2.1 Financial Reporting – Page 13

Category: 2.1 Financial Reporting

2.1 Financial ReportingIAS 8 Accounting Policies, Changes in Accounting Estimates and ErrorsIFRS 15 Revenue from Contracts with customersLevel 2

Nov 2015 Q4 b.

LB Ltd is a construction contract company involved in building commercial properties. Its current policy for determining the percentage of completion of its contracts is based on the proportion of cost incurred to date compared to the total expected cost of the contract.
One of LB Ltd’s contracts has an agreed price of GHS500million and estimated total costs of GHS400million.
The cumulative progress of this contract is:
Year ended:

Based on the above, LB Ltd prepared and published its financial statements for the year ended 30 September 2011. Relevant extracts are:

Contract receivables (150-140) 10
LB Ltd has received some adverse publicity in the financial press for taking its profit too early in the contract process, leading to disappointing profits in the later stages of contracts. Most of LB Ltd’s competitors take profit based on the percentage of completion as determined by the work certified compared to the contract price.
Required:
(i) Assuming LB Ltd changes its method of determining the percentage of completion of contracts to that used by its competitors, and that this would represent a change in an accounting estimate, calculate equivalent extracts of profit or loss and statement of financial position for the year ended 30 September 2012. (7 marks)

View Solution

Based on value of work certified, the contract is 64% complete ((320 / 500) x 100) at 30 September 2012. Extracts for 2012 are:

(ii) Explain why the above represents a change in accounting estimate rather than a change in accounting policy. (2 marks)

View Solution

Accounting policies are the rules, principles and practices adopted by an entity in preparing its financial statements. They should be based upon IFRSs or other financial reporting standards.
Accounting estimates are the measurements and valuations arrived at by an entity in applying accounting policies to specific items and transactions.
In the case of LB Ltd, the accounting policy is in accordance with IAS 11 Construction Contracts. Revenue and costs are recognized according to the stage of completion of the contract. LB’s current means of estimating the stage of completion is based on proportion of cost to date to total cost.
Although the question refers to it as LB’s ‘current policy’, this is an accounting estimate, because it is LB’s method of applying the accounting policy. A different measurement basis, based on the same accounting policy, is to estimate stage of completion based on the value of work certified. In transferring from one to the other, LB is making a change of accounting estimate.

2.1 Financial ReportingConceptual & Regulatory frameworkLevel 2

Nov 2015 Q4 a.

Two of the enhancing qualitative characteristics of useful financial information contained in the IASB’s Conceptual Framework for Financial Reporting are understandability and comparability.
Required:
Explain the meaning and purpose of the above characteristics in the context of financial reporting and discuss the role of consistency within the characteristic of comparability in relation to changes in accounting policy. (6 marks)

View Solution

Understandability:
Financial information is intended to assist users in making economic decisions. For this purpose it is important that financial information is presented in a form which users can understand. However, this does not mean that complex matters which some users may find difficult to understand, and which some directors may like an excuse to exclude, should be left out of financial statements. Reports from which data has been excluded could be incomplete and misleading. The Conceptual Framework states that users can be assumed to have reasonable knowledge of business and economic activities and be prepared to review and analyze the information diligently.

Comparability:
In understanding the financial performance of an entity, users will want to compare its results with those of other entities in the same sector and with its own results for previous periods. The concept of comparability is therefore very important. Comparison between entities is made more possible by IFRSs in which most allowed alternatives have been removed and by the requirement to disclose accounting policies. So if two entities have applied different accounting policies users can be aware of that and allow for it.
Comparing an entity’s results with its performance in prior years requires the application of consistency. An entity should treat financial items and transactions in a consistent manner from year to year, by applying the same accounting policies. Where there is a change of accounting policy from one year to the next, the comparative information must be restated to show what the results for the previous year would have been if the new accounting policy had been applied. The statement of changes in equity also shows the effect on the previous year’s equity balances of the change of accounting policy. The user is therefore able to adjust for the change of accounting policy and observe the changes in underlying performances.

2.1 Financial ReportingFinal account of trading company (Statement of cash flow)Level 2

Nov 2015 Q3

(a) CL Ltd is a wholesaler and retailer of office furniture. Extracts from the company’s financial statements are set out below:

Note:
Non-current assets
During the year the company redesigned its display areas in all of its outlets. The previous displays had cost GHS10million and had been written down by GHS9million. There was an unexpected cost of GHS500,000 for the removal and disposal of the old display areas. Also during the year the company revalued the carrying amount of its property upwards by GHS5million and the accumulated depreciation on these properties of GHS2million was reset to zero.
All depreciation is charged to operating expenses.
Required:
Prepare a statement of cash flows for CL Ltd for the year ended 31 March 2015 in accordance with IAS 7 – Statement of Cash Flows. (15 marks)

View Solution

(b) The directors of CL Ltd are concerned at the deterioration in its bank balance and are surprised that the amount of gross profit has not increased for the year ended 31 March 2015. At the beginning of the current accounting period (i.e. on 1 April 2014), the company changed to importing its purchases from a foreign supplier because the trade prices quoted by the new supplier were consistently 10% below those of its previous supplier. However, the new supplier offered a shorter period of credit than the previous supplier (all purchases are on credit). In order to encourage higher sales, CL Ltd increased its credit period to its customers, and some of the cost savings (on trade purchases) were passed on to customers by reducing selling prices on both cash and credit sales by 5% across all products.
Required:
(i) Calculate the gross profit margin that you would have expected CL Ltd to achieve for the year ended 31 March 2015 based on the selling and purchase price changes described by the directors. (2 marks)

View Solution

Taking the figures for the year ended 31 March 2014 and applying the 10% reduction in purchase costs and the 5% discount to customers, the directors would have expected the gross profit to be as follows:

The actual gross profit % for the year ended 31 March 2015 is: (22,000/65,800 x 100) =33.4%

(ii) Comment on the directors’ surprise at the unchanged gross profit and suggest what other factors may have affected gross profit for the year ended 31 March 2015. (3 marks)

View Solution

The directors should not be surprised at the unchanged gross profit as cost of sales has increased by the same amount as revenue, wiping out any possible increase in gross profit. In fact the actual gross profit margin has fallen from 40% in 2014 to 33.4% in 2015, so despite the 10% reduction in the cost of purchases the company was trading less profitably.
Possible reasons for this could be:

Shipping costs involved in importing goods having to be borne by the recipient;
Import duties Currency exchange losses, perhaps exacerbated by having to pay within a shorter period. Inventory losses – uninsured damage, obsolescence etc;
Selling a larger proportion of goods on which the gross profit % is lower than the average mark-up. Perhaps sales or special offers to customers, which will have to lower the average mark-up. The foreign supplier may have increased his prices at some point during the year;
Also there may have been changes in accounting policy during the year – perhaps depreciation or distribution costs which were treated as expenses in 2014 and have been charged to cost of sales in 2015. If this has happened it will require retrospective restatement so that 2014 and 2015 can be correctly compared.

2.1 Financial ReportingLevel 2Ratio Analysis & interpretation

Nov 2015 Q2

Kack Ltd is a listed company that assembles domestic electrical goods which it then sells to both wholesale and retail customers. Kack Ltd’s management was disappointed in the company’s results for the year ended 31 March 2014. In an attempt to improve performance the following measures were taken early in the year ended 31 March 2015:
A national advertising campaign was undertaken,
Rebates to all wholesale customers purchasing goods above set quantity levels were introduced,
The assembly of certain lines ceased and was replaced by bought in completed products. This allowed Kack Ltd to dispose of surplus plant.

Kack Ltd’s summarised financial statements for the year ended 31 March 2015 are set out below:

Below are ratios calculated for the year ended 31 March 2014:
Return on year end capital employed (profit before interest and tax over total assets less current liabilities) 28.1%
Net assets (equal to capital employed) turnover 4 times
Gross profit margin 17%
Net profit (before tax) margin 6.3%
Current ratio 1.6:1
Closing inventory holding period 46 days
Trade receivables’ collection period 45 days
Trade payables’ payment period 55 days
Dividend yield 3.75%
Dividend cover 2 times

Notes:
*Kack Ltd received GHS 120m from the sale of plant that had a carrying amount of GHS 80m at the date of its sale.
*The market price of Kack Ltd’s share throughout the year averaged GHS3.75 each.
*There were no issues or redemption of shares or loans during the year.
*Dividends paid during the year ended 31 March 2016 amounted to GHS 90m, maintaining the same dividend paid in the year ended 31 March 2015.
Required:
(a) Calculate ratios for the year ended 31 March, 2015 (showing your workings) for Kack Ltd, equivalent to those provided above. (10 marks)

View Solution

Return on Capital Employed (ROCE)
Profit before Interest and Tax / Total Assets – Total Current Liabilities
220/680×100 = 32.3%
Net assets turnover
Turnover / Net Assets
4,000/680 =5.9 times
Gross Profit Margin
Gross Profit /Turnover
550/4,000 ×100 = 13.8%
Net Profit Margin
Profit before Tax / Turnover
200/4,000 ×100 =5%
Current ratio
Current Assets / Current Liabilities
610/480 = 1.27: 1
Closing Inventory holding period
Average Inventory / Cost of Sales
250/3,450 ×365 = 26 days
Trade receivables collection period
Trade Receivable / Credit Sales x 365
360/3,000 ×365 = 44 days
Trade payables payment period
Trade Payables / Credit Purchase x 365
430/3,450 × 365 = 45 days
Dividend yield
Dividend per Share / Market Price per Share x 100
22.5/375*×100 = 6%

*Dividend per share
Dividend Paid / No. of Share
(90/400)/
Dividend cover
Net Profit after Tax / Dividend Paid
150/90 = 1.67 times

(b) Analyse the financial performance and position of Kack Ltd for the year ended 31 March 2015 compared to the previous year. (10 marks)

View Solution

The first thing to notice about Kack’s results is that the ROCE has increased by 4.2 percentage points, from 28.1 to 32.3. On the face of it, this is impressive. However, we have to take into account the fact that the capital employed has been reduced by the plant disposal and the net profit has been increased by the profit on disposal. So the ROCE has been inflated by this transaction and we should look at what the ROCE would have been without the disposal. Taking out the disposal gives us the following ratios:
ROCE =180/ (680+80) × 100 = 23.7%
Net asset turnover = 4,000/760 = 5.3 times
Net profit margin =160/4,000 × 100 = 4%
Comparing these ratios to those for the period ended 31 March 2014 we can see that ROCE has fallen. This fall has been occasioned by the fall in the net profit margin. The asset turnover has improved on the previous year after adding back the disposal.
The net profit margin can be analysed into two factors – the gross profit margin and the level of expenses. The gross profit percentage is 3.2 % down on the previous year. This is probably due to the rebates offered to wholesale customers, which will have increased sales at the expense of profitability. The replacement of some production lines by bought in products will probably also have reduced profit margins. Sales may have been increased by the advertising campaign, but this has been additional expense charged against the net profit. It looks as if management have sought to boost revenue by any available means. The plant disposal has served to mask the effect on profits.
Kack’s liquidity has also declined over the current year. The current ratio has gone down from 1.6 to 1.3. However, there has also been a sharp decline in the inventory holding period, probably due to holding less raw material for production. It could be that the finished good can be delivered direct to the wholesalers from the supplier. This will have served to reduce the current ratio. The receivables collection period has remained fairly constant but the payables payment period has gone down by 10 days. It looks as if, in return for prompt delivery, the finished goods supplier demands prompt payment. This fall in the payables period will have served to improve the current ratio. We do not have details of cash balances last year, but Kack currently has no cash in the bank and a GHS 10 m overdraft. Without the GHS 120m from the sale of plant the liquidity situation would obviously have been much worse.
The dividend yield has increased from 3.75% to 6 %, which looks good as far as potential investors are concerned. But we are told that the dividend amount is the same as last year. As there have been no share issues, this means that the dividend per share is the same as last year. Therefore the increase in dividend yield can only have come about through a fall in the share price. The market is not that impressed by Kack’s results. At the same time the dividend cover has declined. Do the same dividend has been paid on less profit (last year’s dividend cover was 2.0, so profit must have been GHS 180m). Management decided it was important to maintain the dividend, but this was not sufficient to hold the share price up.
To conclude, we can say that Kack’s position and performance is down on the previous year and any apparent improvement is due to the disposal of plant.

2.1 Financial ReportingFinal account of trading company (P&L, statement of financial position )Level 2

Nov 2015 Q1

Below is the summarised draft statement of financial position of DX Ltd, a company listed on the Ghana Stock Exchange, as at 31 March, 2015:

The following information is relevant:
(i) DX Ltd’s statement of profit or loss includes GHS8million of revenue for credit sales made on a ‘sale or return’ basis. At 31 March 2015, customers who had not paid for the goods, had the right to return GHS2.6million of them. DX Ltd applied a mark-up on cost of 30% on all these sales. In the past, DX Ltd’s customers have sometimes returned goods under this type of agreement.
(ii) The non-current assets have not been depreciated for the year ended 31 March 2015.
DX Ltd has a policy of revaluing its land and buildings at the end of each accounting year. The values in the above statement of financial position as at 1 April 2014 when the building had a remaining life of 15 years. A qualified surveyor has valued the land and buildings at 31 March 2015 at GHS180million.
Plant is depreciated at 20% on the reducing balance basis.
(iii) The financial assets at fair value through profit or loss are held in a fund whose value changes directly in proportion to a specified market index. At 1 April 2014 the relevant index was 1,200 and at 31 March 2015 it was 1,296.

(iv) In late March 2015 the directors of DX Ltd discovered a material fraud perpetrated by the company’s credit controller that had been continuing for some time. Investigations revealed that a total of GHS4million of the trade receivables as shown in the statement of financial position at 31 March 2015 had in fact been paid and the money had been stolen by the credit controller. An analysis revealed that GHS1.5million had been stolen in the year to 31 March 2014 with the rest being stolen in the current year. DX Ltd is not insured for this loss and it cannot be recovered from the credit controller, nor is it deductible for tax purpose.
(v) During the year, the company’s taxable temporary differences increased by GHS10miiion of which GHS6million related to the revaluation of the property. The deferred tax relating to the remainder of the increase in the temporary differences should be taken to profit and loss. The applicable income tax rate is 20%.

(vi) The above figures do not include the estimated provision for income tax on the profit for the year ended 31 March 2015. After allowing for any adjustments required in terms (i) to (iv), the directors have estimated the provision of GHS11.4million (this is in addition to the deferred tax effects of item (v).
(vii) During the year, dividends of GHS15.5million were paid. These have been correctly accounted for in the above statement of financial position.
Required:
Taking into account any adjustments required by items (i) to (vii) above:

(Notes to the financial statements are not required).
(a) Prepare a statement showing the recalculation of DX Ltd’s profit for the year ended 31 March 2015; and (7 marks)