MN30315 – Advanced Financial Accounting: January 2023 SOLUTIONS

Section A – Question 1 (compulsory)

Part A

Consolidated statement of income for year ended 30 November 2022

£000
Sales (535,000 + 286,000 - 52,000) 769,000
Cost of sales (276,000 + 154,000 - 52,000 + 3,000) 381,000
Gross profit 388,000
Expenses (98,000 + 51,000) 149,000
Group profit before taxation 239,000
Share of associated company profit (30% x 27,000) 8,100
Profit before tax 247,100
Taxation (55,000 + 10,000) 65,000
Profit for the year 182,100

Attributable to:
Equity shareholders of Cold 171,900
NCI 15% X (71,000 - 3,000) 10,200
182,100
Consolidated statement of financial position as at 30 November 2022
£000
Non-current assets
Property, plant and equipment (310,000 + 186,000) 496,000
Goodwill 37,500
Investment in Associate 63,700
597,200
Current assets
Inventories (95,000 + 71,000 - 3,000) 135,000
Trade receivables (35,000 + 24,000) 59,000
Cash in transit 3,000
Current account - Farm 18,000
Bank (69,000 + 134,000) 203,000
418,000
Total assets 1,015,200
Equity and reserves
£1 Shares 400,000
General reserve 132,350
Retained earnings 241,100
773,450
NCI 62,750
836,200
Current liabilities
Trade payables (84,000 + 30,000) 114,000
Taxation payable (55,000 + 10,000) 65,000
179,000
Total equity and liabilities 1,015,200

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WORKINGS
Goodwill
Investment in Comfort 280,000
187,00
£1 Ordinary shares (85% X £220,000) 0
Retained earnings (85% X £36,000) 30,600
General reserve (85% X £44,000) 37,400
255,000
Goodwill - parent's share 25,000

Fair value of NCI at date of acquisition 57,500

Less 15% of net assets at date of acquisition 45,000
(15% X (£220,000 + £36,000 + £44,000)
Goodwill - share attributable to NCI 12,500
Total Goodwill (to consolidated SoFP) 37,500

Unrealised profit
Net sale = 100/130 X £52,000 = £40,000
Unrealised profit = (£52,000 - £40,000) = £12,000 X 25% = £3,000 3,000
(note sale sub to parent, so Cr Grp Inv & Dr NCI & Grp RE in relevant proportions)

Investment in Farm Ltd

Investment 58,000
Post acquisition retained earnings (39,000 - 30,000) 9,000
Post acquisition general reserve (22,000 - 12,000) 10,000
19,000
X 30% holding in associated company 5,700
63,700

Consolidated general reserve

120,00
Cold 0
Comfort post acquisition (85% X 55,000 - 44,000) 9,350
Farm post acquisition (30% X 22,000 - 12,000) 3,000
Consolidated general reserve 132,350

Consolidated retained earnings

218,000 + 85% (63,000 - 36,000 - 3,000) + 30% (39,000 - 30,000) 241,100

Non-controlling interest
((338,000 - 3,000) X 15%) + 12,500 (GW) 62,750

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Part B
If the revaluation model is adopted, intangible assets are carried at a revalued amount. This
consists of the asset's fair value at the date of revaluation, less any subsequent amortisation
and less any subsequent impairment losses. The circumstances in which this model may be
used are as follows:
(i) The revaluation model cannot be applied to an intangible asset unless its fair value can be
measured reliably, by reference to an active market in that type of asset.
(ii) If the revaluation model is applied to an intangible asset, then it must be applied to the
entire class to which the asset belongs.
(iii) Revaluations should be made with sufficient regularity to ensure that the carrying amount
of an intangible asset does not differ materially from fair value. All of the items within a class
of intangible assets should be revalued simultaneously.

The intangible assets of Companies W, X and Y should be dealt with as follows:

(a) Company W. In 2021, the revaluation loss of £25,000 should be recognised as an

expense when calculating the company's profit or loss for the year. In 2022, £25,000 of the
revaluation gain should be recognised as income when calculating the company's profit or
loss. The remaining £20,000 of the gain should be credited to a revaluation reserve and
recognised as other comprehensive income.

(b) Company X. In 2022, £60,000 may be transferred (in the statement of changes in equity)
from revaluation reserve to retained earnings. The profit on disposal of £35,000 should be
recognised as income when calculating the company's profit or loss for the year.

(c) Company Y. In 2021, the revaluation gain of £10,000 should be credited to a revaluation
reserve and recognised as other comprehensive income. In 2022, £10,000 should be
debited to revaluation reserve and recognised (as a negative figure) in other comprehensive
income. The remaining £15,000 of the revaluation loss should be recognised as an expense
when calculating the company's profit or loss for the year.

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SECTION B
Question 2
Part A
1. Sale of property
NBV 285
Loss -35
Proceeds 250

2. Depreciation PPE
Opening balance 530
Acquisition of Hops 120
Finance lease 85
Closing balance -655
Depreciation 80

3. Goodwill
On acquisition of Hops
Paid 200
FV of NA (210 X 70%) 147
Goodwill 53
Impairment:
B/fwd 44
plus acquired 53
C/fwd -70
27

4. Dividends received from associate

Opening balance 181
IS 134
315
Closing balance -230
85

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5 Dividends paid:
To NCI
Opening balance (98+80) 178
IS 160
Hops Ltd (210 X 30%) 63
Closing balance (83+60) -143
258
To Holding company
Opening balance 62
Dr to equity 168
Closing balance -63
167
6. Taxation
Opening balance 120
IS 310
Closing balance -350
Paid 80

7. Finance lease
Opening balance (75+140) 215
Add 85
Closing balance (130+72) -202
98
Reconciliation of retained earnings:
Opening retained earnings 264
Plus revaluation reserve released 45
Plus profit 561
Less Dividends -168
Closing retained earnings 702

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Calculation of net cash from operating activities
Operating profit 935
Exceptional loss 35
Depreciation 80
Impairment of goodwill 27
71+45-
Increase Inventory
-49 165
88+35-
Decrease Trade receivables
-7 130
Increase Trade payables -44 -54-60+70
Interest paid -38
Tax paid -80
859

(£’00
0) (£’000)
Operating Activities
Net cash from operating activities 859

Investing Activities
Cash received from sale of property 250
Dividend received from associate 85
Purchase of subsidiary -200
Bank and cash acquired from subsidiary 70
205

Financing Activities
Capital element of finance lease payments -98
Dividends paid to NCI -258
Dividends paid to holding company -167
-523
Net increase in cash and cash equivalents for
year 541

Cash and cash equivalents at start of year 99

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 Cash and cash equivalents at end of year 640
Part B
This is a repurchase agreement. Although the legal form of the agreement is that a sale has
occurred, the substance of the transaction seems to be a secured loan. It is unlikely that a
finance company would wish to buy this inventory and it seems much more likely that the
finance company is expecting Midsomer to repurchase the inventory in due course.
Logically, Midsomer will do this if the sales value of the inventory at the time of repurchase is
greater than £5m plus compound interest at 10% p.a. (from 1 April 2021) plus accumulated
storage costs.

The application guidance provided by IFRS15 states that such agreements should be
treated as financing arrangements if the repurchase price exceeds the original selling price
(as in this case).

The £5m should be removed from sales revenue and recognised as a non-current liability.
Also, £3m should be added to closing inventory and removed from cost of sales. A further
£300,000 should be added to closing inventory and removed from trade receivables.

Interest of £500,000 should be shown as an expense in the statement of comprehensive

income and should be added to the carrying amount of the loan.

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Question 3
Part A
Consolidated Statement of financial position for the year ending 30 November 2022

£
Assets
Non-current assets
Tangible (500,500 + 264,000) 764,500
Intangible - Goodwill (W1) 281,600
1,046,100
Current assets
Inventories (36,000 + 68,500 - 3,000) (W2) 101,500
Trade receivables (96,000 + 47,000) 143,000
Cash in transit 15,000 Diff in current a/c bal
Bank (106,000 + 36,500) 142,500
402,000
Total assets 1,448,100

Equity and liabilities

Capital and reserves
Issued capital 400,000
General reserve (150,000 + (85% X (25,000 -
5,000))) 167,000
Retained earnings 193,260
(191,500 - 3,000 + (85% X (86,000 - 42,000 -
38,400)
NCI ((15% X (236,000 - 38,400)) + 296,200) 325,840
1,086,100
Current liabilities
Trade payables (72,000 + 91,000) 163,000
Taxation payable (130,000 + 69,000) 199,000

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 362,000
Total equity and liabilities 1,448,100

Comprehensive statement of income for the year ending 30 Nov 2022

Revenue (999,000 + 412,000 - 26,000) 1,385,000

Cost of Sales (515,000 + 98,000 - 26,000 + 3,000 +
38,400) 628,400

Gross profit 756,600

Expenses (120,500 + 75,000) 195,500

Profit before tax 561,100

Income tax expense (130,000 + 69,000) 199,000

Profit after tax 362,100

Attributable to:

Equity shareholders of Lemon 342,360

NCI in Drizzle (15% X (170,000 - 38,400) 19,740

362,100
Statement of changes in equity
Retaine
Share d General Lemon NCI Total
Capital Earnings Reserve Group
316,90
Opening Balance 400,000 -37,100 167,000 529,900 0 846,800
Dividends 112,000 112,000 10,800 122,800
Comprehensive income 342,360 342,360 19,740 362,100
325,84
Closing balance 400,000 193,260 167,000 760,260 0 1,086,100

W1 - Goodwill

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 Investment in Drizzle 170,000

£1 Ordinary shares (85% X £125,000) 106,250

Retained earnings (85% X £42,000) 35,700

General reserve (85% X £5,000) 4,250

Goodwill - parent's share 23,800

Fair value of NCI at date of acquisition 322,000

LESS 20% of net assets at date of acquisition 25,800

(15% X (£125,000 + £42,000 + £5,000)

Goodwill - share attributable to NCI 296,200

Total Goodwill 320,000

LESS impairment loss (12%) 38,400

In consolidated statement of financial position 281,600

W2 - Unrealised profit on inter-company sales

Net value of sales = £26,000 X 100/130 = £20,000

Profit on sale = £26,000 - £20,000 = £6,000

50% in inventory at year end so adjustment 3,000

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Part B
(a) Goodwill is defined by IFRS3 as "an asset representing the future economic benefits
arising from assets acquired in a business combination that are not individually identified
and separately recognised". This definition refers only to goodwill acquired in a business
combination (i.e. when an entity acquires control of a business). A broader definition might
state that goodwill is an asset that arises from factors such as an entity's good reputation
and may be generated internally as well as being acquired in a business combination.

IAS38 does not allow internally generated goodwill to be recognised as an asset. This is
because the cost and value of such goodwill cannot be determined reliably and therefore
one of the recognition criteria specified in the IASB Conceptual Framework is not satisfied.

(b) In general, goodwill acquired in a business combination is initially measured as the

excess of:
(i) the price paid by the acquirer in the business combination, over
(ii) the acquirer's interest in the net fair value of the acquiree's identifiable assets and
liabilities at the acquisition date.

Goodwill acquired in a business combination should be tested for impairment in each

subsequent accounting period and should be measured at the amount initially recognised
less any accumulated impairment losses.

(c) If goodwill acquired in a business combination appears to have a negative value, IFRS3
requires that the fair value of the price paid by the acquirer (the "consideration") and the fair
values of the identifiable assets and liabilities acquired should be reassessed. Any negative
goodwill which still remains after this reassessment has been performed should be treated
as income from a bargain purchase and should be included in the acquirer's profit or loss.

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Section C
Question 4
Some of the advantages that have been advanced in relation to conceptual frameworks of
accounting include:

 Accounting standards developed by applying the contents of a conceptual framework

should be consistent and logical.

 Because many countries have developed conceptual frameworks that are similar (or
they have adopted the IASC framework), there should be greater international
compatibility between various countries’ accounting rules, and this should lead to
greater consistency and comparability between international financial reports (which
some people have argued is important for flows of foreign investment capital).

 Because conceptual frameworks provide the fundamentals of an accounting system,

standard-setters should be more accountable for their decisions. If they deviate from
key issues addressed in a conceptual framework this should be clear and some
explanation would be necessary.

 Conceptual frameworks provide a means of communicating key concepts to financial

report preparers and users, as well as providing guidance to reporting entities when
no specific standards address a particular issue.

 Because issues such as the objective of financial reporting, recognition criteria, and
so on, have been determined when developing a conceptual framework, then
accounting standard-setters will be subject to less political pressure when developing
new standards.

 Because standard-setters will have consensus on many key issues, the development
of accounting standards should be more economical. There will be no need to go
back to the ‘drawing board’ on many fundamental issues.

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Whilst not directly asked, some of the disadvantages that have been associated with
conceptual frameworks of accounting include:

 Conceptual frameworks are costly to develop.

 The development of conceptual frameworks is subject to political interference—some

people (for example, Hines) argue that conceptual frameworks are no more than a
residual of a political process.

 Tied to the above point, when conceptual frameworks have attempted to consider
issues in which there is much underlying disagreement (for example, measurement
issues), they have tended to lose progress.

 Following on from the above point, conceptual frameworks have tended not to tackle
difficult issues.

 Conceptual frameworks focus on economic (financial) performance alone. As such,

they tend to ignore other aspects of performance, for example, the social and
environmental performance of a reporting entity. Further, by focusing on financial
performance alone, and by giving it prominence, conceptual frameworks tend to
deflect attention away from other important areas of corporate performance.

 They represent a codification of existing practice and do not provide ideal methods of
accounting.

 They only act to provide a means of legitimising a profession under threat.

Whether we accept or reject the above advantages or disadvantages of conceptual

frameworks will really be based on our own personal opinions and beliefs. More specifically,
the extent to which the advantages of conceptual frameworks will actually be realised in
practice may depend on one’s belief as to the seriousness of the profession in implementing
conceptual frameworks. That is, are conceptual framework projects driven by a genuine
concern to ensure consistency in standard setting; legitimise the profession; or both?

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Question 5
The answer should start with a small introduction which describes historical cost accounting
in general. Following this, the main body of the answer can focus on the alternative methods
to historical cost accounting. Mention can be made of some of the limitations of historical
cost accounting and then discuss how the alternative methods have been developed as a
solution to the historical cost accounting method.

For instance, discussion that historical cost accounting is unsuitable for high inflation periods
as it does not take into account changing prices and thus tends to overstate profits in times
of rising prices. As a solution to this problem, CPP accounting was developed which
provides values in terms of purchasing power and thus the values of assets and liabilities are
recorded in the financial statement in real terms i.e. free of rising prices. Then the answer
should go on to explain a bit about CPP: what is meant by CPP, what are its advantages
relative to other methods used in accounting and so on. Similarly, answers should discuss
CCA and fair value accounting. The answer should finally end with a short conclusion
summarising the discussion in the main body of the answer.

Answers must also explain what is meant by fair values and fair value accounting. Good
answers should also mention that if there is an active and liquid market in which assets are
traded that are identical to the asset to be valued, then the fair value will be equivalent to the
asset’s market value. This technique of identifying a fair value is known as ‘mark to market’.
In circumstances where a comparable market value is not available, an alternative is to use
an accepted valuation model to infer the fair value. This technique is known as ‘mark to
model’ and requires the identification of both an accepted valuation model and the inputs
required by the model to arrive at a valuation. In practice, the best estimate of the exit price
(realisable value) is taken as the fair value of the asset.

Following this basic discussion about fair value, the answer should further talk about level 1,
level 2, and level 3 measurements. The IASB and FASB’s proposed (similar) accounting
standards on fair value measurement establish a fair value hierarchy in which the highest
attainable level of inputs must be used to establish the fair value of an asset or liability.
Levels 1 and 2 in the hierarchy are mark to market situations, with the highest level, level 1,
being ‘quoted prices (unadjusted) in active markets for identical assets or liabilities while
level 2 are directly observable inputs other than level 1 market prices (level 2 inputs could
include market prices for similar assets or liabilities, or market prices for identical assets but
that are observed in less active markets). Level 3 inputs are mark to model situations where
observable inputs are not available and risk-adjusted valuation models need to be used
instead. Discussion can be centred around these points, for instance the discussion on the

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reliability of the different levels of fair value measurements by Ronen (2008) can be
explained. Finally, the answer must conclude with a short summary of this discussion.

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