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3.1 Corporate Reporting
Home Level 3 3.1 Corporate Reporting Page 10

Category: 3.1 Corporate Reporting

3.1 Corporate ReportingLevel 3Professional & ethical duties of an accountant

Nov 2016 Q5 a&b

a) Mordern Technology Ghana Limited plans to upgrade its production process and the directors believe that technology-led production is the only feasible way to remain competitive in recent times. However, the company operates from a leased property and the leasing arrangement was established in order to maximise taxation benefits. Surprisingly, the financial statements have not shown a lease asset or liability to date.

A new financial accountant joined Modern Technology Ghana Limited just after the financial year end of 31 July 2016 and is currently reviewing the financial statements to prepare for the upcoming audit and to begin making a loan application to finance the new technology.

The financial accountant believes that the lease relating to both the land and buildings should be treated as a finance lease but the finance director completely disagrees. The finance director does not wish to recognise the lease in the statement of financial position and as a result wishes to continue to treat it as an operating lease. The finance director believes that the lease does not meet the criteria for a finance lease, and it was made clear by the finance director that showing the lease as a finance lease could adversely affect the loan application.

Required:
Discuss the ethical and professional issues which face the financial accountant in the above transaction.                      (5 marks)

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A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. All other leases are classified as operating leases and classification is made at the inception of the lease. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the legal form. Thus in many circumstances, the classification of a lease can be quite subjective. In the case of a lease of land, this is particularly subjective as the title to the land may not pass to the lessee at the end of the agreement but the lease may still be classed as a finance lease where the present value of the residual value of the land is negligible and the risks and rewards pass to the lessee.

Thus, it appears that at first sight this is a difference in a professional opinion, which can be solved by the financial controller seeking advice.

If the features of the lease appear to meet IAS 17 Leases criteria for classification as a finance lease and the treatment used is part of a strategy to understate the liabilities of the entity in order to raise a loan, then an ethical dilemma arises.

Professional accountants are capable of making judgments, applying their skills and reaching informed decisions in situations where the general public cannot. The judgments made by professional accountants should be independent and not affected by business pressures. The code of ethics and conducts for professional accountants is very important because it sets out boundaries outside which accountants should not stray. The financial director should not place the financial controller under undue pressure in order to influence his decisions. If the financial controller is convinced that the lease is a finance lease, then disclosure of this fact should be made to the internal governance authority. The financial controller will have the knowledge that his actions were ethical.

b) The board of directors of Nyamekye Plc, a company listed on the Ghana Stock Exchange need a significant capital injection in order to finance a capital intensive project to consolidate the company’s market share failure of which will result in a loss of 25% of its market share. The management of the company has approached National Commercial Bank (NCB) for a loan facility to undertake the project.

However, the bank’s current lending policies require borrowers to demonstrate good projected cash flow, as well as a level of profitability which would indicate that repayments would be made. Unfortunately, the current projected statement of cash flow would not satisfy NCB’s criteria for lending. The directors have told the bank that the company is in an excellent financial position that the financial results and statement of cash flow projections will meet the criteria and that the chief accountant will forward a report to this effect shortly. The chief accountant has just recently joined Nyamekye Plc and has openly indicated that she cannot afford to lose her job because of her financial commitments and family concerns.

Required:
Discuss the professional and potential ethical conflicts which may arise in the above scenario and the ethical principles which would guide how a professional accountant should act in this situation.                                                                           (5 marks)

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Nyamekye Plc needs a significant injection of capital in order to finance a capital intensive project and the NCB requires the company to demonstrate good projected statement of cash flow and profitability.

However, the projected statement of cash flow does not satisfy the bank’s criteria and the directors have told the bank that the financial results will meet the criteria. Thus there is pressure on the chief accountant to forward a financial report which meets NCB’s criteria.

The chief accountant cannot afford to lose her job because of her financial commitments and family concerns and this in itself creates an ethical dilemma for the accountant, as not only is there self-interest of the accountant involved but also the interests of the company and its workforce.
The accountant has to rely upon her moral and ethical judgement in these circumstances she finds herself in.

Ethical standards are used by members of a profession to decide the right course of action in given circumstances.
Ethics rely on logical and rational reasoning to reach a decision, morals are a behavioural code of conduct to which an individual ascribes and ethical rules create an obligation to undertake a particular course of action.

Conflict can arise between personal and ethical values but when an individual becomes a member of a profession, there is recognition that there is acceptance of the standards of that profession which include its code of ethics and values. The ethical rules of the accounting profession represent an attempt to codify principles. A profession is distinguished by having a specialised body of knowledge, a social commitment, the ability to regulate itself and high social status.

The profession should seek to promote or preserve public interest. Professional accountants make a bargain with society in which they promise to serve the public interest which may, at times, be at their own expense. Accountants, as professionals, cannot rely exclusively on rules to define how they will act ethically. Members of the profession have a responsibility to present the truth in a fair and honest fashion and in a spirit of public service. In such circumstances, accountants should think carefully before seeking creative accounting solutions to particular problems. Thus, in this case, the chief accountant should insist that the report to the National Commercial Bank is a true reflection of the current financial position, irrespective of the consequences for herself.

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3.1 Corporate ReportingLevel 3Ratio Analysis

Nov 2016 Q4

a) It has been suggested that ratio analysis is not necessarily the best way of assessing a company’s performance.
Required:
i) Describe TWO uses of accounting ratios other than performance assessment.                                                              (2 marks)

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i. Ratios are used to express the logical relationships which exist between certain items in the financial statements.
ii. Ratios are also used to assess the liquidity position and financial condition of an enterprise over a period as well as with other similar enterprises.
iii. Ratios provide a better means of comparison than absolute values of financial or operational measurement.
iv. Ratios are useful in assessing the efficiency in managing the entity’s assets.
v. Ratios provide an indication of whether it is safe to invest in an entity.
vi. It is also useful in summarising the information contained in financial statements and in directing the user’s attention to certain key areas which may vary from firm to firm.
vii. Trend analysis, horizontal analysis and vertical analysis are all undertaken using ratios.

ii) Explain any THREE limitations of the use of accounting ratios in appraisal of financial performance.                      (3 marks)

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1. Inconsistent definitions of ratios
2. Financial statements may have been deliberately manipulated (creative accounting)
3. Different companies may adopt different accounting policies (e.g. use of historical costs compared to current values)
4. Different managerial policies (e.g. different companies offer customers different payment terms)
5. Statement of financial position figures may not be representative of average values throughout the year (this can be caused by seasonal trading or a large acquisition of non-current assets near the year-end)
6. The impact of price changes over time/distortion caused by inflation.

b) Below are the financial ratios for the year 2015 for Decimal Limited, a company engaged in the buying and shipment of agricultural products. The ratios for the industry have also been provided.

Required:
Write a report to the Shareholders of Decimal Ltd assessing its performance in comparison with the industry in respect of profitability, liquidity, efficiency and shareholders’ investment.                                                                                      (10 marks)

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                             Decimal Limited
                                 REPORT
From         :
To             :
Date          :
Subject     :
Introduction

i. Profitability:
Both gross profit margin and net profit margin have fallen below the industry average. This may be the result of uncontrolled overhead cost on the presence of large obsolete equipment. Unless steps are taken quickly to improve the income account investors may shift their interest into more profitable companies in the industry.

ii. Liquidity:
Both quick and current ratios fall far below those of the industry as confirmed by the fact that it takes longer to collect its debt than the industry. The problem may have been worsened by the fact that inventory stay longer at Decimal Ltd than in the industry which is not the best use to which resources should be put.

iii. Efficiency:
Even though Decimal Ltd takes longer to collect its debts (5 days), this is compensated by an even longer time to settle the debts (20 days). This means that creditors provide free finance for its operations. However, the holding on to inventory for a long time (10 days) cannot be justified. This should be turned over in like manner as that assets turnover far exceeds that of the market.

iv. Shareholders’ Investment:
Both dividend cover and dividend yield fall below that of the industry. Such a situation is not likely to excite investors especially income – oriented investors who are seeking to recoup their investment in the shortest time possible. This poor performance may be due to the fact that high gearing ratio of Decimal Ltd has effectively put its future in the hands of debenture holders who are reaping the bulk profits in the form of interest charges.

Conclusion
Signature

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3.1 Corporate ReportingCapital Reduction SchemeLevel 3

Nov 2016 Q3

MM Ltd, producers of telecommunication equipment has been making losses in recent times. The directors have proposed a scheme of reorganization, to take effect on 1 October 2013. The statement of financial position of the company at 30 September 2013 is as follows:

Additional information.
i) The ordinary shares are to be written down to GH¢0.25 per share and then to be converted into new ordinary shares of GH¢1.0 per fully paid.
ii) The preference shareholders are to receive 40,000 ordinary shares of GH¢1 per share, fully paid in exchange for their preference shares.
iii) Dividends of 7% preference shares are two years in arrears. In consideration of waiving their rights to arrears of preference dividend, the Preference shareholders have agreed to accept 10,000 new ordinary shares of GH¢1.00 per share, fully paid in final settlement.
iv) The creditors have agreed to take 100,000 new ordinary shares of GH¢1 per share fully paid in part settlement of the amounts due them.
v) The balance on the retain earnings account is to be written off.
vi) Some assets of the company have been revalued and are to be incorporated into the accounts as follows:
.                                                                  GH¢
* Freehold premises                           100,000
* Plant and equipment                       125,000
* Vehicles                                               25,000
* Inventories                                          36,000
vii) An allowance of GH¢3,500 is to be made for doubtful debts
viii) The ordinary shareholders have agreed to inject additional GH¢90,000 cash by acquiring 120,000 ordinary shares at 0.75 per share fully paid.
ix) Reorganization costs amounted to GH¢7, 500.

Required:
a) Prepare a capital reduction account, stated capital account and bank account.                                                              (9 marks)

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b) Prepare a statement of financial position of MM Ltd as at 1 October 2016, after the reorganization.                           (6 marks)

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3.1 Corporate ReportingIAS 24 Related party transactionsLevel 3

Nov 2016 Q2 e.

Mane is an entity specializing in importing a wide range of non-food items and selling them to retailers. Aqeel is Mane’s CEO and founder and owns 40% of Mane’s equity shares:
i) Mane’s largest customer, Zico accounts for 35% of Mane’s revenue. Zico has just completed negotiations with Mane for a special 5% discount on all sales.
ii) During the accounting period, Aqeel purchased a property from Mane for GH¢500,000. Mane had previously declared the property surplus to its requirements and had valued it at GH¢750,000.
iii) Aqeel’s son, Sherif is a director in a financial institution, Cheap Capital. During the accounting period, Cheap Capital advanced GH¢2 million to Mane as an unsecured loan at a favourable rate of interest.

Required:
Explain, with reasons, the extent to which each of the above transactions should be classified and disclosed in accordance with IAS 24 Related Party Disclosures in Mane’s financial statements for the period.                                                            (4 marks)

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According to IAS 24 Related Party Disclosures, a customer with whom an entity transacts a significant volume of business is not a related party merely by virtue of the resulting economic dependence.

Zico is not a related party and the negotiated discount does not need to be disclosed.

A party is related to an entity if it has an interest in the entity that gives it significant influence over the entity. The party is related to an entity if they are a member of the key management personnel of the entity. As founder member and major shareholder holding 40% of the equity, Aqeel is able to exert significant influence and is a related party of Mane. Aqeel is also a related party as he is Mane’s president. He is a member of the key management personnel of Mane. The sale of the property for GHȻ500,000 will need to be disclosed, along with its valuation as a related party transaction.

Providers of finance are not related parties simply because of their normal dealings with the entity. However, if a party is a close member of the family of any individual categorized as a related party, they are also a related party. As Sherif is Aqeel’s son and Aqeel is a related party, Sherif is also a related party. The loan from Cheap Capital will need to be disclosed along with the details of Sherif and his involvement in the arrangements.

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3.1 Corporate ReportingIAS 36 Impairment of assetsLevel 3

Nov 2016 Q2 d.

Afoko Ltd acquired a car taxi business on 1 January 2015 for GH¢230,000. The value of the assets of the business at that date based on net selling price were as follows:
.                                                   GH¢000
Vehicles                                          120
Intangible assets                           30
Trade receivables                         10
Cash                                                50
Trade payables                             (20)
.                                                      190
On 1 February 2015, the taxi business had three (3) of its vehicles stolen. The net selling values of these vehicles was GH¢30,000 and because of non-disclosure of certain risk to the insurance company, the business was uninsured. As a result of this event, Afoko Ltd wishes to recognise an impairment loss of GH¢45,000 inclusive of the loss of the stolen vehicles due to the decline in value of the stolen income generating unit, that is the taxi business. On 1 March 2015, a rival taxi company commenced business in the same area. It is anticipated that the business revenue of Afoko Ltd would be reduced by 25% leading to a decline in the present value in use of the business which is calculated at GH¢150,000. The net selling value of the taxi license has fallen to GH¢25,000 as a result of the rival taxi operator. The net selling values of the other assets have remained the same as at 1 January 2015.

Required:
Recommend how Afoko Ltd should account for the above transaction in its financial statements in accordance with IAS 36 Impairment of Assets.                                                                                                                                                       (6 marks)

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Afoko would recognise the impairment loss in the following way:
When impairment loss is identified, it should be recognised as an expense immediately in the income statement. Where impairment loss relates to a group of assets, usually, the impairment loss should be allocated in priority to those assets which have the most subjective valuations. Impairment identified in this way should usually be allocated to goodwill, thereafter to intangible assets to which there is no active market, thirdly to assets which net selling price is less than their carrying amount and finally to any tangible assets in the unit.

The impairment loss of GHȻ30,000 is recognised first for the stolen vehicles and the balance (GHȻ15,000) is attributed to goodwill.

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3.1 Corporate ReportingIFRS 9 Financial instrumentsLevel 3

Nov 2016 Q2 c.

Abiba Limited is a company operating in Northern Ghana and provides loans to customers and funds the loans by selling bonds in the market. The financial liability is designated as fair value through profit or loss. The bonds have a fair value increase of GH¢100 million in the year to 31 December 2015 of which GH¢5 million relates to the reduction in Abiba’s creditworthiness. The directors of Abiba Ltd have contacted your consultancy firm for your advice on how to account for this movement.

Required:
Discuss, with appropriate computations where necessary, the accounting treatment of the above transactions in the financial statements of Abiba Ltd for the year ended 31 December 2015.                                                                                        (5 marks)

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IFRS 9 requires gains and losses on financial liabilities designated as at fair value through profit or loss such as Abiba’s Ltd to be split into the amount of change in the fair value which is attributable to changes in the credit risk of the liability, which is shown in other comprehensive income, and the remaining amount of the change in the fair value of the financial liability which is shown in the statement of profit or loss.
IFRS 9 allows the recognition of the full amount of change in the fair value in the statement of profit or loss only if the recognition of changes in the liability’s credit risk in other comprehensive income would create an accounting mismatch in profit or loss.

This is determined at initial recognition and is not reassessed. Amounts presented in other comprehensive income are not subsequently transferred to profit or loss, and the entity may only transfer the cumulative gain or loss within equity. As a result, Abiba Ltd should charge GHȻ5 million to OCI and GHȻ95 million to statement of profit or loss.

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3.1 Corporate ReportingIAS 19 Employee benefitsLevel 3

Nov 2016 Q2 b.

The following information relates to the pension scheme of Patience Pass All Limited for the year ended 30 April 2016:
.                                                                                                               GH¢000
Plan assets at 1 May 2015                                                                      96,000
Defined benefit obligation at 1 May 2015                                           100,000
Service cost for year ended 30 April 2016                                           8,000
Discount rate at 1 May 2015                                                                 10%
Re-measurement loss in year ended 30 April 2016                           4,000
Past service cost 1 May 2015                                                                  6,000

The pension costs have not been accounted for in the total comprehensive income as the Accountant of the company is not qualified yet and lacks sufficient knowledge on the provisions of IAS 19 employee Benefits.

Required:
Demonstrate how the above transaction would be accounted for under the provisions of IAS 19 Employee Benefits including relevant extracts to the financial statements for the year ended 30 April 2016.                                                                 (5 marks)

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Pension cost recognised for the year would be:

IAS 19 does not actually specify where service cost and net interest cost should be presented. As a result, it is acceptable to include the net interest cost in finance costs.

IAS 19 states that past service cost should be recognised immediately and the past service cost will be included in the defined benefit obligation at 1 May 2015. Thus there is no need to calculate an interest cost on the past service cost.

Financial statement extracts:

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3.1 Corporate ReportingIAS 17 LeasesLevel 3

Nov 2016 Q2 a.

Hard -Work Ltd is a public limited company in Ghana and it owned a building on which it raised finance to support its operations. Hard -Work Ltd disposed the building for GH¢5 million to a finance company on 1 June 2015 when the carrying amount of the building was GH¢3.5 million. However, the same building was immediately leased back from the finance company for a period of 20 years, which was considered to be equivalent to the majority of the asset’s useful economic life. The lease rentals for the period amounted to GH¢441,000 payable annually in arrears. The interest rate implicit in the lease is 7%. The present value of the guaranteed minimum lease payments is the same as the sale proceeds.

Required:
Demonstrate how Hard-Work Ltd will account for the above transaction for the year ended 31 May 2016 in accordance with IAS 17 Leases. Show relevant extracts to the statement of profit or loss and the statement of financial position all at 31 May 2016.                                                                                                                                                                                   (5 marks)

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The lease in this case is a sale and lease back of which the building is for the major part of the building’s economic life and the present value of the minimum lease payments amounts to all of the fair value of the leased asset. Therefore, the lease should be recorded as a finance lease.

The building is derecognised at its carrying amount and then reinstated at its fair value with any disposal gain, in this instance GHȻ1.5 million (GHȻ5m – GHȻ3.5m) being deferred over the new lease term. The building is depreciated over the shorter of the lease term and useful economic life, so 20 years. Finance lease accounting results in a liability being created, finance charge accruing at the implicit rate within the lease, in this case 7%, and the payment reducing the lease liability in arriving at the year-end balance. The associated double entry for the derecognition is as follows:
.                                         DR GHȻ000           CR GHȻ000
Cash                                        5,000
Building                                                                  3,500
Deferred income                                                 1,500
The asset will be immediately reinstated and accounted for as follows:

Depreciation = GHȻ5, 000, 000/20years = GHȻ250,000 per annum
Deferred income recognized per annum = GHȻ1, 500, 000/20years = GHȻ75,000

 

Financial statement extracts for the first year of the finance lease contract

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3.1 Corporate ReportingConsolidation: Income statement & Stmt of fin. Position (Parent, Associate, Subsidiary)Level 3

Nov 2016 Q1

Below are the separate financial statements of Broad Ltd and two investee companies which also operate in the same industry as the investor entity.

The following information is relevant:
i) On 1 March 2016, Broad Ltd acquired 80% of the equity share capital of Narrow Ltd. The consideration consisted of two elements: a share exchange of three shares in Broad Ltd for every five acquired shares in Narrow Ltd and the issue of a GH¢100 6% loan note for every 500 shares acquired in Narrow Ltd. The share issue has not yet been recorded by Broad Ltd, but the issue of the loan notes has been recorded. At the date of acquisition, shares in Broad Ltd had a market value of GH¢5 each and the shares of Narrow Ltd had a stock market price of GH¢3.50 each.

Broad Ltd had earlier on acquired 2.4 million shares in Shadow Ltd on the stock market at a price of GH¢1.50 per share on 1 January 2016.

ii) At the date of acquisition, the fair values of Narrow Ltd.’s assets were equal to their carrying amounts with the exception of its property. This had a fair value of GH¢1.2 million below its carrying amount. This would lead to a reduction of the depreciation charge (in cost of sales) of GH¢50,000 in the post-acquisition period. Narrow Ltd has not incorporated this value change into its separate financial statements.

iii) Broad‘s group policy is to revalue all properties to current value at each year end. On 30 June 2016, the value of Narrow‘s property was unchanged from its value at acquisition, but the land element of Broad Ltd.’s property had increased in value by GH¢500,000 as shown in other comprehensive income.

iv) Sales from Narrow Ltd to Broad Ltd throughout the year ended 30 June 2016 was GH¢12 million. Narrow made a mark-up on cost of 25% on these sales. Broad Ltd had GH¢2 million (at cost to Broad Ltd) of inventory that had been supplied in the post-acquisition period by Narrow Ltd as at 30 June 2016.

v) In June 2016, Broad Ltd sold goods to Shadow Ltd for GH¢2,000,000, thus achieving a profit mark-up of 25%. The entire consignment remained unsold and was included in the inventory of Shadow Ltd as at 30 June 2016.

vi) Broad’s investments include some available-for-sale investments that have increased in value by GH¢300,000 during the year. The other equity reserve relates to these investments and is based on their value as at 30 June 2015. There were no acquisitions or disposals of any of these investments during the year ended 30 June 2016.

vii) Broad’s policy is to value the non-controlling interest at fair value at the date of acquisition. For this purpose, Narrow’s share price at that date can be deemed to be representative of the fair value of the shares held by the non-controlling interest.

viii) It was determined at the year-end that 10% of the goodwill relating to the acquisition of Narrow was impaired.

Required:
a) Prepare the consolidated statement of profit or loss and other comprehensive income for Broad Ltd. Group for the year ended 30 June 2016.                                                                                                                                                                    (10 marks)

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Note: Narrow’s profits for the year ended 31 December 2015 of GH¢6.8 million are GH¢4.533 million (6,800 x 8/12) pre-acquisition and GH¢2.267 million (6,800 x 4/12) post-acquisition.

b) Prepare the consolidated statement of financial position for Broad Ltd. Group as at 30 June 2016.                          (10 marks)

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3.1 Corporate ReportingCash flow analysisLevel 3

May 2016 Q5 b.

Evaluate with examples, the significance of each of the following to an analyst seeking to estimate the effect on future cash flows or liquidity of a company:
i) a commitment and a contingent liability.                                                  (2 marks)

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A commitment to undertake a transaction should be backed by whether it is probable that future economic benefits will flow to/from the entity or that there is a virtual certainty of inflow/outflow of resources. Commitment usually have significant effect on the future cash flows or liquidity of an entity. For examine, if a bank issues a guarantee to its customers to purchase supplies, the bank must clearly understand that this can lead to liability which may require a provision to be made since it can affect the bank’s future cash flows.

A contingent liability does not have an immediate effect on the future cash flows of an entity unless there is certainty of an obligating event. A contingent liability such as a compensation that may be paid to a customer pending a legal suit for a suspected defective product should be disclosed unless the possible outflow of resources to meet the liability is remote. If the outflow of resources is thought to be remote, no disclosure is required. If is it probable that there is an obligating event which will lead to settlement of liability, then a provision should be made for the contingent liability.

ii) income in advance and a deposit                                                             (1.5 marks)

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Income in advance emanates from contractual agreements to provide goods and services at a future date. Income in advance and deposits received have effect on future cash flows because they are recognized as liabilities until the anticipated service is rendered/goods supplied. Deposits results in inflow of resources to the entity but income in advance do not necessarily lead to cash flows.

iii) an accrual and a provision                                                                    (1.5 marks)

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Accruals are current obligations of an entity that will result in outflow of economic benefits when the obligation is settled. Accruals therefore have significant effect on future cash flows or liquidity of an entity. Increases in accruals may lead to inflows of cash in the short term by freeing up available funds but eventually this will lead to outflow of cash to settle the increased accruals.

A provision is a liability of an uncertainty amount and timing. A provision is treated as a liability provided it can be measured reliably and it will lead to an outflow of economic benefits. Provisions do not affect the future cash flows of an entity unless an obligating event is triggered.

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