ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing
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Chapter 15: Reporting of non-group financial statements
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Example 2: Re-stating draft financial statements
The question
Preparing an answer: workings
Preparing a re-drafted statement of comprehensive income
Preparing a re-drafted statement of financial position
Preparing a re-drafted statement of financial position
3 Example 2: re-stating draft financial statements
3.1 The question
A question that asks you to re-draft a set of financial statements will begin with the
draft financial statements and some additional information.
The summarised draft financial statements of PRD are shown below.
PRD
Incomestatementfortheyearended30June2009
$000
Revenue(note(1) 4,925
Costofsales:(note2) (3,100)
Grossprofit 1,825
Operatingexpenses (600)
Investmentpropertyrentalincome 30
Financecosts (55)
–––––
Profitbeforetax 1,200
Incometaxexpense (300)
–––––
Profitfortheyear 900
–––––
PRD
Statementoffinancialpositionasat30June2009
$000 $000
Non‐currentassets
Property,plantandequipment 7,400
Investmentproperty(note3)1,800
––––––
9,200
Currentassets1,500
––––––
Totalassets10,700
––––––
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Equityandliabilities
Capitalandreserves
Equitysharesof$0.50eachfullypaid 1,600
Revaluationreserve 200
Retainedearnings(note4) 7,650
–
––––
7,850
–––––
9,450
Non‐currentliabilities
7%convertiblebonds,redeemable2012(note5) 500
Deferredtax(note6) 200
700
Currentliabilities550
––––––
Totalequityandliabilities10,700
––––––
The following information is also relevant.
(1) The figure for revenue includes a transaction on 1 July 2008, involving the sale
of goods to Leech Finance Company for $400,000. The goods had a cost of
$150,000. Under the terms of the transaction, PRD has the right to buy back
the goods on 30 June 2010 for $484,000, at which time the goods are expected
to have a value of $550,000. The repurchase price of $484,000 has been set so as
to give Leech Finance a 10% per annum return.
(2) The company has recognised from past experience that after the end of the
reporting period, when annual bonuses have been paid, a large number of
employees leave their job with the company and the company incurs
substantial recruitment costs in order to replace the employees they have lost.
As a result of this expected cost, the company has made an accrued charge of
$60,000 for contingent recruitment costs, and has included these in the cost of
sales and as a current liability in the draft financial statements.
(3) PRD owns two properties. One is an investment property that is rented to a
tenant under an operating lease. PRD uses the fair value model for this
property in accordance with IAS40 Investment property. The other property
is a factory that has some office accommodation, which is used mainly for
production operations but also as head office accommodation. The property is
revalued to current value at the end of each year.
Details of the fair values of the properties are as follows.
Investmentproperty Factory
$000 $000
Valuation30June2008 1,800 2,500
Valuation30June2009 1,750 2,750
The valuations at 30 June 2009 have not been incorporated into the draft
financial statements. In addition, depreciation of the factory of $50,000 has
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been charged in full to cost of sales, but 10% of this charge should have been
made against operating expenses.
(4) The balance of retained earnings has been derived as follows:
$000
Retainedearningsat30June2008 7,100
Profitfortheyearto30June2009 900
Dividendspaidintheyear (350)
–
––––
Retainedearningsat30June2008 7,650
–
––––
(5) 7% convertible bonds 2012
The company issued $500,000 of 7% convertible bonds on 1 July 2008. They are
redeemable at par on 30 June 2012 or are convertible into new shares of the
company at the rate of 25 shares for every $100 nominal value of bonds. An
equivalent ‘straight’ bond without the conversion option would have carried
an interest rate of 10% rather than 7%. Interest of $35,000 has been paid on the
bonds and this is included in the finance charge in the draft financial
statements.
The present value of $1 receivable at the end of years 1 – 4 at discount rates of
7% and 10% are as follows.
Endof: 7% 10%
Year1 0.93 0.91
Year2 0.87 0.83
Year3 0.82 0.75
Year4 0.76 0.68
(5) At 30 June 2009 there are taxable temporary differences of $800,000, excluding
any further differences arising as a consequence of revaluation of the non-
current assets, and the rate of taxation is 30%. The figure for deferred tax in
the draft statement of financial position is the amount that was included in the
financial statements as at 30 June 2008. No adjustment has been made for
changes in the year to 30 June 2009.
(6) Bonus issue;
During the year PRD made a bonus issue (scrip issue) of new shares, on the
basis of one new share for every four shares held. This issue has not been
recorded in the draft financial statements.
Required
Re-draft the financial statements of PRD and produce:
(a) a statement of comprehensive income for the year to 30 June 2009
(b) a statement of financial position as at 30 June 2009
(c) a statement of changes in equity for the year to 30 June 2009.
(25 marks)
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3.2 Preparing an answer: workings
The approach to answering this question is similar to the approach required to
answer the previous example. Several adjustments have to be made and you should
work through each item and try to identify the adjustments that are required.
Everything in this question has been covered by a previous chapter in this study
text, although many of the topics covered differ from those in Example 1.
Revenue
The ‘sale’ transaction to Leech Finance is not a proper sale. PRD will buy back the
goods after two years. In effect, the ‘sale’ is simply a loan at 10% interest, where
Leech holds the goods as collateral (security). The ‘revenue’ of $400,000 should not
be recognised.
Instead the transaction should be reported in the financial statements as a loan,
repayable in 12 months.
At an interest rate of 10%, a finance cost of $40,000 should be included in finance
costs for the year.
There should be a liability in the statement of financial position, repayable in12
months, of $400,000 + $40,000 accrued interest at 10% = $440,000.
Cost of sales
Several adjustments are required for the cost of sales.
The ‘sale’ of goods to Leech Finance
The cost of sales will include the $150,000 cost of the goods ‘sold’ to Leech, and cost
of sales must therefore be reduced by this amount.
The goods should be recognised as a current asset in the statement of financial
position at 30 June 2009, cost $250,000.
Accrued charge for contingent costs
This charge does not meet the definition of a provision (or liability) because the
costs do not arise out of a past event. The $60,000 cannot be included in cost of sales.
The $60,000 is also presumably in the figure for current liabilities if the statement of
financial position, and it should be removed. Current liabilities will therefore be
$550,000 - $60,000 = $490,000.
Factory depreciation
The question also states that although factory depreciation of $50,000 has been
charged (to cost of sales), 10% of the charge should be for operating expenses
(administration costs). $5,000 of the cost should therefore be deducted from cost of
sales and added to operating costs.
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The costs of sales for the year are therefore as follows:
$000
Asinthedraftincomestatement
3,100
Removecostofgoods‘sold’toLeech
(150)
Removeaccruedchargeforcontingentcosts
(60)
Deductdepreciationcostre‐classifiedasoperatingcosts
(5)
–
––––
Costofsales
2,885
–
––––
Properties
(1) Investment property
The investment property is valued at fair value. During the year to 30 June
2009, the property has fallen in value by $50,000 ($1,800,000 - $1,750,000). This
loss should be recognised in profit or loss.
(2) Factory
The factory is valued at fair value at the end of each year, which means that
there will be a gain or loss on revaluation.
$000
Valuationat30June2008 2,500
Depreciationchargefortheyear(given) (50)
–
––––
2,450
Valuationat30June2009 2,750
–
––––
Revaluationgainbeforetax 300
–
––––
The revaluation reserve will be increased by $210,000 (= $300,000 less tax at
30%) and the deferred tax liability increased by $90,000.
7% convertible bond
A convertible bond is a compound financial instrument. The debt element and the
equity element should be separated. The value of the debt element is calculated as
the present value of a ‘straight’ bond redeemable at par after 4 years, using a
discount rate of 10% because this is the yield that would apply to a ‘straight bond’.
The equity element is the residual value – i.e. the difference between the face value
of the bond and the value of a straight bond.
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Annual interest on the 7% bonds is $500,000 × 7% = $35,000.
Cash
flows
Discount
factorat10%
Present
value
$000 $000
Year1interest 35 0.91 31.9
Year2interest 35 0.83 29.0
Year3interest 35 0.75 26.3
Year4interestandredemption 535 0.68 363.8
–––––
Valueasastraightbond451.0
Nominalvalueofconvertibles500.0
–––––
Equitycomponent(residualamount)49.0
–––––
There is an interest charge of $35,000 included in finance costs in the draft accounts,
but the actual interest costs should be calculated as 10% of the value of the debt
element of $451,000. The finance charge should therefore be $45,100 – say $45,000 –
not $35,000. The finance costs for the year should therefore be increased by $10,000
($45,000 - $35,000).
The additional $10,000 finance cost should be treated as an accrual, and added to the
carrying amount of the debt. The debt element of the convertible bond should
therefore be $451,000 + $10,000 = $461,000.
Finance costs
The finance costs for the year need to be adjusted from the figure in the draft
financial statements. There are two adjustments to make, both referred to in earlier
workings.
The ‘sale’ of goods to Leech Finance should be treated as a loan at 10% interest. The
liability is increased from the original amount of the loan ($400,000) to $480,000 – as
indicated earlier – and there is ‘loan’ interest of $40,000 to charge against profit.
There is also an additional charge of $10,000 for interest on the convertible bonds, as
explained earlier.
Financecosts
$000
Asinthedraftfinancialstatements 55
InterestcostonloanfromLeech 40
Additionalinterestcostforconvertibleloan 10
–
––
105
–
––
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Taxation
$000
Taxable temporary differences at 30 June 209, excluding property
revaluation
800
Deferredtaxliabilityonthesedifferencesat30% 240
Deferredtaxliabilityinthedraftaccounts 200
–
––
Increaseindeferredtax,toincludeinprofitorlossfortheyear 40
–
––
Taxable temporary differences at 30 June 209, excluding property
revaluation
800
Revaluationgain 300
Totaltaxabletemporarydifferences 1,100
–
––––
Deferredtaxliabilityat30%(statementoffinancialposition) 330
–
––––
Bonus issue of shares
As a result of the 1 for 4 bonus issue of shares, issued share capital increases from
$1,600,000 to $2,000,000. The increase in issued shares by $400,000 would be set off
against share premium, if any share premium existed. Since there is no share
premium reserve, the $400,000 should be set off against retained earnings.
3.3 Preparing a re-drafted statement of comprehensive income
The information is now available to prepare re-drafted financial statements.
However, remember to adjust the operating expenses for the $5,000 portion of the
factory depreciation charge.
PRD
Statementofcomprehensiveincomefortheyearended30June2009
$000 $000
Revenue(4,925–400)4,525
Costofsales(2,885)
–––––
Grossprofit1,640
Operatingexpenses:(600+depreciation5)(605)
Investmentproperty
Rentalincome 30
Lossonadjustmenttofairvalue (50)
–––
(20)
Financecosts(105)
–
–––
Profitbeforetax910
Incometaxexpense(300+40deferredtax)(340)
–
–––
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Profitfortheyear570
Othercomprehensiveincome
Gainonfactoryrevaluation 300
Relatedtaxation (90)
–––
Othercomprehensiveincome210
–
–––
Totalcomprehensiveincomefortheyear780
–
–––
3.4 Preparing a re-drafted statement of financial position
We also have most of the figures needed to assemble the statement of financial
position, but the figure for retained earnings must be established. This should be
done by starting with the retained earnings at the start of the year, and making the
necessary adjustments for profit and dividends, and also the bonus issue of shares.
Retainedearnings
$000
At1July2008 7,100
Profitfortheyear 510
Dividendspaid (350)
Bonusissueofshares (400)
–
––––
6,860
–
––––
You also need to remember the equity element in the convertible bonds.
PRD
Statementoffinancialpositionasat30June2009
$000 $000
Non‐currentassets
Property,plantandequipment
(7,400+300factoryrevaluation)
7,700
Investmentproperty1,750
––––––
9,450
Currentassets(1,500+inventorywithLeech120)1,620
––––––
Totalassets11,070
––––––
Equityandliabilities
Capitalandreserves
Equitysharesof$0.50eachfullypaid 2,000
Equityelementinconvertiblebonds49
Revaluation
reserve(200+210) 410
Retainedearnings 6,860
––––––
7,270
––––––
9,319
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Non‐currentliabilities
7%convertibleloannote 451
Deferredtax 330
––––––
781
Currentliabilities
‘Loan’fromLeechFinance 480
Othercurrentliabilities(550–60) 490
970
––––––
Totalequityandliabilities11,070
––––––
2.5 Preparing the statement of changes in equity
The statement of changes in equity can also be prepared. Again, you need to be
familiar with the format of this statement so that you can write it down quickly in
your answer paper in the examination.
PRD
Statementofchangesinequityfortheyearended30June2009
Share
capital
Equityin
bonds
Revaluation
reserve
Retained
earnings Total
$000 $000 $000 $000 $000
Balanceat30June2008 1,600 0 200 7,100 8,900
Bonusissue 400 (400) 0
Dividendpayments (350) (350)
Issueofconvertible
bonds
49 49
Profitfortheyear 510 510
Revaluationoffactory 210 210
–
–––––
–
––
–
––– ––––––
–
–––––
Balanceat30June2009 2,000 49 410 6,860 9,319
–
–––––
–
––
–
––– ––––––
–
–––––
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