SUGGESTED SOLUTIONS

12306 – Financial Reporting Framework

CA Professional (Strategic Level I) Examination
June 2014

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA

All Rights Reserved

Answer No. 01

(a) The arrangement is classified as equity under LKAS 32.16 because the contingent
consideration arrangement will result in the issuance of a fixed number of Zebra PLC’s
equity shares if the target is met.
(b) SLFRS 2 requires the expense to be calculated separately for each tranche over the
vesting period for that tranche. That will result in the expense being front-loaded. The
answer is 500 x Rs. 10 for the first tranche plus 250 x Rs. 10 for the second tranche that
should be accounted in the financial statements of the year ended 31.12.2013
(c) As per the LKAS 20 the benefit of a government loan at a below market rate of interest
should be treated as a government grant. The loan should be recognized and measured at
fair value at the transaction date and subsequently it should be measured at amortised cost
in accordance with LKAS 39. Accordingly the loan should be initially measured at a
market rate of 8%, which is 68 million (100 mn *0.6805 calculated present value of the
future cash flow) the difference between the initial carrying value of the loan and loan
proceeds that is 32mn (100 – 68) should be treated as Government Grant.

Initial Recognition and Measurement

Loan - 68 Mn
Government Grant – 32 Mn

Since the loan should be subsequently measured at amortized cost, loan Carrying Value
should be stated in the financial statements at the end of the reporting period is 73.6Mn
(Initial fair Value of Rs. 68Mn should be measured at 8% i.e. 68Mn *1.08). Interest of
5.4 Mn should be charged as interest expenses in the income statement and Government
grant also should be amortized to compensate the expenses. Therefore amortization of
government grants of Rs.8.4Mn should be charged to income statement.

(d) Impairment testing is time intensive and judgmental due to:

 the identification of impairment indicators;
 assessing or reassessing the cashflows;
 determining the discount rates;
 testing the reasonableness of the assumptions; and
 benchmarking the assumptions with the market.
 Calculation of recoverable amounts is difficult and may not have required data
 If the market capitalisation is lower than a value-in-use calculation, then the VIU
assumptions may need challenging, as the cashflow projections might not be as
expected by the market

(e) The initial carrying amount of debt security is Rs. 8,000,000 and the transaction costs of
Rs 600,000 are spent. This treatment applies because the debt security is classified as
held for trading and, therefore, measured at fair value with changes in fair value
recognised in profit or loss.

(2)
 The initial carrying amount of the bond is Rs 11,000,000 i.e. the amount paid for the
bond and the transaction costs. This treatment applies because the bond is not measured
at fair value with changes in fair value recognised in profit or loss. Any changes in fair
value of the bond are taken to reserves until the bond is sold.

Carrying value Re- measured Impairment Fair value less

Rs million Rs million Rs million costs to sell
Rs million
Goodwill 160 160 (160) –
Plant and equipment 280 260 260
Stocks 200 180 180
Financial assets 170 170 170
Financial liabilities (140) (140) (140)
670 630 (160) 470

SLFRS 5 requires that immediately before the initial classification of the disposal group as held-
for-sale, the carrying amounts of the disposal group be measured in accordance with applicable
SLFRS, and any profit or loss dealt with under that SLFRS. The reduction in the carrying
amount of property, plant and equipment will be dealt with in accordance with LKAS 16, and
that of the inventory in accordance with LKAS 2.

Income statement

After the re-measurement, the entity will recognise an impairment loss of Rs 160 m on re-
measurement to the lower of carrying amount and fair value less cost to sell. This loss is
allocated to goodwill in accordance with LKAS 36. Thus, goodwill will be reduced to zero. The
loss will be charged against profit or loss.

Balance sheet

In the balance sheet, the major classes of assets and liabilities classified as held-for-sale should
be separately disclosed on the face of the balance sheet or in the notes. Thus, in this case, there
would be separate disclosure of the disposal group as follows.

Assets Rs.million
Non-current assets
Current assets
Non-current assets and current assets classified as held-for-sale 610
Liabilities
Current liabilities
Liabilities directory associated with non-current assets classified
140
as held-for-sale
Total liabilities

(3)
Answer No. 02

(a) LKAS 28 (definition)

Significant influence

(1) Is the power to participate in financial an operating policy decision of investee but
not control or joint control over those policies.

The standard mentions board representation as an indication of significance

influence but does not provide guidance on how to evaluate the representation in
the context of the size of the board, voting patterns and the like.

(2) Cobra PLC has the right to appoint 2 directors on the Board of Alpha Ltd. which
consists of 11 directors. Hence has power to participate in policy decisions.

(3) Board decisions are passed by 70% majority of directors as per information given.
Since there are 11 members, majority is 8 (11 x 70%).

(4) The other 2 major investors together has only 7 members and hence do not have
clear majority, and therefore no ability to influence on their own.

(5) Hence it appears that Cobra PLC, although having only 20% shareholding, has
significant influence over Alpha.

(b)

(1) they may not have the industry knowledge required to effectively function as a
INED

(2) they may have very different views to that of the directors representing
shareholders and there could be clashes on board decisions

(3) they may not have the same commitment and enthusiasm to that of directors
representing shareholders

(4)
Answer No. 03
(a) The reporting entity shall consider the closeness of the related party relationship and the
following other factors such as whether it is;
 Significance of the transaction in terms of size
 Carried out on non- market terms
 Outside normal day to day business operations, such as the purchase and sale of
businesses
 Disclosed to regulatory or supervisory authorities
 Reported to senior management
 Subject to shareholder approval

(b) This question tests the candidate’s ability to exercise professional judgment. Marks
will be awarded for valid arguments with supporting facts from relevant accounting
standards.

Given the nature of the agreement, the company accounts these agreements under
operating lease. Accordingly, neither asset is capitalized nor liability is recognized.
The company’s current accounting policy is to expense refurbishment/renovation cost
incurred. Now, the company is considering to capitalize one of such expenditure because
the amount incurred is substantial. This accounting treatment is not in line with the
company’s current accounting policy.
And also as the company has not been transferred all the risk and rewards incidental to
this asset, company cannot capitalize this amount incurred for cladding.

(c) As the company is still using the asset, the estimated 10 year useful life time cannot be
considered as accurate and the asset cannot be fully written off from the books of
accounts as the company is still generating economic benefits from the asset.
LKAS 16
Useful life of PPE should be reviewed at least year end and depreciation charge for
current and future years should be adjusted accordingly for any significant changes in
expectations.
Depreciation method also should be reviewed at least each year end, and if there is any
significant change in expected patterns of economic benefits the method should be
changed. Such changes should be accounted as changes in accounting estimate as per
LKAS 8 and requires prospective adjustment in financial statements.
The company has not reviewed the estimated useful life or the depreciation method and
made adjustments and hence although the asset is still being used, it is written off in the
books.
In order to correct the position, the company needs to re-assess the useful lifetime of the
asset and account for it as a change in estimate as per LKAS 8. However restating the
asset value results in a revaluation and as per the standard all the assets in that class need
to be revalued and not only this machinery.

(5)
Answer No. 04

(a) IFRIC 15 was issued in June 2008 in response to concerns raised about the inconsistency
in accounting for real estate sales. Divergence in practice has arisen whereby some
entities recognise revenue when the real estate is transferred to the customer in
accordance with LKAS 18 (revenue) whilst others recognise revenue over the period of
construction in accordance with LKAS 11 (construction contracts).

To address this divergence practice, IFRIC 15 clarifies the determination of whether an

agreement is within the scope of LKAS 11 or LKAS 18. The current accounting policy of
the company should be reviewed according to the criteria given by IFRIC 15.

According to IFRIC 15, a contract shall be identified as to whether it is a construction

contract or a sale of goods (service). This determination shall be made with reference to
the terms and conditions of the contracts signed with the customers.

The main factor is that whether the construction is made for customers specifications or
whether the construction is done for pre-set models or specifications determined by the
constructor. In other words, whether the customer could make major structural changes
to the construction or not would determine the relevant standard to use.

If no structural changes can be done by the customer then it is a sale of good transaction
LKAS18 applicable where revenue shall be recognized when the risk and rewards are
passes. That is at the completion of the units.

Otherwise the contract would fall under LKAS 11 – Revenue should be recognized on the
basis of stage of completion.

(b) Subscriptions to publications and similar items.

When the items involved are of similar value in each time period, revenue is recognised
on a straight-line basis over the period in which the items are dispatched. When the items
vary in value from period to period, revenue is recognised on the basis of the sales value
of the item dispatched in relation to the total estimated sales value of all items covered by
the subscription. Advances received shall be deferred until the performance obligations
are satisfied.

(6)
Answer No. 05

(a) Present value of debt component

Principal – Rs. 10, 000, 000 payable at the end of 5 years
10,000, 000* 1/ (1.08)5
Rs. 6,805, 832

Interest – Rs. 500, 000 payable annually in arrears for 5 years

500, 000* PVAF(8%,5)
500, 000* 3.9927 = Rs. 1,996, 350

Total liability component = Rs. 8,802, 182 ( 6,805, 832 + 1,996, 350)

(b) Equity Component = Rs. 10, 000, 000 – Rs. 8,802,182

= Rs. 1,197,818

(c) Cash Dr Rs. 10, 000, 000

Convertible notes payable Rs. 8, 802, 182
Equity Rs. 1, 197, 818

(7)
Answer No. 06

Machinery
Tax base = carrying amount + future deductible amount – future taxable amount
= 200 + 125 - 200
=125
Advances
Tax base of revenue received in advance = carrying amount – amount of revenue not taxable in
the future
= 800 -800
= 0 (nil)
Inventory
Tax base = carrying amount + future deductible amount – future taxable amount
= 1200+ 1200-1200
=1200

Long term loans

Repayment of loans have no tax consequence. Hence tax base 2,200

Answer No. 07

(a) The interest rate implicit in the lease ('IIR') is the discount rate that, at the inception of the
lease, causes the aggregate present value of

(a) the minimum lease payments; ( Lease rentals + guaranteed

residuals ) and
(b) the unguaranteed residual value

to be equal to the sum of the fair value of the leased asset and any initial direct costs of
the lessor

Method 3 correctly considered all these cash flows, therefore

Implicit Interest rate = 20%

(8)
 (b)

@ 20%
CF Timing AF/DF PV
1-5
Rental 30 years 3.00 89.91

Residual guaranteed 15 5 0.40 6.05

PV of MLP 95.96

Fair Value of the asset 100

PV of MLP as % of Fair
Value 96%

This is a finance lesae as it cover substantial % of Fair value at the inception

of the lease

(c) The lessor's gross investment in the lease is the aggregate of the minimum lease
payments receivable by the lessor under a finance lease and any guaranteed and
unguaranteed residual value to which the lessor is entitled

= ( 30 X 5 ) + 25 = Rs. 175 m

(d) The net investment in the lease is the gross investment discounted at the interest rate
implicit in the lease

Method 1

@ 20%
CF Timing AF/DF PV
1-5
Rental 30 years 3.00 89.91
Residual (guaranteed +
Not guaranteed) 25 5 0.40 10.09

Net Investment in the lease 100.00

Or

Fair Value = Net Investment = Rs. 100m

(9)
Answer No. 08

(a) (i) Name, address and business experience of directors and details of other
directorship held.

(ii) details of directors’ shareholdings

(iii) Sale and purchases of shares by any director in the year immediately preceding
the date of issue of prospectus with the prices of such sale and purchases

(iv) details of directors’ aggregate emoluments including bonus/profit sharing

payments made during last completed financial year.

(v) Directors’ interest in any assets acquired, disposed or leased by the entity during
past two years preceding the issue.

(vi) full particulars of any contract or arrangement in force at the date of the
application in which a director of the entity is materially interested in relation to
the business.

(b) (i) Companies licensed under the banking Act No. 30 of 1988
.
(ii) Companies carrying on leasing business

(iii) factoring companies

(iv) fund management companies

(v) Companies authorised under the Control of Insurance Act, No. 25 of 1962, to
carry on insurance business.

(vi) Companies registered under the Finance Companies Act, No. 78 of 1988.

(vii) Companies licensed under the Securities and Exchange Commission Act, No. 36
of 1987, to operate unit trust.

(viii) Companies licensed under the Securities and Exchange Commission Act, No.36
of 1987, to carry on business as stockbrokers or stock dealers.

(ix) Companies licensed under the Securities and Exchange Commission Act, No. 36
of 1987, to operate a Stock Exchange.

(x) Companies listed in a Stock Exchange licensed under the Securities and Exchange
Commission Act, No.36 of 1987.

(10)
(xi) Other Companies

(a) which have a turnover in excess of Rupees 500 Million;

(b) which at the end of the previous financial year, had shareholders equity in
excess of Rupees 100 Million;

(c) which at the end of the previous financial year, had gross assets in excess
of Rupees 300 Million.;

(d) which at the end of the previous year had liabilities to banks and other
financial institutions in excess of Rupees 100 Million;

(e) which have a staff in excess of 1000 employees.

(xii) Public Corporations engaged in the sale of goods or the provision of services.

(xiii) A group of companies, any one of which fall within any of the above categories.
For this purpose, "a group of companies" means a holding company and its
subsidiaries, the accounts of which have to be consolidated under section 147 of
the Companies Act, No.17 of 1982

(11)
(c)

Executive Non- Independent Non Reason

Executive Independent

W K B De   Is the CEO. Hence has

Silva executive responsibility for
mgt. of co., & involved in the
day to day operations:
Generally, an executive
director brings daily workplace
biasness and they are also bias
towards the decisions on their
performance bonus. Hence an
executive director cannot be an
independent director.
Prof. R   Not involved in day today
Narayan management of the Co. Hence
non executive director. No
other relationship or material
interest in the Co. Hence
independent.
S Dasanayake  Can be either independent Not involved in day today
or non-independent management of the Co. Hence
a non-executive director. He
has a close connection with the
company through SIL (Pvt)
Ltd. However if the contract
value is equivalent to 10% of
turnover of SIL then only the
close connection is material in
which case he is not
independent. If the value of the
contract to sell goods is less
than 10% of the turnover of
SIL, then not material and he
will be treated as independent
director

(12)
 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.

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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
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(13)

12306 – Financial Reporting Framework : CA Professional (Strategic Level I) Examination June 2014