ADVANCED STAGE TECHNICAL INTEGRATION EXAMINATION

MONDAY 5 NOVEMBER 2012

(3 HOURS)

BUSINESS REPORTING
This paper consists of FOUR written test questions (100 marks).
1.

Ensure your candidate details are on the front of your answer booklet.

2.

Answer each question in black ball point pen only.

3.

Answers to each question must begin on a new page and must be clearly numbered.
Use both sides of the paper in your answer booklet.

4.

The examiner will take account of the way in which material is presented.

The questions in this paper have been prepared on the assumption that candidates do
not have a detailed knowledge of the types of organisations to which they relate. No
additional credit will be given to candidates displaying such knowledge.

Interest tables are provided with this examination paper.

IMPORTANT
Question papers contain confidential
information and must NOT be
removed from the examination hall.

You MUST enter your candidate number in this box

DO NOT TURN OVER UNTIL YOU

ARE INSTRUCTED TO BEGIN
WORK

Copyright ICAEW 2012. All rights reserved.

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163064

QUESTION 1
Razak plc is a listed parent company. During the year ended 30 September 2012 Razak plc
increased its shareholding in its only equity investment, Assulin Ltd.
Razak publishes magazines in the UK. You are Kay Norton, a chartered accountant and a
member of the Razak financial reporting team. You report to the Razak group finance
director, Andrew Nezranah, who is also a chartered accountant.
You receive the following email:
To:
Kay Norton
From: Andrew Nezranah
Date: 29 October 2012
I have recently joined the board and I am preparing for our annual update presentation to our
bank.
As part of this update, I have been asked to present the bank with draft consolidated financial
statements for the year ended 30 September 2012. I appreciate that there will be tax issues
to finalise at a later stage, but the bank has said that it is not interested in these at present.
For a number of years Razak plc held 15% of the ordinary share capital of Assulin, a paper
pulp manufacturer. On 31 March 2012 this shareholding was increased to 80%, as we
wanted to secure continuity of supply in relation to paper pulp. Further details of this
transaction can be found in Exhibit 1.
Razak plcs draft financial statements at 30 September 2012 are summarised in Exhibit 2.
In addition I have some concerns about Razak plcs purchase of a bond in Imposter plc
(Exhibit 3).
Please would you:

provide explanations of how the increase in the stake in Assulin will be treated in
Razaks consolidated financial statements;

explain any adjustments needed to account for the purchase of the Imposter bond in
Razaks consolidated financial statements and evaluate any ethical issues arising from
this matter; and

prepare Razaks consolidated statement of financial position at 30 September 2012

after making all relevant adjustments.

Requirement
Reply to Andrews email.
(25 marks)

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Exhibit 1 Shareholding in Assulin

In 2004, Razak plc bought 75,000 shares in Assulin for 6 each. The shares were classified
as available-for-sale. At 30 September 2011, the shares had a fair value of 16 each, and a
cumulative increase in fair value of 750,000 had been recognised in other comprehensive
income and was held in equity. In Razak plcs draft statement of financial position, the
increase in the share valuation has also been included in the investment in Assulin.
On 31 March 2012 a further 325,000 shares in Assulin were purchased for 25 each. This
sum has been added to the investment in Assulin.
In addition to the cash consideration of 25 per share, Razak plc agreed to pay a further 6
per share on 31 March 2014, subject to a condition that Assulins management team, each of
whom owned shares in Assulin, remain with the company to that date. It is considered to be
highly probable that this condition will be met. No adjustments for a contingent payment have
been included in Razaks financial statements. Razak has a cost of capital of 9%.
On 31 March 2012, the fair value of an Assulin share was estimated to be 20. Razak has
decided to use the fair value (full goodwill) method to measure non-controlling interest.
The statements of financial position of Assulin at 30 September 2012 and 31 March 2012
were as follows:
30 September
2012
'000
Non-current assets
Property, plant and equipment
Current assets
Inventories
Receivables
Cash at bank
Total assets
Equity
1 ordinary shares
Retained earnings
Non-current liabilities
Loan from Razak plc
Current liabilities
Trade payables
Tax payable
Total equity and liabilities

31 March
2012
'000

3,460

3,210

610
400
70
4,540

580
280
90
4,160

500
2,740

500
2,540

800

800

290
210
4,540

240
80
4,160

Included in Assulins non-current assets is a property which had a carrying amount of

1.2 million at 31 March 2012. This property was estimated to have a fair value of
2.6 million at this date, and a remaining useful life of five years.

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Exhibit 2 Draft statement of financial position for Razak plc at 30 September 2012
'000
Non-current assets
Property, plant and equipment
Investment in Assulin
Loan to Assulin
Other financial assets
Current assets
Inventories
Receivables
Total assets
Equity
1 ordinary shares
Share premium account
Retained earnings
Available-for-sale reserve
Non-current liabilities
Current liabilities
Bank overdraft
Trade payables
Tax payable
Total equity and liabilities

6,000
9,325
800
1,308
17,433
1,140
960
2,100
19,533

2,800
7,400
2,510
750
13,460
2,788
1,220
865
1,200
3,285
19,533

Exhibit 3 Imposter bond

Razak plc purchased a 6% bond in Imposter on 1 October 2011 (the issue date) at par for
1.2 million. The interest is payable annually in arrears. The bond is redeemable on
30 September 2014 for 1.575 million. It is currently recognised in other financial assets in
the draft statement of financial position at amortised cost, and has been classified as held-tomaturity. The bond has an effective annual rate of interest of 15%.
After paying the interest on its due date of 30 September 2012, Imposter went into
administration in early October 2012. It is estimated that only 40% of the maturity value will
be repaid on the original repayment date of 30 September 2014. No further interest will be
paid.
The annual market interest rate on a similar 2-year, zero-coupon bond is 15% at
30 September 2012.
The chief executive of Razak plc is also a director of Imposter and has a 5% shareholding in
Imposter. The chief executive authorised the purchase of the bond. There is no record of this
matter in the board minutes.

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QUESTION 2
You are working in the tax department of PPD Chartered Accountants as the assistant to the
tax partner, Julie Mentor. PPD are tax advisers to Eclipze plc, a listed, national chain of
furniture retailers. On 1 May 2011 Eclipze acquired the entire ordinary share capital of Dezine
Ltd a bedroom design business, by means of a paper for paper share exchange. Following
the acquisition, PPD now also act as tax advisers to Dezine and to Antonia Loga, the former
majority shareholder of Dezine. Antonia is UK tax resident and domiciled.
Julie gives you the following instructions:
Antonia has provided details of her income and gains for the tax year to 5 April 2012
(Exhibit 1). I have also forwarded you an email received today from Antonia (Exhibit 2).
Please draft a working paper in which you:

set out Antonias income tax computation for the tax year ended 5 April 2012;

explain the adjustments you have made to correct any matters incorrectly treated by
Antonia;

advise Antonia on the capital gains tax implications of the paper for paper acquisition
by Eclipze of her shares in Dezine. Explain any appropriate claims or elections and set
out any additional information you would need in order to make a recommendation; and

reply to Antonias email (Exhibit 2).

Requirement
Prepare the working paper requested by Julie Mentor.
(25 marks)

Exhibits 1 and 2 continued overleaf

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Exhibit 1 Summary of income and gains for year ended 5 April 2012 prepared by
Antonia Loga

Net dividends received from Eclipze

Gross salary/ compensation from Dezine (note 1)
Gross salary from Eclipze (note 2)
Overseas property income (note 3)
Chargeable gain on Eclipze shares (note 4)

Earnings

Dividends

46,800

Chargeable
Gain

85,000
100,000
nil
330,000

Note 1 - Salary and compensation from Dezine

After the takeover of Dezine by Eclipze on 1 May 2011 (see Note 4 below), I was made
redundant from my directorship at Dezine and received 75,000 as compensation for loss of
office. This was in addition to my salary for the month of April 2011 which was 10,000. In
total, therefore, my gross pay was 85,000 and tax deducted under PAYE was 22,000. I
was also allowed to keep my company car, which had a market value of 25,000.
Note 2 - Salary from Eclipze
I have received a salary from Eclipze. This was a gross salary of 100,000 for the period to
31 March 2012, from which tax of 40,000 has been deducted under PAYE.
Note 3 - Overseas property income - villas in Spain
I received rental income of 45,000 (after the deduction of 10,000 tax paid to the Spanish
government) from my villas in Spain. This rental income has been credited to my UK bank
account. As I have already paid tax to the Spanish government, I have not included any of
this income in my summary above.
Note 4 - Chargeable gain on Eclipze shares
My grandfather gave me 5,500 of the 10,000 ordinary shares in Dezine on 31 March 2008
when he retired as managing director of Dezine. I had been working at Dezine in the product
development department for ten years and became managing director when my grandfather
retired. My Dezine shares had a market value of 1.2 million on 31 March 2008 and my
grandfather continued to hold the remaining 4,500 shares.
On 1 May 2011, my grandfather and I accepted an offer from Eclipze plc for all of our shares
in Dezine. The agreed consideration was 30 shares in Eclipze in exchange for each Dezine
share. The share price of each Eclipze share on 1 May 2011 was 8.
I do not have a controlling interest in Eclipze, as it had 15 million ordinary 1 shares in issue
after the takeover of Dezine.
I did not receive any cash for my Dezine shares as I received 165,000 Eclipze shares in
exchange for my 5,500 Dezine shares. However I cannot believe that I have no tax to pay on
this transaction. I estimate that the chargeable gain is 330,000 which I have calculated as
follows:

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000
Value of Eclipze shares at 5 April 2012
165,000 x 10 per share (market price at 5 April 2012)
Less:
Value of Eclipze shares at 1 May 2011
165,000 x 8 per share (market price at 1 May 2011)
Increase in value of my Eclipze shares

1,650

1,320
330

As the share price is increasing I may hold my Eclipze shares for 12 months, but then will
consider selling some of my shares.

Exhibit 2 Email from Antonia Loga

Forwarded email
Date 5 November 2012
Julie
I would like you to advise me on the following tax issues:
Share options
On 1 June 2011, I accepted the position of product development director for Eclipze.
On 1 January 2013, as part of my remuneration package, I will be granted share options in
Eclipze. These may be eligible to be treated as part of an approved company share option
plan. I will be granted the right to buy 3,000 shares in Eclipze at an exercise price equal to
the share price on 1 January 2013, which is estimated to be 10 per share. The options are
exercisable on 31 March 2016.
Assuming the scheme is approved, please estimate the amount of cash I will receive, net of
any tax payable, if I both exercise my options and sell these shares in Eclipze on 31 March
2016. It is estimated that the share price at 31 March 2016 will be 15. Also calculate the
after-tax cash receipt if the share options were granted under an unapproved scheme.
Please advise me whether the scheme is likely to be approved.
Letter from executor of grandfathers will
Sadly my grandfather has recently died and I have just had a letter from the executor of his
will. The executor is asking me whether I still hold the shares in Dezine which my grandfather
gifted to me on 31 March 2008. I am not sure of the tax implications of no longer owning the
Dezine shares. Please could you advise me on whether potentially there are any further tax
implications for me arising from grandfathers gift to me of the Dezine shares and the
subsequent paper for paper share exchange. I do not require any calculations on this
matter.
Antonia

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QUESTION 3
You are Cary Smith, the senior assigned to the audit of Allread Ltd, a UK company with
wholly-owned subsidiaries supplying text books to schools and governments around the
world. You are supervising the planning for the audit of Allreads consolidated financial
statements for the year ending 31 December 2012. Your assistant, Finn Usher, has
performed preliminary analytical procedures on the group financial statements for the nine
months ended 30 September 2012 (Exhibit).
The audit manager has asked you to review Finns work and to prepare two separate
documents:
(i)

Review notes for Finn which identify and explain areas where his analytical
procedures are incomplete or inappropriate. These notes should also set out, for each
area, the further analysis or additional information required; and

(ii)

A briefing document for the audit team which explains the financial reporting issues
and audit risks you have identified from Finns work and outlines the audit procedures
required in response to each issue.

Requirement
Prepare the review notes and the briefing document requested by the audit manager.
(25 marks)

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Exhibit Preliminary analytical procedures prepared by Finn Usher

The data used for these analytical procedures was extracted from the consolidated financial
statements of Allread for the 9 months ended 30 September 2012.
My discussion with Mattie Hall (financial controller) revealed that there is one new whollyowned subsidiary included within the consolidated results, Allread Online Ltd. (Our firm also
audits Allread Online.) This entity was incorporated by Allread in January 2012 to provide
internet journals and other educational material to schools around the world.
Allread Online has its headquarters in the UK but the majority of its staff is based in North
America. It had no revenue in the 9 months to 30 September 2012, but sold its first annual
subscriptions for online publications in October 2012. Subscriptions are sold at consistent
worldwide prices denominated in US$. Allread Onlines accounts are maintained in by the
group accounting department in the UK and show an intangible asset of 1.2 million and a
loan from the parent company, Allread, of 1.4 million. All other amounts for the period to 30
September 2012 are below group planning materiality of 200,000. The intangible asset
represents costs incurred in North America to develop the online publication system and to
publicise the groups new online offering.
Summarised financial statements for the Allread group are as follows:
Consolidated statement of comprehensive income

Actual for 9 months

ended

Revenue
Cost of sales
Gross profit
Gross profit margin
Distribution costs
Administrative expenses
Finance costs
Profit before tax
Income tax expense
Profit for the period

Forecast
for year
ending

Actual
for year
ended

30 Sept
2012
000

30 Sept
2011
000

31 Dec
2012
000

31 Dec
2011
000

19,543
(9,320)
10,223

21,081
(9,980)
11,101

26,500
(12,000)
14,500

26,108
(12,747)
13,361

52%

53%

55%

51%

(977)
(6,878)
(71)
2,297
(688)
1,609

(1,058)
(6,289)
7
3,761
(1,128)
2,633

(1,300)
(9,000)
(106)
4,094
(1,230)
2,864

(1,319)
(8,136)
10
3,916
(1,175)
2,741

Exhibit continued overleaf

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Note
1

2
3

Consolidated statement of financial position

Actual as at

Forecast
as at

Actual as
at

30 Sept
2012
000

30 Sept
2011
000

31 Dec
2012
000

31 Dec
2011
000

1,800
742
2,542

645
1,067
1,712

2,200
800
3,000

600
1,034
1,634

4,201
5,519
95
9,815

3,801
4,910
520
9,231

3,600
4,800
3,015
11,415

3,649
4,702
450
8,801

5
6
7

12,357

10,943

14,415

10,435

5,700
427
6,127

5,832
548
6,380

5,430
500
1,000
6,930

5,619
295
5,914

1,400
340
1,740

490
490

1,400
340
1,740

340
340

Total liabilities

7,867

6,870

8,670

6,254

Equity
Share capital
Share premium account
Retained earnings
Total equity

500
3,000
990
4,490

500
3,000
573
4,073

500
3,000
2,245
5,745

500
3,000
681
4,181

12,357

10,943

14,415

10,435

Non-current assets
Intangible assets
Property, plant and equipment
Current assets
Inventories
Trade and other receivables
Cash at bank

Total assets
Current liabilities
Trade and other payables
Current tax liabilities
Deferred revenue
Non-current liabilities
Borrowings
Deferred tax liabilities

Total liabilities and equity

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Note

8
9

10

Analytical procedures notes

1.

Revenue for the nine months to 30 September 2012 was disappointing compared with
the equivalent prior year period to 30 September 2011, as some government education
authorities have delayed purchases and the general trend away from books to internet
content continues. Performance in Africa is the one exception to this. Revenue in Africa
has risen by over 25% and now represents approximately 30% of the groups total
revenue.
Forecast revenue for the three months ending 31 December 2012 includes 0.5 million
of subscriptions from the new Allread Online business.

2.

Distribution costs are comparable with prior year costs and represent a consistent
percentage of revenue.

3.

Administrative expenses have increased because of two factors:

a.

A prior year audit adjustment to increase the allowance for impairment of

receivables by 400,000 was not booked in the management accounts until March
2012 and therefore appears as an expense in the 9 months ended 30 September
2012. This adjustment was, however, reflected in the prior year statutory accounts.

b.

Salaries in Africa have increased by 200,000 because of increased levels of

business.

These factors have been offset to some extent by significant falls in the equivalent of
overseas costs in countries where exchange rates have weakened against the .
4.

Historically, intangible assets have comprised software purchased from third party
suppliers. The increase of 1.2 million is due to the development costs incurred and
capitalised by Allread Online.

5.

Inventories are higher than expected at 30 September 2012 because of slower than
anticipated sales in Asia and North America and the build-up of inventories for the
growing African market. There is considerable management focus on reducing inventory
levels through special deals. In addition, some of the older books may be donated to
schools in territories where the group is keen to establish itself.

6.

Receivables have increased despite a fall in revenue. This is due to delayed payments
from customers in Africa where there have been some distribution issues caused by a
change in the freight company used. Some customers are refusing to pay until they
receive their books. These issues are expected to be resolved before the year end.

7.

Cash has decreased, despite the profitability of the group, because of increases in
working capital and payment of a dividend of 1.3 million by Allread Ltd.

8.

Tax payments totalling 556,000 have been made during the 9 months ended
30 September 2012. Forecast payments for the final quarter are 469,000.

9.

Deferred revenue relates to Allread Online annual subscriptions invoiced in advance.

10. Borrowings relate to a loan taken out by the parent company to fund the Allread Online
development costs.

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QUESTION 4
You are an assistant manager working on the audit of Artistic Plastic Products plc (APP) for
the year ended 30 September 2012. APP is listed on the London Stock Exchange and
produces household plastic products which are sold globally.
The audit engagement partner, Hector Hermes, called you into his office and came straight to
the point.
We need to sign off on the APP audit by the end of next week. The detailed audit
procedures are nearly complete, but I am concerned about a number of adjustments
identified by the audit senior (Exhibit) which have not yet been appropriately recognised in
the draft financial statements.
With respect to the three issues raised in the audit seniors adjustment document (Exhibit), I
would like you to do the following:

Determine and explain the appropriate financial reporting treatment. Show the journal
entries to correct the draft financial statements for the year ended 30 September 2012,
so we can tell the client the precise adjustments we require; and

Describe the appropriate audit procedures that should be carried out.

I am not concerned about tax or deferred tax at this stage.

Requirement
Respond to the audit engagement partners instructions.
(25 marks)

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Exhibit Adjustment document - prepared by Audit Senior

(1)

Servico plc is APPs preferred global distributor. On 1 January 2012, APP entered into
a 9-month contract for Servico to provide all of APPs UK distribution services.
Settlement on the contract was to be made to Servico on 30 September 2012 in one of
two alternative ways:
Alternative 1
By issuing 600,000 new shares in APP to Servico; or
Alternative 2
By making a cash payment to Servico of an amount equal to the market value of
550,000 APP shares on 30 September 2012.
Under the terms of the contract, Servico could choose which alternative it preferred. In
September 2012 Servico elected to receive APP shares under Alternative 1. APP
issued these shares to Servico on 30 September 2012.
The market value of one APP share was:
at 1 January 2012
at 30 September 2012

2.40
2.95

The fair value, on 1 January 2012, of the right to receive one APP share on
30 September 2012 was 2.30.
The fair value of the UK distribution services provided by Servico under normal cash
settlement terms would have been 1.5 million.
APP has not yet recognised any entries in respect of this arrangement in its draft
financial statements.
(2)

On 30 June 2012 APP issued 10 million 5% convertible bonds at par. Interest on the
bonds is payable annually in arrears. Issue costs payable to professional advisers
were 400,000. Our firm did not advise APP in this matter.
The bonds can, at the choice of the holders, be:

redeemed at par on 30 June 2015; or

converted on 30 June 2015 into ordinary shares in APP at the rate of three
ordinary shares for every 10 bond held.

In the draft financial statements, the proceeds from the bond issue have been
recognised as a non-current liability. The issue costs have been classified as an
administrative expense. Cash received and paid has been recognised. No other
entries have been made. The prevailing market interest rate for similar bonds of
equivalent risk, but without conversion rights, is 9% per annum.
Exhibit continued overleaf

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(3)

APP has a defined benefit pension scheme for its employees. The pension schemes
actuary reviewed the funding of the scheme during the year and provided the following
information:
At 30 September
2012
2011
m
m
Pension fund assets (fair value)
Pension fund liabilities (present value)
For the year ended 30 September 2012:
Current service cost
Employer contributions to pension fund
Benefits paid to retired employees

300
326

280
280

30
32
23

There has been no actuarial valuation for a number of years. Therefore the directors
have assumed the following:
Expected annual return on assets at 30 September 2011
Annual discount rate used in determining obligations

10%
12%

There were no actuarial gains or losses at 30 September 2011. The companys

accounting policy is to recognise actuarial gains or losses in full through other
comprehensive income.
The only entry made in respect of pensions in the draft financial statements for the
year ended 30 September 2012 was to treat the contributions paid by APP to the
pension fund as an administrative expense. APP made these contributions into the
fund on 30 September 2012.

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