1. (A) (A) What Is the Purpose of Preparing Consolidated Financial Statements? (2 Marks)

2004(P1)

Section A

Answer ALL questions in this section. Each question carries 30 marks. Write all your answers in the AL(C)1 answer book provided.

1. (A) (a) What is the purpose of preparing consolidated financial statements? (2 marks)

(b)In January 2003, Lemon Ltd loaned $10 000 000 foe ten months to John, a shareholder of Tea Ltd. John pledged his investment, which represents 60% of the ordinary share capital of Tea Ltd, as security for the loan. When the loan matured, he was unable to repay the debt and transferred the title of the shares to Lemon Ltd. Lemon Ltd tried to find a buyer for these shares but failed. At its year ultimately sold in February 2004.

With respect to Lemon Ltd’s shareholding in Tea Ltd, explain whether Lemon is required to prepare consolidated financial statements as at 31 December 2003. (4 marks)

(B) Michael Ltd acquired 4 000 000 ordinary shares of Jackson Ltd for $7 500 000 on 1 January 2003. The following balances were extracted from the books of the companies at 31 December 2003:

Michael Ltd / Jackson Ltd
$'000 / $'000
Ordinary shares of $1.00 each / 15 000 / 5 000
Share premium / 3 000 / 500
General reserve / 1 400 / 1 750
Profit and loss account / 4 520 / 1 750
Provision for depreciation
- Plant and machinery / 4 980 / 3 150
Accounts payable / 3 050 / 1 600
Tax payable / 1 200 / 1 000
Dividend payable / 750 / 500
33 900 / 15 250
Freehold land (overseas), at cost / 10 000 / 9 000
Plant and machinery, at cost / 7 900 / 4 150
Investment in Jackson Ltd, at cost / 7 500 / -
Inventories / 5 550 / 1 250
Accounts receivable / 1 500 / 750
Bank / 1 450 / 100
33 900 / 15 250

Additional information:

(i)At the acquisition date, the shareholders’ equity of Jackson Ltd consisted of the following:

$
Ordinary share capital / 5 000 000
Share premium / 500 000
General reserve / 1 000 000
Profit and loss account / 1 500 000

The fair value of the land owned by Jackson Ltd on the date of acquisition was estimated to be $9 800 000. The fair values of all other assets were the same as their carrying amounts.

(ii)The group adopts the following policies:

(1)Depreciation is to be provided for plant and machinery at 10% per annum on cost, with a full year’s provision in the year of acquisition and none in the year of disposal. No depreciation is to be provided on freehold land.

(2)Goodwill arising on consolidation is to be amortized over five years on a straight line basis.

(3)Minority interests are to share any unrealized profits or losses (together with any related depreciation adjustment) arising from sales of assets by the subsidiary to the parent according to their proportion of shareholding, but none for sales of assets by the parent to the subsidiary.

(4)Dividend payable to minority shareholders is to be separately disclosed in the financial statements.

(iii)During the year, Michael Ltd purchased a machine at a cost of $600 000 and then immediately sold it to Jackson Ltd for $1 000 000. Jackson Ltd provided depreciation at 10% on the cost ($1 000 000) of this machine.

(iv)Inventories of Michael Ltd included some goods purchased from Jackson Ltd at an invoice price of $4 000 000, comprising a mark-up of 25% on cost by Jackson Ltd.

(v)Included in the accounts receivable of Jackson Ltd was $500 000 owed from Michael Ltd. The same amount had been included in the accounts payable of Michael Ltd.

(vi)Dividend payable by Jackson Ltd represented the unpaid interim dividend for the year 2003. Michael Ltd had not recorded the dividend receivable from Jackson Ltd.

You are required to :

Prepare for the group of Michael Ltd

(a) a statement showing the calculation of goodwill arising on consolidation; (3 marks)

(b) a statement showing the calculation of consolidated profit and loss account balance as at 31 December 2003; (6 marks)

(d) a consolidated balance as at 31 December 2003. (11 marks)

2. (A) X Ltd has the following statement of changes in equity (with some missing figures) showing the movements in share capital and reserves for the year ended 31 December 2003;

Share / Share / Revaluation / Retained / Total
capital / premium / reserve / profits
$'000 / $'000 / $'000 / $'000 / $'000
Balance at 31 December 2002 / 200 000 / 85 000 / 30 840 / 56 690 / 372 530
Change in accounting policy / ? / ?
Restated balance / 200 000 / 85 000 / 30 840 / ? / ?
Realization of reserve on disposal of / ? / ? / ?
properties
Net profit / (loss) for the period / 45 158 / 45 158
Issue of share capital / ? / ? / ?
Balance at 31 December 2003 / ?[a] / ?[b] / ?[c] / ?[d] / ?

Additional information:

(i)At 1 January 2003, the company changed its accounting policy with respect to the treatment of research and development expenditure from amortization over five years to immediate write-off as it was incurred. The retained profits were restated accordingly. Research and development expenditure incurred in 2001 and 2002 are $10 000 000 and $7 000 000 respectively.

(ii)A commercial plaza was purchased on 1 January 1983 at a cost of $20 000 000 with an estimated useful life of 50 years. Depreciation had been provided on a straight-line basis. It was revalued to $15 00 000 on 31 December 2002. At 1 January 2003, it was sold for $16 000 000.

(iii)The par value of ordinary shares is $1 each. In 2003, the authorized share capital was increased from $200 000 00 to $300 000 000. In 2003, an additional 30 000 000 shares were issued for the acquisition of a piece of land having a market value of $48 000 000.

You are required to:

Based on the information given, find out the four missing figures [a] to [d] in the statement of changes in equity above. (6 marks)

(B)Y Ltd has issued 80 000 000 ordinary shares of $0.5 per share. The financial year ends on 31 December. A draft profit and loss account was prepared for publication as follows:

Profit and loss account / Remarks / $'000
for the year ended 31 December 2003
Turnover / 4 523 026
Cost of sales / (3 415 077)
Gross profit / 1 107 949
Selling and distribution expenses / (i) / (351 487)
Administrative expenses / (735 661)
Other operating expenses / (32 814)
Net loss / (12 013)
Prior period adjustment / (ii) / (18 387)
Loss attributable to shareholders / (30 400)
Earnings per share / (iii) / N/A

Remarks:

(i)$5 000 000 5% debentures were issued to raise funds for advertising campaign. As a result the company classified the debenture interest as selling and distribution expenses.

(ii)Some goods were sold to a customer in October 2002 for $18 387 000. On 31 March 2003, the customer was declared bankrupt and the whole debt became uncollectible. As the sales contract was signed and completed in 2002, the company treated the bad debt as a prior period adjustment.

(iii)Since the company was suffering a loss for the year, it did not provide the figure for earnings per share.

You are required to:

Explain and discuss how item (i) to (iii) above should be reported in the published accounts.

(12 marks)

(C)Z Ltd is preparing the financial statements for publication for the year ended 31 December 2003. However, two directors, Josephine and Raymond, had different opinions regarding the accounting policies of the following two items:

Items / Particulars / Josephine’s opinion / Raymond’s opinion
(i) / Goodwill / Purchased goodwill is to be written off in full against reserves in the year of acquisition / Purchased goodwill is to be amortized to profit and loss account on a straight line basis over is estimated useful life.
(ii) / Proposed dividend / Dividend proposed after the balance sheet date should not be recognized as a liability at the balance sheet date. / Dividend proposed after the balance sheet date is to be recognized as a liability at the balance sheet date.

The accountant advised them that inappropriate accounting policies would distort the true and fair view required of financial statements.

You are required to:

(a) Explain how a company can ensure its published accounts fulfil the ‘true and fair view’ requirement. (4 marks)

(b) For each of the above two items, explain which opinions is more appropriate in preparing financial statements suitable for publication. (8 marks)

Section B

Answer any TWO questions from this section. Each question carries 20 marks. Write all your answers in the AL(E) answer book provided.

Chan, Lee and Cheung had been in partnership foe many years and their profit and loss sharing ratio was 2:2:3 respectively. On 1 January 2004, Goodie Ltd took over the partnership business.

The balance sheet of the partnership business at 31 December 2003 was shown as follows:

$ / $
Fixed assets
Machines / 440 000
Motor vehicles 9three in total) / 420 000
Office equipment / 235 000 / 1 095 000
Current assets
Stock / 570 000
Trade debtors / 950 000
1 520 000
Current liabilities
Trade creditors / (850 000)
Bank overdraft / (140 000) / 530 000
1 625 000
Financed by:
Capital accounts
Chan / 500 000
Lee / 500 000
Cheung / 500 000 / 1 500 000
Current accounts
Chan / (260 000)
Lee / 190 000
Cheung / 195 000 / 125 000
1 625 000

Further information:

(i)Goodie Ltd took over most of the assets as follow:

Stock (Category A) / See note (ii)
Machines / $400 000
Motor vehicle (one) / $160 000
Office equipment / $200 000
Goodwill / See below

Goodwill was valued at the weighted average of profits for the past three years. Profits for years 2001, 2002 and 2003 were $90 000, $105 000 and $120 000 respectively. The weights of years 2001, 2002 and 2003 were 1,2 and 3 respectively.

On 1 January 2004, Goodie Ltd issued 1 000 000 ordinary shares (par value of $1 each) as the full purchase consideration.

(ii)Stock costing $570 000 consisted of Categories A and B. Category A costing $300 000 was taken over by Goodie Ltd at a mark up of 10%. Category B was sold to a third party at 20% below cost.

(iii)One motor vehicle was taken over by Lee at the value of $90 000 while another motor vehicle was sold for $110 000.

(iv)All the trade debtors were settled at a discount of 4%.

(v)Trade creditors were fully settled for $840 000.

(vi)Realisation costs amounted to $7000.

(vii)Chan, Lee and Cheung agreed that the shares of Goodie Ltd were to be allotted among themselves in the ratio of 1:2:2 respectively. To show respect to Chan, the founder of the partnership, the partners further agreed that any deficiency in Chan’s capital account after the share allotment was to be shared by Lee and Cheung equally.

You are required to:

(a)calculate the purchase price payable by Goodie Ltd for the partnership business. (4 marks)

(b)Prepare the following accounts in the books of the partnership to record the acbove:

(i)Realisation account

(ii)Bank account

(iii)Partners’ capital accounts (in columnar form) (16 marks)

Yuen Long Cricket Club was incorporated on 1 January 2002, admitting both ordinary members and life members. The summarized bank account of the club for the year ended 31 December 2003 was shown as follows:

$ / $
Balance b/d / 234 000 / Administrative expenses / 928 000
Subscription fees- / Salaries / 378 000
Cheques from ordinary members / 1 578 000 / Sports equipment / 180 000
Deposits from credit card companies / 735 000 / Office equipment trade-in / 50 000
Cheques from life members / 360 000 / Promotion campaign / 18 000
Refund to ordinary member withdrawn / 12 500
Rent and rates / 770 000
Balance c/d / 570 500
2 907 000 / 2 907 000

Additional information:

(i)Some of the balances at 31 December are given below:

2003 / 2002
$ / $
Accumulated fund
Office equipment (net book value)
Sports equipment (net book value)
Subscription fees received in advance
Subscription fees received in arrears
Provision for doubtful debts
Prepaid rent
Accrued rent
Life membership fee (net of amortization) / ?
?
?
?
?
?
24 000
-
? / 719 000
384 000
416 000
76 000
38 000
-
-
7 000
270 000

(ii)Ordinary members were required to pay monthly subscription fee either by cheques or by credit card. If the monthly subscription fees were settled by credit card, credit card companies would deduct a 2% service charge and deposit the net amount to the club’s bank account.

(iii)A promotion campaign was launched in 2003 and gifts were given to ordinary members who paid in advance. The total amount incurred was $18 000.

(iv)Ordinary members could withdraw in any month of the year. 50% of the amount paid in advance would be refunded to them while the balance would be forfeited and treated as ‘other revenue’

(v)Life membership fee would be received in lump sum and amortised over a period of 60 months. Life members were admitted in the past two years on 1 July 2002 and 1 April 2003 respectively.

(vi)The monthly subscriptions fee for ordinary members was $500 each. The following information related to the subscription fees received in advance and subscription fees in arrears at 31 December 2003:

Subscription fee received in advance / Subscription fee in arrears
Number of months prepaid / Number of members / Number of months outstanding / Number of members
1
2 / 80
2 / 1
2
3 / 37
20
6

Provision for doubtful debts is to be made at 50% of subscription fees remaining outstanding for three months.

(vii)On 1 January 2003, a piece of office equipment costing $56 000 was traded in with a cash payment of $50 000. The office equipment traded out was purchased on 1 January 2002 for $10 000.

Fixed assets are to be depreciated at an annual rate of 20% by the reducing balance method, with a full year’s charge in the year of purchase and none in the year of disposal.

You are required to:

Prepare for Yuen Long Cricket Club

(a) an income and expenditure account for the year ended 31 December 2003; and (13 marks)

(b) a balance sheet as at 31 December 2003. (7 marks)

Louie commenced his retail business on 1 January 2003. At the year end, he prepared a draft profit and loss account for the year ended 31 December 2003. As he thought that the bank statement balance would be the same as the bank account balance in the cash book, he inserted the bank statement balance in the trial balance as at 31 December 2003 as follows:

$ / $
Capital / 440 000
Fixed assets (net book value at 31 December 2003) / 180 000
Drawings / 35 000
Trade debtors / 161 000
Trade creditors / 123 000
Stock / 124 000
Accrued expenses / 15 000
Prepaid rental / 5 000
Down payment for an office machine / 9 500
Profit for the year / 15 600
Bank - per bank statement / 80 275
Suspense (balancing figure) / 1 175
594 775 / 594 775

Additional information:

(i)After checking through the bank statement against the bank account in the cash book, Louie discovered that the following items had resulted in a discrepancy between the two balances:

(1)Telephone charge of $425 for December 2003 was settled by autopay.

(2)A customer deposited $7200 directly into the bank account for the full settlement of a trade debt.

(3)Unpresented cheques amounted to $11 000.

(4)An office machine was purchased for business use under finance lease on 1 October 2003. The lease requires a down payment of $9500 in cash on 1 October 2003 plus 6 monthly instalments of $4000 each commencing on 31 October 2003. Autopay of instalments had been arranged with the bank and Louie had only recorded the down payment in respect of the lease. Cash price for the office machine was $30 000. Interests for the finance lease was to be apportioned on a straight line basis.

(ii)Sales of $98 000 were correctly recorded in the sales account but recorded as $89 000 in the customer’s account.

(iii)Electricity expense of $4000 for the business was recorded as Louie’s personal drawings.

(iv)The monthly rental for the business was recorded as Louie’s personal drawings.

(v)The purchases day book was overcast by $4400.

(vi)Depreciation is to be provided on fixed assets on a monthly basis at an annual rate of 20% on cost.

You are required to:

Prepare

(a) a bank reconciliation statement as at 31 December 2003, reconciling the balance as per bank statement with the unadjusted balance as per bank account in the cash book which should have been included in the trial balance above; (2 marks)

(b) journal entries necessary to correct the above errors and omissions; and (10 marks)