ACCA Financial Reporting

Achievement Ladder
Course Exam 2 Answers

Sep22/Dec22/Mar23/Jun23 EDITION
ACCA Financial Reporting (FR) Course Exam 2

Section A

Question 1
The correct answer is: $136,597
$
Lease liability at 1 January 20X1 (PVFLP) 178,000
Interest (178,000  4.83%) 8,597
Lease liability at 31 December 20X1 186,597
Payment in advance 1 January 20X2 (50,000)
136,597
Non-current liability at 31 December 20X1 136,597
Current liability at 31 December 20X1 50,000
186,597
Tutorial note. The payment in advance on 1 January 20X1 will be included in the initial measurement
of the right-of-use asset.

Question 2
The correct answer is: 19.8 cents
$722,000
Earnings per share = = 19.8c
(W1) 3,644,445

Workings
1 Weighted average number of shares
Bonus Weighted
Date Narrative Shares Time fraction average
1.4.20X3 3,000,000 3 $4.20 777,778
 
12 $4.05
1.7.20X3 Rights issue 600,000 5
(1/5)  1,500,000
3, 600,000 12
1.12.20X3 Full market 500,000 4
price  1,366,667
4,100,000 12
3,644,445
2 TERP
$
5 @ $4.20 21.00
1 @ $3.30 3.30
6 24.30

 TERP = $24.30/6 = $4.05

Question 3
The correct answers are:
Value in use
Fair value
The Conceptual Framework identifies two measurement bases: historical cost and current value.
Within current value, there are three alternatives for assets: fair value, value in use and current cost.
Fulfilment value is a current value for liabilities.
Question 4
The correct answers are:
Staff retention
Percentage of each $1 of donations spent on salaries of charity staff
Length of cash cycle
Return on capital employed is not a relevant performance measure for a not-for-profit entity as it
evaluates a profit measure; nor is earnings per share an appropriate measure because it looks at the
profit in respect of the share capital, and most not-for-profit entities will not pay dividends (and many
will be limited by guarantee and not by shares).
Staff retention is a non-profit measure which would therefore be appropriate.
The percentage of donations spent on salaries and the length of the cash cycle are both measures of
efficiency, which would be appropriate for a not-for-profit entity to ensure that as much income as
possible is available for charitable work.
Question 5
The correct answer is: $36,900
$
Revenue (100,800 + (28,400  9/12) – (400  9)) 118,500
Cost of sales (70,400 + (19,600  9/12) – (400  9) + 100*)) (81,600)
36,900

*Unrealised profit: $600,000  20%/120% = $100,000

Question 6
The correct answer is: A contingent liability for $100,000 should be disclosed

Contingent liability $40,000

Provision $60,000
$100,000

This is a single obligation and it is not probable that the case will be lost so a provision cannot be
recognised. Therefore, as it is a possible obligation that can be reliably measured, a disclosure for a
contingent liability should be made.
Question 7
The correct answer is: $97,619
Amount to recognize as sales revenue:
$
Amount paid on delivery 50,000
Amount due a year later (50,000/1.05) 47,619
97,619
The remainder should be treated as finance income.
Question 8
The correct answers are:

A flood destroyed 10% of the company's Adjusting Non-adjusting

inventories
The company made a bonus share issue Adjusting Non-adjusting
A new tax rate was announced and enacted Adjusting Non-adjusting
affecting the measurement of the deferred tax
liability
A customer owing the company a significant Adjusting Non-adjusting
sum at the year end went into liquidation
following protracted financial troubles which had
not previously made public

The flood, bonus issue and new tax rates are all non-adjusting events because they do not relate to
conditions that existed at the year end.
In the case of the tax rate, it cannot be used to measure the tax liability at the year end as there is no
'past event' and therefore no obligation to pay tax at that rate at the year end.
The bankruptcy is an adjusting event after the reporting period because the issue existed at the year
end, and the company found out about it before the financial statements were authorised for issue.

Question 9
The correct answer is: $559,000
$
Cost of associate 550,000
Share of post-acquisition TCI (360,000  6/12  30%) 54,000
Less: share of dividends received by Particle Co (140,000  30%) (42,000)
Less: share of unrealised profit (50,000  20%  30%) (3,000)
559,000
 Question 10
The correct answer is: The asset's fair value must be able to be measured reliably
The definition of an asset in the IASB's Conceptual Framework is:
(a) An asset is a present economic resource controlled by the entity as a result of past events.
(b) An economic resource is a right that has the potential to produce economic benefits. (The
Conceptual Framework for Financial Reporting, paras. 4.3 & 4.4)
The statements 'the asset is a present economic resource controlled by the entity' and 'the asset is
controlled by the entity as a result of past events' are part of the definition of an asset: 'A present
economic resource controlled by the entity as a result of past events'. (The Conceptual Framework
para. 4.3).
The statement 'the asset is a right that has the potential to produce economic benefits' is the definition
of an economic resource as defined in the Conceptual Framework (para. 4.4).

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 Section B Question
16

The correct answer is:

Machine carrying amount Revaluation surplus

$64,286 $1,714
$67,500 $9,000
$65,000 $9,500
$75,000 $10,286

Workings
Machine Revaluation surplus
$ $
1/10/X5 Cost 90,000
YE X6/X7/X8 Depreciation (90–5)/10  3 (25,500)
30/9/X8 Carrying amount 64,500
Revaluation gain 10,500 10,500
New carrying amount 75,000
Depreciation (75–5)/7  1 (10,000)
YE X9 Revaluation transfer (10–8.5) (1,500)
30/9/X9 Carrying amount 65,000 9,000

Question 17
The correct answer is: $190
Carrying Cumulative temporary
amount Tax base difference
$ $ $
1.10.20X5 Cost 90,000 90,000
Depn (90,000 – 5,000)/10 yrs (8,500)
Tax depn 90,000  30% (27,000)
30.9.X6 Carrying amount 81,500 63,000 18,500
Depn (8,500)
Tax depn 63,000  15% (9,450)
30.9.X7 Carrying amount 73,000 53,550 19,450

$
Deferred tax liability b/d at 1 October 20X6 (18,500  20%) 3,700
Expense to P/L in year (balancing figure) 190
Deferred tax liability c/d at 30 September 20X7 (19,450  20%) 3,890

Question 18
The correct answer is: As the revaluation does not affect the tax base, a deferred tax liability is
recognised with a charge to other comprehensive income.
As the tax base is not affected the carrying amount of the asset is higher than the tax base, creating a
deferred tax liability. The resulting charge is made to other comprehensive income rather than the
profit or loss, as this matches the location of the revaluation gain.

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 Question 19
The correct answers are:
When it is required by an IFRS Standard
When it results in reliable and more relevant information
IAS 8 specifically states that a change in policy can only be made when it is required by an IFRS
Standard or it results in reliable and more relevant information.
Question 20
The correct answers are:

Income taxes paid $22,000

Depreciation $8,500
Purchase of PPE $90,000
Revaluation $10,500

The purchase of PPE would have been recorded in the statement of cash flows in the year ended
30 September 20X6 and the revaluation would not affect the statement of cash flows as it is not a
cash item and profit before tax is adjusted for non-cash items, whereas this does not affect profit.
However, the current year income tax payment and the current year depreciation charge ([$90,000 -
$5,000] / 10) are entries that would be included in the statement of cash flows for the year ended
30 September 20X8 (with the depreciation being an adjustment to profit).
Question 21
The correct answer is: Record the liability using the interest rate of an equivalent non-convertible
loan note and record the remainder of the proceeds as equity
IAS 32 Financial Instruments: Presentation requires the issuer of a hybrid or compound instrument
of this nature – containing elements that are characteristic of both debt and equity – to separate out
the components of the instrument and classify them separately.
The loan note liability should be measured at the PV of the future cash flows discounted using the
interest rate of an equivalent non-convertible loan note. The balance of the proceeds on issue should
be recorded as equity.
Question 22
The correct answer is: $13,279,500
Year Cash flows Factor at 10% Present value
$'000 $'000
1 Interest ($15m  7%) 1,050 0.91 955.5
2 1,050 0.83 871.5
3 1,050 0.75 787.5
4 1,050 0.68 714.0
5 Interest + capital 16,050 0.62 9,951.0
Total debt component 13,279.5
Proceeds of issue 15,000.0
Equity component (residual) 1,720.5

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 Question 23
The correct answers are:
Jedders Co has representation on the board of directors of Yama Co
Jedders Co provides key management personnel to Yama Co
IAS 28 states that significant influence is normally evidenced by:
 Representation on the board of directors of the investee
 Participation in the policy-making process
 Material transactions between the investor and investee
 Interchange of managerial personnel
 Provision of essential technical information
(IAS 28, para.27)
Question 24
The correct answer is: $15,315,000
$,000
Cost of investment 15,000
Share of associates profits (2.1  4/12  45%) 315
15,315
No adjustment is made for the sale of goods from Jedders Co to Yama Co as they have all been sold
to third parties by the year end.
Question 25
The correct answer is: $1,395,000
Yama's post acquisition profits (4/12  2.1 + 2.4) = 3.1

Jedders Co's share 3.1  45% = $1,395,000

The profit made by Jedders Co and Yama Co on the sale of goods has all been realized, so no
adjustment is required to the retained earnings calculation. The gain to OCI as a result of a
revaluation in the books of Yama Co would not affect consolidated retained earnings, but it would
affect consolidated revaluation surplus.

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 26 The correct answer is: Faithful representation.
The classification of preference shares is based on their economic substance, not their legal form, ie if
they behave like debt they should be classified as debt. 'Substance over form' is an application of the
fundamental qualitative characteristic of faithful representation.
27 The correct answer is:
$ 4,230,000
$m
Interest $45m  5%  (0.93 + 0.86 + 0.79 + 0.74) 7.47
Repayment $45m  0.74 33.30
Debt component 40.77
Equity component 4.23
45.00
28 The correct answer is:
$ 241,000

Interest to 31 October 20X8

Month 1 ($15m  0.8% = $120,000)
Month 2 ($15.12m  0.8% = $120,960)
Total interest ($120,000 + $120,960) $240,960
Rounded to $241,000
29 The correct answer is: EPS takes into account the additional resources made available to earn profit
when new shares are issued for cash, whereas net profit does not.
EPS is based on profit and therefore if profit is manipulated by accounting policies, EPS will also be
manipulated in the same way.
Diluted EPS is not based on a forecast of future profit trend; it is based on the current year profit adjusted
for any changes caused by potential ordinary shares.
A change in accounting policy affecting the previous year's profit would affect both net profit and EPS.
30 The correct answers are:

The earnings figure to use in diluted EPS is $65 million FALSE

The number of shares to use in diluted EPS is 161.25 million TRUE
Diluted EPS will be the same as basic EPS as conversion has not taken place FALSE
The potential ordinary shares will be treated as dilutive TRUE

The earnings figure to use in diluted EPS will not be $65 million as it needs to be adjusted for the interest
saved on conversion, net of any tax relief.
The number of shares to use in diluted EPS is 161.25 million. There are 11.25 million potential ordinary
shares (($45 million/$100)  25 shares) and 150 million ordinary shares in issue, giving a total of
161.25 million.
Diluted EPS will not be the same as basic EPS as conversion has not taken place as it takes into
consideration the potential ordinary shares and potential change in earnings arising on conversion of the
convertible loan notes.
The potential ordinary shares will be treated as dilutive as conversion would decrease net profit per
share.

TT2023
Section C

Question 21
Feedback

Marking scheme
Marks

(a) Statement of profit or loss and other comprehensive income

Revenue 1
Cost of sales 2½
Distribution costs and administrative expenses 1
Investment income ½
Gain on investments in equity instruments 1
Finance costs ½
Income tax expense 1½
Revaluation loss 1
9
(b) Statement of financial position
Property, plant and equipment 3
Investments in equity instruments 1
Inventories 1
Trade receivables 1
Equity shares ½
Share premium ½
Revaluation surplus (per closing SOCIE) ½
Retained earnings (per closing SOCIE) ½
2% loan notes 1
Deferred tax 1
Trade payables and overdraft ½
Current tax ½
11
Total for question 20
Suggested solution
(a) LLAMA CO
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 30 SEPTEMBER 20X7
$'000
Revenue (180,400 – (W5) 3,900) 176,500
Cost of sales (W1) (75,700)
Gross profit 100,800
Investment income 2,200
Gain on investments in equity instruments (27,100 – 26,500) 600
Distribution costs (W1) (11,000)
Administrative expenses (W1) (17,500)
Finance costs (2,400)
Profit before tax 72,700
Income tax expense (W3) (17,100)
PROFIT FOR THE YEAR 55,600
Other comprehensive income:
Revaluation loss on building (3,000)
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 52,600

(b) LLAMA CO
STATEMENT OF FINANCIAL POSITION AT 30 SEPTEMBER 20X7
$'000
Non-current assets
Property, plant and equipment (W2) 228,500
Investment in equity instruments 27,100
255,600
Current assets
Inventories (37,900 + (W5) 3,000) 40,900
Trade receivables (35,100 – (W5) 3,900) 31,200
72,100
Total assets 327,700

Equity
Equity shares of 50c each 75,000
Share premium 9,000
Retained earnings (40,500 – 15,000 + 55,600) 81,100
Revaluation surplus (14,000 – (W2) 3,000) 11,000
176,100
Non-current liabilities
2% Loan note (W4) 81,600
Deferred tax 10,000
91,600
Current liabilities
Trade payables 34,700
Current tax payable 18,700
Bank overdraft 6,600
60,000
Total equity and liabilities 327,700
Workings
1 Expenses
Distribution Administrative
Cost of sales costs Expenses
$'000 $'000 $'000
Per question 89,200 11,000 12,500
Plant capitalised (24,000)
Depreciation – buildings (W2) 5,000
Depreciation – plant (W2) 12,000
Depreciation – plant additions (W2) 1,500
'Sale or return' transaction (W5) (3,000) – –
75,700 11,000 17,500
2 Property, plant and equipment
Land Buildings Plant Total
$'000 $'000 $'000 $'000
Carrying amount at October 20X6 30,000 100,000 96,000 226,000
Additions* 24,000 24,000
Depreciation
Buildings (100m/20 years) (5,000) (5,000)
Plant b/d ((128m – 32m)  12.5%) (12,000) (12,000)
Plant additions (24m  12.5% 
6/12) – – (1,500) (1,500)
30,000 95,000 106,500 231,500
Revaluation loss (95m – 92m) – (3,000) – (3,000)
Carrying amount at 30 Sept 20X7 30,000 92,000 106,500 228,500
Note. that all of the expenses originally charged to cost of sales in respect of the plant
addition are now capitalised, giving a total amount of $24 million.
3 Taxation
$'000
Current tax charge for year 18,700
Prior year overprovision (400)
Movement in deferred tax (below) (1,200)
Charge to profit or loss 17,100

$'000
Deferred tax liability at 1 October 20X6 11,200
Credit to profit or loss (balancing figure) (1,200)
Deferred tax liability at 30 September 20X7 (40m  25%) 10,000
4 Loan note
$'000
2% loan note proceeds 80,000
Effective interest 2,400
Interest paid (per trial balance) (800)
Balance at 30 September 20X7 81,600
 5 'Sale or return' transaction
Cancel sale:
$'000 $'000
DEBIT Revenue 3,900
CREDIT Trade receivables 3,900
Record closing inventories:
$'000 $'000
DEBIT Inventories (3,900  100%/130%) 3,000
CREDIT Cost of sales 3,000
Question 22
Feedback

Marking scheme
Marks
(a) ½ mark for each relevant ratio Maximum 5

Discussion of: Profitability 4

Liquidity (and working capital ratios) 5
Gearing 2
Other issues 2
Conclusion 1
Available 14
Maximum for (a) 17
(b) 1 mark per relevant point 3
Total Maximum for question 20

Suggested solution
(a) Calculations
Comparator Co Sector average
Return on capital employed 34.6% 22.1%

PBIT 186  34
Debt  Equity 300  335

Net asset turnover 3.8 1.8

Revenue 2,425
Total assets  current liabilities 1,135  500

Gross profit margin 22.9% 30%

Gross profit 555

Revenue 2,425

Net profit (before tax) margin 7.7% 12.5%

Profit before tax 186

Revenue 2,425

Current ratio 1.2 : 1 1.6 : 1

 Comparator Co Sector average
Current assets 595
Current liabilities 500

Quick ratio 0.6 : 1 0.9 : 1

Current assets  inventories 595  275

Current liabilities 500

Inventory holding period 54 days 46 days

Inventories  365 275  365

Cost of sales 1,870
Trade receivables collection period 48 days 45 days
Trade receivables  365 320  365
Revenue 2,425
Trade payables payment period 68 days 55 days
Trade payables  365 350  365
Cost of sales 1,870
Debt to Equity 90% 40%
Interest bearing borrowings 300
Equity 335

Operating performance
The high return on capital employed (ROCE) of 34.6% (compared with 22.1% for all companies)
shows that Comparator Co's assets are being used relatively efficiently. This is despite
Comparator Co having low gross profit margin (22.9% compared with 30%) and net profit margin
(7.7% compared with 12.5%). The low levels of profitability might be due to Comparator Co
operating at the budget end of the market which typically returns reduced margins. Comparator
Co has made up for this low level of profitability by having a very high level of asset utilisation, as
shown by a net asset turnover ratio of 3.8 times, which is more than twice the average of 1.8
times.
There are three things that complicate the analysis above:
(i) Comparator Co's non-current assets are measured at historical cost;
(ii) The age of Comparator Co's non-current assets; and
(iii) The write off of inventories.
These are discussed below:
(i) Comparator Co measures its non-current assets at historical cost whereas others in the
industry measure their land and buildings at fair value. Assuming that land and buildings
prices have been rising, Comparator Co will be carrying its assets at a lower amount than
had they been measured at fair value, which, along with the age of the assets explained in
(ii) below, may explain the higher utilization and higher ROCE reported by Comparator Co.
The use of different accounting policies is a limitation of ratio analysis as it makes
comparison between entities more difficult.
(ii) The carrying amount of Comparator Co's non-current assets is only 15% of their cost,
suggesting that these assets are quite old. This will have boosted the ROCE compared with
a company with newer assets with a higher carrying amount. However, there is not enough
information to investigate this further. Also, these assets will probably need replacing soon,
and because Comparator Co has no cash then it will need to borrow more money. This will
be extremely difficult (and probably expensive) as Comparator Co's gearing ratio is already
very high (90%) compared with the sector average (40%).
(iii) Comparator Co's net profit margin is distorted by the $120,000 charge for writing off inventory.
Without this the net profit margin would have been 12.6%, which is greater than the average of
12.5%. If this write off really is a one off not to be repeated event, then this suggests that the
underlying return on capital employed is 53.5%. However, the sector averages do not include
similar information on one off costs and it is questionable whether the write-off should be
presented separately or should have been written off to cost of sales, which would further
decrease gross profit margin.
Financial position
Long-term
As mentioned above, Comparator Co's gearing ratio is already high and the need to replace old
plant and equipment could push it higher. As the existing equipment cost $3.6 million some years
ago Comparator Co could expect to spend as much again today, all of it on borrowed money,
unless it was possible to enter into lease agreements for the right to use assets for an agreed
period. If replacement assets were bought using loan finance, this would require a gearing ratio
of 1,100%, which the banks would almost certainly not tolerate. Leasing assets will also raise
non-current liabilities which also has a detrimental impact on gearing, but it may be easier to
negotiate with lessors than with banks. If Comparator Co was to measure its non-current assets
at fair value, consistent with the other companies contributing ratios, this would give rise to a
revaluation surplus which would help to reduce gearing and may help it to secure finance,
although it is not possible to quantify the effect of this without further information. The alternative
would be to raise more share capital. At the current market price of $6 a share a further 600,000
shares would need to be issued, which would double the number of shares. This also seems an
unlikely prospect. However, without new loans or share capital there can be no new equipment.
Short-term
Comparator Co's quick and current ratios are below the industry average, which suggests that
there may be short term cash flow problems and poor financial management.
Although the working capital cycle is relatively good (34 days compared with 36), the individual
components are worse implying poor credit control and a shortage of cash to pay suppliers,
although not necessarily a problem with inventory. The inventory holding period of Comparator
Co may be influenced by the fact that it makes the majority of its sales in November and
December and is likely to be holding high levels of inventory at its year end in preparation for this
seasonal trade. Poor credit control can lead to an increase in bad debts and difficulty in
managing working capital. Delaying paying suppliers (who now have to wait 68 days to be paid)
is a short-term fix, but it can back-fire if suppliers lose patience with Comparator Co and demand
cash on delivery, or refuse to deliver at all.
Interest cover, dividends, tax and overdraft
Although the interest cover of ten is good in terms of profits, there is no cash to pay the interest.
Likewise, there is $85,000 tax to pay. We are not told what the overdraft limit is, but it appears
that Comparator Co can only meet its obligations if the overdraft is increased.
 Summary and conclusion
At first sight Comparator Co's operating performance appears to be good compared with its
rivals, but further analysis suggests that this might be boosted by old plant and equipment carried
at historical cost. Comparator Co's financial position is worrying both in the short term and the
long term, and it is difficult to see how Comparator Co will be able to meet its obligations and
invest in the future. Unless things improve Comparator Co's going concern status must be in
doubt.
Appendix: Additional ratios
Comparator Co Sector average
Net profit margin excluding write off 12.6% Not known
Profit before tax  write off 186  120
Revenues 2,425
ROCE excluding write off 53.5% 22.1%
Profit before finance costs  write off 186  34  120
Assets  current liabilities 635

Working capital cycle 34 days 36 days

(54 + 48 – 68) (46 + 45 – 55)
(b) Sector average ratios are by their nature averages, so they may not be an ideal comparison if the
company you are comparing has unique factors. Industry averages remove some of the extremes
of the industry but can result in bland ratios that show no real insightful information.
Within an industry there are likely to be differences in respect of:
 accounting policies;
 year ends; and
 target markets
that will reduce comparability with other companies.
Comparator Co uses historical cost measurement for the non-current assets whereas others
value their land and buildings at fair value. As we noted above, this impacts on asset turnover
and ROCE and can make it difficult to compare the ratios.
Companies may have different year ends, which could skew the comparison, particularly in a
seasonal business. Comparator Co manufactures children's toys and is therefore likely to be
subject to some degree of seasonal trading. Its inventory might be relatively high at its year end
of 30 September in preparation for a busy winter trading period.
Finally, the margins achieved by companies may be impacted by where it is positioned within the
market. If Comparator Co is operating at the budget end of the toy market, it is likely to have
lower gross profit margins that a high quality retailer.
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