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International Financial Reporting EFIMM0122 Question 1 Pharmascience Ltd is a specialty consumer health company in the UK

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International Financial Reporting

EFIMM0122

Question 1 Pharmascience Ltd is a specialty consumer health company in the UK. In early 2020, Pharmascience Ltd launched a project to develop and produce a new range of home fitness equipment which has required significant investment in non-current assets. The Statements of Financial Position for Pharmascience as at 31 December 2020 and 2019 are shown below: 2020 2019 £'m £'m Assets Non-current assets Cost 275.70 121.90 Accumulated depreciation 107.20 48.30 Net book value 168.50 73.60 Current assets Inventories 49.80 68.20 Trade receivables 64.50 51.00 Cash 11.20 Total assets 282.80 204.00 Equity and liabilities Equity Share capital 60.00 40.00 Share premium 40.00 20.00 Retained earnings 83.10 63.00 Total equity 183.10 123.00 Non-current liabilities Long-term loan 40.00 21.40 Current liabilities Trade payables 29.00 42.10 Interest payables 7.30 5.50 Current tax payable 8.50 12.00 Dividend payable 4.50 Bank overdraft 10.40 Total equity and liabilities 282.80 204.00 Notes: 1) A dividend of £4.5m was approved and declared in December 2020. This dividend will be paid in March 2021. 2) During 2020, Pharmascience Ltd disposed of non-current assets costing £25m with an accumulated depreciation of £7.7m. These assets were sold for £20m. There were no other disposals during 2020. 3) Pharmascience’s Income Statement for the year ended 31 December 2020 showed a finance cost of £8m and corporation tax on profits for 2020 was £6m.

REQUIRED a. Prepare a Statement of Cash Flows in accordance with IAS 7 – Statement of Cash Flows for Pharmascience Ltd in respect of the year ended 31 December 2020. (14 marks) b. The directors of Pharmascience Ltd are surprised at the movement on cash for the year given the profits that were recorded. Explain: a) why differences arise between cash flows and profits b) the main differences between profit and cash flows in Pharmascience’s accounts in 2020 c) your assessment of Pharmascience’s cash flow and prediction for future profitability

Question 2 Answer both parts 1 and 2. Part 1 Digital Vision Ltd designs and develops corporate websites and also provides website maintenance and update services. Digital Vision agreed a contract with a new media company to design their website and provide a maintenance and update service for a 36- month period after the launch of the website for a total price of £5,400. The website was launched on 1 September 2020 and the client paid in full on that date. The website design would normally have cost £3,000 and a 36-month website maintenance service would normally be sold for £100 per month.

REQUIRED

b. Explain steps 4 and 5 of the five-step approach to revenue recognition under IFRS 15 with reference to the Digital Vision contract and show how the contract should be accounted for in Digital Design’s financial statements for the year ended 31 December 2020.

Question 3 Answer both parts 1 and 2. Part 1 Connemara Ltd expanded its business on 1 January 2020 with a new production line. The new production line required additional machinery with a cost of £543,600. Connemara has limited access to loan financing and so obtained the necessary machinery through a leasing agreement from their regular equipment supplier. The lease agreement required four annual payments in advance of £150,000 the first commencing on 1 January 2020. The plant would have a useful life of four years with no residual value at the end of this life. Connemara depreciates plant and machinery on a straight-line basis. Connemara’s accounting year runs to 31st December. REQUIRED Show how the leasing of the asset will be presented each year in the financial statements of Connemara Ltd in accordance with IFRS 16 Leases

Part 2 “The spectacular rise and fall of Enron Corp. offers a vivid illustration of how companies can use the legal form of transactions to obscure the economic substance underlying those transactions………….It is the argument of this paper that had the concept of substance over form been applied at Enron, investors and creditors would have been provided with a more realistic view of the company’s financial position and its results of operations, potentially avoiding what became the one of the largest corporate bankruptcies in US history.” (Baker and Hayes, 2004, p767) REQUIRED Explain: a. the concept of substance over form; b. how leases have been used as a form of off-balance sheet financing and how IFRS 16 serves to combat this; and

c. reasons why scandals such as Enron might occur and the impacts of these scandals.

Question 4 Mercury purchased 60 million shares in Venus on 1 July 2019. On that date, the retained earnings of Venus were £27,500,000. Venus has not issued any new shares since the acquisition. On 1 July 2019, the fair value of Venus’ land was calculated to be £15,000,000 and the carrying value of this land on Venus’s accounts was £12,000,000. The land has not subsequently been revalued in the financial statements of Venus and land is not depreciated. There were no other differences between the book value and the fair value of the assets and liabilities of Venus at the date of acquisition. The Statements of Financial Position of Mercury and Venus as at 30 September 2020 are as follows: Mercury Venus £ £ Assets £'000 £'000 Non-current assets Land 120,000 12,000 Property, plant and equipment 240,000 100,000 Investment in Venus 112,000 472,000 112,000 Current assets Inventories 106,000 85,000 Trade receivables 13,800 7,000 Cash 40,000 14,500 159,800 106,500 Total assets 631,800 218,500 Equity Ordinary shares of £1 each 280,000 80,000 Retained earnings 185,000 66,000 465,000 146,000 Liabilities Non-current liabilities Long-term debt 36,000 11,500 Current liabilities Trade payables 62,500 27,300 Other payables 68,300 33,700 Total equity and liabilities 631,800 218,500

Notes: 1) During the year ended 30 September 2020, Mercury sold 30 million units of product to Venus at £2 per unit. The total cost of the 30 million units was £45,000,000. Of these items, 20 million units have been sold onwards to customers outside of the Group during the year and the remaining units were still in the inventories of Venus at year end. 2) On 30 September 2020, Mercury had a trade receivables balance of £2,600,000 due from Venus. On 28 September 2020, Venus sent a cheque for £1,500,000 to Mercury that was not received until 2 October 2020. 3) The management of Mercury estimated that the fair value of goodwill in Venus at 30 September 2020 was £28,000,000. 4) It is the group policy to value non-controlling interest using the proportionate share of net assets method.

REQUIRED a. Prepare the Mercury Group Consolidated Statement of Financial Position as at 30 September 2020 (15 marks) b. During the Annual General Meeting (AGM), a group of Mercury’s shareholders expressed concern regarding the amount of consideration paid by Mercury for the acquisition of its share in Venus. They claimed that ‘Mercury acquired part of Venus, but the amount paid is higher than the acquired share of Venus’ net assets on the balance sheet at acquisition’. The shareholders have asked the management of Mercury to explain the rationale for the amount paid. Write a response to the concern raised by the shareholders, including a discussion on the appropriateness of the balance sheet for measuring company value, an explanation of the concept of goodwill, and using the figures from the question to illustrate your points.

Question 5 On 1st April 2019, Cox Ltd acquired 120,000 shares in Braeburn Ltd from a total share capital of £150,000 (£1 shares). On 1st January 2020, Cox Ltd also acquired 40% of the shares of Fuji Ltd. The Statements of Profit or Loss for the year to 31 March 2020 for the three companies are shown below:

Cox Ltd. Braeburn Ltd. Fuji Ltd. £ £ £ Revenue 625,000 170,000 580,000 Cost of sales -130,000 -65,000 -117,500 Gross profit 495,000 105,000 462,500 Distribution costs -25,000 -20,000 -18,000 Administrative expenses -30,600 -13,500 -18,700 Operating profit 439,400 71,500 425,800 Dividends received 12,000 - - Profit before tax 451,400 71,500 425,800 Taxation -87,000 -15,600 -80,400 Profit for the year 364,400 55,900 345,400

Notes: 1) In February 2020, Braeburn Ltd sold goods to Cox Ltd for £20,000. The sales were made at a profit margin of 25%. At the year-end, 40% of these goods remain in the inventories of Cox Ltd. 2) The income and expenses of Fuji Ltd can be assumed to accrue evenly over the year to 31st March 2020. 3) Braeburn Ltd paid dividends of £10,000 during the year to its shareholders. No other dividends were paid within the group. 4) On 31st March 2020, Braeburn Ltd revalued its non-current assets upwards by £35,000. It is the Cox Group’s policy to revalue group assets.

REQUIRED a. Prepare the Consolidated Statement of Comprehensive Income for the Cox Group for the year ended 31 March 2020.