The Institute of Chartered Accountants of Pakistan

Financial Accounting
Intermediate Examination Spring 2011 Module C March 10, 2011 100 marks - 3 hours

Q.1

Earth, Jupiter and Mars carry on business in partnership sharing profits and losses in the ratio of 5:4:3 respectively. They decided to form a company, Universe Limited (UL). The firms statement of financial position on the date of incorporation of UL i.e. January 1, 2011 is as follows: Rs. in million Capital Accounts Earth Jupiter Mars Current Liabilities Trade creditors Other liabilities Bank overdraft 100 79 60 239 45 12 6 63 302 Non Current Assets Machines and equipment Vehicles Furniture Current Assets Stock-in-trade Trade debtors Short term investments Rs. in million 90 17 15 122 62 70 48 180 302

The conversion scheme was executed on the following terms and conditions: Mars owned the freehold premises which he had let to the partnership. He agreed to sell it to UL for Rs. 40 million against a consideration of 4 million 11% preference shares at par. (ii) Machines having carrying value of Rs. 25 million were taken over by Jupiter at an agreed price of Rs. 23 million. (iii) Earth agreed to discharge the other liabilities against cash payment of Rs. 10 million from his own resources. (iv) It was agreed to appoint Venus as a director in the new company. He subscribed Rs. 20 million and was issued 2 million ordinary shares of Rs. 10 each. (v) The value of goodwill of the partnership firm was agreed at Rs. 50 million. (vi) The details of assets and liabilities taken-over by UL are as under: Stocks- in- trade was taken over at the estimated value of Rs. 60 million. 90% of the trade debts were considered recoverable. All other assets and liabilities were taken over at book value. (vii) The partners balances were settled as follows: Jupiter, who was not willing to continue as an equity-holder, received 0.6 million 12% debentures of Rs. 100 each. 16 million ordinary shares of Rs. 10 each were issued to Earth and Mars in proportion to their final capital balances after incorporating all adjustments. The remaining balances of each partner were settled in cash. Required: Prepare the following: (a) Realization Account (b) Partners Capital Accounts (c) Opening Statement of Financial Position of Universe Limited. (i)

(18 marks)

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Q.2

Following is the summarized trial balance of Moonlight Pakistan Limited (MPL), a listed company, for the year ended December 31, 2010: Rs. in million Debit Credit 2,600 2,104 702 758 354 1,784 220 250 210 400 670 1,200 510 1,600 8 22 544 420 3,608 8,982 8,982

Land and buildings - at cost Plants at cost Trade receivables Stock in trade at December 31, 2010 Cash and bank Cost of sales Selling expenses Administrative expenses Financial charges Accumulated depreciation as on January 1, 2010 Buildings Accumulated depreciation as on January 1, 2010 Plants Ordinary shares of Rs. 10 each fully paid Retained earnings as at January 1, 2010 12% Long term loan Provision for gratuity Deferred tax on January 1, 2010 Trade payables Right subscription received Revenue

Additional Information (i) The land and buildings were acquired on January 1, 2006. The cost of land was Rs. 600 million. On January 1, 2010 a professional valuer firm valued the buildings at Rs. 1,840 million with no change in the value of land. The estimated life at acquisition was 20 years and the remaining life has not changed as a result of the valuation. 60% of depreciation on buildings is allocated to manufacturing, 25% to selling and 15% to administration. (ii) Plants are depreciated at 20% per annum using the reducing balance method. (iii) On March 31, 2010 MPL made a bonus issue of one share for every six held. The issue has not been recorded in the books of account. (iv) Right shares were issued on September 1, 2010 at Rs. 12 per share. (v) The interest on long term loan is payable on the first day of July and January. No accrual has been made for the interest payable on January 1, 2011. (vi) MPL operates an unfunded gratuity scheme for all its eligible employees. The provision required as on December 31, 2010 is estimated at Rs. 23 million. Rs. 3 million were paid during the year and debited to the provision for gratuity account. Cost of gratuity is allocated to production, selling and administration expenses in the ratio of 60% : 20% : 20%. (vii) The tax charge for the current year after making all related adjustments is estimated at Rs. 37 million. The timing differences related to taxation are estimated to increase by Rs. 80 million, over the last year. The applicable income tax rate is 35%. Required: In accordance with the requirements of Companies Ordinance, 1984 and International Financial Reporting Standards, prepare the following: (a) Statement of Financial Position as of December 31, 2010. (b) Income Statement for the year ended December 31, 2010. (Comparative figures and notes to the financial statements are not required) (22 marks)

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Q.3

The following information relates to Galaxy International (GI), a listed company, which was incorporated on January 1, 2009. (i) (ii) The (loss) / profit before taxation for the years ended December 31, 2009 and 2010 amounted to (Rs. 1.75 million) and Rs. 23.5 million respectively. The details of accounting and tax depreciation on fixed assets is as follows: 2010 2009 Rs. in million 15 15 6 45

Accounting depreciation Tax depreciation (iii) (iv) (v) (vi)

In 2009, GI accrued certain expenses amounting to Rs. 2 million which were disallowed by the tax authorities. However, these expenses are expected to be allowed on the basis of payment in 2010. GI earned interest on Special Investment Bonds amounting to Rs. 1.0 million and Rs. 1.25 million in the years 2009 and 2010 respectively. This income is exempt from tax. GI operates an unfunded gratuity scheme. The provision during the years 2009 and 2010 amounted to Rs. 1.7 million and Rs. 2.2 million respectively. No payment has so far been made on account of gratuity. The applicable tax rate is 35%.

Required: Prepare a note on taxation for inclusion in the companys financial statements for the year ended December 31, 2010 giving appropriate disclosures relating to current and deferred tax expenses including a reconciliation to explain the relationship between tax expense and accounting profit. (20 marks) Q.4 Sunshine Education Systems (SES) has a network of schools in major cities of Pakistan. It has entered into a franchise agreement with Neptune Schooling Systems (NSS). SES would charge franchise fee of Rs. 9 million. Of this amount, Rs. 1.8 million is payable at the time of signing the agreement and the balance in four annual installments of Rs. 1.8 million each. In return, SES would provide the following services/benefits: Allow NSS to use SESs brand name. Offer expert advice in selecting the location for the schools, selection of teachers, management training and quality control. Provide initial set up comprising of books, unlimited access to teachers resources available on the SESs website, etc. at a discount of 20%. Generally, SES provides these rights to nonfranchisee at a cost of Rs. 1.2 million. Carry out promotional activities for the benefit of NSS during the next five years at Rs. 9,000 per month which is included in the franchise fee. It is the policy of SES to charge Rs. 7,500,180 from those franchisees who opt to pay the full amount upfront, which is the present value of five installments discounted at the rate of 10%. Required: Suggest the journal entry in the books of SES at the time of signing of the agreement, under each of the following situations: (a) (b) The collectability of the future installments is reasonably assured and significant portion of the services have already been performed. Substantial portion of services are yet to be performed and collectability of future installments is very uncertain. However, down payment has been received and is not refundable. (08 marks)

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Q.5

Star-Bright Pharmaceutical Limited (SPL), a listed company, purchased a brand on January 1, 2005 at a cost of Rs. 382 million. It has incurred a substantial amount on further development of the brand, in subsequent years. It is the policy of SPL to amortize the development expenditures which meet the recognition criteria as given in IAS-38 Intangible Assets, over a period of ten years. The amortization commences when the development expenditures first meet the recognition criteria. However, it was discovered during the year 2010 that the development expenditure incurred after acquisition had erroneously been written-off to the profit and loss account, details of which are as follows: Year ended December 31, 2007 December 31, 2008 December 31, 2009 December 31, 2010 Rs. in million 24 54 38 43

The draft financial statements (before correction of error) show that retained earnings as at December 31, 2010 was Rs. 1,950 million (2009: Rs. 1,785 million). Required: In accordance with the requirements of International Financial Reporting Standards, prepare relevant extracts of the Statement of Financial Position along with the note on intangible assets after incorporating the required corrections. (Ignore tax) (16 marks) Q.6 The following information pertains to Skyline Limited (SL) for the financial year ended December 31, 2010: A customer who owed Rs. 1 million was declared bankrupt after his warehouse was destroyed by fire on February 10, 2011. It is expected that the customer would be able to recover 50% of the loss from the insurance company. (ii) An employee of SL forged the signatures of directors and made cash withdrawals of Rs. 7.5 million from the bank. Of these, Rs. 1.5 million were withdrawn before December 31, 2010. Investigations revealed that an employee of the bank was also involved and therefore, under a settlement arrangement, the bank paid 60% of the amount to SL on January 27, 2011. (iii) SL has filed a claim against one of its vendors for supplying defective goods. SLs legal consultant is confident that damages of Rs. 1 million would be paid to SL. The supplier has already reimbursed the actual cost of the defective goods. (iv) A suit for infringement of patents, seeking damages of Rs. 2 million, was filed by a third party. SLs legal consultant is of the opinion that an unfavorable outcome is most likely. On the basis of past experience he has advised that there is 60% probability that the amount of damages would be Rs. 1 million and 40% likelihood that the amount would be Rs. 1.5 million. Required: Advise SL about the amount of provision that should be incorporated and the disclosures that are required to be made in the financial statements for the year ended December 31, 2010. (16 marks) (THE END) (i)