above)

Gain on disposal

(11,725)
10,850

Non-controlling interest at disposal

NCI at acquisition
NCI share of profits from acquisition to start of financial year (25% x (12.75m 2.75m))
NCI share of profits until 1 March 2013 (25% x 7.2m x 9/12)
Total

000
3,125
2,500
1,350
6,975

For the period 1 March to 31 May 2013 the equity accounting method would be used, and Bauhaus should
show 630,000 (7.2m x 3/12 x 35%) in the statement of comprehensive income in respect of profits from
associated company.
The NCI would have 25% of the profit of MM in the statement of comprehensive income for the nine months that
the company is a subsidiary. This gives a figure of 1.35 million (7.2m x 9/12 x 25%).

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The entries which have gone through Bauhaus financial statements are:
000
7,200
(1,800)

Full 12 months profit of MM

Less an adjustment for 25% to NCI
Included in Bauhaus consolidated profit

5,400

However what should be in Bauhauss consolidated profit is the following:

9 months profit of MM
Less an adjustment for 25% to NCI x 9/12

000
5,400
(1,350)

Included in Bauhaus consolidated profit should be

4,050

Therefore the adjustment that is needed to retained earnings is

5.4m 4.05m = 1.35m
ie 1.8 million in respect of the adjustment for the 9 months subsidiaries profit less
0.45 to correct the NCI entry originally made see below

1,350

Journal entries
Dr NCI

000
450

Dr Retained earnings

1,350

Cr Net assets
Being reversal of NCI adjustment made by the client replaced by
the correct NCI adjustment (net adjustment 0.45m)
Dr NCI at disposal
Cr Disposal of subsidiary

1,800

6,975
6,975

Cr Goodwill on consolidation
Dr Disposal of subsidiary

11,725

Cr Consolidated net assets

Dr Disposal of subsidiary

18,400

Dr Suspense account
Cr Profit on disposal
Dr Investment

000

11,725

18,400

20,000
34,000
14,000

Being journals to remove subsidiary from consolidated financial

statements and record the profit on disposal
Dr Investment in associate (7.2 million x 3/12 x 35%)
Cr Income statement
Being share of associates profits for 3 months

630
630

2: Team Bauhaus
The share option scheme is equity settled, and has a four year vesting period. Because it is equity settled the
fair value of the options has to be used at the grant date when the scheme was set up, which is 1 June 2011.
Also the options are equity settled, there will therefore be implications for diluted EPS.
As all the cyclists were still with Team Bauhaus at 31 May 2012, there would have been a charge of 1.44
million (20,000 x 12 x 24 x ) in the income statement for that year, and the same amount credited to equity in

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the statement of financial position. This appears to have been correctly dealt with in the financial statements for
the previous year.
For equity settled schemes the fair value at the grant date is always used where possible to determine the total
cost of the scheme in the financial statements.
Because four members of Team Bauhaus departed they would not be entitled to any share options, and so the
total expense would be based on eight riders remaining in the scheme, as none are expected to leave according
to the team manager.
At 31 May 2013, the total credit to equity would be restated to 1.92 million (20,000 x 8 x 24 x 2/4). The
increase in the year of 480,000 would be charged to the income statement and credited to equity.
Journal required:
000
6,960

Dr Share option reserve

Cr Retained earnings

000
6,960

Dr Income statement
Cr Share option reserve
Being charge for the year

480
480

3: New York Wheels

As a 100% owned subsidiary, NYW should be consolidated from 1 June 2012.
Goodwill will arise on the transaction. At 1 June 2012 it would be calculated as:

Cost of shares
NCI at acquisition
Less: Net assets at acquisition
Goodwill

$000
12,000
(8,000)
4,000

The goodwill will initially be measured using the exchange rate at the acquisition date to give a figure of 2.5
million ($4 million/1.6). This has to be restated at 31 May 2013 using the closing exchange rate to 2.758 million
($4 million/1.45). The increase in goodwill is part of the exchange movement arising in the year.
A goodwill impairment review is required at 31 May 2013.
In the group income statement the average rate should be used not the acquisition rate. Therefore NYW will
contribute 2 million to profit for the year ended 31 May 2013 ($3 million/1.5), this is not the figure calculated by
Andrea of 1.875 million ($3 million/1.6).
The closing rate is used to translate all of the assets and liabilities of NYW in the consolidated statement of
financial position. Andrea has currently only included the results for NY Wheels in the income statement and
has restated the cost by the increase in profit. Therefore a full consolidation of this subsidiary is required. An
exchange movement for the year will arise, this is taken to other comprehensive income. This will therefore also
appear in the statement of changes in equity.
The exchange gain is calculated as follows:
000

Opening net assets

Profit for year
Goodwill
Total gain

$8 million @ closing rate of 1.45

$8 million @ opening rate of 1.6
$3 million @ closing rate of 1.45
$3 million @ average rate of 1.5
$4 million @ closing rate of 1.45
$4 million @ opening rate of 1.6

5,517
(5,000)
2,069
(2,000)
2,758
(2,500)

000
Gain

517
69
258
844
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To correct Andreas accounting:

000
Cr Cost of investment 7.5m + 1.875m
Dr Goodwill
Dr Consolidated net assets 5.517m + 2.069m
Cr OCI (0.844m) IS (0.125m)

000
9,375

2,758
7,586
969

Proof of adjustment of 0.969 million

Andrea has posted 1.875 million to the income statement. The statement of comprehensive income should
show the profit at average rate of 2 million - taken together with the exchange gain of 0.844 million = 2.844
million. Therefore the journal adjustment is 2.844 million - 1.875 million = 0.969 million.
5: Revised statement of changes in equity

At 31 May 2012

Equity
share
capital 1
shares
000
80,000

Share
premium

Retained
earnings

Share
option
reserve

Noncontrolling
interest

000
48,000

000
49,500

000
1,440

000
5,625

000
184,565

1,350

40,925

(6,975)

(6,975)

Profit for the year

39,575

Disposal of
subsidiary
Share option
expense

480

Exchange gain for

year

At 31 May 2013

480

844

Ordinary dividends
paid

844

(4,000)
80,000

48,000

85,919

Total

(4,000)
1,920

215,839

Summary of adjustments to profit for the year

'000
Per Draft

29,800

Profits of MM incorrectly credited for whole year

(5,400)

Profits of MM correctly credited for 9 months

Gain on MM disposal
Associate profits
Share option expense
Increased profits of NYW (2m 1.875m)
Revised profit for the year

4,050
10,850
630
(480)
125
39,575

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6: Earnings per share

000
40.925
(1.350)
39.575

Revised net income

Less: NCI share of profit
Group share of profit for year

Equity shares

8 million

Basic EPS

4.95 pence per share

Diluted EPS

4.947 pence per share (see below)

Diluted EPS
IAS33 requires the basic EPS to be adjusted by the number of free shares held under options. However where
such options are treated under IFRS 2 and have not yet vested, the calculation needs to be adjusted in
accordance with the fair value of services yet to be rendered (per IAS33 para 47A and IAS33IE example 5A).
Thus
Number of options to vest

20,000 x 8

= 160,000

Fair value of services yet to be rendered:

160,000 x 24 x (2 /4)

= 1,920,000

Per option (= 1,920,000/ 160,000)

12

Adjusted exercise price (210 + 12)

Number of shares under option

Number of shares that would have been issued at average market price.
[160,000 (222/230)]

222

160,000

(154,435)

Number of shares treated as issued for nil consideration

5,565

Diluted earnings per share = 39.575 million / (8 million + 5,565) = 4.94

Alternative working
Amount to be received on exercise: 160,000 x 222
Number of shares issued at average market price (35,520,000/230)
Number of 'free' shares i.e. shares treated as issued for nil consideration
(160,000 - 154,435)

35,520,000
154,435

5,565

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Examiners comments
General comment on candidates performance
There were a wide range of answers from the excellent to the very poor and it was not uncommon for the
requirement to prepare a revised statement of changes in equity and the EPS calculation not to be attempted by
the weaker candidates. It was notable that candidates are far better at describing where financial reporting
treatments are incorrect, suggesting and calculating appropriate adjustments than actually setting out a journal
entry to adjust the financial statements. This is a key skill from earlier studies which many seem to have been
lost. Candidates often presented an incomplete journal or one which didnt balance.
Detailed comments
Mission Mouldings Ltd - disposal of shares in a subsidiary
In general this element was reasonably well completed by most candidates with the majority correctly
calculating the goodwill on acquisition, net assets at disposal, the sales proceeds and fair value of remaining
shares. However few were able to correctly determine the non-controlling interest at disposal or to provide
correcting journals that balanced.
Common errors included:

Omitting the share capital or including it as 500,000 not 250,000 in the calculation of goodwill
Not understanding the principle of what to include in the computation for NCI at the point of disposal.
(Common to see candidates missing this years profits, not taking 25% of the profits post acquisition).
Not noticing the instruction in the question to use the fair value method, or not understanding the
instruction.

Team Bauhaus share options

Most candidates made a good attempt at this element and were able to identify at least one correcting journal.
Common mistakes were:

Taking the market price of the share at the grant date instead of the FV of the option.
Not spotting the 4 year period so allocating over 3 years or 5 years (some thought that the remainder
should be allocated over 3 years as this was the time left instead of correcting last years figures).
Ignoring the previous year position and thus charging 960,000 (1,920,000 x 2/4) in the current year.

The majority recognised Andreas adjustment was incorrect and produced journals to correct it based on
their own figures.
New York Wheels acquisition of overseas subsidiary
Almost all candidates correctly identified that this was the acquisition of a subsidiary and were able to calculate
some of the elements of the exchange gain. Again, very few were able to provide correcting journals.
Calculations of goodwill were done well as was the translation. Many picked up that the profit for the year was
incorrect and should have been translated at the average rate. Common mistakes were:

Calculating exchange differences but not stating whether they were gains or losses.
Omitting the journal.

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Revised statement of changes in Equity

Most candidates scored well on this section, with follow-through marks being awarded for candidates own
figures.
The most common mistakes and omissions were:

Not bringing forward the correct share option balance even though students had corrected it in the
earlier part of the question
Not adjusting the profit figure adequately (although this could be because they had failed to complete
journals earlier and this would have made the task more straight-forward)
Not cancelling the NCI even though the subsidiary had been disposed of and the new subsidiary had no
NCI

EPS and diluted EPS

Many candidates identified that an adjustment was required in respect of the free shares demonstrating that
they understood the principle of dilution. Some attempted to calculate the adjustment required to calculate the
diluted EPS.
Common mistakes were:
Taking the profit of 31.6 million from the question without using their adjustments or including profit for
NCI or just using the closing balance on retained earnings.
Diluting the shares with 160,000.
Using the nominal value of the shares (80m) instead of the number of shares (8m).

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TI Business Reporting Advanced Stage July 2013

Question 2 Kare Ltd

Scenario
The company Kare Ltd is owned by a consortium and itself also owns a number of group companies. The
candidate, reporting to the finance director, is first required to explain the current group structure in terms of
the way in which tax losses can be relieved. The candidate must therefore identify that trading loss relief is
available between Kare, ResHome and Goodhealth but the loss relief is restricted in respect of the mid-year
acquisition of Goodhealth.
Kare is owned by a consortium which means that consortium relief is also available to the UK corporate
shareholder Branmoor Ltd. The group structure has implications for chargeable gains in that the gain in
ResHomes can be treated as arising in Goodhealth.
In calculating the maximum loss relief available, the candidate then needs to appreciate that the amount of
capital gain treated as arising in Goodhealth can be greater than the capital loss in Goodhealth. This will
enable any loss not relievable under group relief to be eliminated by the chargeable gain surrendered to it
by ResHomes. Calculating the maximum cash to be paid to Kare requires consideration of the number of
associated companies and the relevant marginal tax rates.
The candidate is also asked to evaluate advice left by the predecessor in handover notes and to make
appropriate recommendations. To answer this section the candidate must appreciate when this advice is
inappropriate by reference not just to technical knowledge but also taking into consideration the boards
objectives of maximising cash flow and minimising compliance costs.

Requirements

Technical
marks

Explain the ways in which the tax

losses for the year ended 31 March
2013 (Exhibit 1) can be used within
the current group structure.

In return for losses surrendered by

Kare, its shareholders and
subsidiaries have agreed to pay to
Kare an amount of cash equal to the
additional tax they would otherwise
have paid. Calculate: (i) the
maximum loss relief available to the
consortium shareholders; and (ii) the
amount of cash agreed to be paid to
Kare by the shareholders and
subsidiaries in respect of the loss
surrendered.

Skills
marks
4

Skills assessed

Apply technical knowledge to the

scenario to identify relevant group
companies for loss relief purposes.
Apply technical knowledge to
determine implications of
consortium relationship including:
Restriction of loss to relevant %
Overseas company not eligible to
receive loss but creates consortium
relationship.
Identify consortium relief after offset
of Kares other income and
potential group relief claims.
Identify restriction of loss from
Goodhealth due to acquisition
during the year.
Apply technical knowledge to
determine that chargeable gain in
ResHomes can be set off against
Goodhealths capital loss.
Identify opportunity to save tax by
transferring chargeable gain to
Goodhealth to maximise loss relief
claim.
Use appropriate tax rates for
determining the cash to be paid for
the loss relief.

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The Kare board considers cash flow

to be an important objective.
However, it would also like to reduce
tax compliance time and costs. In
light of these objectives, evaluate
making appropriate
recommendations, the proposals set
out by your predecessor in his
handover notes (Exhibit 2).

Available marks
Maximum marks

13

Appreciate the difference between

cash flow and tax rate effectiveness
in relation to the boards objectives
for cash flow.
Identify that exemption not possible
in the current year and not
appropriate since losses not
relievable in early years.
Recommend appropriateness of
incorporation of PE.
Advise on need for expert help in
overseas tax jurisdiction.
Conclude on whether advice given
by predecessor is valid and
appropriate in relation to VAT.
Apply scepticism to appraise the
recommendations of predecessor.

12
25

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Working paper for the attention of Jon Kildare

Explanation of the group structure and its effectiveness in the use of tax losses.
The group structure of Kare is as follows:

SGF

Branmoor
70%

30%

Kare

80%

55%

MedServ

ResHomes

Goodhealth

95%

HGH

100%

There are two companies which together own more than 75% of Kare. Neither owns more than 75% of
Kare which means that it is a consortium company. Both resident and non-resident companies are taken
into account when determining whether a consortium exists. The fact therefore that SGF owns 30% of
Kare and is not UK resident means that although it is unlikely to be able to partake in loss relief claims, it
nonetheless enables a consortium to be created and therefore the potential for loss relief to Branmoor to
exist.
As Branmoor is a consortium member it can make a consortium claim for its share of Kares losses.
Branmoor will pay Kare the equivalent amount of tax it has saved. Although this benefits cash flow for
Kare, it may not be effective in terms of tax rate.
The amount of consortium relief that can be surrendered to Branmoor is the lower of the Branmoors
available profits and Kares available losses ie the consortium members percentage holding in the
consortium company x consortium company taxable total losses eligible for consortium relief
The loss available to Branmoor will be reduced by any potential current year claims by Kare and any
potential group relief claims. This is regardless of whether such claims are actually made.

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Any actual group relief claims for other losses in the group are taken into account therefore any loss
surrendered by Goodhealth to ResHomes reduces any potential loss surrender by Kare Ltd to
ResHomes.
For group relief purposes, Kare, ResHomes, HGH and Goodhealth form a 75% group. The group
structure therefore enables losses both capital and trading to be relieved by these group members.
MedServ is not part of the group relief; and therefore its losses are not available for group relief. Its losses
can however be used either by means of a carry forward against future trading profits of the same trade
or by carry back to previous years profits should any be available.
Branmoor is an associated company but can only receive consortium relief. There are therefore 6
associated companies for tax rate purposes.
Calculate the maximum loss relief available to Kares subsidiaries and to the consortium shareholders.
For the purposes of calculating consortium relief, the loss in Kare will first be treated as if set against any
other profits of the same accounting period and then it will be treated as if group relieved to ResHomes
and HGH.
000
Loss
Overseas PE profits (See note below)
Property income
Loss available in Kare for group relief

(1,200.0)
136.0
326.2
(737.8)

Note: Double tax relief is available for the overseas tax on the profits of the permanent establishment.
However, as double tax relief for the overseas tax will not be available as the profits are eliminated in the
year ended 31 March 2013, the overseas tax of 24,000 (160,000 x 15%) can instead be treated as an
expense and deducted from the overseas profits as follows:
160,000 - 24,000 = 136,000
Before a claim for Consortium relief, consideration must be given to any potential group relief claims.
ResHomes is a member of the group relief group with Kare and has taxable profits of 415,800.
ResHomes also has a chargeable gain calculated as follows:
000
Sales proceeds
Less cost
Unindexed gain
Indexation allowance
248.0 194.2/194.2 = 0.277
0.266 x 400,000
Chargeable gain

745.6
(400.0)
345.6

(106.4)
239.2

Indexation (245.8 194.2)/194.2 = 0.266

This makes ResHomes potential total taxable profits of:
Trading profit
Chargeable Gain

000
415.8
239.2
655.0

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Goodhealth is also a member of the group relief group and has a trading loss of 210,000. There is also a
potential group relief claim between ResHomes and Goodhealth which is restricted because Goodhealth
only joined the group part way through the year.
ResHomes can claim the lower of Goodhealths trading loss and its own taxable total profits which relates
to the period they were members of the same group, ie 1 July 2012 31 March 2013. Goodhealths loss
of 9/12 x 210,000 = 157,500 is clearly the lower amount and may be surrendered as group relief. This
leaves a trading loss unrelieved in Goodhealth of 52,500.
Goodhealth also has a capital loss of 90,000. ResHomes can treat part of its chargeable gain
(239,200) arising on the sale of the residential home, as arising in Goodhealth. The amount that is to be
transferred should be sufficient to set off against the capital loss (90,000) and to utilise the amount of
loss in Goodhealth not surrendered as group relief to ResHomes (52,500). Therefore in total 142,500
of ResHomes chargeable gain is treated as being transferred to Goodhealth:
000
Goodhealth trading loss
Less group relief to ResHomes 9/12 x 210,000
Amount of loss not group relieved - see below

(210.0)
157.5
(52.5)

Chargeable gain treated as arising in Goodhealth

142.5

Capital loss in Goodhealth (warehouse sold for 390,000 less cost

480,000)

(90.0)

Chargeable gain
Less: Goodhealths trading loss after group relief to ResHomes

52.5
(52.5)

Taxable profits

Nil

Taxable total profits for ResHomes will therefore be:

000
Trading income
Chargeable gain (239,200 142,500 surrendered to Goodhealth)
Group relief from Goodhealthh
Balance - Group relief from Kare
Taxable profit

Kare
Loss available for surrender as group relief
Group relief surrender to ResHomes
Group surrender to HGH
Consortium claim
Branmoor 70% x 334,800
Loss available for carry forward

415.8
96.7
512.5
(157.5)
(355.0)
Nil

000
(737.80)
355.00
48.00
(334.80)
234.36
(100.44)

There are six associated companies, so the upper and lower limits are divided by six (assuming Branmoor has
no other subsidiaries).

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Upper:

1,500,000/6

= 250,000

Lower:

300,000 / 6

= 50,000

Branmoor
Trading income
Less consortium relief
Taxable total profits

000
400.00
(234.36)
165.64

Tax saved from loss surrendered to Branmoor

165,640 x 24%
Less marginal relief

39,753.60
(843.60)

(250,000 165,640)/100
Tax liability
Tax liability excluding Consortium relief
400,000 x 24%

38,910.00

Payment therefore to Kare

57,090.00

96,000.00

Summary of payments to Kare from Branmoor and group companies

From
Branmoor
ResHomes (355,000 x 24%)
HGH (48,000 x 20%)

57,090
85,200
9,600
151,890

(Losses to carry forward in Kare = 100,440)

Evaluation of proposals and appropriate recommendations
Carry forward of losses
Carrying forward the loss may be marginally more effective in terms of the amount of tax saved (737,800 x
24% = 177,072). However this would not improve cash flow which is considered important by the board of
directors. Tax relief would only be obtained when the corporation tax for the accounting period to 31 March 2014
is paid on 1 January 2015 (assuming that the company is not making payments on account).
Exemption from tax of PE profits
Kare would not be able to exempt the PEs profits for the current accounting period since the election must be
made before the start of the accounting period. This election may not also be appropriate since it would be
irrevocable. Also all permanent establishments created by Kare in the future would come within the exemption.
As the PE in Ruritan made a loss in the initial periods and if other new ventures followed a similar model and
made losses in the opening periods then an election would certainly not be advisable since losses would not be
relievable against UK profits of Kare.
Incorporation would seem to be possible and would enable profits generated in Ruritan to be taxed at 15%
instead of at UK rates. However advice from Ruritanian tax expert would be required to assist with the tax
implications of the subsidiary in Ruritan. Dividends received from the newly incorporated company would
probably be exempt from tax in the UK. It seems there will be chargeable gains on property transferred on
incorporation. However provided that the consideration for the shares in the new Ruritan subsidiary is not in

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cash, such gains would be deferred until the shares in the new Ruritan subsidiary are sold. Therefore cash
consideration would trigger a chargeable gain and should be considered carefully.
However, crystallising a gain on incorporation of the PE may not be a negative point. If there are capital losses
in the group, this could be an opportunity to offset these losses against the gain on incorporation of the PE. This
issue needs further investigation and estimations of chargeable gains and losses across all subsidiaries are
required before Kare proceeds further with plans for incorporation.
The application of CFC rules may also need to be considered as a newly incorporated company does not fall
within the initial 12 months exempt period. There would be considerable compliance costs involved in this.
Change in business strategy Goodhealth
Restriction in the use of losses may apply where there is a change in ownership of a company if there is a major
change in the nature or conduct of the trade within three years before or after the change in ownership. (Also if
the trading activities become small or negligible before the change followed by a revival of the trade which is not
the case in this scenario.) Moving the trade on-line could be construed as a change in the nature of the trade. If
this is found to be the case, losses brought forward before the acquisition of Goodhealth by ResHomes could
not be relieved against future trading profits of Goodhealth. Therefore any changes of the business model need
to be considered carefully if brought forward losses are not to be lost
VAT and e-commerce
The location of the server will not relieve Goodhealth from the responsibility to charge VAT to its customers in
the UK. With respect to physical goods, tax applies in the country to which the goods are delivered.
VAT group
Companies under common control can apply for a group registration for VAT. A VAT group is treated as a single
entity which submits one VAT return. Not all companies eligible for group registration need be included in the
group registration. For example depending on the facts, it may not be appropriate to include ResHomes and
MedServ in the group registration as they are making exempt supplies. Including these companies may restrict
the ability to reclaim input VAT. Also it may be appropriate to exclude HGH as it makes some zero rated
supplies and is likely to be in a repayment position. Including HGH in the group registration may delay the
repayment of VAT and would have a negative cash flow effect.
The advice given by the predecessor suggests that he lacks understanding about certain key tax issues.
Therefore a sceptical approach should be taken and a review of computations submitted and prepared by the
predecessor should be undertaken.
Examiners comments
General comment on candidates performance
Many candidates did not consider the instructions given in the scenario which were a clearly defined and
ignored the task to explain how the losses could be used within the existing group structure. Instead some
candidates plunged head first into preparing calculations of the use of losses.
Candidates who did provide explanations recognised the consortium/group structure, the members of the group
relief group and that the losses available for consortium relief were after maximum current year and group relief
claims demonstrated good written communication skills. Often the theory explained wasnt executed in practice
and when the figures were produced they didnt always follow these principles.
A significant minority of candidates assumed that there were 5 associates not 6 and some assumed the number
of associates for calculating the tax for Branmoor was different than for the other companies.
The treatment of the DTR on the branch profits was often confused, rarely did a candidate suggest the expense
relief route but there were many deductions for DTR at the bottom of tax computations with no real explanation
as to why. Some candidates also incorrectly restricted CY loss relief to maintain DTR or simply ignored the
branch profits altogether.
The calculations of the capital gain and loss were generally done correctly and were often offset. It was
uncommon for the gain to be left in Goodhealth to use the losses not available for group relief.
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Probably the weakest answers were those that added all the losses together (often including MedServ) and
those that gave figures for group relief without clearly indicating which company the losses came from and to
which they were being surrendered. Sometimes it was only apparent what reliefs were being given by looking at
the payments for group relief section.
Payments for group relief were often taken as the losses not the tax on the losses and without consideration of
appropriate tax rates. Most candidates recognised HGH saved tax at the small profits rate.
Howlers seen too often include:

Indexing the CGT loss for Goodhealth.

Not rounding the IA for ResHomes both of these points are basic brought forward knowledge.
Treating MedServ as eligible for group relief.
Taking 9/12 of the capital loss.

Evaluation of the proposals of the predecessor

Most candidates made a reasonable attempt at the predecessors recommendations. Comments on carry
forward the losses and the PE were generally good.
However candidates had a tendency to explain tangential issues at considerable length while sometimes
overlooking the key point. Thus for example, some candidates wrote at length about Kare's options for carrying
losses forward and back, but ignored the cash flow or rate implications of the loss reliefs which was a key point
of the question. The 'kitchen sink' approach must be very time-consuming, and often very few marks were
awarded for several pages of writing.
The conditions for PE exemption were not noted and very few commented on the fact that the election for the
current year is too late. Most appreciated that the election would be irrevocable but did not continue to explain
what this would mean for Kare. Most commented that there would be a gain on incorporation which could be
deferred but did not identify that deferral would not be possible since the shares were being transferred for cash.
Weak candidates did not identify there might be a restriction on the use of Goodhealths brought forward losses
due to the change in the nature of the trade and some thought that it would restrict group relief.
The VAT and e-commerce produced very mixed answers. The standard answer compared the UK and OECD
position on servers being PEs and confused corporation tax principles and VAT. Others discussed VAT in
relation to the provision of services.
The application of the VAT group to the scenario was often explained well by good candidates. Weaker
candidates restated the standard advice re excluding zero rated/pertly exempt companies without explaining
why this was appropriate.
Few candidates applied professional scepticism to consider that if this advice is so poor, what would the quality
of previous work done by the predecessor.

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TI Business Reporting Advanced Stage July 2013

Question 3 UniSel

Scenario
The candidate is an audit senior brought in to complete the audit of a new audit client UniSel Ltd which was
set up by three Universities to exploit commercially the intellectual property arising from research activities.
UniSel is too small to require an audit however under a clause in the shareholders agreement an audit has
been requested by one of the shareholders, ECU after concerns about the relatively high level of invoicing
to ECU in comparison with invoices raised to the other two shareholders.
The UniSel chief executive officer Marco Nyler has the casting vote on the UniSel board and is also on a
bonus scheme which will result in a bonus payable to him of 50,000 based on revenue exceeding 6
million. The bookkeeper is inexperienced and taken together with the dominance of Marco, the candidate
must evaluate the financial reporting and auditing issues in the scenario against the potential for Marco to
be adopting creative accounting techniques to achieve his bonus target.
An ethical issue arises when one of the finance director of one of UniSels shareholders, ECU, requests to
be updated on the UniSel audit. ECU is also an audit client of the firm.
Requirements
(i)

Audit risks and potential

financial reporting issues
identified from information
provided

Technical
marks
8

Skills
marks
6

Skills assessed

(ii)

Identify potential to manipulate

results due to dominant
personality and inexperienced
bookkeeper. .
Apply scepticism to level of fees
charged to ECU.
Recognise incentive to increase
revenue due to bonus.
Apply technical knowledge to
determine potential for
capitalisation under IAS 38.
Identify potential cut off errors
Identify cash flow issue.
Link 2 contracts with Hickman
research and apply IAS 18 and
determine appropriate financial
reporting treatment.
Apply scepticism to the level of
accrued income and deferred
revenue to determine the
potential risk of misstatement

Audit procedures required on

revenue for the year ended 31
May 2013

Recommend appropriate audit

procedures relevant to address
audit risks.

Notes on ethical issues arising

from the audit of UniSel and
explanation of how to respond
to Marys request for
information

Identify need for client

confidentiality.
Recommend clear reporting
responsibilities.
Advise that Mary should ask the
Unisel board member for an
update on the audit.
Identify potential conflicts of
interest as acting for both
parties.
Recommend appropriate safe
guards (informing the client,
separate teams, teams to sign
confidentiality agreements,

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independent partner review)

Total marks
Maximum marks

(i)

20
28

Audit risks and financial reporting issues identified

Dominant CEO with incentive to manipulate results

Marco clearly exercises significant influence over the board of directors and the operations of the company.
His bonus scheme means that he has the incentive to manipulate revenue. Marcos dominant position and
inexperienced bookkeeper potentially give him the opportunity to do so without much challenge. There is also
opportunity to exercise judgment in some of the accounting matters and some complex questions of revenue
recognition. Given that Beatrice understands little about the business she will be reliant on Marco and his team
to let her know for example, how much revenue should be recognised on a particular contract.
Higher charges to ECU
Charges for commercial development work are higher to ECU than to other University shareholders and have
increased in the year while those to South University have decreased and those to North University remained
reasonably static. This could be bona fide if for instance ECU were bringing forward more ideas or presenting
them to UniSel at an earlier stage of development. However it is also possible that the development committee
is making decisions which favour South University over ECU, especially given the composition of the
development committee which includes the board director representing South University. Once an idea is
licensed by UniSel, all three shareholders effectively bear the further development costs evenly. Whereas up
until that point they were borne solely by the University whose research had given rise to the idea. The point at
which propositions are licensed is therefore crucial and any inequity or perceived inequity could lead to
disputes about amounts billed and possibly issues with future funding.
Capitalisation of development costs
UniSel is incurring an increasing level of cost in developing propositions arising from intellectual property
licensed from the university shareholders. At present all such costs are written off to the income statement as
they are incurred. It is however possible that some of the costs meet the criteria for capitalisation under
IAS38:57 and thus should be capitalised. This seems likely as UniSel will only enter into licence agreements
once a proposition is well developed and has reached the point where it can be marketed to third parties and
hence commercial viability would appear to be reasonably assured. However, some of the costs incurred will
be marketing costs which should not be capitalised so careful consideration of the costs will be required.
Revenue cut-off for consultancy income
The consultancy income is billed monthly in arrears and recognised in revenue when it is billed. Unless all
billings are issued on the last day of the month, it is likely to give rise to a cut off issue as revenue for the last
month of the year will not have been recognised.
Going concern
Cash balance has decreased significantly in the year and further working capital may be required if the
business is to grow. We will need to obtain cash flow forecasts for a period of not less than one year from the
date of signing to ensure that there is reasonable evidence that sufficient cash will be available to pay the
companys debts as they fall due. If this relies on additional shareholder funding then we will need assurances
from the shareholders. This may be an issue if ECU is unhappy with the management and the perceived equity
of the current arrangements.
Bonus Accrual
We will need to make sure adequate accrual has been made for Marcos bonus as is not included in profit
figure as presently reported. The bonus should be also reassessed once all audit adjustments have been
processed. Enquire as to whether any other staff members are entitled to payments under bonus or other
incentive schemes.

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Bonus scheme depends only on revenue and not on profit and this may have incentivised Marco to enter into
non profitable contracts such as that with Smyth Laboratories.
Increased staff costs
Significant increase in staff costs has not been explained and needs to be understood, although it is not
unreasonable given increased levels of activity.
Tax
Appears to be no provision for tax at present although company has made a profit. Will need to consider
carefully current and deferred tax position and any tax losses brought forward from prior year or pre
incorporation expenditure.
Income from Smyth Laboratories
Smyth Laboratories is not a related party of UniSel although both companies share a common director in
Marco Nyler. However the daily rate of 300 does seem low, especially as it is below the rate charged to the
university shareholders. There is therefore a possibility that the arrangement with Smyth Laboratories may be
loss making and thus an onerous contract for which a provision may be necessary if UniSel has a commitment
to deliver more hours at this rate. Under IAS37, any excess unavoidable costs should be provided at the point
at which the contract becomes onerous.
In addition, the connection with Marco increases the likelihood that the arrangement may be more complex
than it appears with the lower rate being agreed due to some reciprocal arrangement.
The 350,000 from this arrangement was also key to exceeding the revenue target for Marcos bonus and the
lower rate may have been agreed simply to increase revenue. This may still be bona fide but will need careful
consideration.
Contract with Hickman Research
There are also consulting revenues with this client so will need to consider whether the 2 contractual
arrangements are really separable or part of a single contractual arrangement which should be considered
together.
IAS18 requires separate transactions to be considered together when they are linked in such a way as that the
commercial effect cannot be understood without reference to the series of transactions as a whole.
Even if the contracts are separate, we need to consider carefully the recognition point for the 1 million upfront
licence fee by consideration of the detailed terms of the licence. It may be acceptable to recognise up front
providing UniSel has no ongoing obligations and the amount is non-refundable.
However as the amount is equivalent to a royalty of 4% on 5 million per year for 5 years there is also the
possibility that it should be regarded as a prepaid royalty for subsequent years. It is also likely that there will be
some obligations on UniSel and therefore the up-front element should be deferred over the 5 year period.
The associated costs of the royalty to the university will still be payable on receipt of third party income but
recognition of cost should be spread in line with revenue.
We also need to consider whether there are any additional royalties due for that year.
US Company royalties 650,000
We need to look at the policy for recognition of on-going royalties. On-going royalties should be recognised at
the point they are earned and UniSel has the right to receive them. This is likely to be at the point when the
third party makes the sale unless there is a significant uncertainty either about the amount or the collectability.
IAS18 requires royalty income to be recognised on an accruals basis in accordance with the substance of the
relevant agreement.
The 300,000 for year end 31 December 2012 should have been partially recognised in the prior year. As this
is a first year audit it is important to look at opening position as well as the year end position especially when
the opening balance sheet was unaudited. Hence the beginning of year cut off is of equal importance because
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the inclusion of these sales has contributed to exceeding the target revenue for the year.
Accrual for remaining 5 months looks high compared to prior year and clearly involves judgment. It is crucial
that this is subjected to sceptical audit work as it has contributed significantly to meeting of revenue and profit
targets. Likely to be more recent information than was used to make the estimate and sales for 5 months to 31
May 2013 should now be known.
Level of receivables, accrued income and deferred income
Significant level of receivables raises questions about collectability and also the timing of revenue recognition
as we would not normally expect a long delay in payment.
Accrued revenue is high and includes more than the US Royalties discussed above, there is likely therefore to
be other judgmental items which will need careful consideration. We need to ensure also that the associated
costs such as the royalty payable to the Universities are also accrued, where necessary.
Conversely, deferred revenue is very low given that there could well be contracts with up front revenue and
ongoing obligations. Completeness of deferred revenue is likely to be a significant area of audit focus.
(ii)

Audit procedures on revenue

Ensure that we have a good understanding of the companys revenue recognition policies for each
revenue stream and we have assessed those policies for acceptability. Documentation as it stands
does not set this out clearly.

Tutorial note - Consideration was given in the marking to candidates who highlighted the need to look at
the agency versus the principal question. Although it is clear from the question that the contract is with
UniSel and it would be difficult to argue for a net revenue presentation.

Look at agreements and other documentation supporting a sample of revenue contracts including
those which have an individually material effect on revenue. Determine from each contract what
revenues are payable and what deliverables UniSel has committed to deliver. Review should cover
licence, royalty, consultancy agreements and also consider whether multiple contracts with one
customer are linked. Key factors to consider include whether:

The agreement was signed within the period and there is clear evidence of a contractual
arrangement with UniSel under which it is valid to recognise revenue.
There are multiple elements
The price for each can be determined
All obligations have been delivered
There is clarity concerning the period over which obligations will be delivered
There are any other unusual factors which raise additional issues and questions

For each contract in the sample determine what revenues should be recognized in the year ended 31
May 2013 and compare this to the revenue UniSel has recognized. Determination should include
consideration of whether cut-off is correct at the beginning and end of the year and the completeness
of any deferred revenue.

For the consulting revenues and those charged to the university shareholders, obtain details of the
time spent by the staff working for a sample of clients and ensure that this can be reconciled to the
days of work which have been recognised in revenue and billed to the clients.

Consider the overall analytical review procedures which compare the total amount of billable time
incurred by the staff with the revenues earned from the time. By doing so assessing the
reasonableness of the total revenue recognised. Verify assumptions and data used by testing it and
ensuring that it can be corroborated by information from payroll and other departments not directly
linked to accounting.

Review consulting invoices and those issued to the shareholder universities in May 2013 and June
2013 and ensure that the revenue has been recognized for all the services provided before the year
end.

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(iii)

Test the completeness of the licence and the royalty revenue by selecting a sample of contracts from
the contract files and ensuring that only expected revenues are included. Pay particular attention to
any estimated royalty revenue, ensuring that it is based on reliable and recent information from the
customer and not from a projection received some time ago. Where possible verify that accrued
revenue has been received since the year end.

Consider the classification and disclosure of the revenue reported within the accounts and ensure that
the disclosures are complete and accurate.
Response to Marys request for information and other ethical matters

Confidentiality of client information is the key to any audit appointment and client information should not be
disclosed to those outside the audit team.
Whilst there is clearly information arising from the UniSel audit which will be of interest to Mary and ECU, (most
notably an assessment of whether the development committee is making fair decisions regarding the timing of
licensing arrangements) this information cannot simply be shared with Mary.
ECU is a shareholder but the auditors responsibility is to report to the shareholders as a body, information
cannot be imparted to just one shareholder.
ECU has a director on the Board of UniSel and it would be normal for the auditor to report to those charged
with governance, however once again this report should be to the whole board.
Even if there were evidence of fraud against ECU, communication would not be direct to ECU but to the police
or the relevant authorities.
Hence there is not really anything which can be reported to Mary at the meeting without breaching client
confidentiality. This potentially places Gerrards in a difficult position as it does have knowledge relevant to the
ECU audit.

Communication should be to UniSel Board or the shareholders as a whole although it is important to ensure
that the ECU member is present and has full access to the information to share with their management team.
Mary should be encouraged to ask questions through the UniSel Board member for ECU.
The position as auditor of both clients places Gerrards in a potential conflict of interest position.
Gerrards will need to put safeguards in place if it is to continue to act for both parties. This may include
notifying UniSel and ECU of the potential conflict; using separate engagement teams and preventing access to
information; issuing clear instructions to the teams about confidentiality and potentially requiring team
members to sign up to particular confidentiality undertakings; involving an independent review partner to
assess how the potential conflict has been dealt with from an audit perspective. It looks like the same manager
is involved on both teams at present which may not be acceptable.
Given Marcos character and highly influential role, we need to consider whether there are any indicators which
would mean that the firm might choose not to work for UniSel.

Examiners comments
The most common weakness to answers to this question was an inability to identify the pertinent ethical issues
arising from the audit of UniSel. Many candidates majored on the business ethical issues of Marco's dominance in
the business and his bonus (these are audit risks rather than ethical issues) rather than looking at the question from
the auditor's point of view. Although candidates were expressly asked for a response to Mary's request on an update
on the audit, it was common to find that candidates overlooked this.

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Some candidates did very well on the identification of audit risks and relevant audit testing of revenue. However, few
managed to say much of relevance on the financial reporting issues and weaker candidates tended to leave out this
aspect completely.
Detailed comments
Audit risks were generally identified well. The FR aspects were often more vague and difficult to interpret. Many said
that revenue would be recognised when the risks and rewards were transferred but the question required more
specific knowledge to be applied to different types of revenue e.g. revenue received in advance (to be spread),
revenue that should be recognised when accrued not invoiced and revenue that may be linked (1 or 2 contracts
very few identified this point). Candidates sometimes merged the risks and financial reporting aspects together. This
approach is acceptable however it was often not clear whether the candidate was identifying a risk or a financial
reporting issue. Sometimes the financial reporting issue identified consisted of a comment from the question which
was given no credit in marking e.g. staff costs have increased.
Audit procedures on revenue were generally fine and answered very well. It was pleasing to see that these were
often focussed and related to revenue as required by the scenario.
Performance on ethics
Candidates who adopted the correct approach to the ethics section did identify the confidentiality issue and potential
self-interest threat of representing both clients. There seemed to be some confusion between risks and ethics, so
many discussed Marcos personality.
Fortunately only a few weak candidates said that we could discuss the issues arising on the audit with Mary.

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Question 4
Scenario
The scenario in this question is a UK based machine tools manufacture with the as its functional currency.
The company expanded at the beginning of the current accounting period by opening a manufacturing
division in Thailand in order to serve customers based in East Asia. The candidate is working on the audit of
Stoghopper and a colleague has raised a number of audit issues with respect to the Thai operation as
follows:
Translation of multi-currency bank account balances where normal control procedures have not
operated to convert a yuan receipt from a Chinese customer into the Thai currency (the baht) prior to
the year end.
An interest free loan to a supplier has been made in the year.
There has been an impairment indicator with respect to a new production facility in Thailand following
a patent by a competitor of a more efficient production process.
Candidates are required for each of the above three issues: first to set out and explain the appropriate
financial reporting treatment; second to describe audit risks and related audit procedures

Requirements

Set out and explain the

appropriate financial reporting
treatment in the financial
statements of Stoghopper for the
year ended 30 June 2013.

Technical
marks
4

Skills
8

Skills assessed

Prepare notes describing the

audit risks and related audit
procedures.

Available marks
Maximum marks

1.

Issue 1 bank accounts

1.1

Financial reporting treatment

Apply technical knowledge to

translate multi-currency cash
balances using the correct functional
currency.
Determine fair value of loan by
applying discounting then translate
as a monetary liability.
Use judgment to apply a sceptical
approach to the validity of the
calculations of the FD and then
reassess the impairment using the
closing exchange rate to determine
recoverable amount.
Assimilate information to attribute
appropriate audit procedures to each
audit risk.
Identify both issues of control and
substantive audit procedures.
Identify a range of risks relating to
loan eg control risk, market risk and
credit risk.
Assess the risks relating to a range of
estimates needed to determine
recoverable amount.

17
23

Sale transaction
The sale should be recorded at the exchange rate at date of transaction. A receivable would be recorded at the
same time. As the transaction has not been entered in the cash book the receivable will still be outstanding at
the year end and will therefore be overstated at the year end.

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Cash balances
The balance on the Number 1 account of 440m baht is a monetary asset and needs to be translated into
Stoghoppers functional currency of sterling at the year-end exchange rate on 30 June 2013 of
1 = 55 baht. (With most sales and costs in the UK it is clear that the Stoghopper functional currency is sterling).
Similarly the other bank account with a balance of 2 million yuan needs to be translated to sterling at the year
end. Ideally, this should be translated directly to sterling from yuan at the 1/yuan year end exchange rate.
However assuming currency markets are efficient then this can be translated first into baht and then sterling
using the information provided. Thus
2 million yuan x 5.1

10,200,000 baht

Total baht bank balances (10.2m +440m)

450.2m baht

8,185,455

Sterling equivalent
Number 1 account (450.2m baht/55)

This figure will be shown in the statement of financial position of Stoghopper at 30 June 2013.
Exchange gain
On receipt, the value of the yuan in sterling is 2 million yuan x 5/54.5
At 30 June 2013 value of yuan in sterling is 2 million yuan x 5.1/55
Exchange gain

= 183,486
= 185,455
1,969

Tutorial note: any movement on the /baht exchange rate from that previously reported would give rise to an
exchange difference on the cash balance as a monetary asset. However insufficient information is provided to
calculate this.
1.2

Audit risks and procedures

Audit risk
Bank account balances are not being properly
controlled giving rise to unauthorised exchange
rate differences

Audit procedures
Review treasury policy, instructions to banks to
transfer funds and treasury policies to find out
why the yuan balance was not transferred
immediately on receipt.

If cash is not controlled then there is a risk of

misappropriation

Investigate who has control to authorise

receipts and payments from each bank account
(central control from UK?)

Unidentified bank balances

Obtain full disclosure of all bank accounts from

managers (trace transactions between
accounts as corroborative evidence).
Obtain bank confirmations from all bank
accounts including nil balances as a test for
under and over statement.

Timing differences between bank and cash

book

Perform bank reconciliation (or review clients

reconciliation). Review all differences between
bank and cash and trace to source
documentation to verify validity and timing.

Window dressing between bank accounts

Examine significant transactions post year end

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2.

Issue 2 Loan to supplier

2.1

Financial reporting treatment

IAS39 para 43 requires a financial asset to be measured initially at fair value. A zero interest rate is not a fair
value, but the fair value can be determined by using a market yield to discount to a present value.
The initial fair value of the loan when issued on 1 July 2012 is therefore:
400m baht/ (1.06)

356m baht

In terms of sterling this would be translated at this date as:

356m baht/50

7.12m

Treating the loan as held to maturity then, using the amortised cost method, the loan at the financial year end of
30 June 2013 is:
356m baht x 1.06

377.36m baht

This is a monetary asset and would be translated at the year-end rate of 55 baht = 1. In the financial
statements of Stoghopper it would therefore be translated as:
377.36m baht/55

6.86m

There are two elements to these transactions for financial reporting purposes: (i) interest income on the loan;
and (ii) exchange loss.
The interest income is recognised as the effective rate even though there is no cash received. As it accrues
over the year, it is translated at the average exchange rate. The interest cost in baht is therefore:
356m baht x 6%

21.36m baht

406,857

Translated into this is:

21.36m baht /52.5

The exchange loss has two elements:

On the interest
On the loan
The exchange loss on the interest is:
21.36/52.5 - 21.36/55 = 18,494
The exchange loss on the loan is:
356m/50 - 356m/55

647,273

Reconciliation:
Interest income
Exchange loss
On interest
On loan

406,857
(18,494)
(647,273)

This reconciles with the opening balance divided by the opening exchange rate less the closing balance divided
by the closing exchange rate as above.(7.12m - 6.86m) = 0.26 million

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2.2

Audit risks and procedures

Audit risk

The supplier may not be able to repay the loan

and it should then be impaired. This is a
particular risk as there are no cash interest
payments to observe that these can at least be
serviced.

Audit procedures
Check procedures used to verify the
creditworthiness of the supplier when the loan
was originally extended.
Verify the terms of the loan and the security
available from Rangoon if the loan is not
repaid.
Enquire whether there is a charge over assets
as security for the loan.
Examine correspondence (legal
correspondence, board minutes, as well as
letters/emails/memos with Rangoon) for any
possibility of early repayment.
Consider audit visit to Thailand or instructing
local auditors.

The market rate of interest of 6% may not be a

risk equivalent in which case the validity of the
loan and the interest payments would be
incorrect.

Compare rates to corporate loans to similar

companies where interest is paid in full.

Classification of the loan as held to maturity

may be inappropriate.

Confirm terms of the loan agreement.

Examine correspondence for any possibility of
early repayment.

Control risk in authorising a large loan on

favourable term in a country where there has
been no previous experience from physical
presence.

Review level of authorisation of loan (main

board).
Review treasury procedures to attest
information on creditworthiness, legal advice
and means of drawing up loan agreement.
Consider link between loan terms and
contractual supply agreement with Rangoon.
E.g. deep discounting of purchase cost of
goods as part of loan agreement.

Check appropriateness of exchange rates.

Verify exchange rates and estimate average

exchange rates.
Check date on which loan was extended.

3.

Issue 3 impairment of production facility

3.1

Financial reporting treatment

Cost
Depreciation
Carrying amount

Baht
600m
100m
500m

Expressed in baht the asset is not impaired as the recoverable amount is the value in use of 520m baht (which
is greater than the fair value less costs to sell)

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However for the purpose of testing for impairment the carrying amount should be measured at the normal
historic exchange rate, but the recoverable amount should be determined at the closing exchange rate.
Thus the carrying amount in s is 500m baht/ 50 =

10m

The recoverable amount in s is 520m baht/55 =

9,454,545

There is therefore an impairment charge of 545,455 on this basis.

3.2

Audit risks and procedures

Audit risk

Audit procedures

Inappropriate asset life and therefore

inappropriate depreciation

Review the basis on which the useful life was

determined. It may seem that 6 years is short
useful life for a new production facility. If output
is to be reduced (i.e. reduced sales due to the
competitors development) the useful life may
be extended.

Impairment indicator is valid

Investigate nature of competitors development

to ensure this is a valid impairment indictor

Impairment review has been properly carried

out re value in use - some subjectivity required

Has a reliable estimate been made? How have

future cash flows been determined? (E.g. past
sales, exchange rates used, budgeted costs);
has an appropriate interest rate been used to
discount net cash inflows? Has an appropriate
cash generating unit been identified?
Re-perform calculation, testing sensitivity to
assumptions.

Residual value may be non-zero

Enquire why zero residual? Has any residual

been built into value in use calculation?

Impairment review has been properly carried

out re Fair value less costs to sell

If the FV less costs to sell are less than the

value in use then it is irrelevant in determining
the recoverable amount. In this respect the risk
is low unless (i) the value in use has been
substantially overstated; or (ii) the FV less
costs to sell have been substantially
understated by management.

Impact of the rival companys development has

been significantly underestimated

Examine available evidence about rival

company (e.g. patent office records; industry
intelligent; Stoghoppers own records and
calculations). Estimate whether new production
will be brought into use by rival within the next
6 years of the Stoghopper asset life.

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TI Business Reporting Advanced Stage July 2013

Examiners comments
General comment on candidates performance
Many candidates struggled with the calculations in this question and some incomplete answers were submitted
which suggested lack of knowledge in this technical area of the syllabus rather than poor time management.
However, the audit risks and procedures were performed particularly well and many candidates scored full
marks in this part of the question.
Detailed comments
Some candidates were challenged by all three financial reporting issues. In the first issue, the foreign currency
translation was done correctly by only a minority of candidates. In the second issue, although most got the point
about the need to discount the financial asset, few actually did so. Of those who discounted it, not all translated
it correctly. A few thought it was a financial liability. In the third issue many candidates concluded that no
impairment was necessary. Some thought that impairment was necessary but only because they got the basic
IAS 36 decision rule wrong. Relatively few correctly identified the need to translate recoverable amount at
closing rate.
The audit aspects were handled better on the whole than the financial reporting, although a common error was
to identify procedures only, and not risks and related procedures as required.

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