by Paul Robins
Relevant to Paper 10 and of interest to Paper
13 (Professional)
This is the third in a series of articles that examines the issue of
good examination technique in financial reporting papers. In the last two
articles we considered a questions from Paper 13 – Financial Reporting
Environment (FRE). This month and next month we will look at a question
from Paper 10 – Accounting and Audit Practice. Future articles in the
series will consider examination questions from other financial reporting
papers. The material that is covered in this month’s and next month’s
article is primarily of relevance to Paper 10 students but Paper 13
students may find the material to be useful for basic revision.
In previous articles we explained the key steps you should take in
answering any examination question. Since Paper 10 students may well not
have referred to the previous articles these key steps are reproduced
below:
- Read the requirements first – even if they are situated at the end
of the question.
- Read the question through thoroughly before starting to attempt any
part of it.
- As you read the question ask yourself why the information you are
reading has been provided.
- Decide on the particular knowledge and skills you need to be able to
tackle the requirements. In practice you may sometimes do this as you
read through the question itself (see the previous step). However if the
scenario is particularly complicated you may need to go back and assess
the required knowledge and skills as a separate step.
- Assess whether you actually possess the knowledge and skills you
have identified in the previous step.
- Tackle as much of the question as you can in the time available.
- Never overrun on time, even if you feel you can gain more marks in a
particular question.
The format of Paper 10 is as follows:
- Section A contains 3 accounting questions for 25 marks each. You
need to answer 2 of these 3. Questions 1 and 2 are usually fairly
computational, whilst Question 3 tends to be more written. Very often
Question 1 is a consolidation.
- Section B contains a compulsory integrated accounting and auditing
question for 30 marks. The marks are split 50:50 between accounting and
auditing.
- Section C contains a compulsory auditing question for 20 marks.
You can see that the split between accounting and auditing marks on
this paper is 65:35. You can also see that there is a limited amount of
choice in Section A. Where choice is available in an examination it is
worth remembering the following.
- Make your choice early on in the examination. From then on try to
imagine all the questions you have chosen are compulsory and the others
don’t exist.
- NEVER cross through a ‘choice’ question after having spent
significant time on it and change your choice. This is examination
suicide. As we said in the previous article in this series, lack of time
is your biggest enemy, not lack of knowledge.
In this first article on Paper 10 examination technique we will look at
a computational question. Since consolidations is such a key area in this
paper and indeed in the successor paper (Paper 13 under the current
syllabus, Paper 3.6 under the new syllabus) we will devote this month’s
article to a discussion of examination technique with reference to a
consolidation question. Based on past papers the examiner seems to set a
consolidated balance sheet rather more often than a consolidated profit
and loss account. Therefore we will look at a past question that asks for
the preparation of a consolidated balance sheet.
Examination technique for consolidated accounts This series
assumes you have already studied the basics of consolidated accounts and
are reasonably familiar with the procedures involved. One of the problems
in writing a generic article on examination technique in this area is that
there are so many different ways of presenting the consolidation workings.
In some respects, this shouldn’t matter too much because it is worth
remembering that at the end of the day a consolidation question is
basically an aggregation exercise. This means that there will usually be
quite a few relatively easy marks available for adding up. In the
experience of the writer many students approach consolidated balance sheet
questions in the wrong order. Many start off by computing goodwill,
minority interest, and consolidated reserves and produce the balance sheet
only at the end of this exercise. Given that the big enemy in the
examination is lack of time this means that such students run the risk of
missing out on relatively easy marks. The writer’s suggested order of
tackling a question that deals with the consolidated balance sheet would
be:
- Read the question and identify the group structure. At Paper 10 the
group structure is usually fairly straightforward – just one subsidiary
and perhaps one associate.
- Identify information in the question that will affect the basic
aggregation principle – for example, inter-group balances or unrealised
inter-group profits.
- Produce the whole of the net assets side of the consolidated balance
sheet (where the easy marks are) leaving a space for unamortised
goodwill and investment in associates (if required).
- Slot in the share capital and share premium accounts as being the
parent company figures – more easy marks.
- Compute the minority interest. This is more straightforward than
goodwill and consolidated reserves since it is in the closing net assets
of the relevant subsidiary. There is no need to distinguish between pre
and post acquisition reserves.
- Compute the unamortised goodwill on acquisition of the subsidiary
and associate (if included).
- Compute the investment in associate – share of net assets at the
balance sheet date plus related unamortised goodwill.
- Slot in consolidated reserves as the balancing figure and prove if
there is time – which there probably won’t be in the examination.
A typical past examination question On 1 April 1998 Hample
plc acquired 90% of the equity shares in Sopel Ltd. On the same day Hample
plc accepted a 10% loan note for £200,000 which was repayable at £40,000
per annum (on 31 March each year) over the next five years. Sopel Ltd’s
retained profits at the date of acquisition were £2,200,000. (See Balance
Sheet)
The following information is relevant:
- Included in Sopel Ltd’s property at the date of acquisition was a
leasehold property recorded at its depreciated historic cost of
£400,000. The leasehold had been sublet for its remaining life of only
four years at an annual rental of £80,000 payable in advance on 1 April
each year. The directors of Hample plc are of the opinion that the fair
value of this leasehold is best reflected by the present value of its
future cash flows. An appropriate cost of capital for the group is 10%
per annum.
The present value of a £1 annuity received at the end of
each year where interest rates are 10% can be taken as: 3 year
annuity £2.50 4 year annuity £3.20
- The software of Sopel Ltd represents the depreciated cost of the
development of an integrated business accounting package. It was
completed at a capitalised cost of £2,400,000 and went on sale on 1
April 1997. Sopel Ltd’s directors are depreciating the software on a
straight-line basis over an eight-year life (i.e., £300,000 per annum).
However, the directors of Hample plc are of the opinion that a five-year
life would be more appropriate as sales of business software rarely
exceed this period.
- The stock of Hample plc on 31 March 1999 contains goods at a
transfer price of £25,000 that were supplied by Sopel Ltd who had marked
them up with a profit of 25% on cost.
- On 31 March 1999 Sopel Ltd remitted to Hample plc a cash payment of
£55,000. This was not received by Hample plc until early April. It was
made up of annual repayment of the 10% loan note of £40,000 (the
interest had already been paid) and £15,000 of the current account
balance.
- Consolidated goodwill is amortised over a five-year life.
Required:
- The Consolidated Balance Sheet of Hample plc for the year ended 31
March 1999 (20 Marks)
- Included in Hample plc’s ‘other investment’ are 6,000 ‘A’ shares in
Woodbridge Ltd. These shares were acquired during the year to 31 March
1999. The total share capital of Woodbridge Ltd is made up
of:
Ordinary voting A shares - 10,000 Ordinary non-voting B shares
- 20,000
All of Woodbridge Ltd’s equity shares are entitled to the same dividend
rights; however during the year to 31 March 1999 Woodbridge Ltd made
substantial losses and did not pay any dividends.
Hample plc has treated its investment in Woodbridge Ltd as an ordinary
investment on the basis that:
- it is only entitled to a minority of any dividends that Woodbridge
Ltd may pay (i.e., 6,000/30,000 = 20%);
- it does not have any directors on the Board of Woodbridge Ltd; and
- it does not exert any influence over the operating policies or
management of Woodbridge Ltd.
Balance Sheets as at 31
March 1999 |
|
|
£000 Hample
plc |
|
£000 Sopel
Ltd |
Fixed
assets |
|
|
|
|
Intangible –
software |
|
– |
|
1,800 |
Tangible: |
|
|
|
|
Property |
|
600 |
|
900 |
Plant and
equipment |
|
1,520 |
|
1,090 |
Investments |
|
|
|
|
– equity in Sopel
Ltd |
|
4,110 |
|
– |
– 10% loan note Sopel
Ltd |
|
200 |
|
– |
– others |
|
65 |
|
210 |
|
|
6,495 |
|
4,000 |
Current
assets |
|
|
|
|
Stock |
719 |
|
560 |
|
Debtors |
524 |
|
328 |
|
Sopel Ltd current
account |
75 |
|
– |
|
Cash |
20 |
|
– |
|
|
1,338 |
|
888 |
|
Creditors: amounts
falling due within one year |
|
|
|
|
Trade creditors |
475 |
|
472 |
|
Hample plc current
account |
– |
|
60 |
|
Taxation |
228 |
|
174 |
|
Operating
overdraft |
– |
|
27 |
|
Dividend payable |
100 |
|
– |
|
|
(803) |
|
(733) |
|
Net current
assets |
|
535 |
|
155 |
Creditors: amounts falling
due after more than one year |
|
|
|
|
10% loan note |
|
– |
|
(160) |
Government
grants |
|
(230) |
|
(40) |
Net assets |
|
6,800 |
|
3,955 |
Share capital and
reserves |
|
|
|
|
Ordinary shares of £1
each |
|
2,000 |
|
1,500 |
Share premium |
2,000 |
|
500 |
|
Retained
earnings |
2,800 |
4,800 |
1,955 |
2,455
| |
Required: Discuss the accounting treatment of Woodbridge Ltd
by Hample plc’s directors and state how you believe the investment should
be accounted for. (5 marks) (25 marks)
Analysis of question
- The two part question requires a consolidated balance sheet for 20
marks, and an analysis of the treatment of an investment for 5 marks.
- If part (a) is done first there is a danger it will take up the
whole of the allotted time for this question. Therefore it might be
worth attempting part (b) first and then spending the rest of the
available time on part (a). There’s nothing wrong with doing this in an
examination provided it’s feasible.
- Part (b) asks you to reflect on the fact that Hample owns only 6,000
of the 30,000 shares in Woodbridge. This looks on the face of it like a
20% holding which would not normally confer subsidiary status. However
Hample owns 6,000 out of 10,000 voting shares (the ‘B’ shares are
non-voting). Therefore under FRS2 this makes Woodbridge a subsidiary.
This is the key issue for part (b). Notice we are told not to change the
answer to part (a) for this conclusion.
- The group structure here is relatively straightforward for part (a).
Hample owns 90% of the equity share in Sopel. This means that the
minority interest is 10%. The investment was made on 1 April 1998, the
start of the year.
- There are a number of reasons why we can’t simply aggregate the net
assets of Hample and Sopel to give the consolidated figures. These
are:
- The need to restate the leasehold property of Sopel to fair value
(based on the expected future cash inflows).
- The need to ascribe a useful life of 5, rather than 8 years to the
software of Sopel.
- The need to eliminate unrealised profit on sales from Sopel to
Hample.
- The need to account for cash in transit of £55,000. £15,000 of
this amount reconciles the current account difference (£75,000 –
£60,000) and £40,000 the ‘loan note difference’ (£200,000 –
£160,000).
Tackling part (a) We will first produce the top half of the
consolidated balance sheet figure by figure, excluding unamortised
goodwill. We need workings for the figures that don’t just add across.
Working 1: Intangible asset – software The group policy is to
write this asset off over 5 (rather than 8) years. This implies a
write-off of £480,000 each year (£2,400,000/5). The annual write-off in
the individual financial statements of Sopel is £300,000 (£2,400,000/8).
Since the asset arose on 1 April 1997 (two years before the balance sheet
date) its written down value is £1,440,000 (£2,400,000 – £960,000) at the
balance sheet date. The fair value of the software at the date of
acquisition (one year after the software was originally included in the
accounts of Sopel) is £1,920,000 (£2,400,000 – £480.000). The carrying
value in the accounts of Sopel at the date of acquisition is £2,100,000
(£2,400,000 – £300,000).
Working 2: Property The fair value of Sopel’s leasehold
property at the date of acquisition is based on the present value of the
expected future cash flows – £80,000 each year for four years in advance.
Using the discount factors provided this gives a present value of:
£80,000 + £80,000 x 2.50 = £280,000 (notice that the cash flows are in
advance). Therefore since the property has a useful life of four years
from the date of acquisition its fair value at the balance sheet date is
£210,000 (£280,000 X ¾). Its value in Sopel’s own accounts is £300,000
(£400,000 X ¾). Therefore an adjustment to closing assets of £90,000 is
needed, and the consolidated property figure is £1,410,000 (£600,000 +
£900,000 – £90,000).
Working 3: Stock The unrealised profit in stock is £5,000
(£25,000 x 25/125). Therefore consolidated closing stock is £1,274,000
(£719,000 + £560,000 – £5,000).
Working 4: Cash The closing cash figure includes the cash in
transit of £55,000 and so is £75,000 (£20,000 + £0 + £55,000).
The share capital and share premium figures will be those for Hample
plc so at this stage we can write out the majority of the consolidated
balance sheet. We will put question marks where we haven’t yet worked out
the figures:
|
£000 |
£000 |
Fixed assets |
|
|
Intangible – software (W1) |
1,440 |
|
Intangible – goodwill |
? |
|
Tangible – property (W2) |
1,410 |
|
Tangible – plant |
2,610 |
|
Investments |
275 |
|
|
|
? |
Current assets |
|
|
Stocks (W3) |
1,274 |
|
Debtors |
852 |
|
Cash (W4) |
75 |
|
|
2,201 |
|
Current liabilities |
|
|
Trade creditors |
947 |
|
Taxation |
402 |
|
Operating overdraft |
27 |
|
Dividend payable |
100 |
|
|
1,476 |
|
Net current assets |
|
725 |
Government grants |
|
(270) |
|
|
? |
Capital and reserves |
|
|
Ordinary shares of £1 |
|
2,000 |
Share premium |
|
2,000 |
Profit and loss account |
|
? |
|
|
? |
Minority interest |
|
? |
|
|
? |
Notice we have completed the vast majority of the consolidated balance
sheet. All we have left to do is minority interest, goodwill and
consolidated reserves. We will now compute these in turn.
Minority interest – Sopel
|
£000 |
Net assets at the balance sheet date |
3,955 |
Adjustments: |
|
Software (W1) (£1,800,000 – £1,440,000) |
(360) |
Property (W2) |
(90) |
Stock (W3) |
(5) |
|
3,500 |
Minority share (10%) |
350 |
Goodwill on consolidation – Sopel
|
£000 |
£000 |
Cost of investment |
|
4,110 |
Net assets at the date of acquisition: |
|
|
Share capital |
1,500 |
|
Share premium |
500 |
|
Retained earnings: |
|
|
As per Sopel accounts |
2,200 |
|
Adjustment for software |
|
|
(£1,920,000 – £2,100,000) |
|
|
– see W1 |
(180) |
|
Adjustment for property |
|
|
(£280,000 – £400,000) |
|
|
– see W2 |
(120) |
|
|
3,900 |
|
Group share (90%) |
|
(3,510) |
So total goodwill equals |
|
600 |
One year’s amortisation (1/5) |
|
(120) |
So closing unamortised goodwill equals |
|
480 |
We have now computed every figure except the consolidated profit and
loss reserve. If we were short of time at the end of the question would
slot this in as a balancing figure. In this case you should be able to
check that the figure required to balance the balance sheet is £2,320,000.
The final consolidated balance sheet will therefore be:
|
£000 |
£000 |
Fixed assets |
|
|
Intangible – software (W1) |
1,440 |
|
Intangible – goodwill |
480 |
|
Tangible – property (W2) |
1,410 |
|
Tangible – plant |
2,610 |
|
Investments |
275 |
|
|
|
6,215 |
Current assets |
|
|
Stocks (W3) |
1,274 |
|
Debtors |
852 |
|
Cash (W4) |
75 |
|
|
2,201 |
|
Current liabilities |
|
|
Trade creditors |
947 |
|
Taxation |
402 |
|
Operating overdraft |
27 |
|
Dividend payable |
100 |
|
|
1,476 |
|
Net current assets |
|
725 |
Government grants |
|
(270) |
|
|
(6,670) |
Capital and reserves |
|
|
Ordinary shares of £1 |
|
2,000 |
Share premium |
|
2,000 |
Profit and loss account |
|
2,320 |
|
|
6,320 |
Minority interest |
|
350 |
|
|
6,670 |
It would be cheating in an article not to prove the consolidated
profit and loss reserve figure so here goes:
|
£000 |
£000 |
Profit and loss balance of Hample |
|
2,800 |
Post-acquisition profits of Sopel: |
|
|
Per own accounts |
|
|
(£1,955,000 – £2,200,000) |
(245) |
|
Additional amortisation of software (W1) |
(180) |
|
Reduced depreciation of property (W2) |
30 |
|
Unrealised profit on stock (W3) |
(5) |
|
|
(400) |
|
Group share (90%) |
|
(360) |
Write off goodwill on consolidation |
|
(120) |
Taken to consolidated balance sheet |
|
2,320 |
Closing remarks Exam technique is all important in any
question, but particularly one in which you face acute time pressure.
Consolidated accounts questions certainly fall into the ‘time pressure’
category. Whatever your method for consolidation workings of such figures
as minority interest, goodwill etc., (and there are a number of perfectly
sound methods) make sure you obtain the relatively straightforward
aggregation marks. The best way to pass any examination is to get the vast
majority of the straightforward marks available for each question and a
reasonable proportion of the more testing marks.
Paul Robins BSc MBA ARCS FCA, is a freelance lecturer and
consultant |