SUGGESTED SOLUTION TO QUESTION 1

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					SUGGESTED SOLUTION TO QUESTION 1 PART 1 WORKINGS a) Fair value of debentures Year 2 3 4

(50 MARKS) (32 MARKS

Balance 1 200 800 400

Interest 168 112 56 (2)

Capital 420 420 420 (2)

Factor (12%) 0,797 0,712 0,636 (2) (R‟000) 2 335 1 290 304 1 937 5 886

P.V. 468,6 378,8 302,5 1 149,9 (2)

b) Calculation of tangible NAV PPE: 2 500 – 30% (2 500 – 1 950) Goodwill Investments: 1 338 – 50% x 30% (1 338 – 1 018) Tax loss: 80% x R1,9m x 20% Net current assets

(3) (1) (4) (3) (1)

Less Non-participating portion of preference shares: 8/10 x R1m Debentures, per (a) Deferred tax Minorities Available for ordinaries & part-prefs Allocation: Number of ordinaries R1,250m / 50c = P. pref-equivalent ½ x 1m Ratio is thus 1 to 5; p-prefs receive one-sixth. This leaves 5/6 x R3,318m = R2 ;765m for 2,5m ordinaries. NAV per share is thus R2,765m / 2,5m = 110,6c Set out

800 1 150 343 275

(2) (1) 2 568 (1) 3 318 2 500 000 500 000 3 000 000 (4) (2) (2) 32

PART 2 1.

(18 MARKS)

Adding back the dividends, it is apparent that the net cash inflow from operating activities substantially exceeds the after-tax profit figure – eg. in 2003, this amounts to R594 + R258m = R852m, compared with the after-tax profits of R454m. (3) The reason for the above lies in the working capital management of Pick „n Pay ; it is apparent that in each of the three years, the funding provided from trade and other payables exceeds the amount required for investment in stock and trade receivables; for example, in 2003 R429m was received in funding from suppliers as against R282m (R149,9 + R123,3) required for stocks and trade receivables. (3) The add-back for depreciation is more or less equal to the amount spent on equipment and vehicles in 2001 and 2003; in 2002, there appears to have been a relative underspend, the replacement capital expenditure being R137,6m versus depreciation of R251,1m (note that the financials do not, unfortunately, split expenditure on equipment and vehicles as between replacement and maintenance of the current level of operations). (3)

2.

3.

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4.

These strong figures for cash generation suggest that the poor liquidity ratios referred to in the question are not a cause for concern. (2) The question arises as to what Pick „n Pay did with its strong cash flows, as the cash resources at year end are little changed from the end of 2001. (1) It is clear that the major direction of Pick „n Pay‟s free cash flows has been to make acquisitions (R605m + R232m) and to repurchase shares (R92m + R300m). This amounts to more than R1,2bn in all. Consequently, a certain amount of interest-bearing debt has been raised in 2003 (R171m). (3) (3) 18

5.

6.

Set out

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QUESTION 2 SUGGESTED SOLUTION Part A 3 Marks for format, including letter in correct format ANO Financial consulting PO Box 778 Constantia 7848 MG Developments (Pty) Ltd PO Box 334 Constantia 7848 Att: Mr Grant Dear Mr Grant Thank you for your query relating to the recognition of revenue on the Constantia development. We set out below our response. The criteria of AC111 relating to revenue recognition, should be considered. 1. SALE OF LAND

Revenue from the sale can only be recognised once the following 3 criteria per AC111 have been satisfied. 1.1 PERFORMANCE transfer the (1) the revenue (1)

The key criterion to satisfying the performance requirement is that the seller must significant risks and rewards of ownership of the assets sold. Where there are any significant acts of performance that remain to be completed, then should not be recognised, (or a portion thereof deferred).

Where there are substantial future development costs still to be incurred, the performance criteria have not been satisfied, as significant acts of performance remain to be completed. (1) Estimated future costs at the 2002 year-end totalled R1 000 000, which definitely indicates significant outstanding acts of performance. On this criteria alone revenue recognition should be deferred. (1) Estimated future costs at the 2003 year-end totalled R100 000. As only R100 000 of R6,6m costs have still be incurred, this indicates that all significant acts of performance can be considered to be completed (1). Therefore revenue should not be deferred on this criterion. (1) It does not appear that managerial control is retained. (1)

1.2 MEASURABILITY There must be no significant uncertainty as to the measurability of the revenue and associated costs. (1) Given the nature of developments, while there are still significant future estimated development costs to be incurred, it is unlikely that these costs can be measured with reasonable certainty. The measurability criteria would therefore not be satisfied. (1)
Financial Accounting 3T – Supplementary Exam Solution 2004 3

QUESTION 2 Suggested solution cont’d Estimated future costs at the 2002 year-end totalled R1 000 000. It is therefore probable that there is significant uncertainty as to the actual future costs, and on this criteria alone revenue recognition should be deferred. (1) Estimated future costs at the 2003 year-end totalled R100 000. This is immaterial in relation to the R6,6m total costs, and possible inaccuracies in estimation are not going to have a significant impact of revenue. (1) In my judgement, the uncertainty as to actual future costs has therefore reduced to an insignificant level, and in my opinion revenue should not be deferred on this criteria. (1) 1.3 COLLECTIBILITY

The collectability of the amount must be assessed by considering - payments made to date - resale value of the land (considering that legal title has remained with the developer who can resell the land if any buyer defaults) - credit worthiness of each buyer

(3)

A deposit of 34% of the cash selling price, and retention of legal title by the seller should satisfy the criteria of collectibility. (1) Debtor B: As there has been no deposit on this sale, it may have been more prudent to defer recognition of the revenue on this sale until the buyer has clearly indicated a commitment to the sale, particularly as there are still many unsold units. (1) 1.3.1 Subsequent uncollectibility

Provided that the collectibility was assured at the time that the other criteria necessary for recognition of revenue from the sale were satisfied, then any amount, which subsequently appears uncollectible, should be provided for as a bad or doubtful debt, and not as an adjustment to revenue. (AC111 para 23) (1) Debtor A: The market value of the property should be compared to the debtor's investment. Provided that the market price is in excess of that, no provision need be made. (1) 1.4 JUDGEMENT

For the 2002 year, 2 of the 3 requirements of AC111 have not all been complied with, as: significant acts of performance remain to be completed; there is significant uncertainty as to the future costs (1) Therefore revenue recognition should be postponed. (1)

For the 2003 year, the 3 requirements have all been met, and revenue from all plots sold to date should now be recognised. (1) 2. FINANCE CHARGES

Where collectibility of the amount due is reasonably assured, revenue from finance charges must be recognised on the accrual basis, using the effective rate method: (1) Capital outstanding x rate x applicable period. (1)

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QUESTION 2 Suggested solution cont’d The capital outstanding is calculated as the present value of the expected future cash flows. (1) Each sale should be recognised at R400,000 + (200,000 x 5,33) = R1,466,985 (2) Interest will therefore be recognised at 1,466,985 x 10% x portion of year outstanding. (1) Where collectibility is not reasonably assured, finance revenue should only be recognised as the cash instalments are received. (1) 2.1 2002 (1)

No revenue from the sale of plots should be recognised, as discussed above. 2.2 2003

During this period, the recognition criteria for revenue are met and the sales of the Interest accruing on the balance of the sales amounts should be (1) recognised as revenue in this year. If it has been decided at the date of sale that the collectibility of debtor B is uncertain, then no interest should be accrued until the debtor makes a deposit and starts paying the instalments. (1) (Same for Debtor B) Assuring you of our best attention at all times Yours sincerely ANO Part B a. Deferred tax asset: 10,000 – 3,400 = 6,600 x 30% = R1,980 Dr (3) Current tax: 630 – (2,930 x 30%) = 249 Cr (3) b. The question here is not whether the items meet the definition of a liability or not. (1) Rather, we should examine the timing of payments expected to be made. (1) If payments are going to be made in the foreseeable future, the item is more like debt. (1) If not, its nature is closer to equity than debt. (1) Deferred tax Unfortunately, it is not possible to arrive at a definitive answer as to whether deferred tax meets the definition of a liability. This will be dependent on the time frame in which the tax liability is expected to arise. In most cases, however, deferred tax is not expected to be paid in the foreseeable future. (1) For this reason, it is unlikely to affect the risk of the firm and should be classified as equity. (1) However, if the deferred tax liability is expected to result in payments being made in the foreseeable future, it should be regarded as debt. (1) Minority interest It is unlikely that a payment will be made to settle the minority interests. (1) Therefore, minority interest should be regarded as equity. (1)

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QUESTION 2 – PART B SUGGESTED SOLUTION 1. Bank reverse incorrect entry Machinery 510 000 510 000 540 000 Machinery 540 000

Supplier (record purchase at spot on date ownership transfers) (Euros 50 000 x 10,2) Depr expense 92 000

Acc Depr (depreciation expense for the yr (510 000 – 50 000) 20%) Forex loss 60 000

92 000

Supplier restate supplier at payment date (11.4 – 10.2) 50 000 Supplier (@ 11.4) 570 000 Bank (@10.8) Forex gain (11.4 – 11.2) Forex asset (11.2 – 10.89) 2. Proceeds on sale Acc depr 90 000 40 000 Vehicle at valuation Profit on sale 3. Rev CA Hist Cost / Tax Value 800 (200) 600 (200) 400 (50) 350 350 (175) 175 Temp diff D. Tax B/S

60 000

540 000 10 000 20 000

120 000 10 000

(4)

Rev Res

31.12.01 31.12.02 Sold Revalue Depr 31.12.03 New vehicle 1.1.03 800 (80) 720 200 920 (460) 460

400 (30) 370 200 570 (285) 285

120cr (9)dr 111cr 60cr 171cr (86) 85

280cr (21)dr 259cr 140cr 399cr (199) 200

360 (90) 270

360 (90) 270

-

-

-

Carrying value 31.12.03

460 + 270 = R730 000
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Financial Accounting 3T – Supplementary Exam Solution 2004

SOLUTION TO QUESTION 2 continued 4. Computer Equipment Total parts 6 x 50 000 = 6 half yr periods at 6% 300 000

PV of Min lease parts 1. 2. 3. 4. 5. 6. 50 000 47 170 44 500 41 980 39 605 37 365 260 620 Finance charges

Capital 260 620 (50 000) 210 620 (37 363) 173 257 (39 605) 133 652 (41 981) 91 671

1.1.02 12 637 1.7.02 10 395 1.1.03 8 019 1.7.03 5 500 Lease liability 31.12.03 Net book value 31.12.03 Def tax Op bal 31.12.03 Other temp diffs MV Comp equip Lease liab Instal due CV 91 671 + 5 500 = 260 620 x 1/3 = TV Temp diff

97 171 86 873 D tax B/S 80 000cr

86 873 (97 171) -

50 000

(240 000)dr 285 000cr 86 873cr (97 171)dr 50 000cr

25 410dr

BS IS

25 410dr 105 410dr

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SUGGESTED SOLUTION TO QUESTION 3 1. WANOS Headline earnings

= =

554438/165.1 1.665 x 3358195000

= =

3358195000 R55913946 (3)

2. It must be probable that the deferred tax asset wil be realised in the future and therefore that future profits are expected . For disclosure separate from the deferred tax liability the deferred tax asset will have arisen in a different legal entity within the group. (3) 3. a. 29.5% b. current tax (current year and prior years separately) deferred tax (current year and prior years separately) tax on associates earnings STC c. Income not taxable Expenses not deductible Temporary differences on which deferred tax is not provided STC

(1)

(1 each, max 3)

(1 each, max 3)

4. Proportional consolidation If equity accounting were used there would be a line item in the balance sheet and the income statement referring to investment in joint ventures and earnings from joint ventures respectively. (3) 5. By function Depreciation Amortisation Auditors‟ remuneration Directors‟ emoluments Profit/loss on disposal of non-currrent assets Staff costs The components of revenue

(1 each, max 4)

6. Property is revalued to a revaluation reserve and depreciated (other than land) therefore it cannot be investment property as investment property is either carried at historic cost, depreciated; or is revalued to the income statement and not depreciated. (2) 7. The capitalised lease assets are obviously held under finance lease as operating leases are not capitalised! (2) 8. a)

b)

c)

Return on equity gives the amount of profit attributable to ordinary shareholders of the holding company as a percentage. This return is therefore stated after deducting all expenses and amounts attributable to others. (2) Return on capital employed indicates the operating profit generated by the total non-current funds invested in the group. This indicates how profitable the group operations are and is therefore calculated before finance costs tax and associates. (2) net asset turn indicates how effective the group has been in generating revenue from its assets. It does not reflect profitability. (2)

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9. Asset turn has not changed. Gearing has reduced. This is unlikely to cause an increase in profits unless gearing was so high as to have been negative. The reduction in gearing is more likely to have caused a decrease in return on equity. Therefore operating is the most likely cause of the increase in return on equity. (1 each, max 3)

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SUGGESTED SOLUTION TO QUESTION 4 PART A Goodwill is the excess paid over the fair value of the separately identifiable net assets of an enterprise. To be recognised on the balance sheet positive goodwill needs to meet the definition and recognition criteria of an asset; ie a resource, controlled by the enterprise, from which it is probable that future economic benefits will flow, and its cost is measurable. Where the purchase price is less than the fair value of the separately identifiable net assets of an enterprise (negative goodwill) its nature is more complex and it has been treated in many different ways in the past. For it to become equity it must first be recognised in the income statement. To be so recognised as income it must meet the definition of income as an increase in economic benefits that result in an increase in equity, other than by contributions from equity participants. AC131 accounts for positive goodwill as an asset which must be amortised over its useful life on the basis that purchased goodwill has a finite life and it is replaced with internally generated goodwill which cannot be recognised because its cost cannot be separately measured. AC131 discloses negative goodwill as a negative asset but recognises it in income by matching it first with anticipated future losses, then over the life of non-monetary assets. Any excess is recognised immediately. Its actual nature is not clarified but is treated as a mixture of income and provision, but it does not really meet the definition of a liability. ED161 simplifies the treatment of goodwill. “negative goodwill” is recognised immediately as a gain, after reassessing the fair value of the net assets to ensure they are fair. This is easier to understand in terms of AC000 as its nature is then income. Positive goodwill, in terms of ED 161 is not amortised, but an annual impairment test is required to ensure it is not overstated. This approach assumes that goodwill is not a “wasting” asset. However it does imply that goodwill is measurable, other than by purchase (impairment test) and it is likely that this value includes some element of internally generated goodwill. This raises the question of whether internally generated goodwill could not also be recognised where it is not preceded by purchased goodwill. (1 each, max 15) PART B Mr N Sense P O Box 666 Never Never Land Dear Nono, Re: purchase of shares in Windy Corner Pty Ltd Thank you for requesting my advice on this investment. It is not quite as simple a decision as Mr Wise has implied. I have set out some points which I think you should consider below: The purchase of 40% of a company will normally confer significant influence but not control. As Windy Corner is a private company, it may be difficult to obtain a return in the form of dividends if the controlling shareholder does not wish to make distributions. The controlling shareholder is also the managing director. The resale value of a minority holding is also going to be far lower than for a controlling shareholding. 40% is sufficient to block major decisions requiring a special resolution and does therefore confer some protection.

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For these reasons the price of a 40% shareholding should be substantially lower than R4million, as the price of the whole business contains a premium for control. It was also offered by a company with expertise in the industry, presumably wishing to either expand or control a competitor. An offer to purchase only 40% should only be made at a substantial discount to the requested price and preferably with some contractual agreement regarding dividends. The possibility of joint control could be explored. An offer to purchase 50% for R5million may be acceptable to both parties. A contractual agreement on joint control would be necessary. This is in fact not dependant on the percentage held and could allow either party to own more shares than the other. Please contact me to discuss this further if you so wish. Regards

I M A Graduate (3 marks for letter and general layout; 1 mark each valid point, max 12 – 15 marks for the question as a whole)

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SUGGESTED SOLUTION TO QUESTION 5 1. machinery

510 000 (1) supplier 510 000 (1) [record purchase at spot on date ownership transfers. Euro 50000 x 10,2] (1) depreciation expense 92 000 accumulated depreciation [record depreciation for the year (510 000-50000)20%] forex loss 60 000 60 000 (1) (1) (1) (1) (1) (1) (1) (1) (1) (1)

92 000

supplier [restate supplier at payment date 50000(11.4-10.2]

supplier (@ 11.4) 570 000 bank (@10.8) 540 000 forex gain (11.4-11.2) 10 000 forex asset (11.2-10.8) 20 000 [record payment of supplier and close out of forex contract] bank machinery [ reverse incorrect entry] 2. proceeds on sale accumulated depreciation vehicle at valuation profit on sale 540 000 540 000

(1) (1)

90 000 40 000 120 000 10 000

(1) (1) (1) (1) (1)

valuation at 1.1.02 = 80 000 x 2/3 = 120 000 3. Delivery vehicles
Revalued carrying amount Historic cost/tax value Temporary difference Deferred tax (balance sheet)

Revaluation reserve

31.12.01 31.12.02 Sold Revalue Depreciation 31.12.03 New vehicle 1.1.03 Depreciation 800 (80) 720 200 920 (460) 460

800 (200) 600 (200) 400 (50) 350 ---350 (175) 175

400 370 200 570 285

120cr 111cr 60cr 171cr 85cr

280 259 140 399 200

(1) (1) (1) (1) (1)

360 (90) 270 Carrying value 31.12.03

360 (90) 270 ---460+270 = R730 000

(1) (1)

Computer equipment Total payments: 6 x 50 000 Present value of minimum lease payments:

=

300 000

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6 half year periods at 6% per half year 50 000 x (1 + 4.9174) Total 260 620

(1) (1)

Date Finance charges Capital 01.01.02 01.01.02 01.01.02 31.06.02 12 637 01.07.02 01.07.02 31.12.02 10 395 01.01.03 01.01.03 30.06.03 8 019 01.07.03 31.12.03 Lease liability 31.12.03 5 500

260 620 (50 000) 210 620 (37 363) 173 257 (39 605) 133 652 (41 981) 91 671

(1)

(1)

(1)

(1)

91 671 + 5 500

=

97 171 (1) 86 873 (1)

Net book value of computer equipment 260 620/3 = Deferred tax: CV TV

Opening bal. 31.12.03 Other diffs Vehicles Computers Lease liability Instalment due Balance 31.12.03 86 873 (97 171) 50 000

Temporary Deferred difference tax balance sheet 80 000cr (240 000)dr 285 000cr 86 873cr (97 171)dr 50 000cr

(1) (1) (1) (1) (1) (1) (1)

84 702dr

25 410 dr

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