Financial Accounting

& Reporting

Exam
30 April 2013

Time allowed – Three (3) hours

(plus 15 minutes reading time)

This open-book exam contains four (4) short-answer questions

of 20 marks each, totalling 80 marks

This paper contains 13 pages (including this page) (over to page 2)

© The Institute of Chartered Accountants in Australia, 2013

Chartered Accountants Program

Question 1 (20 marks)

Background information
Fruit Salad Limited (Fruit Salad) is a listed entity that purchases fruit from farmers in
a variety of locations, which it then cans for sale in the Australian and Asian markets.
Recent economic and environmental conditions have put significant pressure on Fruit
Salad’s cash flow. Fruit Salad’s chief financial officer, Peter, is looking at various options
to improve the cash flow in the medium to long term. However, he is also concerned
about how these options will impact on Fruit Salad’s financial statements.

Part A (6 marks)
The main Fruit Salad processing plant is located in the Ribena Shire, and Fruit Salad
is a major employer in the region. The Ribena Shire council is concerned about the
ongoing viability of farmers in the region should the processing plant be relocated to
another region. It has offered to purchase the processing plant and lease it back to Fruit
Salad. The plant cost $25,000,000, and at 1 July 20X2 its book value was $17,500,000.

The proposed terms of the lease agreement are:

•• Lease term: 10 years

•• Selling price of plant: $22,500,000
•• Fair value of plant: $22,500,000
•• Annual payment in arrears: $3,555,500
•• Lessee to pay executory costs on signing: $17,500
•• Interest rate implicit in lease: 12% per annum
•• Expected remaining useful life of plant: 10 years

Required

(a) If the lease agreement is signed on 1 July 20X2 and effective as of (4 marks)
that date, calculate the net impact of the lease transaction on the
statement of profit or loss and other comprehensive income for the
year ended 30 June 20X3. Ignore the impact of tax.
(b) Explain to Fruit Salad’s board the conditions that must exist for the (2 marks)
profit on the sale of the plant to be recognised immediately.
6 marks

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Question 1 (cont.)

Part B (6 marks)
Fruit Salad is looking to replace its pay-increase system with an employee share option
scheme for its senior executive team, effective from 1 July 20X3 (grant date). The terms
of the employee share option scheme are:

•• Number of options per employee: 1,000

•• Number of employees: 15
•• Vesting period: Three years, conditional on the employees remaining employed with
Fruit Salad
•• Exercise condition: Only if the share price exceeds $6.50 at 30 June 20X6
•• The value of the options measured at grant date is $4.75
Assumptions:

01.07.20X3 30.06.20X4 30.06.20X5 30.06.20X6

Trading price of shares $5.50 $6.00 $6.90 $6.35

Number of employees that resigned 0 1 3

during the year

Number of employees expected to 3 3 0

resign in future years

Required

Calculate the remuneration expense for each of the financial years

from 20X4 to 20X6 in relation to the options to be granted on 1 July
20X3. Ignore the impact of tax.
6 marks

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Question 1 (cont.)

Part C (8 marks)
For the year ended 30 June 20X7, Fruit Salad reported a profit after tax of $8.5 million.

Details of Fruit Salad’s securities for the year ending 30 June 20X7 are as follows:

Ordinary shares
•• At 1 July 20X6, 20 million $1 fully paid ordinary shares were on issue.
•• On 1 September 20X6, there was a private placement of one million fully paid
ordinary shares for $6.50 per share, which was the current share price at the time
of issue.
•• On 1 January 20X7, Fruit Salad made a 1:3 bonus issue whereby each shareholder
received one ordinary share for every three ordinary shares held.

Preference shares
•• On 30 June 20X7, one million $6.00 preference shares were on issue and have been
classified as equity. There were no movements in Fruit Salad’s preference shares
during the year.

Other information
•• Preference share dividends are paid half-yearly (on 31 December and 30 June)
at a rate of 10% per annum.
•• Dividends paid on ordinary shares during the year ended 30 June 20X7 totalled
$2 million.
•• The basic earnings per share (EPS) disclosed in Fruit Salad’s financial statements for
the year ended 30 June 20X6 was $0.48.

Required

Calculate the basic EPS figures that are required to be disclosed

in Fruit Salad’s financial statements for the year ended 30 June 20X7.
8 marks

End of Question 1
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Question 2 (20 marks)

Background information
High Seas Limited (High Seas) is a company that operates a luxury cruise liner business.
On 1 March 20X2, High Seas entered into a fixed-price agreement with Namura Fu, a
Japanese shipbuilding company, to construct a new cruise liner, the Southern Aurora, for
the purpose of operating tours from Melbourne and Auckland to Antarctica.

Agreement with Namura Fu

The total contract price for the construction of the Southern Aurora is fixed at ¥7,000
million, which High Seas must pay to Namura Fu in instalments, scheduled as follows:

•• ¥1,500 million on 1 March 20X2 (the date of signing the agreement).

•• ¥1,100 million on reaching certain construction milestones (which were met on
1 December 20X2).
•• ¥3,000 million on the delivery of the Southern Aurora by Namura Fu to High Seas
(anticipated to be 1 September 20X3 –18 months after signing the contract).
•• ¥1,400 million on the final sign-off of the vessel’s seaworthiness (anticipated to
be 30 November 20X3).

Financing the Southern Aurora acquisition

To finance the acquisition of the Southern Aurora, High Seas signed a loan agreement
with Dekai Bank on 15 February 20X2, on the following terms:

•• A drawdown loan facility of ¥6,000 million (the remaining ¥1,000 million of the
purchase price is to be funded from High Seas’ existing cash reserves).
•• Interest payable at a rate of 6.5% per annum, to be paid on 31 December each year
of the agreement.
•• An establishment fee of ¥2 million, payable on signing the loan agreement.
•• Interest-only payments due for the first three years of the loan agreement
(until 15 February 20X5).
As at 31 December 20X2, the following amounts had been drawn down on the loan
facility:

•• ¥1,250 million on 1 March 20X2.

•• ¥1,100 million on 1 December 20X2.
The effective interest rate on the loan is 7.3458%. The interest for the period
to 31 December 20X2, based on the effective interest rate, is ¥83,123,849.

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Question 2 (cont.)
Other information
Relevant exchange rates are as follows:

Date A$ = ¥

15 February 20X2 1.00 = 83.25

1 March 20X2 1.00 = 82.75

1 December 20X2 1.00 = 80.25

31 December 20X2 1.00 = 79.00

Part A (15 marks)

You are Lucinda Grant, the financial accountant for High Seas.

High Seas has a functional currency of Australian dollars and a 31 December year end.
The entity does not prepare half-yearly financial statements.

It is now 31 December 20X2.

Required

Prepare all journal entries for the year ended 31 December 20X2
to account for the events in the background information in High Seas’
accounting records. Ignore the impact of tax.
15 marks

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Question 2 (cont.)

Part B (5 marks)
You are Haruna Yamato, financial accountant for Namura Fu.

In the period to 31 December 20X2, Namura Fu has incurred costs of ¥2,200 million
in relation to the construction of the Southern Aurora. Although the entity does not expect
to make a loss on the contract, its management is not able to reliably determine the total
cost of completing construction of the ship.

Namura Fu has a functional currency of Japanese yen and a 31 December year end.

Required

Explain how you should account in Namura Fu’s 31 December 20X2

financial statements for:
(i) the costs incurred to date in the construction of the Southern
Aurora, and
(ii) the first two instalment payments received from High Seas
5 marks

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Question 3 (20 marks)

Background information
Darius Young is a newly qualified Chartered Accountant working as the financial
accountant for Water Bottle Limited (Water Bottle). Water Bottle manufactures a range of
eco-friendly water bottles for sale to customers in Australia.

Water Bottle prepares general purpose financial statements in accordance with

International Financial Reporting Standards (IFRS), and has a functional currency
of Australian dollars. Its year end is 30 June.

Part A (15 marks)

On 15 March 20X7, Water Bottle had a forecast inventory purchase of plastics from
a United States (US) supplier for US$7,200,000 on 30 June 20X7.

On the same date, Water Bottle entered into a forward contract to buy US$7,200,000,
maturing on 30 June 20X7 (based on a forward rate of A$1 = US$1.07) to be settled net
in cash, to hedge the forecast inventory purchase.

Darius has been told that the forward contract was appropriately designated into a cash
flow hedging relationship and the required documentation completed. The documentation
stated the hedge was to be assessed cumulatively each quarter from 31 March 20X7.
Water Bottle has a policy of recognising hedge accounting impacts in the financial records
at the date of each assessment.

Darius has also collated the following information:

•• Relevant spot exchange rates:

Date A$ US$

15 March 20X7 1 = 1.06

31 March 20X7 1 = 1.04

30 June 20X7 1 = 1.03

•• Fair value of the forward contract:

Date A$

31 March 20X7 185,000

30 June 20X7 543,000

•• A daily interest rate of 0.05% for present value (PV) calculations is appropriate.

Days to cash flow 0 7 91 97 101 107

PV factor at 0.05% 1 0.997 0.956 0.953 0.951 0.948

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Question 3 (cont.)
On 30 June 20X7, Water Bottle paid US$7,200,000 for the inventory.

Required

(a) Calculate the change in the present value of the future cash flows (5 marks)
using the cumulative ratio dollar offset method.
(b) Calculate the hedge effectiveness as at 31 March 20X7 and 30 (2 marks)
June 20X7.
(c) Prepare the accounting journal entries for the recognition and (8 marks)
operation of the cash flow hedge. Ignore the impact of tax.
15 marks

Part B (5 marks)
Darius reviews Water Bottle’s draft financial statements, and notes the following:

1. Water Bottle has standard terms of 30 days for all trade receivables. One trade
receivable of $150,000 which is owed by Retail Limited (Retail) has been identified
as 65 days old. Further investigation by Water Bottle’s management has revealed
that Retail is currently experiencing financial difficulty and is likely to enter into
administration. Water Bottle’s management have assessed that Water Bottle is likely
to receive $10,000 payment for Retail’s debt.

2. Water Bottle loaned $15,000 to Struggling Suzy (Suzy), which prepares the designs
for its water bottles. Water Bottle made the loan on arm’s-length terms at 5% per
annum. The agreement required Suzy was to repay the amount over a two-year
period. Suzy has made monthly repayments in accordance with the loan contract,
but has missed the last three months’ repayments. The balance owing on the loan
is currently $12,750. Management has spoken to Suzy, and the parties have entered
into an agreement whereby Water Bottle has forgiven Suzy for $7,750 of the balance
owing.

Required

For each of the two (2) items in Part B:

(i) Explain what evidence there is of impairment.
(ii) Prepare the journal entry required to recognise that impairment.
Ignore the impact of tax.
5 marks

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Question 4 (20 marks)

Background information
Gilchrist Limited (Gilchrist) is a reporting entity that manufactures and distributes
cricket equipment and clothing. To extend its marketing capabilities, it acquired a 51%
interest in Sachin Limited (Sachin) on 1 July 20X1 from Cairns Limited (Cairns). Sachin
manufactures premium cricket bats that are used by top batsmen around the world.

Over recent years, Cairns has sold 74% of its 100% ownership interest in Sachin in order
to allow it to make other investments.

The remaining 23% ownership interest in Sachin is held by unrelated investors, none
of whom hold an interest above 1%.

Gilchrist Cairns Remaining

Limited Limited shareholders

51% 26% 23%

Sachin Limited

Sachin’s constitution, which is a form of contractual arrangement, requires that a 75%

majority of its shareholders approve decisions concerning relevant company activities,
including changes to Sachin’s strategy and approving capital expenditure and operating
budgets. Each shareholder holds proportionate voting rights in Sachin.

Part A (4 marks)

Required

Explain whether Gilchrist has joint control over Sachin. Justify your
conclusion.
4 marks

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Question 4 (cont.)

Part B (13 marks)

Part B is related to Part C

Details of Gilchrist’s acquisition of the 51% interest in Sachin at 1 July 20X1 are tabled
as follows:

Costs associated with acquisition $

Gilchrist – cash consideration 7,000,000

Gilchrist – independent valuer fees 50,000

Gilchrist – legal fees 60,000

Sachin – legal fees for reviewing acquisition agreement 40,000

Total costs 7,150,000

Identifiable net assets at acquisition date $

Share capital 2,000,000

Revaluation surplus 1,000,000

Retained earnings 7,000,000

Net assets 10,000,000

Additionally:

•• At acquisition date, Gilchrist agreed to assume a $300,000 liability incurred by Sachin

four years earlier to an external party. Gilchrist was in the process of refinancing
its borrowings at the time of the Sachin acquisition, and was able to achieve
a lower interest rate on its own debts by taking on Sachin’s $300,000 borrowing.
The $10 million of net assets presented in the table above excludes the impact of this
liability.
•• Sachin has an unrecorded brand name that was valued by an independent
valuer at $400,000 at acquisition date and has a tax base of $0. This brand name
is to be recognised and amortised over 10 years.
•• At 1 July 20X1, Sachin held inventory with a book value of $500,000 (which was its
original cost) and a fair value of $850,000. Inventory turnover for both Gilchrist and
Sachin is approximately 60 days.
•• Gilchrist uses the partial goodwill method to calculate goodwill arising on business
combinations.

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Question 4 (cont.)
Intragroup transactions
•• There are limited transactions between Gilchrist and Sachin.
•• In late June 20X2, Sachin sold cricket bats to Gilchrist to sell in its online store.
Sachin charged Gilchrist $96,000 for the bats, which included a 20% mark up on
cost. The inventory was listed for sale in Gilchrist’s online store in July 20X2, and sold
by September 20X2.
•• Sachin paid a $200,000 dividend on 29 November 20X2.

Other information
The tax rate is 30%.

Required

Assuming that Gilchrist controls Sachin and prepares financial reports

in accordance with IFRS 10 Consolidated Financial Statements:
(a) Calculate the goodwill that will be recognised in the consolidated (6 marks)
financial statements at the acquisition date. Justify any exclusions
from your calculation.
(b) Identify the category of input that the independent valuer is most (2 marks)
likely to have used to measure the fair value of the brand name
at acquisition. Briefly explain your answer.
(c) Excluding the acquisition and non‑controlling interest journals, (5 marks)
prepare the consolidation journal entries required to prepare the
consolidated financial statements for the year ended 30 June
20X3.
13 marks

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Question 4 (cont.)

Part C (3 marks)
Part C is related to Part B

During the year ended 30 June 20X4, Sachin received bad publicity regarding the labour
conditions of its workforce. As a result, the company lost 80% of its market share.

Required

Explain the impact, if any, of the loss of Sachin’s market share on

the goodwill to be recognised in Gilchrist’s consolidated financial
statements for the year ended 30 June 20X4, including any flow-on
effect to the non-controlling interest.

You are not required to prepare or explain any journal entries that
Sachin may record.
3 marks

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