CL2- Financial Reporting

&
Governance
Special Online Examination

December 2020

All Rights Reserved

 SECTION 1

Question 01

1.1

Relevant learning outcome/s: 1.1.1

Study text reference: Pages 2 – 13
Correct answer: B

1.2

Relevant learning outcome/s: 1.2.2

Study text reference: Page 34
Correct answer: C

1.3

Relevant learning outcome/s: 4.1.3

Study text reference: Page 666
Correct answer: D

1.4

Relevant learning outcome/s: 1.2.2

Study text reference: Page 22
Correct answer: A

1.5

Relevant learning outcome/s: 1.1.1

Study text reference: Pages 14 and 15
Correct answer: A

1.6

Relevant learning outcome/s: 2.2

Study text reference: Page 112
Correct answer: D

1.7

Relevant learning outcome/s: 2.2

Study text reference: Page 485
Correct answer: B
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1.8

Relevant learning outcome/s: 2.2

Study text reference: Page 393
Correct answer: B

1.9

Relevant learning outcome/s: 2.2

Study text reference: Page 413
Correct answer: C

1.10

Relevant learning outcome/s: 2.2

Study text reference: Page 461
Correct answer: C

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 SECTION 2

Question 02

Relevant learning outcome/s: 2.1

Study text reference: Pages 242 – 244 and 153 – 159

(a) Investment property

Per paragraph 16.8 of the SME standard, if a reliable measure of fair value is no
longer available without undue cost or effort for an item of investment property
measured using the fair value model, the entity shall thereafter account for that
item in accordance with Section 17 until a reliable measure of fair value becomes
available. The carrying amount of the investment property on that date becomes
its cost under Section 17. Paragraph 16.10(e) (iii) then requires disclosure of this
change. It is a change of circumstances and not a change in accounting policy .
Recording the investment property at cost on 31 March 2019, as the fair value
could not be measured without undue cost or effort, is not correct. MPL has to
consider the carrying value of Rs. 45 million as the cost as at 31 March 2019 and
it should be depreciated over the remaining useful life until a reliable measure of
fair value becomes available. Accordingly, depreciation that should be recognised
for the year is Rs. 4.5 million and not Rs. 4 million, and the carrying value of the
investment property as at 31 March 2020 should be Rs. 40.5 million.
Government grant
An entity shall recognise government grants that impose specified future
performance conditions on the recipient in the income statement only when the
performance conditions are met. Grants received before the revenue recognition
criteria are satisfied will be recognised as a liability.

Since the performance conditions were not met as at 31 March 2020, MPL cannot
recognise any revenue for the year. The entire grant amount should be recognised
as a liability. Therefore, adjustments made by MPL are not accurate per the
requirements of the SME standard. If the company has to pay a fine, that amount
should be recognised as an expense.

(b)
Rs.
Profit per the draft financial statements 11,230,400
Reversal of incorrect depreciation 4,000,000
Correct depreciation (4,500,000)
Reversal of government grant recognised as
revenue (8,000,000)
Adjusted net profit 2,730,400

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Question 03

Relevant learning outcome/s: 2.2

Study text reference: Pages 212 – 216

(a)

(i) Showroom sales staff cannot be treated as customers per SLFRS 15. They are the
people who market the products to customers. Hence, sales incentives paid to sales
staff cannot be reduced from revenue and need to be shown as an expense under
distribution expenses.
(ii) There is a revenue contract between MCP and distributors. Hence the company
should account for the commission payment as a reduction of its transaction price.
The company should estimate the amount of the commission based on past history
and adjust revenue upfront.
(iii) In this contract MCP acts as the principal, and the commission agent functions on
behalf of MCP in consideration for a commission payment. Therefore, the revenue
contract is only with the final customers of MCP and not with the agents. Hence the
commission payment cannot be netted off with revenue, and it should be classified
under distribution expenses.

(b) SLFRS 16 requires lessees to recognise a right of use asset and an associated liability
at the inception of the lease. Since the company would follow the modified
retrospective approach, the standard will apply in determining the lease liability for
lease cash flows for the financial year beginning on or after 1 January 2019.

The initial measurement of the lease liability will be the present value of the
minimum lease payments. The cost of right of use assets will include the amount of
lease liabilities recognised, initial direct costs incurred, and lease payments made
at or before the commencement date.

The discount rate used to measure the present value of the minimum lease
payments is the rate of interest implicit in the lease – essentially the rate of return
earned by the lessor on the leased asset.

The right of use asset is subsequently depreciated in accordance with LKAS 16

Property, Plant and Equipment (assuming it is a tangible asset). The lease liability is
effectively treated as a financial liability that is measured at amortised cost, using
the rate of interest implicit in the lease as the effective interest rate.

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Question 04

Relevant learning outcome/s: 5.1

Study text reference: Pages 80 – 82

(i) Fundamental ethical principles violated

Integrity: The accountant recording expenditure without supporting explanations

cannot be considered as being honest and fair.

Objectivity: The accountant cannot demonstrate that he did not allow bias,
conflict of interest.

Professional competence and due care: Allowing an expense to be processed

without supporting explanation cannot be considered as acting with due care and
diligence.

Professional behaviour: By doing this, the accountant discredits the profession.

Ethical threats

Self-interest: A self-interest threat occurs when a financial or other interest

inappropriately influences the accountant’s judgement or behaviour. In this case
the accountant’s salary increment has influenced his behavio ur.

Intimidation: This results from the undue influence of the CEO.

(ii) Fundamental ethical principles violated

Integrity: The accountant undertaking the assignment without disclosing the fact
that he lacks the required skills and expertise, cannot be considered as being
honest and fair.

Professional competence and due care: Accepting work without having the
necessary skills and knowledge cannot be considered as acting with due care and
diligence.

Professional behaviour: By doing this, the accountant discredits the profession.

Ethical threats

Self-interest: A self-interest threat occurs when a financial or other interest

inappropriately influences the accountant’s judgement or behaviour. In this case,
the fee for the assignment has influenced his behavio ur.

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(iii) Fundamental ethical principles violated

Integrity: The finance manager selecting a company for investment of the

company’s funds, due to the financial advantage his wife has, cannot be considered
as being honest and fair.

Objectivity: The finance manager cannot demonstrate that he did not allow bias,
conflict of interest.

Professional behaviour: By doing this, the accountant discredits the profession.

Ethical threats

Self-interest: A self-interest threat occurs when a financial or other interest

inappropriately influences the accountant’s judgement or behaviour. In this case,
the financial advantage to his wife has influenced his behavio ur.

Advocacy: This threat occur as the finance manager is promoting the employer to
a point where his objectivity is compromised (i.e. by promoting shares of a listed
entity that is a client of his wife).

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Question 05

Relevant learning outcome/s: 4.1

Study text reference: Pages 644 – 650

(a)

KJ Industry
31 March 2020 31 March 2019 average
Accounts receivable
collection period 60 days 44 days 50 days
Inventory turnover
period 64 days 56 days 72 days
Accounts payable
payment period 57 days 30 days 46 days
Cash conversion cycle 66 days 69 days 76 days

(b) The number of days taken to recover debtors has significantly increased compared
to 2019 and the industry average. This has to be checked with the normal credit
period granted to customers. If it is higher than the normal credit period, this
increase may be due to poor management of receivables. It may also indicate that
the receivables are impaired. However, it is also possible that the company is
granting an extended credit period to attract customers.

The increase in the inventory turnover period compared to 2019 could be a sign of
poor management of inventory. However, KJ is in a better position when compared
to the industry average. It is worth understanding whether economic, competitive
or any other social factors like COVID-19 have caused a sudden and significant drop
in sales resulting in an increase in the inventory holding period in 2020. It may also
be due to holding slow moving/non-moving items without reducing them to their
net realisable value.

In terms of accounts payable days, KJ is in a better position in 2020 compared to

2019 and the industry. The increase in accounts payable days indicates that the
company has been able to negotiate longer credit periods with creditors. It appears
that the company is financing its working capital mainly through suppliers .

The cash conversion cycle is favourable in 2020 than in 2019 and the industry
average. The CCC indicates how efficiently a company’s management is using short-
term assets and liabilities to generate cash and help the company’s financial health
with respect to cash management. The figure also helps to assess the liquidity risk
linked to a company’s operations. In this case, KJ has been able to convert its trade
receivables, inventory and trade payables into cash within 66 days in 2020
compared to 69 days in 2019 and 79 taken by the industry. Accordingly, KJ has been
able to reduce the liquidity risk in the current year.

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 SECTION 3

Question 06

Relevant learning outcome/s: 3.2

Study text reference: Pages 521 – 540

Ranmal (Pvt) Ltd

Consolidated Statement of Financial Position as at 31 December 2019
RPL TPL W1 W2 W2 W3 W4 W5 W6 Group
Rs. ‘000
Assets
Non-current
assets
Property, plant
and equipment 1,120,300 220,300 10,000 (333) 1,350,267
Intangible assets 20,100 12,000 16,000 48,100
Goodwill 39,070 (7,814) 31,256
Investment in
subsidiary 250,000 - (250,000) -
Investment in
associate 75,000 - 958 75,958
1,465,400 232,300 1,505,581

Current assets
Inventory 213,400 89,400 (188) 302,613
Trade
receivables 93,200 103,100 196,300
Prepayments 60,000 5,000 65,000
Cash and cash
equivalents 23,200 13,400 36,600
389,800 210,900 600,513

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Total assets 1,855,200 443,200 (184,930) (333) - (7,814) 958 (188) 2,106,093
Equity and
liabilities
Equity
Stated capital 700,000 150,000 (150,000) 700,000
Retained
earnings 760,700 181,000 (132,000) (250) (3,587) (5,860) 958 (188) (12,250) 788,523
1,460,700 331,000 1,488,523
Non-controlling
interest 30,000 (83) (1,953) 12,250 40,213
1,528,736
Non-current
liabilities
Retirement
benefit
obligation 73,800 9,800 83,600
Deferred
consideration 59,790 3,587 63,377
Deferred tax
liability 3,400 700 7,280 11,380

77,200 10,500 158,357

Current
liabilities
Trade payables 241,700 93,900 335,600
Accrued
expenses 75,600 7,800 83,400
317,300 101,700 419,000
Total equity
and liabilities 1,855,200 443,200 (184,930) (333) - (7,814) 958 (188) - 2,106,093

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W1: Goodwill

Rs. ‘000
Purchase consideration
- Cash paid 250,000
- Deferred consideration
(Rs. 75,000/1.12^2) 59,790
309,790
FV of NCI 30,000
339,790
Less: Net assets
Stated capital 150,000
Retained earnings 132,000
FV increase of building 10,000
DTL on building FV gain (2,800)
FV of intangible asset 16,000
DTL on intangible asset (4,480)
300,720
Goodwill 39,070

W2

Rs. ‘000
Finance cost of deferred consideration
(59,790 * 12% * 6/12) 3,587
Depreciation on building valuation
(10,000/15 * 6/12) 333

W3

Rs. ‘000
Goodwill impairment
(39,070 * 0.2) 7,814

W4: Investment in associate

Rs. ‘000
Cost 75,000
Post-acquisition profit
(23,000/12 * 2) * 25% 958
75,958

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W5: URP

Rs. ‘000
URP (Rs. 4,500 * 20/120) * 25% 188

W6

Rs. ‘000
Post-acquisition profit 49,000
NCI (25%) 12,250

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Question 07

Relevant learning outcome/s: 2.1 and 2.2

Study text reference: Pages 257-287-189-153

(a) The finance cost related to unwinding the warranty provision as at 31 March 2019
is Rs. 1,015,000 (7,250,000 * 14%). This finance cost should be charged to the
income statement in 2019/20. Hence the warranty provision with the unwinding
effect is Rs. 8,265,000.

Out of the incurred amount during 2019/20, Rs. 6,862,500 (15,250,000 * 45%)
should be charged to the income statement as the warranty provision applicable to
2019/20. The balance 55% (Rs. 8,387,500) is the actual incurred amount applicable
to the previous year. Hence Rs. 122,500 should be charged to the income statement
as the under provision expense for 2018/19.

The carrying amount of the warranty obligation as at 31 March 2020 to be

recognised in the statement of financial position as a current liability is computed
as follows.

Provision (Rs.) Probability (%) Expected cash flows (Rs.)

8,725,000 15% 1,308,750
6,285,000 45% 2,828,250
4,873,000 30% 1,461,900
1,548,000 10% 154,800
Expected cash flow 5,753,700
Risk adjustment (8%) 460,296
Risk adjusted expected cash flow 6,213,996
Discount factor (12%) 0.8929
Carrying amount of obligation as at
31 March 2020 5,548,211

The following is the break-up of the total warranty-related expenses charged to the
income statement in 2019/20.

Item Rs.
Finance cost (unwinding effect) 1,015,000
Under provided warranty amount for 2018/19 122,500
Warranty provision for probable claims for 2019/20 6,862,500
Warranty provision for probable claims for 2019/20 5,548,211
13,548,211

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(b) Events after the end of the reporting period are those events that occur between the
end of the reporting period and the date when the financial statements are
authorised for issue. There are two types of events.

1. Those that provide evidence of conditions that existed at the end of the
reporting period (adjusting events after the end of the reporting period)

2. Those that are indicative of conditions that arose after the end of the
reporting period (non-adjusting events after the end of the reporting
period)

In this case Milanka’s reporting period ends on 31 March 2020 and the financial
statements were authorised for issue on 10 May 2020. The increment required in
the warranty provision as a result of the increase in prices of imported material and
spares was finalised on 30 April 2020. Therefore, this is an event that occurred after
the balance sheet date.

The price of the product has increased after the year-end, and that situation was not
there at the year-end. The price increase is purely based on the circumstance or
indicative condition that occurred after the year-end. Hence this is considered a
non-adjusting event.

If the financial impact is material, it is to be disclosed in the financial statements

together with the nature and possible financial effect of it.

(c) A cash-generating unit (CGU) that goodwill has been allocated to, should be tested
for impairment annually whenever there is an indication that the unit may be
impaired (by comparing the carrying amount of the unit, including the goodwill, to
the recoverable amount of the unit).

If the recoverable amount of the unit exceeds its carrying amount, the unit and the
goodwill allocated to that unit should be regarded as not impaired. If the carrying
amount of the unit exceeds the recoverable amount of the unit, the entity should
recognise an impairment loss.

In this case, the carrying amount of the CGU is Rs. 24,250,000 and the recoverable
amount, which is the higher of its value-in-use and its fair value less cost to sell, is
calculated below.

Value-in-use

2020/21 2021/22 2022/23 2023/24 2024/25

Net cash inflow (Rs.) 5,500,000 4,275,000 3,875,000 2,568,000 6,257,000
DF (15%) 0.8696 0.7561 0.6575 0.5718 0.4972
NCF 4,782,609 3,232,514 2,547,875 1,468,262 3,110,835

Value-in-use (Rs.) 15,142,095

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Fair value less cost to sell

Fair value (Rs.) Cost to sell (Rs.) FV – Cost to sell (Rs.)

Assets (Category A) 7,250,000 (72,500) 7,177,500
Assets (Category B) 7,750,000 (38,750) 7,711,250
14,888,750

Because the carrying amount of the CGU (Rs. 24,250,000) exceeds its recoverable amount
(Rs. 15,142,095), the entity recognises in the income statement an impairment loss of Rs.
9,107,905. It allocates the impairment loss first to goodwill and then to other assets of
the unit on a pro rata basis according to the carrying amount of each asset in the CGU.

However, when allocating the impairment loss, the carrying amount of an asse t (in this
case assets of categories A and B individually) cannot be reduced to below their fair value
less costs to sell. The impairment loss allocation amongst assets of the CGU is summarised
below.

Allocation of impairment loss

CV of asset CV of asset
Rs. Goodwill (Cat A) (Cat B)
Carrying value (before
impairment) 24,250,000 3,500,000 12,500,000 8,250,000

Total impairment loss 9,107,905

Firstly: Allocated to goodwill (3,500,000) (3,500,000) (½ mark)

Balance loss to all allocated on a
pro-rata basis 5,607,905
Pro-rata ratio based on carrying
amount 0.60 0.40

Loss allocation on pro-rata basis (3,378,256) (2,229,649)

Carrying amount (impairment
loss allocated on pro-rata basis) 9,121,744 6,020,351

Fair value less cost to sell 7,177,500 7,711,250

Loss to reallocate to assets of Cat
A 1,690,899

(1,690,899) 1,690,899
Correct loss allocation amongst
assets (9,107,905) (3,500,000) (5,069,155) (538,750)

Carrying value (after

impairment) 15,142,095 - 7,430,845 7,711,250

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(d)

Investment property As at 31 March 2019 As at 31 March 2020

Rs. Rs.
Gross carrying amount 25,000,000 25,000,000
Less: Accumulated depreciation (937,500) (1,367,188)
(25Mn/40) * 1.5 0.9375Mn + (24.062mn/(55 + 1))
Net carrying amount 24,062,500 23,632,813

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 Notice of Disclaimer

The answers given are entirely by the Institute of Chartered Accountants of Sri Lanka (CA Sri
Lanka) and you accept the answers on an "as is" basis.

They are not intended as “Model answers’, but rather as suggested solutions.

The answers have two fundamental purposes, namely:

1. to provide a detailed example of a suggested solution to an examination question; and

2. to assist students with their research into the subject and to further their understanding and
appreciation of the subject.

The Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka) makes no warranties with
respect to the suggested solutions and as such there should be no reason for you to bring any
grievance against the Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka).
However, if you do bring any action, claim, suit, threat or demand against the Institute of
Chartered Accountants of Sri Lanka (CA Sri Lanka), and you do not substantially prevail, you
shall pay the Institute of Chartered Accountants of Sri Lanka's (CA Sri Lanka’s) entire legal
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© 2013 by the Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka).
All rights reserved. No part of this document may be reproduced or transmitted in any form or
by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior
written permission of the Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka).

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Corporate Level 2 - Special Online Examination December 2020