Financial Accounting Policy and Practice

Module Title: Financial Accounting Policy and Practice

• YOUR ANSWERS AND ALL YOUR CALCULATIONS MUST BE TYPED and submitted as a SINGLE MICROSOFT WORD FILE. Please, use font type ‘Arial’, and font size 12. Scanned and / or photographed handwritten answers are NOT acceptable, and will NOT be considered / marked.

• You must SHOW ALL YOUR WORKINGS/CALCULATIONS to justify your answers. You can copy and paste any Microsoft Excel worksheet(s) onto the document.

SECTION A

This question is compulsory and must be attempted.
Question 1

Papachi plc uses the acquisition method for consolidation of financial statements and equity accounting for associates. Papachi plc uses the fair value method for calculating goodwill and valuing the non-controlling interest.

On 1 January 2019, Papachi plc acquired 80% of the equity voting shares of Suraya ltd. On 1 January 2019, the executive directors of Papachi plc agreed to pay for the acquisition of Suraya ltd in the following ways:
i. a share exchange consisted of four shares in Papachi plc for every five acquired shares in Suraya ltd.
ii. a cash consideration of £5,700,000 paid immediately – only the cash element has been recorded.
iii. The parent will pay a further consideration of £5.00 per share acquired on 1 January 2020.

Papachi plc has a cost of capital of 10% and has only recorded the cash consideration in the accounts. The discount factor at 10% is 0.909.

The share prices at the date of acquisition are shown below.
Papachi plc £5.00
Suraya ltd £3.50

Both companies have the same accounting year end of 31 December 2019. The financial statements for both Papachi plc and Suraya ltd for the year ended 31 December 2019 are shown below.

Statement of comprehensive income for the year ended 31 December 2019

31 Dec 2019 31 Dec 2019
Papachi plc Suraya ltd
£000s £000s
Revenue 67,500 27,000
Cost of sales 47,250 22,500
Gross profit 20,250 4,500
Operating expenses (6,694) (225)
other income 206 0
Finance costs (225) (675)
Profit before tax 13,538 3,600
Income tax expense (3,375) (675)
Profit for the year 10,163 2,925
Other comprehensive income:
Gain on revaluation of land 563 0
Total comprehensive income 10,725 2,925

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Statements of Financial Position as at 31 December 2019

Papachi plc Suraya ltd
31 Dec 2019
31 Dec 2019

£000s £000s
Non-current assets
Property, plant and equipment (PPE) 21,735 9,000
Investment in associate 39,375 0
Investments in subsidiary and others 9,158 0
70,268 9,000
Current assets
Inventory 6,323 3,628
Receivables 7,650 4,134
Bank 4,028 1,238
18,001 9,000

Total Assets 88,268 18,000

Equity and Liabilities
Ordinary shares of £1 each 28,125 2,250
Retained earnings 43,718 4,950
Revaluation reserve 4,050 0
75,893 7,200
Non-current liabilities
8% loan notes 1,125 5,625
Current liabilities 11,250 5,175

Total Equity and Liabilities 88,268 18,000

Additional notes:

(i) The fair value exercise conducted at the date of acquisition showed the following changes to Suraya ltd’s non-current assets valuation:
a. office building included in the PPE had a fair value of £3,375,000 in excess of the book value and deemed to have a remaining useful life of five years. Depreciation is calculated on a straight-line basis and charged to cost of sales;
b. the fair value of land was £1,500,000 above the book value. This land was further increased by £150,000 at the reporting date.

(ii) At the date of acquisition of Suraya ltd, Papachi plc’s directors recognise a separately identifiable brand due to a list of key Surya ltd clients and have valued the brand at £1,750,000. The directors have agreed that the brand has a useful life of five years and that any amortisation is charged to cost of sales. The brand value has not been recorded in the books of the parent.

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(iii) Papachi plc sold goods to Suraya ltd worth £250,000 per month during the year. Papachi plc made a mark-up on cost of 40% on all these sales. At the reporting year end, £441,000 of goods still remained in the inventory of Suraya ltd.

(iv) At 31 December 2019, Suraya ltd’s current account balance showed £3.000,000. This balance did not agree with that of Papachi plc; the difference was due to a payment of £750,000 made by Suraya ltd on 30 December 2019. However, this had not been received in the parent’s bank until the end of January 2020.

(v) The fair value of the non-controlling interest at the date of acquisition has been agreed; the share price of the subsidiary is deemed to be an appropriate value for the non-controlling interest.

(vi) The annual impairment assessment showed that due to poor environment conditions, the consolidated goodwill is to be impaired by £800,000 and the impairment is shown in the operating expenses.

(vii) On 31 December 2019, Papachi plc purchased a £1,500,000 8% loan note from Suraya.

(viii) In addition to the above, Papachi plc purchased 30% of the voting shares of Adinath ltd on 1 January 2019 paying a cash consideration of £39,375,000. Adinath ltd’s income statement shows a net profit after tax of £5,600,000 for the 12-month period to 31 December 2019. This purchase has been recorded in the books of Papachi plc. There is no impairment for the associate.

(ix) Note that all income and expenditure items accrue evenly during the year.

Required
Prepare the consolidated statement of comprehensive income for Papachi plc for the year ended 31 December 2019, and the consolidated statement of financial position of Papachi plc as at 31 December 2019.

(Total: 40 Marks)

[END OF SECTION A] [SECTION B BEGINS ON THE FOLLOWING PAGE] 

SECTION B

Answer TWO questions.

Question 2
Required:
Given the difficulties associated with the production of conceptual frameworks for financial accounting and reporting, why should the accounting profession persist with such expensive and time consuming activities?
Critically discuss the above.

(Total: 30 Marks)

Question 3
It has been argued that finding an acceptable alternative to historic cost measurement basis in financial reporting is difficult because preparers of financial statements like the simplicity and objectivity associated with historic costs.

Required:
Critically discuss the perceived problems associated with historic cost measurement basis, suggest and explain alternative measurement bases that may be used in financial reporting, and justify how such alternative measurement bases may make accounting information more relevant and may provide a better estimate of the value of a company and the risk relating to its activity.

(Total: 30 Marks)