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Advanvced Financial Reporting May 2017
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Advanvced Financial Reporting & Analysis
Revision Kit

QUESTION 1a

Q ➢ Consolidated income statement for the year ended 31 March 2017
A

Solution


A
80%
\/
B
40%
>
D
A
>
C = 80% x 75% = 60%
75%
\/
C


W1

Goodwill
B Ltd C Ltd
Purchase consideration 800 600 x 80% 480
Less:Net assets acquired
OSC 500 400
Share premium 300 250
Retained profit 100 100
Revaluation 20
920 x 80% (736) 750 x 60% (450)
64 30
Impairment (32) (15)
32 15


W2

Depreciation on revalued plant
20 x 20% = 4 x 3 = 12

W3

Intergroup sales and URP
C to B 50% x 200 x 50% 50
B to A 40% x 250 x 25% 25
URP 75


Total Intergroup sales

200 + 250 = 450

W4

Intergroup balances
40 + 50 = 90

W5

investment in associate
Investment cost 400
Share of Post acquisition profit 40% x (310 - 150) 64
464


W6

Retained profit
Holding company profit 590
Add:post acquisition R.E of investee
B = 80% x (429.5 - 100 - 25 - 12 + 64{associate profit}) 285.2
C = 60% x (236 - 100 - 50) 51.6
Impairment of goodwill(32 + 15) (47)
879.8


W7

Non-controlling interest
B Ltd 20% x (500 + 300 + 5 + 429.5 - 25 - 12 + 64) 256.3
C Ltd 40% x (400 + 250 + 236 - 50) 334.4
Less investing in C = 20% x 600 (120)
470.7



A Group
Consolidated income statement for the year ended 31 March 2017
Sh."million"
Revenue(1,200 + 850 + 600 - 450) 2,200
Cost of sales(650 + 450 +320 + 4 + 75 - 450) 1,049
Gross profit 1,151
Other income 50 + 29.5 - [(80% x 60) + (75% x 10) + (40% x 50)] 4
Expenses
Distribution cost(120 + 70 + 90) (280)
Admin cost(180 + 80 + 120) (380)
Finance cost(20 + 10 + 30) (60)
Impairment of goodwill(32 + 15) (47)
PBT 388
Tax expenses(60 + 80 + 12) (152)
PAT 236
Add associate share of PAT 40% x 100 40
Total profit 276

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QUESTION 1b

Q ➢ Consolidated statement of financial position as at 31 March 2017
A

Solution


A Group
Consolidated statement of financial position as at 31 March 2017
Sh."million"
Assets
Non-current assets
PPE(1,400 + 800 + 1,200 + 20 -12) 3,408
Intangible assets(250 + 180 + 200) 630
AFS asset(50 + 30) 80
Goodwill(32 + 15) 47
Investment in associate 464
Current assets
Inventory(100 + 80 + 90 - 75) 195
Trade and other receivables(160 + 140 + 150 - 90) 360
Bank and other cash balances(40 + 60 + 30) 130
5,314
Equity and liabilities
OSC 1,000
Share premium 400
AFS reserve 10 + (80% x 5) 14
Retained profit 879.8
NCI 470.7
Non-current liabilities
10% loan stock (200 + 100 + 300) 600
Deferred tax(40 + 30 + 20) 90
Current liabilities
Trade and other payables(280 + 425.5 + 260 -90) 875.5
Bank loans(200 + 400 + 150) 750
Current tax(80 + 100 + 54) 234
5,314

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QUESTION 2(a)

Q ➢ Explain the accounting treatment of embedded derivatives under IFRS 9 “Financial Instruments” Embedded Derivatives
A

Solution


Under IFRS 9 "Financial Instruments," embedded derivatives are components of hybrid financial instruments that have both a non-derivative host contract and an embedded derivative feature. These embedded derivatives have characteristics that are similar to standalone derivatives, such as options, forward contracts, or interest rate swaps.

IFRS 9 requires entities to separate embedded derivatives from their host contracts and account for them separately under certain circumstances.

Criteria for separation are as follows:

  1. Separation is required if the economic characteristics and risks of the embedded derivative are not closely related to those of the host contract. This means that the embedded derivative must have a different risk or economic impact compared to the overall hybrid instrument.
  2. Separation is not required if the hybrid instrument is measured at fair value through profit or loss (FVPL) and the embedded derivative is also closely related to the host contract.


If separation is required, the embedded derivative is accounted for as a separate financial instrument, while the host contract is accounted for under the appropriate accounting standard relevant to its nature (e.g., loans, bonds, leases). The initial fair value of the embedded derivative is determined at the inception of the hybrid instrument.

The subsequent accounting treatment of the embedded derivative depends on its classification:

  1. Fair Value Through Profit or Loss (FVPL): If the embedded derivative is classified as FVPL, it is measured at fair value with changes recognized in profit or loss in each reporting period.
  2. Designated as at Fair Value Through Profit or Loss: If the entity designates the hybrid instrument as at FVPL and separates the embedded derivative, both the embedded derivative and the host contract are measured at fair value with changes recognized in profit or loss.
  3. Other Cases: If the embedded derivative is not classified as FVPL or designated as at FVPL, it is measured in accordance with the classification of the host contract. The changes in fair value of the embedded derivative are recognized in other comprehensive income (OCI) unless the fair value changes are attributable to credit risk. In that case, they are recognized in profit or loss.

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QUESTION 2(b)

Q ➢ Differences between Fair Value Hedge and Cash flow Hedge and their accounting treatment
A

Solution


Fair Value Hedge and Cash Flow Hedge are two types of hedging relationships recognized under IFRS (International Financial Reporting Standards) accounting standards. They are used by entities to manage the risks associated with financial instruments or specific transactions.

  1. Fair Value Hedge:

    ➦ Fair Value Hedge is a hedging relationship where the entity aims to hedge the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment. The objective is to offset the impact of changes in fair value on profit or loss.

    Features of a Fair Value Hedge include:

    • Designation: The hedging relationship must be formally designated and documented at the inception of the hedge.
    • Relationship between Hedged Item and Hedging Instrument: The hedging instrument must have a specific risk that is highly correlated with the risk being hedged in the hedged item.
    • Accounting Treatment:
      ➢ Changes in the fair value of the hedging instrument and the hedged item are recognized in profit or loss.
      ➢ Any ineffective portion of the hedge is also recognized in profit or loss.
      ➢ The fair value changes in the hedged item attributable to the hedged risk are offset by the corresponding changes in the fair value of the hedging instrument.

  2. Cash Flow Hedge:

    ➦ Cash Flow Hedge is a hedging relationship where the entity aims to hedge the exposure to variability in cash flows arising from a recognized asset or liability, a highly probable forecast transaction, or a firm commitment. The objective is to offset the impact of such variability on profit or loss.

    Features of a Cash Flow Hedge include:

    • Designation: The hedging relationship must be formally designated and documented at the inception of the hedge.
    • Relationship between Hedged Item and Hedging Instrument: The hedging instrument must be expected to have an impact on the cash flows being hedged.
    • Accounting Treatment:
      ➢ Changes in the fair value of the hedging instrument are recognized in other comprehensive income (OCI), specifically in the cash flow hedge reserve.
      ➢ The effective portion of the hedge, representing the portion that offsets the variability in cash flows, is also recognized in OCI.
      ➢ Any ineffective portion of the hedge is recognized in profit or loss.
      The amounts recognized in OCI are reclassified to profit or loss when the hedged item affects profit or loss (e.g., when the forecast transaction affects profit or loss).


NOTE

➦ It's important to note that the accounting treatment for both Fair Value Hedges and Cash Flow Hedges requires proper documentation, ongoing effectiveness assessment, and compliance with the specific requirements outlined in IFRS standards, particularly IAS 39 and IFRS 9. Entities must disclose the nature and extent of their hedging activities, including the hedging instruments used and their impact on financial statements.

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QUESTION 2(c)

Q ➢ Journal entries to record the transactions with regard to the share options for each of the years ended 31 December 2014, 31 December 2015 and 31 December 2016
➢ Explain how your answer in (c) (i) above would be different if the employees had the option to be paid the cash equivalent to the market price of the shares vested
A

Solution


Journal entries to record the transactions with regard to the share options for each of the years ended 31 December 2014, 31 December 2015 and 31 December 2016

Comair Ltd
Period Equity Expenses
2014 (1,000 x 95%) x 500 x 30 x 1 / 3 = 4,750,000 4,750,000
2015 (1,000 x 92%) x 500 x 30 x 2 / 3 = 9,200,000 4,450,000
2016 (1,000 - 24 - 17 - 6) x 500 x 30 x 3 / 3 = 14,295,000 5,059,000


2014 2015 2016
Dr Expenses 4,750,000 4,450,000 5,095,000
Cr Equity 4,750,000 9,200,000 14,295,000


(ii) Explain how your answer in (c) (i) above would be different if the employees had the option to be paid the cash equivalent to the market price of the shares vested

In equity-settled share-based transactions, options are valued based on the grant date price, whereas in cash-settled transactions, options are valued based on the price at the end of each period.

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QUESTION 3(a)

Q ➢ Basic EPS for the year ended 30 April 2016
A

Solution


Basic EPS
=
PATOSH
WANOS


PATOSH 2016 = 3,630 - (6% x 500) = 3,600
WANOS 2016 = 2,400

3,600 / 2,400 = 1.5


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QUESTION 3(b)

Q ➢ The basic earnings per share (EPS) for the year ended 30 April 2017.
A

Solution


Basic EPS
=
PATOSH
WANOS


PATOSH 2017 = 3,185 - (6% x 500) = 3,155

WANOS
Date Share transaction No of shares Weight Shares
01 / 05 / 2016 bal b/d 2,400,000 1 2,400,000
01 / 11 / 2016 Bonus shares(1 / 6 x 2.4) 400,000 400,000
2,800,000 2,800,000
01 / 03 / 2017 Rights issue - At full price 1 / 7 x 2,800
400 x 8.5 / 12.5		 272,000 2 / 12 45,333
3,072,000 2,845,333
Bonus shares = (400 - 272) 128,000 118,556
3,200,000 2,963,889


3,155 / 2,963.889 = 1.06

Workings

Weighted bonus shares = 128,000 x 2,845,333 / 3,072,000 = 118,556

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QUESTION 3(c)

Q ➢ Adjusted EPS for the year ended 2016 that would be shown in the year 2017 as a comparative for the EPS
A

Solution


No of shares outstanding 2,400,000
Bonus shares 400,000
Bonus on right issue(128 x 2,800) / 3,072 116,667
2,916,667
EPS
=
3,600,000
2,916,667
=
1.23

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QUESTION 3(d)

Q ➢ The diluted EPS
A

Solution


Potential OS (Convertible loans)

Incremental profit (interest) 8% x 1,000 x 0.7 = 5,600

Incremental shares = Sh.1,000 = 125 shares
Sh 1,000,000 = ? => 125,000 Shares

Diluted EPS
=
3,155,000 + 56,000
2,963,889 + 125,000
=
1.04

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QUESTION 4(a)

Q ➢ Contents of Management Commentary in an entity’s financial statements
A

Solution


The management commentary, also known as the management discussion and analysis (MD&A), is a section of an entity's financial statements that provides additional context and analysis to help users of the financial statements understand the entity's financial performance, position, and future prospects.

Contents of Management Commentary in an entity’s financial statements

➧ Overview of the Business: A description of the entity's business activities, including its products or services, markets, and competitive environment. It may also discuss any significant changes in the business during the reporting period.

➧ Key Performance Indicators (KPIs): Discussion and analysis of the key financial and non-financial metrics that are relevant to assessing the entity's performance. This may include revenue growth, profitability ratios, market share, customer satisfaction, and other performance measures.

➧ Financial Performance: An analysis of the entity's financial results, including revenue, expenses, profit margins, and earnings. It may highlight significant trends, changes in financial ratios, and factors impacting profitability.

➧ Financial Position: An assessment of the entity's financial position, including its assets, liabilities, and equity. It may discuss liquidity, solvency, and capital structure, as well as any significant changes in the financial position during the reporting period.

➧ Risk and Uncertainties: Identification and discussion of the key risks and uncertainties that may impact the entity's future performance. This may include market risks, operational risks, regulatory risks, and other factors that could affect the entity's ability to achieve its objectives.

➧ Strategy and Outlook: An explanation of the entity's strategic objectives, initiatives, and plans for the future. It may discuss the entity's competitive advantages, market opportunities, and any material events or developments that could impact its future performance.

➧ Corporate Governance and Compliance: Information on the entity's corporate governance practices, including the structure of the board of directors, key committees, and internal control systems. It may also address compliance with applicable laws, regulations, and accounting standards.

➧ Other Disclosures: Additional relevant information that management believes is necessary to provide a comprehensive understanding of the entity's financial performance and prospects. This may include discussions on environmental and social matters, research and development activities, and significant transactions or events.

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QUESTION 4(b)

Q ➢ Deferred tax balance as at 30 April 2017
➢ Diferred income tax account as at 30 April 2017
A

Solution


(i) Deferred tax balance as at 30 April 2017

Deferred tax balance as at 30 April 2017
Item Carrying amount Tax base Temporary difference
PPE 14,000 2,800 11,200
Prepayment 3,200 1,500 1,700
Interest bearing loan (16,000) (17,000) 1,000
AFS 12,000 14,000 (2,000)
Inventories 7,500 11,000 (3,500)
Intangible asset 4,000 0 4,000
Trade and other payables (8,000) (6,600) (1,400)
Trade receivables 6,650 7,000 (350)
10,650


(ii) Diferred income tax account as at 30 April 2017

Deferred tax account
AFS(2,000 x 30%)
600
Balance
3,195
-
3,795
Bal b/d
1,200
Revaluation - PPE 3,000 x 30%
900
P & L
1,695
3,795

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QUESTION 5(a)

Q ➢ Reasons for developing a conceptual framework for the preparation and presentation of financial statements
A

Solution


➧ Enhancing Consistency: A conceptual framework provides a consistent set of concepts and principles that guide the preparation and presentation of financial statements. It establishes a common understanding among preparers, auditors, and users of financial statements, leading to more consistent and comparable financial reporting.

➧ Providing Guidance: The framework provides guidance on various accounting issues and helps address practical problems in financial reporting. It assists in determining appropriate accounting policies, measurement bases, recognition criteria, and disclosure requirements.

➧ Promoting Transparency and Reliability: A conceptual framework promotes transparency by providing a clear rationale for the choices made in financial reporting. It ensures that financial statements are reliable and relevant, enhancing the credibility of financial information and facilitating informed decision-making by users.

➧ Facilitating Standard Setting: A conceptual framework serves as a foundation for developing accounting standards. It provides a framework within which standard-setting bodies can establish consistent and coherent accounting rules. It helps standard setters evaluate proposed standards and ensures that new standards align with established principles.

➧ Assisting Preparers and Auditors: The framework assists preparers of financial statements in selecting appropriate accounting treatments and making informed judgments. It also helps auditors assess the compliance of financial statements with the conceptual framework and evaluate the reasonableness of accounting policies and disclosures.

➧ Supporting Education and Research: A conceptual framework provides a basis for accounting education and research. It helps educators teach accounting concepts and principles effectively and enables researchers to investigate accounting issues and contribute to the development of accounting theory.

➧ Adapting to Evolving Business Practices: As business practices and economic environments evolve, a conceptual framework allows for the interpretation and application of accounting principles to new and complex transactions. It provides a basis for addressing emerging issues and ensuring that financial reporting remains relevant and reliable.

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QUESTION 5(b)(i)

Q ➢ Differentiate between a service segment and a geographical segment
A

Solution


Service Segment:

A service segment, also known as a business segment or operating segment, focuses on the different types of services or products offered by an entity. It involves the disaggregation of the entity's operations based on the nature of the services provided or the products offered. The primary criterion for defining service segments is the similarity of the services/products being provided, the production processes involved, and the nature of the risks and returns associated with each service/product.

Key points about service segments:

➢ Basis of Segmentation: Service segments are defined based on the nature of the services or products offered by the entity.
➢ Types of Services/Products: Each service segment represents a distinct line of business or type of service/product provided by the entity.
➢ Evaluation of Performance: Service segments are analyzed based on their revenue, expenses, profitability, and other relevant performance measures. This helps assess the contribution of each service segment to the overall financial performance of the entity.
➢ Management Decision-Making: Service segments assist management in making strategic decisions regarding resource allocation, product/service development, and performance evaluation.

Geographical Segment:

A geographical segment, also known as a geographic area segment or regional segment, focuses on the different geographical areas or locations in which an entity operates. It involves the disaggregation of the entity's operations based on the geographic regions or countries where it conducts business. The primary criterion for defining geographical segments is the existence of risks and returns that are different from those in other geographic areas.

Key points about geographical segments:

➢ Basis of Segmentation: Geographical segments are defined based on the different geographic areas or regions in which the entity operates.
➢ Geographic Areas: Each geographical segment represents a specific geographic area, such as countries, regions, or continents, in which the entity has significant operations or customers.
➢ Evaluation of Performance: Geographical segments are analyzed based on their revenue, expenses, profitability, and other relevant performance measures. This helps assess the contribution of each geographic area to the overall financial performance of the entity.
➢ Exposure to Risks: Geographical segments highlight the entity's exposure to risks and opportunities specific to different geographic regions, such as economic conditions, regulatory requirements, political stability, and currency fluctuations.

Summary

While a service segment focuses on different types of services/products offered by an entity, a geographical segment focuses on the different geographic areas in which the entity operates. The service segment analysis helps assess the performance of different lines of business, while the geographical segment analysis helps understand the performance and risks associated with different geographic regions.

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QUESTION 5(b)(ii)

Q ➢ Types of Employee Benefits with a brief description of the accounting treatment for each
A

Solution


(i) Short-term employment benefits:

Short-term employment benefits include benefits such as salaries, wages, bonuses, and paid leaves that are expected to be settled within 12 months after the employees have rendered the services. The accounting treatment for short-term benefits is straightforward. They are recognized as an expense in the income statement in the period in which the employees have provided the related services. Any liabilities associated with these benefits, such as accrued salaries or vacation pay, are recognized as current liabilities on the balance sheet.

(ii) Long-term benefits:

Long-term benefits are employee benefits that are not expected to be settled within 12 months. This category typically includes benefits such as long-service leave, sabbatical leave, or jubilee benefits. The accounting treatment for long-term benefits varies based on the nature of the benefit:

➧ Actuarial gains and losses: For benefits with defined benefit plans, actuarial gains and losses, which arise from changes in actuarial assumptions or experience adjustments, are recognized immediately in other comprehensive income (OCI).

➧ Past service costs: Any costs resulting from changes in the defined benefit plans that relate to past service of employees are recognized in the income statement.

(iii) Post-employment benefits:

Post-employment benefits can be classified into defined contribution plans and defined benefit plans.

➧ Defined contribution plans: In defined contribution plans, employers make fixed contributions to a separate fund or scheme on behalf of the employees. The accounting treatment involves expensing the contributions in the income statement when the employees have rendered the related service. Any unpaid contributions at the end of the reporting period are recognized as liabilities.

➧ Defined benefit plans: In defined benefit plans, employers promise specific benefits to employees based on factors such as years of service and final salary. The accounting treatment is more complex and involves actuarial calculations. The present value of the defined benefit obligation and the fair value of plan assets are recognized on the balance sheet. Actuarial gains and losses are recognized in OCI. The net defined benefit liability or asset is recognized on the balance sheet, with changes in the liability or asset and related expenses recognized in the income statement and OCI.

(iv) Termination benefits:

Termination benefits refer to voluntary or compulsory redundancy benefits provided by the entity. These benefits are recognized and accounted for when the entity has demonstrated a commitment to terminate the employee's services, such as a detailed formal plan. The accounting treatment involves recognizing the liability for termination benefits and the related expense in the income statement.

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QUESTION 5(c)

Q ➢ With Comparison to conventional financial reporting and social responsibility reporting, explain two practical challenges peculiar to social responsibility accounting.
A

Solution


Subjectivity and Measurement:

One practical challenge in social responsibility accounting is the subjective and qualitative nature of many social and environmental factors. Unlike financial information that is often based on objective and quantitative measures, social responsibility reporting deals with a wide range of intangible and non-financial aspects. Measuring and quantifying the social and environmental impacts can be challenging due to the lack of universally accepted standards and the dependence on subjective judgment. For example, assessing the environmental impact of a company's operations or determining the social value generated by its community engagement initiatives can involve complex calculations and subjective estimations.

Lack of Standardization and Reporting Frameworks:

Another challenge is the absence of universally accepted standards and reporting frameworks for social responsibility accounting. While there are various guidelines and frameworks available, such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) standards, they are not mandatory and allow for flexibility in reporting practices. This lack of standardization makes it difficult to compare and benchmark the social responsibility performance of different entities. Additionally, the absence of consistent metrics and reporting formats can lead to inconsistencies in data collection and reporting practices across organizations, making it challenging for stakeholders to analyze and interpret the information effectively.

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