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Financial Accounting And Reporting, Revised Edition Solution Manual

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    3 Brief contents Chapters Pages Part 1 Introduction to accounting on a cash flow and accrual accounting basis 5 1. Accounting and reporting on a cash flow basis 6 2. Accounting and reporting on an accrual accounting basis 11 Part 2 Preparation of internal and published financial statements 16 3. Preparation of financial statements of comprehensive income, changes in equity and financial position 17 4. Annual report: additional financial disclosures 39 5. Statements of cash flows 54 Part 3 Regulatory framework – an attempt to achieve uniformity 65 6. Financial reporting – evolution of global standards 66 7. Concepts – evolution of an international conceptual framework 68 8. Ethical behaviour and implications for accountants 71 Part 4 Income and asset value measurement systems 74 9. Income and asset value measurement: an economist’s approach 75 10. Accounting for price-level changes 88 11. Revenue recognition 106 Part 5 Statement of financial position – equity, liability and asset measurement and disclosure 122 12. Share capital, distributable profits and reduction of capital 123 13. Liabilities 133 14. Financial instruments 141 15. Employee benefits 160 16. Taxation in company accounts 171 17. Property, plant and equipment (PPE) 180 18. Leasing 193 19. Intangible assets 200 20. Inventories 212 21. Construction contracts 223

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    4 Part 6 Consolidated accounts 241 22. Accounting for groups at the date of acquisition 242 23. Preparation of consolidated statements of financial position after the date of acquisition 261 24. Preparation of consolidated statements of income, changes in equity and cash flows 269 25. Accounting for associates and joint arrangements 286 26. Introduction to accounting for exchange differences 305 Part 7 Interpretation 322 27. Earnings per share 323 28. Review of financial ratio analysis 340 29. Analysis of published financial statements 367 Part 8 Accountability 388 31. Corporate governance 389 32. Integrated reporting: sustainability, environmental and social 394 Weblinks for Financial Accounting and Reporting 404

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    5 PART 1 Introduction to accounting on a cash flow and accrual accounting basis

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    6 C H A P T E R 1 Accounting and reporting on a cash flow basis Question 1 – Sasha Parker (a) Cash budget (£000) Jan Feb Mar Apr May June Total Initial capital 150.00 82.50 232.50 Customers 60.00 75.00 135.00 Total receipts 150.00 82.50 60.00 75.00 367.50 Machinery 30.00 30.00 Motor vehicles 24.00 24.00 Premises 75.00 75.00 Drawings 1.20 1.20 1.20 1.20 1.20 1.20 7.20 Suppliers 30.00 48.00 60.00 60.00 60.00 258.00 Rates 1.20 1.20 Wages 2.25 2.25 2.25 2.25 2.25 2.25 13.50 General expenses 0.75 0.75 0.75 0.75 0.75 3.75 Insurance – – – – – 2.10 2.10 Total payments 132.45 35.40 52.20 64.20 64.20 66.30 414.75 Net cash flow 17.55 (35.40) (52.20) 18.30 (4.20) 8.70 Balance b/f – 17.55 (17.85) (70.05) (51.75) (55.95) Balance c/f 17.55 (17.85) (70.05) (51.75) (55.95) (47.25) (47.25) (b) Statement of cash flows (£000) Realised operating cash flows for the period ended 30 June 20X1 Receipts from customers 135.00 Payments: Suppliers 258.00 Rates 1.20 Wages 13.50 General expenses 3.75 Insurance 2.10 278.55 (143.55)

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    Barry Elliott, Financial Accounting and Reporting , 18e, ’s Manual 7 For information only Statement of financial position as at 30 June 20X1 £000 Capital – introduced 232.50 – withdrawn (7.20) Net operating cash flows: Realised (143.55) Unrealised (7.80) 73.95 Premises (NRV) 75.00 Vehicles (NRV) 19.20 Machinery (NRV) 27.00 Net cash balance ( 47.25) 73.95 (c) Further information regarding Sasha Parker Nature of business linked to Parker’s business background, technical ability, special skills, know-how, existing/terminated business involvement, contacts, associates and related parties. Type of business unit to be used, and rationale for its selection. Sources of long- and short-term capital. Products’ life cycle and cash flow projections over product life cycle. Initial investment in fixed assets and their terminal value at the end of the life cycle. Parker’s attitude to risk, and how this affects the choice of discount rate and payback period. Question 2 – Mr Norman (a) Purchases budget (€000) Jan Feb Mar Apr May June Sales 15.00 20.00 35.00 40.00 40.00 45.00 Gross profit 3.00 4.00 7.00 8.00 8.00 9.00 Purchases 12.00 16.00 28.00 32.00 32.00 36.00 Payments 12.00 16.00 28.00 32.00 32.00

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    Barry Elliott, Financial Accounting and Reporting , 18e, ’s Manual 8 Notes: This is a start-up situation. Purchases equal projected sales less a gross margin on sales at 20%. Goods are bought in the month of sale; assume stocks remain constant. (b) Statement of cash flows (£000) Jan Feb Mar Apr May June Total Initial capital 50.00 50.00 Cash sales 7.50 10.00 17.50 20.00 20.00 22.50 97.50 Credit sales – 7.50 10.00 17.50 20.00 20.00 75.00 57.50 17.50 27.50 37.50 40.00 42.50 222.50 Premises 80.00 80.00 Rent and rates 2.20 2.20 2.20 2.20 2.20 2.20 13.20 Suppliers 12.00 16.00 28.00 32.00 32.00 120.00 Commission 0.30 0.40 0.70 0.80 0.80 3.00 Wages 0.60 0.60 0.60 0.60 0.60 0.60 3.60 Insurance 3.50 – – – – – 3.50 86.30 15.10 19.20 31.50 35.60 35.60 223.30 Net cash flow (28.80) 2.40 8.30 6.00 4.40 6.90 Balance b/f – (28.80) (26.40) (18.10) (12.10) (7.70) Balance c/f (28.80) (26.40) (18.10) (12.10) (7.70) (0.80) (0.80) (c) Statements of operating cash flows and financial position Realised operating cash flows for the period ended 30 June 20X8 £000 Receipts from customers 172.50 Payments: Suppliers 120.00 Rates 13.20 Wages 3.60 Commission 3.00 Insurance 3.50 143.30 29.20

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    Barry Elliott, Financial Accounting and Reporting , 18e, ’s Manual 9 Notes: The cash flow statement with summary attached is effectively a six-month cash budget showing the cash received, cash paid each month and the resulting month-end balances. It is necessary to separate sales and purchase transactions into cash and on-credit, and to identify clearly the month of receipt and payment. Commission is paid in the month after the sale is made, and all other cash flows are clearly indicated and allocated to specific months. Note that the format of the cash flow statement brings out key figures – for management decision and control. For example: month-end balances – assist in the control of liquidity; cash deficiencies – identify how much must be financed; early warning – allows management to approach appropriate sources; cash surpluses – identify amounts to be invested on the best terms. Statement of financial position as at 30 June 20X8 £000 Capital – introduction 50.00 Net operating cash flows: Realised 29.20 : Unrealised (4.00) 75.20 Premises (NRV) 76.00 Net cash balance (0.80) 75.20 Notes: This statement shows net assets of £75,200. Make up: premises £76,000 less the negative cash balance £800. The negative cash balance indicates the need for overdraft arrangements. The statement is based on cash flow concept: It ignores accrual-based figures (£36,900 less £25,250). Accruals are not regarded as real assets and liabilities. Critics of the cash flow concept would maintain that its utility has, therefore, been seriously diminished. (d) Letter to the bank requesting an overdraft facility The maximum overdraft facility of £28,800:

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    Barry Elliott, Financial Accounting and Reporting , 18e, ’s Manual 10 will be required at the end of January; will be eliminated by July. Overdraft will fall progressively as per the cash budget. It might be practical to request a limit of £30,000: for the full six-month period; reducing it to £15,000 thereafter to allow for contingencies. The facility is only to be called on as required. Refer to the cash budget to support the request: confirm that it is based on the most likely scenario; agree to a repayment schedule. Specify that collateral security is available in the form of premises if it should be required. If not an existing customer: give outline details of business background; explain future plans; market.

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    11 C H A P T E R 2 Accounting and reporting on an accrual accounting basis Question 1 – Sasha Parker (a) Cash budget (€000) Jan Feb Mar Apr May June Total Initial capital 150.00 75.00 225.00 Customers 60.00 75.00 75.00 210.00 Total receipts 150.00 60.00 75.00 150.00 435.00 Machinery 30.00 30.00 Motor vehicles 24.00 24.00 Premises 75.00 75.00 Drawings 1.50 1.50 1.50 1.50 1.50 1.50 9.00 Suppliers 30.00 48.00 60.00 60.00 60.00 258.00 Rates Wages 2.25 2.25 2.25 2.25 2.25 2.25 13.50 General expenses 0.75 0.75 0.75 0.75 0.75 3.75 132.75 34.50 52.50 64.50 64.50 64.50 413.25 Net cash flow 17.25 (34.50) (52.50) (4.50) 10.50 85.50 Balance b/f – 17.25 (17.25) (69.75) (74.25) (63.75) Balance c/f 17.25 (17.25) (69.75) (74.25) (63.75) (21.75) (21.75) All balances are overdrawn except for January 20X1 Feb Mar Apr May June o/d 17.25 69.75 74.25 63.75 4.65 Note: No entries will be made for the 20X0/X1 local taxes that are paid in Feb 20X2 – this situation arose because Sasha Parker had assumed that the business would only pay the taxes from the start of the tax year, e.g. 1.4.20X1. However, there will be an entry in the profit and loss account and the statement of financial position.

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    Barry Elliott, Financial Accounting and Reporting , 18e, ’s Manual 12 (b) Sasha Parker – profit and loss account for six months ended 30 June 20X1 €000 €000 Sales [60.00 + (5 × 75.00)] 435.00 Purchases 378.00 Closing inventory (30.00) Cost of sales 348.00 Gross profit 87.00 Wages 13.50 General expenses 4.50 Local taxes (1.1.X1–30.6.X1) 4.00 Insurance 13.20 Depreciation: – Vehicles 2.40 – Machinery 1.50 39.10 Net profit 47.90 Budgeted statement of financial position as at 30 June 20X1 Capital 225.00 Net profit 47.90 Less : drawings ( 9.00) 263.90 Non-current assets Premises 75.00 Vehicles 24.00 Less : depreciation 2.40 21.60 Machinery 30.00 Less : depreciation 1.50 28.50 Current assets Inventory 30.00 Trade receivables (3 × 75.00) 225.00 Insurance 13.20 268.20 Current liabilities Trade payables 120.00 Local taxes (1.1.X1–30.6.X1) 4.00 Bank overdraft 4.65 General expenses 0.75 (129.40) Net current assets 138.80 263.90

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    Barry Elliott, Financial Accounting and Reporting , 18e, ’s Manual 13 (c) Possible action to deal with exceeding agreed overdraft limit Approach the bank to re-negotiate the overdraft or arrange a loan facility for an agreed term. The amount and the period for which additional facilities are required depend on preparing a projected cash flow statement for a longer period taking into account future plans, e.g. owner’s drawings requirement and any additional capital expenditure. In particular, consider alternatives such as the following: Leasing vehicles and/or machinery Mortgaging the property Getting debts in quicker manner Introducing more capital Obtaining or providing loan capital. Question 2 – Mr Norman (a) Purchases budget ($000) Jan Feb Mar Apr May Jun Sales units 1.65 2.20 3.85 4.40 4.40 4.95 − Closing inventory 0.55 0.96 1.10 1.10 1.24 + Closing inventory 0.55 0.96 1.10 1.10 1.24 1.38 Purchases units 2.20 2.61 3.99 4.40 4.54 5.09 Purchases Sales $000 $000 Jan (2,200 × 40) 88.00 82.50 (1,650 × 50) Feb (2,610 × 40) 104.40 110.00 (2,200 × 50) Mar (3,990 × 40) 159.60 192.50 (3,850 × 50) Apr (4,400 × 40) 176.00 220.00 (4,400 × 50) May (4,540 × 40) 181.60 220.00 (4,400 × 50) Jun (5,090 × 40) 203.60 247.50 (4,950 × 50) 913.20 1,072.50

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    Barry Elliott, Financial Accounting and Reporting , 18e, ’s Manual 14 (b) Cash flow forecast ($000) Jan Feb Mar Apr May June Total Initial capital 150.00 150.00 Cash sales 41.25 55.00 96.25 110.00 110.00 123.75 536.25 Credit sales 41.25 55.00 96.25 110.00 110.00 412.50 191.25 96.25 151.25 206.25 220.00 233.75 1,098.75 Premises 80.00 80.00 Commission 1.65 2.20 3.85 4.40 4.40 16.50 Suppliers 88.00 104.40 159.60 176.00 181.60 709.60 Administration 8.00 8.00 8.00 8.00 8.00 8.00 48.00 Wages 17.00 17.00 17.00 17.00 17.00 17.00 102.00 Insurance 0.35 0.35 Total payments 105.35 114.65 131.60 188.45 205.40 211.00 956.45 Net cash flow 85.90 (18.40) 19.65 17.80 14.60 22.75 Balance b/f – 85.90 67.50 87.15 104.95 119.55 Balance c/f 85.90 67.50 87.15 104.95 119.55 142.30 (c) Budgeted statement of income for six months ended 30 June 20X8 $000 $000 Sales 1,072.50 Purchases 913.20 Closing inventory (1,380 units × £40) (55.20) Cost of sales 858.00 Gross profit 214.50 Wages 102.00 Administration 48.00 Commission (2% of 1,072.50) 21.45 Insurance 0.18 Amortisation of lease 8.00 179.63 Net profit 34.87

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    Barry Elliott, Financial Accounting and Reporting , 18e, ’s Manual 15 Budgeted statement of financial position as at 30 June 20X8 $000 $000 Capital 150.00 Net profit 34.87 184.87 Non-current assets Leasehold premises 80.00 Less amortisation (8.00) 72.00 Current assets Inventory 55.20 Trade receivables 123.75 Pre-payments − insurance 0.17 Cash 142.30 321.42 Current liabilities Trade payables 203.60 Commission 4.95 208.55 Net current assets 112.87 184.87 (d) Investment of surplus funds Acid test ratio At the end of the first six-month trading, Norman’s statement of financial position shows that the acid test ratio is 1.28:1 (266.22/208.55) – this is higher than the basic 1:1 ratio but it should be compared with the ratio of similar businesses in the same industry in order to establish a norm. It would appear, however, that the business has surplus funds to invest. Amount to invest A projected cash flow statement is required, taking into account future plans regarding the owner’s drawing requirements, future capital commitments and working capital criteria, e.g. debtor collection and creditor payment terms. Period to invest The projected cash flow will give an indication of the period of the investment, e.g. it could range from overnight on the money market to term investments. The important aspect is that the owner should be aware of the projected cash flows, so that return on surplus funds can be maximised.

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    16 PART 2 Preparation of internal and published financial statements

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    17 C H A P T E R 3 Preparation of financial statements of comprehensive income, changes in equity and financial position Question 1 – Old NV (a) Statement of income (internal) for the year ended 31 December 20X1 €000 Sales 12,050 Less : returns 350 11,700 Inventory at 1.1. 20X1 825 Purchases 6,263 Carriage on purchases 13 Less: returns ( 313) 6,788 Inventory at 31.12.20X1 1,125 5,663 Depreciation of plant 313 5,976 Gross profit 5,724 Administration: Wages 738 Administration expenses (286 − 12) 274 Directors’ remuneration 375 Selling: Salesmen’s salaries 800 Distribution: Distribution expenses 290 Depreciation of vehicles 187 Carriage 125 Financial: Goodwill impairment 177 Audit fee 38 Debenture interest 25 Rent receivable (100) 2,929 2,795 Tax 562 Profit for year 2,233

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