Accountancy & Auditing, Paper I

The accountant of LRN Co. has prepared the following list of account balances as at 31 December 2014:

Trial balance as at 31 December 2014:

PKR'000 PKR'000

50pesa ordinary shares (fully paid) 450

10% debentures (secured) 200

Retained earnings 1.1.2014 242

General reserve 1.1.2014 171

Land and buildings 1.1.2014 (cost) 430

Plant and machinery 1.1.2014 (cost) 830

Accumulated depreciation:

Buildings 1.1.2014 20

Plant and machinery 1.1.2014 222

Inventory 1.1.2014 190

Sales 2,695

Purchases 2,152

Ordinary dividend 15

Debenture interest 10

Wages and salaries 254

Light and heat 31

Sundry expenses 113

Suspense account 135

Trade accounts receivable 179

Trade accounts payable 195

Cash 126

4,330 4,330

Notes to trial balance:

(a) Sundry expenses include PKR 9,000 paid in respect of insurance for the year ended 1 September 2015. Light and heat does not include an invoice of PKR 3,000 for electricity for the three months ending 2 January 2015, which was paid in February 2015. Light and heat also include PKR 20,000 relating to salesman's commission.

(b) The suspense account is in respect of the following items:

PKR'000

Proceeds from share issue of 100,000 ordinary shares 120

Proceeds from sale of plant 300

480

Less consideration for acquisition of MAY & Co 285

135

(c) The net assets of Mary & Co were purchased on 3 March 2014. Assets were valued as follows:

PKR'000

Equity instruments 231

Inventory 34

265

All the inventory acquired was sold during 2014. The equity instruments were still held by Learning at 31.12.2014. Goodwill has not been impaired in value.

(d) The property was acquired some year ago. The buildings element of the cost was estimated at PKR 100,000 and the estimated useful life of the assets was fifty years at the time of purchase. As at 31 December 2014 the property is to be revalued at PKR 800,000.

(e) The plant which was sold had costs PKR 350,000 and had a net book value of PKR 274,000 as at 1.1.2014. PKR 36,000 depreciation is to be charged on plant and machinery for 2014.

(f) The management wish to provide for:

• Debenture interest due

• A transfer to general reserve of PKR 16,000

• Audit fees of PKR 4,000

(g) Inventory as at 31 December 2014 was valued at PKR 220,000 (at cost)

(h) Tax is to be ignored

(i) Take all depreciation to cost of sales

Required:

Prepare the financial statements of LRN Co as at 31 December 2014. You do not need to produce notes to the statements.

(a) The objective of IFRS 5 Non-current Assets Held for Sale and Discontinued Operations specifies, amongst other things, accounting for and presentation and disclosure of discontinued operations.

Required:

Define a discontinued operation and explain why the disclosure of such information is important to users of financial statements.

(b) RCR Co's sole activity is the operation of hotels all over the world. After a period of declining profitability, Radar's directors made the following decisions during the year ended 31 March 2013:

– it disposed of all of its hotels in country A;

– it refurbished all of its hotels in country B in order to target the holiday and tourism market. The previous target market in country B had been aimed at business clients.

Required:

Treating the two decisions separately, explain whether they meet the criteria for being classified as discontinued operations in the financial statements for the year ended 31 March 2013.

(c) At a board meeting on 1 July 2012, PPP Co's directors made the decision to close down one of its factories on 31 March 2013. The factory and its related plant would then be sold.

A formal plan was formulated, and the factory's 250 employees were given three months' notice of redundancy on 1 January 2013. Customers and suppliers were also informed of the closure at this date.

The directors of PPP Co. have provided the following information:

Fifty of the employees would be retrained and deployed to other subsidiaries within the group at a cost of PKR 125,000; the remainder will accept redundancy and be paid an average of PKR 5,000 each.

The factory plant has a carrying amount of PKR 2.2 million but is only expected to sell for PKR 500,000 incurring PKR 50,000 of selling costs; however, the factory itself is expected to sell for a profit of PKR 1.2 million.

The company rents a number of machines under operating leases which have an average of three years to run after 31 March 2013. The present value of these future lease payments (rentals) at 31 March 2013 was PKR 1 million; however, the lessor has said they will accept PKR 850,000 which would be due for payment on 30 April 2013 for their cancellation as at 31 March 2013.

Penalty payments due to non-completion of supply contracts are estimated at PKR 200,000.

Required:

Explain and quantify how the closure of the factory should be treated in PPP Co's financial statements for the year ended 31 March 2013.

Note: The closure of the factory does not meet the criteria of discontinued operation.

On 1 January 2012, VX Co. acquired 90% of the equity share capital of GN Co. in a share exchange in which VX Co. issued two new shares for every three shares it acquired in GN Co. Additionally, on 31 December 2012, VX Co. will pay the shareholders of GN Co. PKR 1.76 per share acquired. VX Co's cost of capital is 10% per annum.

At the date of acquisition, shares in VX Co. and GN Co. had a stock market value of PKR 6.50 and PKR 2.50 each, respectively.

Income statements for the year ended 30 September 2012

VX CO PKR'000 | GN CO PKR'000

Revenue 64,600 | 38,000

Cost of sales (51,200) | (26,000)

Gross profit 13,400 | 12,000

Distribution costs (1,600) | (1,800)

Administrative expenses (3,800) | (2,400)

Investment income 600 | Nil

Finance costs (420) | Nil

Profit before tax 8,080 | 7,800

Income tax expense (2,800) | (1,600)

Profit for the year 5,280 | 6,200

Equity as at 1 October 2011

Equity shares of PKR 1 each 30,000 | 10,000

Retained earnings 54,000 | 35,000

The following information is relevant:

(i) At the date of acquisition, the fair values of GN Co's assets were equal to their carrying amounts with the exception of two items:

– An item of plant had a fair value of PKR 1.8 million above its carrying amount. The remaining life of the plant at the date of acquisition was three years. Depreciation is charged to cost of sales.

– GN Co. had a contingent liability which VX Co. estimated to have a fair value of PKR 450,000. This has not changed as at 30 September 2012. GN Co. has not incorporated these fair value changes into its financial statements.

(ii) VX Co's policy is to value the non-controlling interest at fair value at the date of acquisition. For this purpose, GN Co's share price at that date can be deemed to be representative of the fair value of the shares held by the non-controlling interest.

(iii) Sales from VX Co. to GN Co. throughout the year ended 30 September 2012 had consistently been PKR 800,000 per month. VX Co. made a mark-up on cost of 25% on these sales. GN Co. had PKR 1.5 million of these goods in inventory as at 30 September 2012.

(iv) VX Co. investment income is a dividend received from its investment in a 40% owned associate which it has held for several years. The underlying earnings for the associate for the year ended 30 September 2012 were PKR 2 million.

(v) Although GN Co. has been profitable since its acquisition by VX Co, the market for GN Co's products has been badly hit in recent months and VX Co. has calculated that the goodwill has been impaired by PKR 2 million as at 30 September 2012.

Required:

(a) Calculate the consolidated goodwill at the date of acquisition of Greca.

(b) Prepare the consolidated income statement for Viagem for the year ended 30 September 2012.

HN is a fitness center, offering 'pay as you go' gym facilities. It has a fully fitted gym with the capacity to accommodate 200 users at one time. It also has 100 car parking spaces and an onsite cafe, both of which are only for customers using the gym. The fitness center has shower facilities for customers and HN provides all customers with a clean towel to use on entry. It is open 360 days a year, from 7.00am until 9.00pm.

Customers pay PKR 8.40 for access to the gym for one hour plus unlimited time in the café. If customers want to use the car park, they have to pay an additional PKR 1 per visit and 80% of visiting customers use the car park. HN has been monitoring the number of customers attending throughout each day for the month of June, which was considered to be an average month, and for which HN was open for 30 days. It has determined that the average number of customers per day is 330 with 40 of these customers attending during the time of 9.00am to 5.00pm .

The total costs of the fitness center for June, excluding the café, have also been recorded and analyzed as follows:

Fixed costs per month = PKR 48,000

Variable cost per customer = PKR 1.20

On average, half of the customers also used the cafe in June, with an average spending per customer of PKR 2.20. Of this spending, 60% related to drinks, which have a profit margin of 60%, and the remainder related to food items, which have a profit margin of 40%. The specific fixed costs associated with running the café are PKR 3,600 for the month.

Creche proposal

After reviewing all of the above information, the manager of HN has put together a proposal to close the café at the fitness center and convert it into a creche for children. This would mean that parents could leave their children in the creche whilst they use the fitness center between the hours of 9.00am and 5.00pm only. The charge for the creche would be PKR 4 per child, per hour.

Initial research suggests that customers have an average of two children each. The creche is expected to attract new customers and increase the average number of customers between 9.00am and 5.00pm by 300%. Only these new customers will use the creche facilities. Car park usage is expected to continue to be 80%. The fixed costs associated with running the creche are estimated to be PKR 8,000 per month, with a variable cost of PKR 0.50 per child, per hour.

Required: (20 marks)

(a) Calculate both the number of customers HN needs to break even and the margin of safety as a percentage for the month of June for:

(i) The gym; and

(ii) The café.

(b) Explain what each of your calculations in (a) tells Health Nuts about the performance of the gym and the café.

(c) Advise Health Nuts, considering both financial and non-financial factors, whether it should replace the café with a crèche.

Y Co. owns a number of restaurants. It is a well-established company, and its restaurants have gained a favorable reputation for the quality of their meals.

Y Co's restaurants are all set in rural locations, where there is limited competition and this enabled them to develop a loyal customer base. Restaurants design their own menus and décor to fit with the requirements of their local market.

Y Co has been consistently profitable, however as is the case across the restaurant industry, profit margins are quite low and there is still a constant need for Y Co to monitor costs.

One of Y Co's restaurants is located in the small town of Town C. Town C has recently been the location for the filming of a popular television series and visitor numbers to the town have increased significantly as a result. Y Co's restaurant in Town C has noticed a similar increase in customer numbers.

At the start of the current month a new restaurant opened in Town C. The manager of Y Co's restaurant in Town C has expressed concerns about the impact this new competitor will have on their ability to achieve profit targets for the rest of the year.

Budgets for all of Y Co's restaurants are prepared by the head office. At the start of each year, restaurant managers are given an annual budget, which is split into months. At the end of each month, the manager receives a statement comparing actual monthly performance against budget.

The statement for the Town C restaurant for the most recent completed month is as follows:

| Actual | Budget | Variance

Number of customers | 1,800 | 1,500 |

| PKR | PKR | PKR

Revenue | 87,300 | 75,000 | 12,300 F

Costs:

Food and drink | 26,100 | 22,500 | 3,600 A

Staff wages | 38,250 | 31,500 | 6,750 A

Heat, light and power | 8,100 | 7,500 | 600 A

Rent, rates and other overheads | 12,600 | 12,000 | 600 A

Profit | 2,250 | 1,500 | 750 F

Notes:

(1) Rent, rates and other overheads are apportioned to its restaurants by Y Co's head office, based on a fixed annual charge.

(2) All other budgeted costs are treated as variable costs, based on the expected number of customers.

Y Co currently adopts an incremental approach to budgeting, with the annual budget figures for each year being based on the previous year's figures. However, a new finance director has recently joined the company, and he has questioned whether this is suitable for all Y Co's restaurants.

The new finance director has also suggested that the company should adopt a more participative approach to budgeting.

Required:

(a) (i) Prepare a flexed budget for the Town C restaurant.

(ii) With reference to your answer from part (i), explain the main weaknesses in the current monthly budget statements issued to the restaurants as a basis for managing performance.

(b) Discuss whether an incremental approach to budgeting is appropriate for Y Co.

BBB Ltd. is involved in a manufacturing business, it uses standard costing to evaluate its performance for every given period. In period A the management of the company is very disappointed in the performance of the company, they have hired a management accountant to help them better understand the actual picture of the business and make decisions. Following is the budget control report shared with the consultant that is prepared by accounts assistant: Item Budgeted Actual Sale (units) 30,000 24,000 Revenue (PKR) 60,000 52,800 Direct material (PKR) 15,000 14,400 Fixed overheads (PKR) 10,000 10,300 Required: (a) Calculate the following variances using flexed budgets (that is, considering actual activity level): i. Total sales variance (3) ii. Total direct material variance (3) iii. Total fixed overheads variance (3) (b) The management has provided the following additional data to better understand the variances: Item Budgeted Actual Direct labor cost (PKR) 7,500 72,00 Labor hours 6,000 5,600 i. Calculate labor rate variance. (4) ii. Calculate labor efficiency variance. (4) iii. Explain why this segregation of total labor variance is important. (3)