by Francis Braganza
Writing in their outstanding Advanced Financial Accounting (Financial
Times Prentice Hall) Richard Lewis and David Pendrill say, “As academic
accountants, we find it extremely difficult to assimilate and understand
the vast volume of official pronouncements and, therefore, have considerable
sympathy for accountants working at the coalface. We are now firmly
of the view that there is too much detailed regulation and that there
should be a pause to reflect on whether or not the extensive changes
which have been made are actually bringing improvements in practice.”
Most students preparing for the advanced accounting papers with their
burgeoning syllabuses would wholeheartedly agree. Perhaps Sir David
Tweedie’s retirement from chairmanship of the Accounting Standards Board
will provide this longed-for hiatus!
In the meantime candidates must expect mixed i.e. ‘contrived’ questions
as the examiner attempts to do justice to the vast syllabus (and reward
the well-prepared candidate). In the following question candidates were
asked to redraft a company’s financial statements in line with the auditor’s
advice and relevant accounting standards. In my view the question was
actually a standards question masquerading as a consolidation question.
I have left off the four mark attachment on FRS 14 EPSs share options.
The summarised draft consolidated financial statements of Jensen plc
to 31 March 2000 are shown below:
Jensen plc |
Profit and Loss Account year to 31 March
2000 |
|
£000 |
£000 |
Turnover |
|
2,800 |
Cost of sales |
|
(1,750) |
Gross profit |
|
1,050 |
Operating costs |
|
(344) |
|
|
706 |
Finance costs |
|
(64) |
|
|
642 |
Taxation |
|
(150) |
Profit after tax |
|
492 |
Minority interest |
|
(20) |
|
|
472 |
Extraordinary charge |
(180) |
|
Tax (relief) on extraordinary charge |
54 |
|
|
|
(126) |
|
|
346 |
Dividends |
|
(100) |
Retained profit for year |
|
246 |
Balance Sheet as at 31 March 2000 |
|
£000 |
£000 |
Tangible fixed assets |
|
2,540 |
Current assets |
1,900 |
|
Creditors: amounts falling due within one year |
(1,520) |
|
|
|
380 |
|
|
2,920 |
Creditors: amounts falling due after more than one year |
|
|
12% Redeemable Debentures |
|
(200) |
|
|
2,720 |
Less: Minority interest |
|
(140) |
Net assets |
|
2,580 |
Share capital and reserves: Ordinary shares £1 each
|
|
1,200 |
Reserves:
Profit and loss account: |
|
|
– b/f 1 April 1999 |
1,134 |
|
– year to 31 March 2000 |
246 |
|
|
|
1,380 |
|
|
2,580 |
|
The above consolidated financial statements have been drafted by inexperienced
accounting staff. The following information relates to issues that the
accounting staff had particular difficulties with:
(i) Retail car sales
In September 1999 Jensen plc held a one-month promotional campaign aimed
at increasing its retail sales of new cars. A special edition manufacturer’s
model called the ‘Interceptor’ was sold during September. The promotion
consisted of offering within the normal selling price:
- free finance over two years;
- an extended three year warranty against mechanical failure.
In total 100 of these cars were sold under the offer terms.
Details relating to the finance of the cars sold under the offer are:
|
£ |
Selling price included in turnover
(15,000 x 100) |
1,500,000 |
Paid for by:
Initial deposit paid in September 1999
(£3,000 x 100) |
(300,000) |
Initial hire purchase debtor |
1,200,000 |
Received 6 monthly instalments of
£500 x 100 |
(300,000) |
Hire purchase debtor at 31 March 2000 |
900,000 |
• receivable within one year
12 x £500 x 100
|
600,000 |
• receivable after more than one year
6 x £500 x 100 |
300,000 |
Applying the same finance rates as Jensen plc uses for normal hire
purchase sales the true finance cost of the promotional sales over the
two-year finance agreement would be £1,200 per car. It has been
calculated that this would normally be earned as follows:
In the year to
– 31 March 2000 £500 per car
– 31 March 2001 £450 per car
– 31 March 2002 £250 per car
The manufacturer of the cars will reimburse any warranty claims in
the first 12 months. From past experience the second and third year’s
‘free’ warranty will cost an average of £150 per car. Jensen plc
has not provided any amount for warranty claims in the year to 31 March
2000 as they are covered by the manufacturer’s warranty until September
2001.
(ii) Business combination
On 31 March 2000 Jensen plc issued 200,000 shares (market value £4
each) in a 1 for 1 share exchange to acquire the entire share capital
of Aston plc. The business combination has been accounted for as a merger.
The summarised results of Aston plc are:
Profit and loss account year to 31 March 2000 |
|
£000 |
Turnover |
600 |
Cost of sales |
(350) |
Gross profit |
250 |
Operating costs |
(90) |
|
160 |
Taxation |
(60) |
Profit after tax |
100 |
No dividends have been paid or proposed by Aston plc. |
Balance Sheet as at 31 March 2000 |
|
|
£000 |
Net assets |
800 |
Ordinary shares £1 each |
200 |
Profit and loss account |
600 |
Net assets |
800 |
The fair values of Aston plc’s net assets at the date of acquisition
were equal to their book values.
Advice from the company’s auditors in respect of the combination is
that it does not meet the requirements of a merger under FRS 6 and should
be treated as an acquisition. Aston plc’s trading on 31 March 2000 can
be taken to be negligible.
(iii) Extraordinary item
This was the cost incurred during the year of making the company’s computer
“year 2000” compliant. As this cost will never recur it has been treated
as an extraordinary item.
(iv) 12% redeemable debenture issue
On 1 April 1999 redeemable debentures with a nominal value of £200,000
were issued at a discount of 5% (i.e. at £95 per £100 nominal
amount). They are redeemable on 31 March 2004 at a premium of 10%. Jensen
plc has treated the whole of the discount as a finance cost and ignored
the premium on redemption. On the grounds of materiality, amortisation
of the discount and premium can be treated on a straight-line basis.
Jensen plc |
|
|
Consolidated Profit and Loss Account for
year ended 31.3.2000 |
|
|
£000 |
Turnover (2,800 original – 120 (i) Retail Car Sales – 600
(ii) business combination: pre-acquisition turnover) |
|
2,080 |
Less: Cost of Sales (1,750 + 15 (i) Warranty provision
– 350 (ii) pre-acquisition COS) |
|
(1,415) |
Gross profit |
|
665 |
Less: Operating costs i.e. Distribution & Administration
Expenses
(344 - 90 (ii) pre-acquisition + 180 (iii) was treated as
extraordinary, should be
exceptional, but in NOTES only: in P&L shown as Admin.
Expenses) |
|
(434) |
Operating profit |
|
231 |
Add: Other operating income (50 (i): HP Interest) |
|
50 |
|
|
281 |
Less: Interest Payable and Similar Charges
(Finance Costs originally 64 – 10 (iv) removing old whole
discount
+ 6 new, correct, charge) |
|
(60) |
Consolidated Profit before tax |
|
221 |
Less: Taxation (originally 150 – 60 (ii) pre-acquisition
tax – 54
(iii) tax relief on exceptional Admin. charge, shown under
Operating Costs above, formerly extraordinary charge shown
separately,
and lower down the original P&L) |
|
(36) |
Consolidated Profit after tax |
|
185 |
Less: Minority Interest (unchanged, not in Aston
acquired during the year,
which is 100% held) |
|
(20) |
Consolidated Profit for the financial year |
|
165 |
Less: Dividends |
|
(100) |
Consolidated Retained Profit for the financial year |
|
65 |
Add: Retained Profit brought forward: could be shown
directly in CBS instead
(original 1,134 – 500 (ii) Previous year’s pre-acquisition
P&L Reserves
included under Merger accounting, but excluded under Acquisition
accounting) |
|
634 |
Consolidated Retained Profit carried forward |
|
699 |
Jensen Group plc |
|
|
Consolidated Balance Sheet as at 31.3.2000 |
|
|
|
£000 |
£000 |
Tangible Fixed Assets (unchanged) |
|
2,540 |
Current Assets:
(original 1,900 previously included 900 HP Debtors
including interest of 70, now eliminated since it relates
to future years \ 1,900 - 70 (ii)) |
1,830 |
|
Less: Creditors: Amounts falling due within one year
(original 1,520 + 15 (i) warranty provision) |
(1,535) |
|
|
|
295 |
Total Assets less Current Liabilities |
|
2,835 |
Less: Creditors: Amounts falling due after more than
one year
12% Redeemable Debentures
(original 200 – 10 + 6 (iv): see P&L finance cost charges
– the Balance Sheet reflects the double-entry) |
|
(196) |
|
|
2,639 |
Less: Minority Interest (unchanged) |
|
(140) |
|
|
2,499 |
|
|
£000 |
Capital and Reserves
Called up Ordinary Shares of £1 each (unchanged) |
|
1,200 |
Share Premium (600 (ii) whereas not recorded under
Merger accounting as formerly adopted, is recorded under Acquisition,
being 200 shares issued @ £3 i.e. £4 issue price
less £1 nominal value) |
|
600 |
Consolidated Profit and Loss Account |
|
699 |
|
|
2,499 |
|
Required:
Redraft the consolidated financial statements of Jensen plc for the
year to 31 March 2000 to comply with the auditor’s advice and relevant
accounting standards in relation to items (i) to (iv) above.
The Examiner says:
This question was the worst answered question on the paper. Often candidates
simply restated the original question with only a token attempt at the
required adjustments. A major part of the redrafting concerned accounting
for a business combination as an acquisition rather than as a merger.
Although this may sound daunting, it was in fact quite straightforward.
As the combination occurred at the year-end, the main effect was that
all of the results of the subsidiary should be eliminated from the consolidated
profit and loss account. Balance sheet adjustments involved eliminating
pre-acquisition profits and calculating the share premium account. Good
candidates scored well, but many candidates got very confused, sometimes
adding rather than deducting the adjustments. It seems, from past examination
experience, that candidates are quite able to account for mergers and
acquisitions, but seem unable to appreciate the financial effects of
the difference between them. This displays a ‘mechanistic’ approach
to learning, rather than a more desirable understanding and application
approach.
Other problem areas were:
- many candidates appreciated that the year 2000 compliance costs
should not be an extraordinary item, but were unable to properly account
for the different tax aspects of an exceptional item;
- for the sale of the retail cars, there was an appreciation that
they should be treated as financed sales, but again were unsure how
to account for them;
- warranty provisions were omitted; and
- the debenture issue discount and redemption premiums were not (or
incorrectly) amortised.
WORKINGS and explanatory notes
Per Q. Y/e 31.3.2000
(i) Retail Car Sales: the “Interceptor”
FRS 5 requires that these have to be accounted for using the substance
of the transactions. The key concept is that the so-called “free finance”
is built into the price structure: there is no such thing as “free finance”
despite the marketing slogan!
Therefore, we must eliminate the finance element included in the Selling
Price and therefore in Turnover and HP Debtors:
|
DR
£ |
CR
£ |
DR Turnover (100 cars @ £1,200 true finance cost given in
Q, to be used under FRS 5 principles) |
120,000 |
|
CR Interest Receivable (P&L A/c): other operating income 100
cars @ £500 – this is interest relevant to the current year
i.e. y/e 31.3.2000) |
|
50,000 |
CR HP Interest Receivable Suspense account (100 cars @ £700,
being £450 regarding next year + £250 the year after
next) |
|
70,000 |
(Effect of above: removing £1,200 finance cost i.e. Interest,
so that Turnover only includes cash selling price.)
The above sorts out the P&L and to some extent the Balance Sheet,
which latter’s adjustment must be taken further:
Balance Sheet – there are three points here:
- The HP Debtor £900,000 as per Q (in (i)) must be reduced
by future HP Interest Receivable (in Suspense Account), i.e. reduced
by £70,000. £900,000 as per Q less £70,000 = £830,000.
- As part of this is receivable in more than 1 year, a Note should
show £275,000 (being £300,000, as per Q less £25,000
which is 100 cars x £250 receivable in the year after next i.e.
y/e 31.3.2002).
- Incidentally UITF 4 requires this to be shown on the face of the
Consolidated Balance Sheet, if it is material in the context of the
rest of Current Assets.
Retail Car Sales – extended three year warranty aspect:
* the first year is covered by the manufacturer’s warranty \ no need
to provide.
* based on past experience, provide for 100 cars x £150 = £15,000
at the time of sale i.e. by current year end of 31.3.2000. This treatment
also satisfies the accruals concept (SSAP 2 and recent FRS 18) i.e.
if sale made, automatically provide for £15,000: FRS 12, Provisions,
Contingent Liabilities and Contingent Assets – if > 50% chance, provide.
Double Entry (to ensure books balance!)
DR P&L (Cost of Sales) 15,000
CR Provision for warranties 15,000
(Often shown under Creditors and Accruals in the CBS though some – with
more information given in the Q – could be shown after > 1 year)
(ii) Business Combination: Acquisition of Aston
Key concept: Merger to be restated as an acquisition (this is really
a test of understanding of the differences between FRS 2, Acquisitions
and FRS 6, Mergers).
Notice that the acquisition occurred on the last day of the current
financial year and therefore none of the pre-acquisition results should
be consolidated, rather than all of them.
Therefore, remove all of the P&L figures of Aston from the Consolidated
P&L:
|
£000 |
£000 |
Reduce Turnover (earlier was a credit) |
600 |
|
& Reduce: Cost of Sales * |
|
350 |
Operating Costs * |
|
90 |
Tax * |
|
60 |
(* these were in CPLA as debits)
|
NEXT aspect: the difference between Goodwill on Acquisition and Consolidation
Difference on Merger:
Goodwill on Acquisition |
£000 |
Purchase Consideration (200 x £4) = |
800 |
Less: Group Share of net Assets at FV at acquisition (= Book Value
in this Q) 100% x 800 = |
(800) |
/
\
|
|
OSC 200 P&L Res. 600
|
|
Goodwill \ = |
Nil |
Consolidation Difference under Mergers
|
£000 |
Investment: 200 x £1 (Share Premium not recorded under Mergers) |
200 |
Less: 100% of OSC of Aston (Pre-Merger P & L Res. of 600 not
frozen, but included in Consolidated Reserves) |
(200) |
Consolidation Difference \ = |
Nil |
NO ENTRIES ARE \ NEEDED for Goodwill.
(iv) Amortised over 5 years (debenture term) @ £6,000 p.a. \ Remove
£10,000 and add £6,000 instead, to “finance costs” in the
CPL Account and do the same to the Debentures in the CBS. (Alternatively,
charge the discount on issue of debentures against the credit balance
in Share Premium via a transfer from the P & L account reserve.)
Francis A Braganza BCom (Hons) FCA is a co-founder of Accountancy
Tutors Ltd and a senior lecturer in AAP and Financial Reporting with
AT Emile Woolf Colleges
|