PRACTICE & REVISION KIT

CA SRI LANKA CURRICULUM 2020

 Second edition 2020

ISBN 9781 5097 3166 4

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ii
Contents

Page
Question Index iv
Introduction vi
How to use this Practice & Revision Kit vii
Format of the Exam ix
Exam techniques x
Action verbs xii
Learning outcomes xv
Questions 3
Answers 89
Mock exam questions 249
Mock exam answers 261

Contents iii
 Question index

Title Marks Time Page

allocated allocated Question Answer
(Minutes)
Part A: Interpretation and Application of Sri Lanka Accounting Standards and
Recent Developments in Financial Reporting
1 Accounting queries 25 45 3 89
2 Prochain 25 45 5 92
3 Panel 25 45 7 95
4 Ambush 25 45 8 99
5 Enigma 25 45 9 102
6 Masham 25 45 11 104
7 Complexity 25 45 13 108
8 Carsoon 25 45 14 111
9 Calendar 25 45 15 114
10 Verge 25 45 17 117
11 Moorland 25 45 19 122

Part B: Preparation and Presentation of Consolidated Financial Statements

12 Glove 25 45 21 126
13 Ejoy 25 45 23 132
14 Swing 25 45 25 138

Part C: Evaluating Risk of Material Misstatement in Financial Statements

15 Risk and Going Concern 25 45 27 141
16 Maleats Group Plc 25 45 28 145
17 Laurel Group Plc 25 45 30 149
18 Silva Group 25 45 32 154

Part D: Corporate Governance and Non-Financial Reporting

19 Calcula 25 45 35 159
20 Glowball 25 45 36 163
21 Country A 25 45 38 166
22 Comfort Hotels 25 45 39 170

iv SL1 | Advanced Business Reporting

 Title Marks Time Page
allocated allocated Question Answer
(Minutes)
Part E: Ethical Issues in Financial Reporting and the Regulatory Framework
23 David 25 45 41 174
24 WWW 25 45 42 177

Part F: Case Study Questions

25 Johan 50 90 44 181
26 Carpart 50 90 48 186
27 Mica 50 90 52 191
28 Robby 50 90 56 197
29 Ashanti 50 90 61 206
30 Rose 50 90 66 216
31 Warrburt 50 90 70 225
32 Nandasiri Ltd 50 90 77 231
33 Healthwise 50 90 81 238

Question Index v
 Introduction

Welcome to the Practice & Revision Kit for the Institute of Chartered Accountants of
Sri Lanka professional examinations for curriculum 2020.
One of the key criteria for achieving exam success is question practice. There is
generally a direct correlation between candidates who revise all topics and practise
exam questions and those who are successful in their real exams. This Practice &
Revision Kit gives you ample opportunity for such practice in the run up to your
exams.
The Practice & Revision Kit is structured to follow the modules of the Study Text, and
comprises banks of non-complex mini scenario and functional scenario questions as
appropriate. Suggested solutions to all questions are supplied.
We welcome your feedback. If you have any comments about this Practice &
Revision Kit, or would like to suggest areas for improvement, please email
[email protected].
Good luck in your exams!

BPP LEARNING MEDIA

vi SL1 | Advanced Business Reporting

How to use this Practice & Revision Kit

This Practice & Revision Kit comprises banks of practice questions of the style that
you will encounter in your exam. It is the ideal tool to use during the revision phase of
your studies.
Questions in your exam may test any part of the syllabus so you must revise the
whole syllabus. Selective revision will limit the number of questions you can answer
and hence reduce your chances of passing. It is better to go into the exam knowing a
reasonable amount about most of the syllabus rather than concentrating on a few
topics to the exclusion of the rest. You should at all costs avoid falling into the trap of
question spotting, that is trying to predict what are likely to be popular areas for
questions, and restricting your revision and question practice to those.
Practising as many exam-style questions as possible will be the key to passing this
exam. You must do questions under timed conditions and ensure you write full
answers to the discussion parts as well as doing the calculations.
Planning your revision
When you begin your course, you should make a plan of how you will manage your
studies, taking into account the volume of work that you need to do and your other
commitments, both work and domestic.
In this time, you should go through your notes to ensure that you are happy with all
areas of the syllabus and practise as many questions as you can. You can do this in
different ways, for example:
 Revise the subject matter a module at a time and then attempt the questions
relating to that module; or
 Revise all the modules and then build an exam out of the questions in this
Practice & Revision Kit.
Using the practice questions
The best approach is to select a question and then allocate to it the time that you
would have in the real exam. All the questions in this Practice & Revision Kit have
mark allocations, so you can calculate the amount of time that you should spend on
the question.
Using the suggested solutions
Avoid looking at the answer until you have finished a question. It can be very
tempting to do so, but unless you give the question a proper attempt under exam
conditions you will not know how you would have coped with it in the real exam
scenario.

How to use this Practice & Revision Kit vii

 When you do look at the answer, compare it with your own and give some thought to
why your answer was different, if it was.
If you did not reach the correct answer make sure that you work through the
explanation or workings provided, to see where you went wrong. If you think that you
do not understand the principle involved, go back to your own notes or your study
materials and work through and revise the point again, to ensure that you will
understand it if it occurs in the exam.
Our suggested solutions are comprehensive, but in some discursive questions it may
be that you have made points that are not included in the suggested solution that are
equally valid. In the real exams you should be given credit for such points.

viii SL1 | Advanced Business Reporting

Format of the exam

Mode: Paper based examination, open book

Time: 3 hours
Pass Mark: 50%

The exam comprises of two sections, as follows:

Section 1
Total 50 marks: Two (2) questions of twenty five (25) marks each based on complex
scenarios requiring evaluation and solutions based on synthesis.
Section 2
Total 50 marks: Common 'pre-seen' provided prior to the exam to familiarise with
particular business context, and at exam 'un-seen' material provided to set the scene
for assessment under each course module. Answering needs a balancing of a number
of angles, and delivered in a professional manner.

Format of the exam ix

 Exam techniques

Using the right technique in the real exam can make all the difference between
success and failure.
Here are a few pointers:
1. At the start of the exam, read through the questions and decide in what order
you are going to attempt the exam. You have to write your answers in the
order set out in the question and answer booklet, but you can attempt the
questions in any order that you like.
Some candidates like to attempt the easiest questions first, on the basis that will
enable them to gain the easiest available marks quickly, and build up their
confidence.
If you select a question on a topic area about which you feel confident, and do
that first, you will build up your confidence right at the start, which will help to
calm you if you are nervous and set the tone for the rest of the exam. You should
decide what approach is best for you.
2. Having established the order that you are going to do the exam, allocate the
time available to the questions and work out at what time you will need to
stop working on one question and move on to the next. When you reach the end
of the allocated time for the question that you are working on, STOP. It is much
easier to gain the straight forward marks for the next question than to spend a
long time working on the previous question in the hope of gaining one or two
final marks.
3. Read the question. Read it carefully once, and then read it again to ensure that
you have picked everything up. Make sure that you understand what the
question wants you to do, rather than what you might like the question to be
asking you.
4. Answer all parts of the question. Even if you cannot do all of the calculation
elements, you will still be able to gain marks in the discussion parts.
5. Don't worry if you think that you have made a mistake in a computational part
of a question. You will not earn the mark for that particular part, but you will
still be able to gain credit for correct application in the later parts of the
question, even if you are using the wrong figure.
6. When starting to read a question, especially a long case study, read the
requirement first. You will then find yourself considering the requirement as
you read the data in the scenario, helping you to focus on exactly what you have
to do.

x SL1 | Advanced Business Reporting

7. Plan your answer before you start to write your response, especially for longer
case studies. This will help you to focus on the requirements of the question and
to avoid irrelevance.
8. Try to make sure that your answer relates to the specifics of the question
itself. If you are asked to consider the impact of the scenario on someone named
in the question, make sure that you do that, so your answer is as relevant as
possible.
9. If you finish the exam with time to spare, use the rest of the time to review your
answers and to make sure that you answered every requirement for every
question.

Exam techniques xi
 Action verbs checklist

Knowledge Process Verb List Verb Definitions

Tier - 1 Remember Define Describe exactly the nature, scope or meaning

Recall important
information Draw Produce (a picture or diagram)

Identify Recognise, establish or select after consideration

List Write the connected items one below

the other
Relate To establish logical or causal connections

State Express something definitely or clearly

Tier - 2 Calculate/Compute Make a mathematical computation

Comprehension
Explain important Discuss Examine in detail by argument showing
information different aspects, for the purpose of arriving at a
conclusion
Explain Make a clear description in detail
revealing relevant facts
Interpret Present in understandable terms or to translate

Recognise To show validity or otherwise, using knowledge

or contextual experience
Record Enter relevant entries in detail

Summarise Give a brief statement of the main points

(in facts or figures)

Classify Allocate into categories

Describe Communicate the key features

Provide Give illustrations to support or illuminate

a point or assertion

Tier - 3 Application Apply Put to practical use

Use knowledge in a
Assess Determine the value, nature, ability
setting other than the or quality
one in which it was
learned/solve close- Demonstrate Prove, especially with examples
ended problems
Graph Represent by means of a graph
Prepare Make ready for a particular purpose

Prioritise Arrange or do in order of importance

Reconcile Make consistent with another

Solve To find a solution through calculations and/
or explanations

xii SL1 | Advanced Business Reporting

Knowledge Process Verb List Verb Definitions

Conduct Organize and carry out a task

Communicate Transmit thoughts or knowledge

Display Make evident or noticeable

Perform Do or execute, usually in the sense of

a complex procedure

Reconcile Make or prove consistent or compatible

or show differences

Set Fix or establish

Select Choose from a range of options

or possibilities
Support Assist to make decisions by providing
appropriate information about
respective concepts
Use Apply in a practical way
Undertake Commit to do or perform
Tier - 4 Analysis Analyse Examine in detail in order to determine
the solution or outcome
Draw relations among
Compare Examine for the purpose of
ideas and to compare
discovering similarities
and
Contrast Examine in order to show
contrast/solve open- unlikeness or differences
ended problems
Construct Build or make a diagram, model
or formula

Differentiate Constitute a difference that

distinguishes something
Outline Make a summary of significant features

Write Provide word descriptions to express an opinion

or idea
Tier - 5 Evaluate Advise Offer suggestions about the best course of
Formation of action in a manner suited to the recipient
judgments and Convince To persuade others to believe something
decisions about the using evidence and/or argument
value of methods, ideas, Criticise Form and express a judgment
people or products
Comment Provide written remarks expressing an opinion
in both positive and negative perspectives
Evaluate To determine the significance by careful appraisal

Conclude Form a judgment about, or determine or resolve

the outcome of, an issue through a process
involving reasoning
Determine Ascertain or conclude after analysis and
consideration; judge

Exam techniques xiii

 Knowledge Process Verb List Verb Definitions
Justify Give valid reasons or evidence for

Review Study critically with a view

to correction or improvement
Recommend A suggestion or proposal as to the
best course of action
Resolve Settle or find a solution to a
problem or contentious matter
Validate Check or prove the accuracy

Tier - 6 Synthesis Compile Produce by assembling information

Solve unfamiliar problems by collected from various sources
combining different aspects Design Devise the form or structure according to
to form a unique or novel a plan
solution Develop To disclose, discover, perfect or unfold a
plan or idea

Propose To form or declare a plan or intention

for consideration or adoption

Anticipate Foresee, or experience or realise

beforehand

Draft Write original material for the scrutiny

of others

Formulate Devise and put into words

Plan Devise the plan for an assurance

engagement

Report Give the formal final conclusion for an

assurance engagement

Submit Send a completed document to a

particular party

Suggest Put forward an idea or give reasons

Synthesize Make or propose a new concepts or ideas

by combining existing knowledge in
different aspects

xiv
SL1 | Advanced Business Reporting
Learning outcomes

Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

A. Interpretation 1.1 Level A 1.1.1 Advise on the application of Sri Annexure 01 - Accounting 2, 9, 25, 27, 28, 33
and Application of Thorough knowledge and Lanka Accounting Standards in solving Standards Levels
Sri Lanka comprehension of the standard to complicated matters.
Accounting identify significant complicated issues
Standards (S and any potential implications to the
LFRS/LKAS/IFRIC/ financial statements, and to exercise
SIC) and Recent professional judgment in the evaluation
Developments in and application of standards in resolving
Financial Reporting a complicated matter related to financial
reporting. 1.1.2 Recommend the appropriate
accounting treatment to be used in
 A "complicated matter" includes
complicated circumstances in
transactions and/or events which
accordance with Sri Lanka Accounting
require thorough analysis of the
Standards.
matter and evaluation of standards.
 It may require the analysis, 1.1.3 Evaluate the outcomes of the
application and evaluation of application of different accounting
relevant standard/s. (Refer treatments.
Appendix 3)
1.1.4 Propose appropriate accounting
policies to be selected in different
circumstances.

Learning outcomes xv
 Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

1.1.5 Evaluate the impact of the use of

different expert inputs to financial
reporting.

1.1.6 Advise appropriate application and

selection of accounting/ reporting
options given under standards.

1.1.7 Design the appropriate disclosures

to be made in the financial statements.

1.2 Level B 1.2.1 Apply Sri Lanka Accounting Annexure 01 - Accounting 1, 2, 3, 4, 5, 6, 7, 8, 9,

Good knowledge and comprehension of Standards in solving moderately Standards Levels 10, 11, 25, 26, 27, 30,
the standard to identify moderately complicated matters. 31, Mock Q1, Mock
complicated issues and any potential Q2, Mock Q3
implications to the financial statements,
and to exercise professional judgment in 1.2.2 Recommend the appropriate
the analysis and application of standards accounting treatment to be used in
in resolving a moderately complicated complicated circumstances in
matter related to financial reporting. accordance with Sri Lanka Accounting
Where: A "moderately complicated Standards.
matter" includes transactions and/or
events which require an analysis of a
matter and evaluation of such matter 1.2.3 Demonstrate a thorough
with the related standard/s. knowledge of Sri Lanka Accounting
(Refer Appendix 3) standards in the selection and
application of accounting policies.

xvi
SL1 | Advanced Business Reporting
Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

1.2.4 Demonstrate the appropriate

application and selection of
accounting/reporting options given
under standards.

1.2.5 Outline the disclosures to be made

in the financial statements.

1.3 Level C 1.3.1 Explain the concepts/principals of Annexure 01 - Accounting 3, 7, 8, 9, 10, 11, 25,
Conceptual knowledge and Sri Lanka Accounting Standards. Standards Levels 26, 27, Mock Q1
understanding of the standard to
identify simple issues, to exercise
reasonable professional judgment in the
application of standards in resolving a 1.3.2 Apply the concepts/principals of
simple (straightforward) matter related the standards to resolve a
to financial reporting. simple/straight forward matter.
A "simple transaction or event" includes
transactions or events which require
direct and conceptual application of 1.3.3 List the disclosures to be made in
standards. (Refer Appendix 3) the financial statements.

Learning outcomes xvii

 Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

1.4 New exposure drafts and 1.4.1 Evaluate the possible impact of Possible impact to preparation 9
implications of the adoption to the new exposure drafts on financial of financial statements and
existing presentation / disclosures statements. special disclosure requirements

B. Preparation and 2.1 Separate & Consolidated Financial 2.1.1 Compile consolidated financial Consolidated Financial 12, 13, 14, 28, 29, 30,
Presentation of Statements statements for a group with more than Statements in complex group 31, Mock Q3
consolidated two subsidiaries, sub-subsidiaries or structures
which includes:
Financial foreign subsidiaries.
Statements  investments in
Subsidiary/Subsidiaries/Sub
subsidiaries including foreign
operations.
 Investment in joint arrangements &
Associates 2.1.2 Recompile a consolidated set of Implications to financial
financial statements, post-acquisition, statements under different levels
merger or divestment. of investment / control/
influence (Application of SLFRS
3/ SLFRS 10/ LKAS 27)
2.1.3 Evaluate the information provided Circumstances to which SLFRS
and identify the existence of joint 11 is applicable
ventures.

2.1.4 Compile financial statements for Accounting for investments in

joint ventures. joint arrangements

2.1.5 Advice appropriate accounting Circumstances to which LKAS 28

treatment to be used when there is an is applicable
investment in an associate.

xviii SL1 | Advanced Business Reporting

Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

2.1.6 Compile financial statements when Accounting for investments in

there is an investment in an associate associates

C. Evaluating Risk 3.1 Risk of Material Misstatements 3.1.1 Demonstrate the meaning and  Financial Reporting 15, 33
of Material components of risk of material framework
Misstatement in misstatement in the context of financial
Financial reporting framework.  Inherent risk and control
Statements risk
 SLAuS 200
3.2 Financial Statement Assertions 3.2.1 Demonstrate the use of financial  SLAuS 315
statements assertions by management in
preparing financial statements and the
application of assertions in identifying
potential misstatements in financial
statements.
3.3 Business risks and risk of material 3.3.1 Evaluate for a specified scenario  SLAus 200 15, 16, 17, 18, 32
misstatements including risk of how significant business risk results in  SLAuS 240 – Types of Fraud
frauds risk of material misstatements in  Fraud risk indicators
financial statements including the
presence of fraud risk factors.

Learning outcomes xix

 Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

3.4 Going Concern 3.4.1 Evaluate events and conditions Application of LKAS 1 and SLAuS 15, 32
affecting the validity of going concern 570 to determine the validity of
assumption used in preparing financial going concern basis and
statements in determining the implication of a material
disclosures required on material uncertainty on auditors' opinion
uncertainty.
3.5 Materiality 3.5.1 Apply the concept of materiality in SLAuS 300 materiality practice 16, 17, 18
evaluating misstatements in financial statement
statements.
3.6 Data Analytics for users of 3.6.1 Interpret financial and non- Ratio analysis / trend analytics, 31
financial statements financial information using data regression / correlation and
analytics to draw conclusions useful for other useful techniques
economic decision making of users of
financial statements.
3.7 Data Analytics in risk assessment 3.7.1 Application of data analytics and  Data analytics techniques 17, 32, 33
and in discovering material statistical techniques in performing including predictive analysis
misstatement due to errors or frauds. analytical procedures to evaluate and other statistical
potential misstatements in financial techniques that could be
statements. used in analysing financial
statements
 Journal entry analysis
 SLAuS 520 definition of
analytical procedures and its
application in audits

xx SL1 | Advanced Business Reporting

Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

3.8 Internal Control Framework 3.8.1 Demonstrate components of an  SLAuS 315

integrated internal control framework
and its importance in ensuring the  COSO 2013 – Integrated
reliability of financial statements. Control Framework

3.9 Internal Controls over Financial 3.9.1 Evaluate in a specified scenario, Key internal financial controls 18
Reporting components of internal controls relating including IT application
to financial reporting to identify internal controls and controls over
control deficiencies. journal entries.
3.10 Internal Controls relevant in 3.10.1 Advise group management on  SLAuS 600 – Groupwide 18
preparing group financial statements internal controls including groupwide controls
controls applicable in preparing

consolidated financial statements  Group instruction to

including related party transactions. components
 Controls over identification
and elimination of related
party transactions and other
consolidated adjustments
D. Corporate 4.1 Corporate governance and 4.1.1 Criticise an annual report of a Corporate governance 19, 20, 21, 22, 29
Governance and sustainability reports including company in a given scenario, on the disclosures
Non-Financial integrated reporting basis of adequacy of corporate
Reporting governance disclosures.
4.1.2 Compile an integrated report along Integrated report along with a
with a sustainability report for a given sustainability reports,
entity. Knowledge including business
environment in which the entity
operates

Learning outcomes xxi

 Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

4.1.3 Evaluate integrated/sustainability Integrated/sustainability reports

reports in accordance with the “triple in accordance with the “triple
bottom line principle” and GRI and IIRC bottom line principle” and GRI
guidelines. and IIRC guidelines
4.2 Corporate governance theory and 4.2.1 Discuss the concept of corporate Operational, relationship, 21, 22
practices governance from different perspectives. stakeholder, financial economics,
societal perspectives of
corporate governance the
difference between governance
and management
4.2.2 Evaluate the role and limitations of Case study discussion on
corporate governance in preventing Governance failures including
corporate failures. those caused by global economic
crisis, unethical behaviour and
examination of role and
limitation of corporate
governance in preventing such
failures
4.2.3 Demonstrate the regulatory This should cover both local and
framework pertaining to the corporate international regulations
governance.

4.2.4 Demonstrate contemporary issues Including key trends around the

and trends on corporate governance. world US, EU, India, Japan and UK

xxii SL1 | Advanced Business Reporting

Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

4.2.5 Discuss different Models of American rules-based model

Corporate governance. UK/Commonwealth principles-
based model; Continental
European two-tier model
Corporate Governance
convergence or differentiation
4.3 Board of Directors 4.3.1 Evaluate the effectiveness of a Characteristics of an effective 21, 22
board, in the perspective of governance. board, role of executive and non-
executive directors, role of
Chairman, SID, Board
composition, diversity,
performance appraisal and
decision (FRC), Board
information, agenda etc. The six
Cs of effective board behaviour
(Commitment, Character,
Collaboration, Competence,
Creativity, Contribution)
4.3.2 Discuss functions of the board Strategy formulation; policy
including performance and making; supervision of executive
conformance. management; and accountability
to shareholders and others
4.3.3 Evaluate functions of Board/Board True and fair view, internal
Committee in ensuring integrity of controls over financial reporting,
financial and business reporting. integrated reporting, going
concern, related party
transactions, ESG reporting

Learning outcomes xxiii

 Syllabus Area Knowledge Component Learning Outcomes Specific Knowledge Question

4.4 Audit Committee 4.4.1 Evaluate the effectiveness of audit Best practices drawn from 22
committee based on corporate different codes/reports/
governance best practices. international guidance

4.4.2 Evaluate the role of audit Ability to relate and evaluate

Committee in strengthening control functions of audit committee to
environment. elements of control environment

4.4.3 Advice interaction between SLAuS 260, 265, discussing

external auditor and audit committee in reporting issues at early stage
ensuring the effectiveness of an (Proposed modifications, Key
independence of audit. audit matters, Emphasis of
matters/other matters/going
concerns issues
E. Ethical Issues in 5.1 Recent ethical issues 5.1.1 Advise on accurate presentation of Presentation of financial 23, 24, 28, 29, 30,
Financial Reporting financial statements for a given set of statements for a given set of Mock Q3
and the Regulatory circumstances, with reference to global circumstances, with reference to
Framework examples. global examples, Ethical issues in
financial reporting and the
regulatory framework

xxiv SL1 | Advanced Business Reporting

Questions

2 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

PART A: INTERPRETATION AND APPLICATION OF SRI LANKA ACCOUNTING

STANDARDS AND RECENT DEVELOPMENTS IN FINANCIAL REPORTING
Questions 1 to 11 cover Interpretation and Application of Sri Lanka Accounting
Standards and Recent Developments in Financial Reporting.

1 Pensions 45 mins
(a) Joydan
Joydan, a public limited company, is a leading support services company
which focuses on the building industry. The company would like advice on
how to treat certain items under LKAS 19 Employee Benefits. The company
operates the Joydan Pension Plan B which commenced on 1 November 20X6
and the Joydan Pension Plan A, which was closed to new entrants from
31 October 20X6, but which was open to future service accrual for the
employees already in the scheme. The assets of the schemes are held
separately from those of the company in funds under the control of trustees.
The following information relates to the two schemes.
Joydan Pension Plan A
The terms of the plan are as follows.
(i) Employees contribute 6% of their salaries to the plan.
(ii) Joydan contributes, currently, the same amount to the plan for the
benefit of the employees.
(iii) On retirement, employees are guaranteed a pension which is based
upon the number of years' service with the company and their final
salary.
The following details relate to the plan in the year to 31 October 20X7:
Rs m
Present value of obligation at 1 November 20X6 200
Present value of obligation at 31 October 20X7 240
Fair value of plan assets at 1 November 20X6 190
Fair value of plan assets at 31 October 20X7 225
Current service cost 20
Pension benefits paid 19
Total contributions paid to the scheme for year to 31 October 20X7 17
Remeasurement gains and losses are recognised in accordance with LKAS 19.
Assume that contributions are paid into the plan and pension benefits are
withdrawn from the plan on 31 October 20X7.

CA Sri Lanka 3
Questions

Joydan Pension Plan B

Under the terms of the plan, Joydan does not guarantee any return on the
contributions paid into the fund. The company's legal and constructive
obligation is limited to the amount that is contributed to the fund. The
following details relate to this scheme:
Rs m
Fair value of plan assets at 31 October 20X7 21
Contributions paid by company for year to 31 October 20X7 10
Contributions paid by employees for year to 31 October 20X7 10
The interest rate on high quality corporate bonds for the two plans are:
1 November 20X6 31 October 20X7
5% 6%
The company would like advice on how to treat the two pension plans, for
the year ended 31 October 20X7, together with an explanation of the
differences between a defined contribution plan and a defined benefit plan.

Required
Prepare a briefing note for the directors of Joydan which includes:
(i) An explanation of the nature of and differences between a defined
contribution plan and a defined benefit plan with specific reference to
the company's two schemes. (8 marks)
(ii) The accounting treatment for the two Joydan pension plans for the year
ended 31 October 20X7 under LKAS 19 Employee Benefits. (8 marks)
(b) Wallace
Wallace, a listed entity with a reporting date of 31 October, operates a
defined benefit pension plan for its employees. During September 20X7,
Wallace decided to relocate a division from one country to another, where
labour and raw material costs are cheaper. The relocation is due to take
place in May 20X8. On 30 September 20X7, a detailed formal plan for the
relocation was approved and the affected employees were informed. Half of
the affected division's employees will be made redundant in December 20X7,
and will accrue no further benefits under Wallace's defined benefit pension
plan. The resulting reduction in the net pension liability due to the relocation
is estimated to have a present value of Rs. 15 million as at 31 October 20X7.
The directors of Wallace have correctly recognised a restructuring provision
relating to the relocation in the financial statements for the year ended
31 October 20X7, but would like advice on how to account for the reduction
in the net pension liability.

4 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

The directors are aware that the IASB has recently amended LKAS 19 but are
unsure of the detail of the amendments or whether they will have any effect
on Wallace's financial statements for the year ended 31 October 20X7.

Required
Prepare a briefing note for the directors of Wallace which includes:
(i) An explanation of how to account for the reduction in the net pension
liability for the year ended 31 October 20X7 in accordance with
LKAS 19 Employee Benefits. (5 marks)
(ii) An explanation of the amendments to LKAS 19 issued in 2018 (Plan
Amendment, Curtailment or Settlement (Amendments to LKAS 19)) and
of any effect of these amendments, giving consideration to materiality,
on Wallace's financial statements for the year ended 31 October 20X7.
You should assume that the amendments are effective for Wallace for
the year ended 31 October 20X7. (4 marks)
(LO 1.2.1, 1.2.2) (Total = 25 marks)

2 Prochain 45 mins
Prochain, a public limited company, operates in the fashion industry and has a
financial year end of 31 May 20X6.
The company sells its products in department stores throughout the world.
Prochain insists on creating its own selling areas within the department stores,
which are called 'model areas'. Prochain is allocated space in the department store
where it can display and market its fashion goods. The company feels that this helps
to promote its merchandise. Prochain pays for all the costs of the 'model areas'
including design, decoration and construction costs. The areas are used for
approximately two years after which the company has to dismantle the 'model
areas'. The costs of dismantling the 'model areas' are normally 20% of the original
construction cost and the elements of the area are worthless when dismantled.
The current accounting practice followed by Prochain is to charge the full cost of
the 'model areas' against profit or loss in the year when the area is dismantled.
The accumulated cost of the 'model areas' shown in the statement of financial
position at 31 May 20X6 is Rs. 20 million. The company has estimated that the
average age of the 'model areas' is eight months at 31 May 20X6. (7 marks)
Prochain acquired 100% of a sports goods and clothing manufacturer, Badex,
a private limited company, on 1 June 20X5. Prochain intends to develop its own
brand of sports clothing which it will sell in the department stores.
The shareholders of Badex valued the company at Rs. 125 million based upon
profit forecasts which assumed significant growth in the demand for the 'Badex'
brand name. Prochain had taken a more conservative view of the value of the
company and measured the fair value as being in the region of Rs. 108 million to

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Rs. 112 million of which Rs. 20 million relates to the brand name 'Badex'. Prochain
is only prepared to pay the full purchase price if profits from the sale of 'Badex'
clothing and sports goods reach the forecast levels. The agreed purchase price was
Rs. 100 million plus a further payment of Rs. 25 million in two years, on
31 May 20X7. This further payment comprises a guaranteed payment of
Rs. 10 million with no performance conditions and a further payment of
Rs. 15 million if the actual profits during this two-year period from the sale of
Badex clothing and goods exceed the forecast profit. The forecast profit on Badex
goods and clothing over the two-year period is Rs. 16 million and the actual profits
in the year to 31 May 20X6 were Rs. 4 million. Prochain did not feel at any time
since acquisition that the actual profits would meet the forecast profit levels.
(8 marks)
After the acquisition of Badex, Prochain started developing its own sports clothing
brand 'Pro'. The expenditure in the period to 31 May 20X6 was as follows.
Period from Expenditure type Rs m
1.6.X5–31.8.X5 Research as to the extent of the market 3
1.9.X5–30.11.X5 Prototype clothing and goods design 4
1.12.X5–31.1.X6 Employee costs in refinement of products 2
1.2.X6–30.4.X6 Development work undertaken to finalise design of 5
product
1.5.X6–31.5.X6 Production and launch of products 6
20
The costs of the production and launch of the products include the cost of
upgrading the existing machinery (Rs. 3 million), market research costs
(Rs. 2 million) and staff training costs (Rs. 1 million). Currently an intangible asset
of Rs. 20 million is shown in the financial statements for the year ended
31 May 20X6. (6 marks)
Prochain owns a number of prestigious apartments, which it leases to famous
persons who are under a contract of employment to promote its fashion clothing.
The apartments are let at below the market rate. The lease terms are short and are
normally for six months. The leases terminate when the contracts for promoting
the clothing terminate. Prochain wishes to account for the apartments as
investment properties with the difference between the market rate and actual
rental charged to be recognised as an employee benefit expense. (4 marks)

Required
Analyse the information provided in order to recommend how the above items
should be dealt with in the financial statements of Prochain for the year ended
31 May 20X6 under Sri Lanka Financial Reporting Standards. (Assume a discount
rate of 5.5% where necessary and work to the nearest Rs. 100,000.)
(LO 1.1.3, 1.2.1, 1.2.2) (Total = 25 marks)

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3 Panel 45 mins
The directors of Panel, a public limited company, are reviewing the procedures for
the calculation of the deferred tax liability for their company. They are quite
surprised at the impact on the liability caused by changes in accounting standards
such as SLFRS 1 First time adoption of International Financial Reporting Standards
and SLFRS 2 Share-based payment. Panel is adopting Sri Lanka Financial Reporting
Standards for the first time as at 31 October 20X5 and the directors are unsure
how the deferred tax provision will be calculated in its financial statements ended
on that date including the opening provision at 1 November 20X3.

Required
(a) Explain how changes in accounting standards are likely to have an impact
on the deferred tax liability under LKAS 12 Income taxes. (5 marks)
(b) Explain the basis for the calculation of the deferred taxation liability on first
time adoption of SLFRS including the provision in the opening SLFRS
statement of financial position. (4 marks)
Additionally, the directors wish to know how the provision for deferred
taxation would be calculated in the following situations under LKAS 12
Income taxes:
(i) On 1 November 20X3, the company had granted ten million share
options subject to a two-year vesting period. The options had a fair
value of Rs. 40 million on the grant date and all are expected to vest.
Local tax law allows a tax deduction at the exercise date of the intrinsic
value of the options. The intrinsic value of the ten million share options
at 31 October 20X4 was Rs. 16 million and at 31 October 20X5 was
Rs. 46 million. The increase in the share price in the year to
31 October 20X5 could not be foreseen at 31 October 20X4.
The options were exercised at 31 October 20X5. The directors are
unsure how to account for deferred taxation on this transaction for the
years ended 31 October 20X4 and 31 October 20X5.
(ii) Panel is leasing plant over a five-year period. The right of use asset was
recorded at the present value of the minimum lease payments of
Rs. 12 million at the inception of the lease which was 1 November 20X4.
The asset is depreciated on a straight-line basis over the five years,
its useful life, and has no residual value. The annual lease payments are
Rs. 3 million payable in arrears on 31 October and the effective interest
rate is 8% per annum. The directors have not leased an asset before and
are unsure as to its treatment for deferred taxation. The company can
claim a tax deduction for the annual rental payment as the lease does not
qualify for tax relief.
(iii) A wholly owned subsidiary, Pins, a limited liability company,
sold goods costing Rs. 7 million to Panel on 1 September 20X5,

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and these goods had not been sold by Panel before the year end of
31 October 20X5. Panel had paid Rs. 9 million for these goods.
The directors do not understand how this transaction should be dealt
with in the financial statements of the subsidiary and the group for
taxation purposes. Pins pays tax locally at 30%.
(iv) Nails, a limited liability company, is a wholly owned subsidiary of
Panel, and is a cash generating unit in its own right. The value of the
property, plant and equipment of Nails at 31 October 20X5 was
Rs. 6 million and purchased goodwill was Rs. 1 million before any
impairment loss. The company had no other assets or liabilities.
An impairment loss of Rs. 1.8 million had occurred at 31 October 20X5.
The tax base of the property, plant and equipment of Nails was
Rs. 4 million as at 31 October 20X5. The directors wish to know how
the impairment loss will affect the deferred tax liability for the year.
Impairment losses are not an allowable expense for taxation purposes.
(c) Advise, with suitable computations, how the situations (i) to (iv) above will
impact on the accounting for deferred tax under LKAS 12 Income taxes
in the group financial statements of Panel. Assume a tax rate of 30%.
(The situations in (i) to (iv) above carry equal marks.) (16 marks)
(LO 1.2.1, 1.2.2, 1.3.2) (Total = 25 marks)

4 Ambush 45 mins
Ambush loaned Rs. 200,000 to Bromwich on 1 December 20X3. At the inception of
the loan the 12-month expected credit losses were assessed but no provision was
thought to be necessary. The effective and stated interest rate for this loan was
8%. Interest is payable by Bromwich at the end of each year and the loan is
repayable on 30 November 20X7. At 30 November 20X5, the directors of Ambush
have heard that Bromwich is in financial difficulties and is undergoing a financial
reorganisation. The directors feel that it is likely that they will only receive
Rs. 100,000 on 30 November 20X7 and no future interest payment. Interest for the
year ended 30 November 20X5 had been received. The financial year end of
Ambush is 30 November 20X5.

Required
(a) Outline the requirements of SLFRS 9 as regards the impairment of financial
assets held at amortised cost. (10 marks)
(b) Explain the accounting treatment under SLFRS 9 of the loan to Bromwich in
the financial statements of Ambush for the year ended 30 November 20X5.
(6 marks)
The impairment of trade receivables has been calculated using a formulaic
approach, which is based on a specific percentage of the portfolio of trade
receivables. The general provision approach has been used by the company at

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 SL1 Advanced Business Reporting | Questions

30 November 20X5. At 30 November 20X5, one of the credit customers, Tray,

has come to an arrangement with Ambush whereby the amount outstanding of
Rs. 4 million from Tray will be paid on 30 November 20X6 together with a penalty
of Rs. 100,000. The total amount of trade receivables outstanding at
30 November 20X5 was Rs. 11 million including the amount owed by Tray.
The following is the analysis of the trade receivables.
Balance Cash expected Due date
Rs m Rs m
Tray 4 4.1 30 November 20X6
Milk 2 2.0 31 January 20X5
Other receivables 5 4.6 On average 31.1.X5
11 10.7
Ambush has made an allowance of Rs. 520,000 against trade receivables which
represents the difference between the cash expected to be received and the
balance outstanding plus a 2% general allowance. Milk has a similar credit risk to
the 'other receivables'. (Use a discount rate of 5% in any calculations.)

Required
(c) Advise Ambush as to the acceptability of its approach towards the
impairment of trade receivables under SLFRS 9, and recommend an
alternative acceptable approach if required. (9 marks)
(LO 1.2.1, 1.2.2, 1.2.3) (Total = 25 marks)

5 Engina 45 mins
Engina, a foreign company, has approached a partner in your firm to assist in
obtaining a local Stock Exchange listing for the company. Engina is registered in a
country where transactions between related parties are considered to be normal
but where such transactions are not disclosed. The directors of Engina are
reluctant to disclose the nature of their related party transactions as they feel that
although they are a normal feature of business in their part of the world, it could
cause significant problems politically and culturally to disclose such transactions.
The partner in your firm has requested a list of all transactions with parties
connected with the company and the directors of Engina have produced the
following summary.
(i) Every month, Engina sells Rs. 50,000 of goods per month to Mr Satay,
the Finance Director at cost price. The annual turnover of Engina is
Rs. 300 million. Additionally, Mr Satay has purchased his car from the
company for Rs. 45,000 (market value Rs. 80,000). The director, Mr Satay,
earns a salary of Rs. 500,000 a year, and has a personal fortune of many
millions of rupees.

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(ii) A hotel property had been sold to a brother of Mr Soy, the Managing Director
of Engina, for Rs. 3.5 million (net of selling cost of Rs. 0.2 million). The market
value of the property was Rs. 4.3 million but in the foreign country, property
prices were falling rapidly. The carrying amount of the hotel in the books of
Engina was Rs. 5 million and its value in use was Rs. 3.6 million. There was an
oversupply of hotel accommodation due to government subsidies in an
attempt to encourage hotel development and the tourist industry.
(iii) Mr Satay owns several companies and the structure of the group is as follows.
Mr Satay

100% ownership 80% ownership

of Car Limited of Wheel Limited

100% ownership
of Engina Limited

Engina earns 60% of its profits from transactions with Car and 40% of its
profits from transactions from Wheel.
Mr Satay's 80% ownership of Wheel Limited is established by his
shareholding of 100% of the Class A voting shares in that company.
The remaining 20% of the company is owned by Exhaust Limited (which is
not related to Mr Satay). Exhaust Limited holds 100% of the Class B voting
shares in Wheel Limited.

Required
(a) Evaluate the information provided and apply the requirements of LKAS 24
to identify whether a related party transaction exists and advise on the
disclosures to be made in respect of related parties in Engina's financial
statements. (20 marks)
(b) During the year, Wheel Ltd paid a dividend to its shareholders. Wheel and
Exhaust agreed that an unwanted property would be transferred from
Wheel to Exhaust in lieu of a Class B share cash dividend, since this was
more advantageous for tax purposes. The property had a carrying amount of
Rs. 450,000 at the date of transfer and a fair value of Rs. 520,000.
Outline the appropriate accounting treatment for this transaction.
(5 marks)
(LO 1.2.1, 1.2.2, 1.2.5) (Total = 25 marks)

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6 Masham 45 mins
Masham is a diversified company that operates in the agricultural and food
produce sectors. It operates a number of tea plantations and dairy farms
throughout Sri Lanka, as well as three food processing plants. The company has
recently employed a new financial accountant, Richard Perera, who has sent you
the following email in your capacity as a senior working on Masham's external
audit and advisory team.

To: Lucy Da Silva

From: Richard Perera
Date: 21 January 20X3
Subject: Accounting issues
Dear Lucy
I am starting to work on the preparation of the financial statements for Masham
for the year ended 31 December 20X3, and I would like some advice on a number
of matters.
In particular I would like to know how to account for the following issues and the
effect that they will have on the financial statements.
(a) The Finance Director tells me that I must consider the effects of SLFRS 13
when preparing the financial statements and perform a fair value exercise on
certain assets. This is a relatively new standard and one that I didn't study at
college, so I really am a little lost. The assets in question are as follows.
(i) A piece of farm machinery met the criteria to be classified as held for
sale at 31 December 20X3. At that date it had a carrying amount of
Rs. 220,000. The company hasn't yet secured a buyer, however, has
identified active markets for the machine in India and Thailand.
Neither of these markets is greater than the other in terms of the
number of sales transactions of similar machines. The market price of
such a machine is Rs. 244,680 in India and Rs. 237,800 in Thailand. If
the machine were sold to an Indian buyer, transaction costs would
amount to Rs. 4,600 and transport costs to Rs. 29,300. If the machine
were sold to a Thai buyer, transaction costs would be Rs. 3,900 and
transport costs Rs. 18,660.
(ii) The company owns land which it accounts for under the LKAS 16
revaluation model. The land was donated to Masham by a party that
specified it must be used for agricultural purposes. Masham is not
restricted from selling the land but it is not clear whether the usage
restriction would transfer with title. We are trying to clarify this.
Without the restriction, the land could be used for commercial
development and would have a higher market value than it does for the

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current use. The owner of the adjacent property has a legal right of way
to access his property via the land – without this right, the land would
be worth approximately 5% more. (10 marks)
(b) The food processing plants are each classified as a cash-generating unit for
the purposes of impairment testing. At 31 December 20X3, the carrying
amount of each plant was:
CGU 1 CGU 2 CGU 3
Rs'000 Rs'000 Rs'000
PPE 30,000 46,000 16,000
Goodwill 5,000 – –
Net current assets 16,000 24,000 13,000
Brand 4,500
51,000 74,500
The goodwill in CGU 1 arose when an 80% stake in a competitor 29,000
was The
previous owners retained the other 20% shareholding; this NCI was
measured as a proportion of net assets for the purpose of acquisition
accounting.
The brand is used across all Masham processed food; I've allocated it to
CGU 2 on the basis that the carrying amount of that CGU seemed very low.
The Finance Director has asked me to conduct an impairment test as a result
of poor market conditions and has provided me with the following
information.
I'm not quite sure what to do with this information though – I'd appreciate
guidance.
CGU 1 CGU 2 CGU 3
Rs'000 Rs'000 Rs'000
Fair value 45,150 80,000 33,250
Cost of disposal
– Legal 250 190 200
– Reorganisation 100 35 30
Value in use 43,950 79,500 33,500
. (10 marks)
(c) I think I am correct in saying that both tea bushes and dairy cattle are
biological assets and so must be accounted for in accordance with LKAS 41.
That is an accounting standard that I studied at college, although as I have
never used it in practice I am a little rusty. Please could you confirm my
understanding that biological assets must be remeasured to fair value with
any changes recognised within equity? (5 marks)
Thanks very much – I look forward to hearing from you,
Kind regards
Richard

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 SL1 Advanced Business Reporting | Questions

Required
Prepare notes in response to the financial accountant's email in preparation for a
telephone conversation to discuss the issues.
(LO 1.2.1, 1.2.2, 1.2.4) (Total = 25 marks)

7 Complexity 45 mins
(a) Complexity borrowed Rs. 470 million on 1 December 20X4 when the market
and effective interest rate was 5%. On 30 November 20X5, the company
borrowed an additional Rs. 450 million when the current market and
effective interest rate was 7.4%. Both financial liabilities are repayable on
30 November 20X9 and are single payment notes, whereby interest and
capital are repaid on that date.
Complexity's creditworthiness has been worsening. It has entered into an
interest rate swap agreement which acts as a hedge against a Rs. 20 million
2% bond issue which matures on 31 May 20X6. The directors of Complexity
wish to know in which circumstances it can use hedge accounting. In
particular, they need advice on hedge effectiveness and whether this can be
calculated.
Required
(i) Explain the accounting for the financial liabilities under SLFRS 9 under
the amortised cost method, and additionally using fair value method as
at 30 November 20X5. (6 marks)
(ii) Advise Complexity's directors as to the circumstances in which it can
use hedge accounting and whether it can calculate hedge effectiveness.
(9 marks)
(b) The type and value of financial instruments that Complexity holds has
increased in recent years which has resulted in increased disclosures
regarding financial instruments in the financial statements. Complexity's
reporting accountant is concerned that the users of the financial statements
find financial instruments complicated and has argued that there is no point
in providing detailed information in this area as the users will not
understand the disclosures.
Required
(i) Explain, from the perspective of the users of financial statements, how
the measurement of financial instruments under SLFRSs can create
confusion. (6 marks)
(ii) Consider the reporting accountant's view that detailed disclosures in
respect of financial instruments do not provide useful information to
the users of financial statements (4 marks)
(LO 1.2.2, 1.2.3, 1.2.4, 1.3.3) (Total = 25 marks)

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8 Carsoon 45 mins
Carsoon Co is a company which manufactures and retails motor vehicles. It also
constructs premises for third parties. It has a year end of 28 February 20X7.
(a) The entity enters into lease agreements with the public for its motor
vehicles. The agreements are normally for a three-year period. The customer
decides how to use the vehicle within certain contractual limitations. The
maximum mileage per annum is specified at 10,000 miles without penalty.
Carsoon is responsible for the maintenance of the vehicle and insists that the
vehicle cannot be modified in any way. At the end of the three-year contract,
the customer can purchase the vehicle at a price which will be above the
market value, or alternatively hand it back to Carsoon. If the vehicle is
returned, Carsoon will then sell the vehicle on to the public through one of
its retail outlets. These sales of vehicles are treated as investing activities in
the statement of cash flows.
The directors of Carsoon wish to know how the leased vehicles should be
accounted for, from the commencement of the lease to the final sale of the
vehicle, in the financial statements including the statement of cash flows.
(9 marks)
(b) On 1 March 20X6, Carsoon invested in a debt instrument with a fair value of
Rs. 60 million and has assessed that the financial asset is aligned with the fair
value through other comprehensive income business model. The instrument
has an interest rate of 4% over a period of six years. The effective interest
rate is also 4%. On 1 March 20X6, the debt instrument is not impaired in
any way. During the year to 28 February 20X7, there was a change in
interest rates and the fair value of the instrument seemed to be affected.
The instrument was quoted in an active market at Rs. 53 million but the
price based upon an in-house model showed that the fair value of the
instrument was Rs. 55 million. This valuation was based upon the average
change in value of a range of instruments across a number of jurisdictions.
The directors of Carsoon felt that the instrument should be valued at
Rs. 55 million and that this should be shown as a Level 1 measurement
under SLFRS 13 Fair Value Measurement. There has not been a significant
increase in credit risk since 1 March 20X6 and expected credit losses should
be measured at an amount equal to 12-month expected credit losses of
Rs. 4 million. Carsoon sold the debt instrument on 1 March 20X7 for
Rs. 53 million.
The directors of Carsoon wish to know how to account for the debt
instrument until its sale on 1 March 20X7. (8 marks)
(c) Carsoon constructs retail vehicle outlets and enters into contracts with
customers to construct buildings on their land. The contracts have standard
terms, which include penalties payable by Carsoon if the contract is delayed,
or payable by the customer, if Carsoon cannot gain access to the construction
site.

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 SL1 Advanced Business Reporting | Questions

Due to poor weather, one of the projects was delayed. As a result, Carsoon
faced additional costs and contractual penalties. As Carsoon could not gain
access to the construction site, the directors decided to make a counter-claim
against the customer for the penalties and additional costs which Carsoon
faced. Carsoon felt that because a counter claim had been made against the
customer, the additional costs and penalties should not be included in
contract costs but shown as a contingent liability. Carsoon has assessed the
legal basis of the claim and feels it has enforceable rights.
In the year ended 28 February 20X7, Carsoon incurred general and
administrative costs of Rs. 100 million, and costs relating to wasted
materials of Rs. 50 million.
Additionally, during the year, Carsoon agreed to construct a storage facility
on the same customer's land for Rs. 70 million at a cost of Rs. 50 million. The
parties agreed to modify the contract to include the construction of the
storage facility, which was completed during the current financial year. All of
the additional costs relating to the above were capitalised as assets in the
financial statements.
The directors of Carsoon wish to know how to account for the penalties,
counter claim and additional costs in accordance with SLFRS 15 Revenue from
Contracts with Customers.
(8 marks)

Required
Advise Carsoon on how the above transactions should be dealt with in its financial
statements with reference to relevant Sri Lankan Financial Reporting Standards.
(LO 1.2.1, 1.2.2, 1.3.2) (Total = 25 marks)

9 Calendar 45 mins
Calendar has a reporting date of 31 December 20X7. It prepares its financial
statements in accordance with Sri Lankan Financial Reporting Standards.
Calendar develops biotech products for pharmaceutical companies. These
pharmaceutical companies then manufacture and sell the products. Calendar
receives stage payments during product development and a share of royalties
when the final product is sold to consumers. A new accountant has recently joined
Calendar's finance department and has raised a number of queries.
(a) (i) During 20X6 Calendar acquired a development project through a
business combination and recognised it as an intangible asset. The
commercial director decided that the return made from the completion
of this specific development project would be sub-optimal. As such,
in October 20X7, the project was sold to a competitor. The gain arising
on derecognition of the intangible asset was presented as revenue

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in the financial statements for the year ended 31 December 20X7 on

the grounds that development of new products is one of Calendar's
ordinary activities. Calendar has made two similar sales of development
projects in the past, but none since 20X0.
The accountant requires advice about whether the accounting
treatment of this sale is correct. (6 marks)
(ii) While searching for some invoices, the accountant found a contract
which Calendar had entered into on 1 January 20X7 with Diary,
another entity. The contract allows Calendar to use a specific aircraft
owned by Diary for a period of three years. Calendar is required to
make annual payments.
On 1 January 20X7, costs were incurred negotiating the contract. The
first annual payment was made on 31 December 20X7. Both of these
amounts have been expensed to the statement of profit or loss.
There are contractual restrictions concerning where the aircraft can
fly. Subject to those restrictions, Calendar determines where and when
the aircraft will fly, and the cargo and passengers which will be
transported.
Diary is permitted to substitute the aircraft at any time during the
three-year period for an alternative model and must replace the
aircraft if it is not working. Any substitute aircraft must meet strict
interior and exterior specifications outlined in the contract. There are
significant costs involved in outfitting an aircraft to meet Calendar's
specifications.
The accountant requires advice as to the correct accounting treatment
of this contract. (9 marks)

Required
Advise the accountant on the matters set out above with reference to
Sri Lankan Financial Reporting Standards.
(b) The new accountant has been reviewing Calendar's financial reporting
processes. She has recommended the following:
 All purchases of property, plant and equipment below Rs. 50,000 should be
written off to profit or loss. The accountant believes that this will
significantly reduce the time and cost involved in maintaining detailed
financial records and producing the annual financial statements.
 A checklist should be used when finalising the annual financial statements
to ensure that all disclosure notes required by specific SLFRSs and LKASs
are included.

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 SL1 Advanced Business Reporting | Questions

Required
With reference to the concept of materiality, evaluate the acceptability of
the above two proposals.
Note. Your answer should refer to IFRS Practice Statement 2: Making
Materiality Judgements. issued by the International Accounting Standards
Board.
(LO 1.1.6, 1.2.2, 1.3.2, 1.4.1) (10 marks)
(Total = 25 marks)

10 Verge 45 mins
(a) Verge entered into a contract with a government body on 1 April 20X1 to
undertake maintenance services on a new railway line. The total revenue
from the contract is Rs. 50 million over a three-year period. The contract
states that Rs. 10 million will be paid at the commencement of the contract
but although invoices will be subsequently sent at the end of each year, the
government authority will only settle the subsequent amounts owing when
the contract is completed. The invoices sent by Verge to date (including the
Rs. 10 million above) were as follows:
Year ended 31 March 20X2 Rs. 28 million
Year ended 31 March 20X3 Rs. 12 million
The balance will be invoiced on 31 March 20X4. Verge has only accounted
for the initial payment in the financial statements to 31 March 20X2 as no
subsequent amounts are to be paid until 31 March 20X4. The amounts of the
invoices reflect the work undertaken in the period. Verge wishes to know
how to account for the revenue on the contract in the financial statements
to date.
The interest rate that would be used in a separate financing transaction
between Verge and the government agency is 6%. This reflects the credit
characteristics of the government agency. (7 marks)
(b) In February 20X2, an inter-city train caused what appeared to be superficial
damage to a storage facility of a local company. The directors of the company
expressed an intention to sue Verge but in the absence of legal proceedings,
Verge had not recognised a provision in its financial statements to 31 March
20X2. In July 20X2, Verge received notification for damages of Rs. 12 million,
which was based upon the estimated cost to repair the building. The local
company claimed the building was much more than a storage facility as it was
a valuable piece of architecture which had been damaged to a greater extent
than was originally thought. The head of legal services advised Verge that the
company was clearly negligent but the view obtained from an expert was that

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the value of the building was Rs. 8 million. Verge had an insurance policy that
would cover the first Rs. 2 million of such claims. After the financial
statements for the year ended 31 March 20X3 were authorised, the case came
to court and the judge determined that the storage facility actually was a
valuable piece of architecture. The court ruled that Verge was negligent and
awarded Rs. 3 million for the damage to the fabric of the facility. (7 marks)
(c) Verge was given a building by a private individual in February 20X2. The
benefactor included a condition that it must be brought into use as a train
museum in the interests of the local community or the asset (or a sum
equivalent to the fair value of the asset) must be returned. The fair value of
the asset was Rs. 15 million in February 20X2. Verge took possession of the
building in May 20X2. However, it could not utilise the building in
accordance with the condition until February 20X3 as the building needed
some refurbishment and adaptation and in order to fulfil the condition.
Verge spent Rs. 10 million on refurbishment and adaptation.
On 1 July 20X2, Verge obtained a cash grant of Rs. 2,500,000 from the
government. Part of the grant related to the creation of 20 jobs at the train
museum by providing a subsidy of Rs. 50,000 per job created. The remainder
of the grant related to capital expenditure on the project. At 31 March 20X3,
all of the new jobs had been created. (8 marks)

Required
Advise Verge on how the above accounting issues should be dealt with in its
financial statements for the years ending 31 March 20X2 (where applicable)
and 31 March 20X3.
(d) The finance director at Verge has proposed a change to the accounting policy
for measuring the cost of inventory which is to be implemented from 1 April
20X3. Verge prepares interim financial statements to 30 September each
year.

Required
Explain how a change in accounting policy for inventories should be
addressed in the interim financial statements to 30 September 20X3.
(3 marks)
(LO 1.1.1, 1.1.2, 1.2.1, 1.2.2, 1.3.1) (Total = 25 marks)

18 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

11 Moorland 45 mins
(a) Moorland commenced construction of a new factory on 1 February 20X6,
and this continued until its completion which was after the year end of
31 May 20X6. The direct costs were Rs. 200 million in February 20X6 and
then Rs. 500 million in each month until the year end. Moorland has not
taken out any specific borrowings to finance the construction of the factory,
but it has incurred finance costs on its general borrowings during the period,
which could have been avoided if the factory had not been constructed.
Moorland has calculated that the weighted average cost of borrowings for
the period 1 February to 31 May 20X6 on an annualised basis amounted to
9% per annum. Moorland needs advice on how to treat the borrowing costs
in its financial statements for the year ended 31 May 20X6.

Required
Advise how the above events would be shown in the financial statements of
Moorland under Sri Lankan Financial Reporting Standards. (6 marks)
(b) Moorland is a listed entity with several subsidiaries. Tybull is Moorland's
only overseas subsidiary and Moorland has always disclosed Tybull as an
operating segment within the consolidated financial statements. The
directors of Moorland are considering how the company identifies its
operating segments and the rationale for disclosing segmental information.
In particular, they are interested in whether it is possible to reclassify their
operating segments and whether this may impact on the usefulness of
segmental reporting for the business. There have been no internal
organisational changes at Moorland for the past five years.
The CEO of Moorland has proposed to report 'underlying earnings per share'
in its annual report, calculated by adjusting earnings for various items that
are considered to be non-recurring, divided by the weighted average number
of ordinary shares outstanding during the period. A similar performance
measure is disclosed by several companies in the same industry as
Moorland. The CEO believes that presenting underlying earnings per share
will aid investors in their analysis of Moorland's performance, and therefore
it should be presented prominently. In calculating underlying earnings per
share, one item the CEO wishes to exclude from earnings is a large
impairment loss relating to the goodwill of a subsidiary. He believes that this
cost can be excluded as it is unlikely to reoccur.

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Questions

Required
(i) Advise the directors as to how operating segments are identified and
whether they can be reclassified. Include in your discussion whether
Tybull should be treated as a separate segment and how it may impact
on the usefulness of the information if its results were not separately
disclosed in accordance with SLFRS 8 Operating Segments. (8 marks)
(ii) Evaluate the usefulness to investors of Moorland's plan to report
underlying earnings per share, and suggest ways in which the directors
could improve its usefulness to investors. (6 marks)
(c) As well as preparing consolidated financial statements, the investors of
Moorland also require the parent company to produce separate financial
statements. One of the new directors has asked for a note comparing how
the subsidiaries of Moorland would be accounted for in the separate
financial statements and the consolidated financial statements.

Required
Compare the treatment of subsidiaries in consolidated and separate
financial statements. (5 marks)
(LO 1.2.1, 1.2.3, 1.2.4, 1.3.2) (Total = 25 marks)

20 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

PART B: PREPARATION AND PRESENTATION OF CONSOLIDATED FINANCIAL

STATEMENTS
Questions 12 to 14 cover the Preparation and Presentation of Consolidated
Financial Statements.

12 Glove 45 mins
The following draft statements of financial position relate to Glove, Body and Fit,
all public limited companies, as at 31 May 20X7.
Glove Body Fit
Rs m Rs m Rs m
Assets
Non-current assets
Property, plant and equipment 260 20 26
Investment in Body 60
Investment in Fit 30
Investments in equity instruments 10
Current assets 65 29 20
Total assets 395 79 46

Stated capital 150 40 20

Other reserves 30 5 8
Retained earnings 135 25 10
Total equity 315 70 38

Non-current liabilities 45 2 3
Current liabilities 35 7 5
Total liabilities 80 9 8
Total equity and liabilities 395 79 46
The following information is relevant to the preparation of the group financial
statements.
(a) Glove acquired 80% of the 40 million ordinary shares of Body on 1 June 20X5
when Body's other reserves were Rs. 4 million and retained earnings were
Rs. 10 million. The fair value of the net assets of Body was Rs. 60 million at
1 June 20X5. Body acquired 70% of the 20 million ordinary shares of Fit on
1 June 20X5 when the other reserves of Fit were Rs. 8 million and retained
earnings were Rs. 6 million. The fair value of the net assets of Fit at that date
was Rs. 39 million. The excess of the fair value over the net assets of Body and
Fit is due to an increase in the value of non-depreciable land of the companies.
There have been no issues of ordinary shares in the group since 1 June 20X5.
(b) Body owns several trade names which are highly regarded in the market
place. Body has invested a significant amount in marketing these trade
names and has expensed the costs. None of the trade names has been

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Questions

acquired externally and, therefore, the costs have not been capitalised in the
statement of financial position of Body. On the acquisition of Body by Glove,
a firm of valuation experts valued the trade names at Rs. 5 million and this
valuation had been taken into account by Glove when offering Rs. 60 million
for the investment in Body. The valuation of the trade names is not included
in the fair value of the net assets of Body above. Group policy is to amortise
intangible assets over ten years.
(c) On 1 June 20X5, Glove introduced a defined benefit retirement plan.
During the year to 31 May 20X7, loss on re-measurement on the defined
benefit obligation was Rs. 1m and gain on re-measurement on the plan
assets was Rs. 900,000. These have not yet been accounted for and need to
be treated in accordance with LKAS 19. The net defined benefit liability is
included in non-current liabilities.
(d) Glove has issued 30,000 convertible loan stocks with a three-year term
repayable at par. The loan stock was issued at par with a nominal value of
Rs. 1,000 per bond. Interest is payable annually in arrears at a nominal
interest rate of 6%. Loan stock can be converted after three years into
300 shares of Glove. The loan stock was issued on 1 June 20X6 when the
market interest rate for similar debt without the conversion option was 8%
per annum. Glove does not wish to account for the loan stock at fair value
through profit or loss. The interest has been paid and accounted for in the
financial statements. The loan stock has been included in non-current
liabilities at its nominal value of Rs. 30 million.
(e) On 31 May 20X7, Glove acquired plant with a fair value of Rs. 6 million.
In exchange for the plant, the supplier received land, which was currently
not in use, from Glove. The land had a carrying amount of Rs. 4 million and a
fair value of Rs. 7 million. In the financial statements at 31 May 20X7,
Glove had made a transfer of Rs. 4 million from land to plant in respect of
this transaction.
(f) Goodwill has been tested for impairment at 31 May 20X6 and 31 May 20X7
and no impairment loss occurred.
(g) It is the group's policy to measure the non-controlling interest at acquisition
at its proportionate share of the fair value of the subsidiary's identifiable net
assets.
(h) Ignore any taxation effects.

Required
Compile the consolidated statement of financial position of the Glove Group at
31 May 20X7 in accordance with Sri Lanka Financial Reporting Standards (SLFRS).
(LO 2.1.1) (25 marks)

22 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

13 Ejoy 45 mins
Ejoy, a public limited company, has acquired two subsidiaries. The details of the
acquisitions are as follows,

Fair value
Ordinary of net % of share
Date of share Reserves assets at Cost of capital
Company acquisition capital at acq. acq. investment acquired
Rs m Rs m Rs m Rs m
Zbay 1.6.X4 200 170 600 520 80
Tbay 1 .12.X5 120 80 310 192 60
Any fair value adjustments relate to non-depreciable land. The draft statements of
profit or loss and other comprehensive income for the year ended 31 May 20X6 are:
Ejoy Zbay Tbay
Rs m Rs m Rs m
Revenue 2,500 1,500 800
Cost of sales (1,800) (1,200) (600)
Gross profit 700 300 200
Other income 70 10 –
Distribution costs (130) (120) (70)
Administrative expenses (100) (90) (60)
Finance costs (50) (40) (20)
Profit before tax 490 60 50
Income tax expense (200) (26) (20)
Profit for the year 290 34 30
Other comprehensive for the year
(not reclassified to profit or loss)
Gain on property revaluation net of tax 80 10 8
Total comprehensive income for the year 370 44 38
Total comprehensive income for year 31.5.X5 190 20 15
The following information is relevant to the preparation of the group financial
statements.
(a) Tbay was acquired exclusively with a view to sale and at 31 May 20X6 meets
the criteria of being a disposal group. The fair value of Tbay at 31 May 20X6
is Rs. 344 million and the estimated selling costs of the shareholding in Tbay
are Rs. 5 million. Selling costs increase proportionately with the level of
shareholding.
(b) Ejoy entered into a joint arrangement with another company on 31 May 20X6,
which met the SLFRS 11 definition of a joint venture. The joint venture is a
limited company and Ejoy has contributed assets at fair value of Rs. 20 million
(carrying value Rs. 14 million). Each party will hold five million ordinary
shares of Rs. 1 in the joint venture. The gain on the disposal of the assets
(Rs. 6 million) to the joint venture has been included in 'other income'.

CA Sri Lanka 23
Questions

(c) Zbay has a loan asset which was carried at Rs. 60 million at 1 June 20X5
which was the present value of the principal and interest cashflows due.
The loan's effective interest rate is 6%. On 1 June 20X5 the company felt that,
because of the borrower's financial problems, it would only receive
Rs. 20 million in approximately two years, on 31 May 20X7. At 31 May 20X6,
the company still expects to receive the same amount on the same date.
The loan asset is held at amortised cost.
(d) On 1 June 20X5, Ejoy purchased a five-year bond with a principal amount of
Rs. 50 million and a fixed interest rate of 5% which was the current market
rate. The bond is classified as measured at fair value through profit or loss.
Because of the size of the investment, Ejoy has entered into a floating
interest rate swap. Ejoy has designated the swap as a fair value hedge of the
bond. At 31 May 20X6, market interest rates were 6%. As a result, the fair
value of the bond has decreased to Rs. 48.3 million. Ejoy has received
Rs. 0.5 million in net interest payments on the swap at 31 May 20X6 and the
fair value hedge has been 100% effective in the period, and you should
assume any gain/loss on the hedge is the same as the loss/gain on the bond.
No entries have been made in the statement of profit or loss and other
comprehensive income to account for the bond or the hedge.
(e) No impairment of the goodwill arising on the acquisition of Zbay had
occurred at 1 June 20X5. The recoverable amount of Zbay was
Rs. 630 million and the value in use of Tbay was Rs. 334 million at
31 May 20X6. Impairment losses on goodwill are charged to cost of sales.
(f) Assume that profits accrue evenly throughout the year and ignore any
taxation effects.
(g) It is the group's policy to measure the non-controlling interest at its
proportionate share of the fair value of the subsidiary's identifiable net
assets.

Required
Compile a consolidated statement of profit or loss and other comprehensive
income for the Ejoy Group for the year ended 31 May 20X6 in accordance with
Sri Lanka Financial Reporting Standards.
(LO 2.1.1, 2.1.4) (25 marks)

24 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

14 Swing 45 mins
On 1 September 20X5 Swing Co acquired 70% of Slide Co for Rs. 5,000,000
comprising Rs. 1,000,000 cash and 1,500,000 shares of Swing Co.
The statement of financial position of Slide Co at acquisition was as follows.
Rs'000
Property, plant and equipment 2,700
Inventories 1,600
Trade receivables 600
Cash 400
Trade payables (300)
Income tax payable (200)
4,800
The consolidated statement of financial position of Swing Co as at 31 December 20X5
was as follows.
20X5 20X4
Non-current assets Rs'000 Rs'000
Property, plant and equipment 35,500 25,000
Goodwill 1,400 –
36,900 25,000
Current assets
Inventories 16,000 10,000
Trade receivables 9,800 7,500
Cash 2,400 1,500
28,200 19,000
65,100 44,000
Equity attributable to owners of the parent
Stated capital 18,100 12,000
Revaluation surplus 350 –
Retained earnings 32,100 21,900
50,550 33,900
Non-controlling interest 1,750 –
52,300 33,900
Current liabilities
Trade payables 7,600 6,100
Income tax payable 5,200 4,000
12,800 10,100
65,100 44,000

CA Sri Lanka 25
Questions

The consolidated statement of profit or loss and other comprehensive income of

Swing Co for the year ended 31 December 20X5 was as follows.
20X5
Rs'000
Profit before tax 16,500
Income tax expense (5,200)
Profit for the year 11,300
Other comprehensive income (not reclassified to P/L)
Revaluation surplus 500
Total comprehensive income for the year 11,800
Profit attributable to:
Owners of the parent 11,100
Non-controlling interest 200
11,300
Total comprehensive income for the year attributable to
Owners of the parent 11,450
Non-controlling interest 200 + (500  30%) 350
11,800
Notes
(1) Depreciation charged for the year was Rs. 5,800,000. The group made no
disposals of property, plant and equipment.
(2) Dividends paid by Swing Co amounted to Rs. 900,000.
It is the group's policy to measure the non-controlling interest at acquisition at its
proportionate share of the fair value of the subsidiary's identifiable net assets.

Required
Compile the consolidated statement of cash flows of Swing Co for the year ended
31 December 20X5. No notes are required.
(LO 2.1.1) (25 marks)

26 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

PART C: EVALUATING RISK OF MATERIAL MISSTATEMENT IN FINANCIAL

STATEMENTS
Questions 15 to 18 cover Evaluating Risk of Material Misstatement in Financial
Statements.

15 Risk and Going Concern 45 mins

(a) Jaf Group operates a chain of fashion clothing shops for young women. The
head office is based in Jafna. There are 280 shops spread across Sri Lanka
and a further 65 shops in the European Union. The clothing is manufactured
mainly in Sri Lanka and India by third party manufacturers and fixed
quantities are pre-ordered six months in advance of the season. Most of the
shop buildings are held on long leases although a small number are owned
by the Group.
Approximately, 40% of the shops outside the Sri Lankan market are run on a
franchise basis whereby shop fittings are supplied and installed by the Jaf
Group and paid for by the franchisee over five years, after which time they
are replaced; the clothes are sold at a 40% discount on local retail price to
the franchisees on a sale or return basis. Franchisees choose which lines of
the full season's range of clothes they wish to hold, based on samples.

Required
Identify and explain FIVE business risks and FIVE risks of material
misstatement for Jaf Group. (10 marks)
(b) Karava Ltd ('Karava') is an established pharmaceutical company that has for
many years generated 90% of its revenue through the sale of two specific
cold and flu remedies. Karava has lately seen a real growth in the level of
competition that it faces in its market and demand for its products has
significantly declined. To make matters worse, in the past the company has
not invested sufficiently in new product development and so has been trying
to remedy this by recruiting suitably trained scientific staff, but this has
proved more difficult than anticipated.
In addition to recruiting staff, the company also needed to invest Rs. 100m in
plant and machinery. The company wanted to borrow this sum but was
unable to agree suitable terms with the bank; it therefore used its overdraft
facility, which carried a higher interest rate. Consequently, some of Karava's
suppliers have been paid much later than usual and hence some of them
have withdrawn credit terms meaning the company must pay cash on
delivery. As a result of the above the company's overdraft balance has grown
substantially.
The directors have produced a cash flow forecast and this shows a
significantly worsening position over the coming 12 months.

CA Sri Lanka 27
Questions

The directors have informed you that the bank overdraft facility is due for
renewal next month, but they are confident that it will be renewed. They also
strongly believe that the new products which are being developed will be
ready to market soon, and hence trading levels will improve and therefore
that the company is a going concern. As a result, they do not intend to make
any disclosures in the accounts regarding going concern.

Required
(i) Evaluate the information provided for potential indicators that the
company is not a going concern and outline the audit procedures that
the auditor of Karava should perform in assessing whether or not the
company is a going concern. (10 marks)
(ii) The auditors have been informed that Karava's bankers will not make a
decision on the overdraft facility until after the audit report is
completed. The directors have now agreed to include going concern
disclosures.
Assess the impact on the audit report of Karava if the auditor believes
the company is a going concern but a material uncertainty exists.
(5 marks)
(LO 3.1.1, 3.3.1, 3.4.1) (Total = 25 marks)

16 Maleats Group Plc 45 mins

Maleats Group Plc, a listed entity, operates a large number of restaurants
throughout the country, which are operated under four well-known brand names.
The company's strategy is to offer a variety of different dining experiences in
restaurants situated in city centres and residential areas, with the objective of
maximising market share in a competitive business environment.
Key financial information

20X9 20X8
Draft Final
Rs. (m) Rs. (m)
Company revenue 225.0 202.5
Revenue is derived from four restaurant chains,
each having a distinctive brand name:
Chomping Chimps family bistros 120.0 99.0
Quick-bite outlets 56.3 60.0
Urban Bites grills 45.0 43.5
Organucopia cafés 3.8 –
Company profit before tax 20.3 23.3
Company total assets 630.0 502.5
Company cash at bank 17.4 52.5

28 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

Business segments
The Chomping Chimps chain of restaurants provides family-friendly dining in an
informal setting. Most of the restaurants are located in residential areas. Each
restaurant has a large children's play area containing climbing frames and slides,
and offers a crèche facility, where parents may leave their children for up to two
hours. Recently there has been some media criticism of the quality of the child
care offered in one crèche, because a child had fallen from a climbing frame and
was slightly injured. One of the Chomping Chimps restaurants was closed in
December 20X8 for three weeks following a health and safety inspection which
revealed some significant breaches in hygiene standards in the kitchen.
The Quick-bite chain offers fast-food. The restaurants are located next to busy
roads, in shopping centres, and at railway stations and airports. Maleats Group Plc
has launched a significant marketing campaign to support the Quick-bite brand
name. In 20X9 Rs. 22.5bn was spent in relation to the advertising and marketing of
this brand. In January 20X9 the company started to provide nutritional
information on its menus in the Quick-bite restaurants, following pressure from
the government for all restaurants to disclose more about the ingredients of their
food. 50% of the revenue for this business segment is derived from the sale of
'chuckle boxes' – self-contained children's meals which contain a small toy.
The Urban Bites grills offer a more sophisticated dining experience. The emphasis
is on high quality food served in luxurious surroundings. There are currently 250
Urban Bites grills, and ZYX Co is planning to expand this to 500 by May 20Y0. The
grills are all situated in prime city centre locations and are completely refurbished
every two years.
The Organucopia Café Chain Ltd. is the group's first acquisition and was acquired
in the current year to increase the range of restaurants. There are only 30
restaurants in the chain, mostly located in affluent residential areas. The
restaurants offer eco-friendly food, guaranteed to be free from artificial
flavourings and colourings, and to have been produced in an environmentally
sustainable manner. All of the 30 restaurants have been newly refurbished by
Maleats Group Plc and are capitalised at Rs. 31.5bn. This includes all directly
attributable costs, and borrowing costs capitalised relating to several short-term
loans taken out to finance the acquisition of the sites and construction of the
restaurants. Maleats Group Plc is planning to double the number of Organucopia
cafés operating within the next twelve months.
Laws and regulations
Two new regulations were issued by the government recently which will impact
on Maleats Group Plc The regulations come into effect from September 20X9:
 Minimum wage regulation has increased the minimum wage by 15%. One third
of Maleats Group Ltd's employees earn the minimum wage.

CA Sri Lanka 29
Questions

 Advertising regulations now forbid the advertising of food in a manner

specifically aimed at children.

Required
(a) Evaluate the business risks facing Maleats Group Plc with reference to the
financial and non-financial information above. (15 marks)
(b) Outline four risks of material misstatement in the financial statements of
Maleats Group Plc (10 marks)
(LO 3.3.1, 3.5.1) (Total = 25 marks)

17 Laurel Group Plc 45 mins

Laurel Group Plc is a listed entity. The Group sells its products under well-known
brand names, most of which have been acquired with subsidiary companies. The
Group is highly acquisitive, and there are more than 40 subsidiaries and 15
associates within the Group.
Products include cosmetics, hair care products and perfumes for men and women.
Research into new products is a significant activity, and the Group aims to bring
new products to market on a regular basis.
Extract from projected and actual financial statements
Consolidated statement of financial position
Notes Projected Actual
31 May 20X7 31 May 20X6
Rs (m) Rs (m)
Assets
Non-current assets
Property, plant and equipment 1 92 78
Intangible assets – goodwill 18 18
Intangible assets – acquired brand 2 80 115
names
Intangible assets – development
costs 25 10
Total non-current assets 215 221
Current assets 143 107
Total assets 358 328
Equity and liabilities
Equity
Equity share capital 100 100
Retained earnings 106 98
Non-controlling interest 23 23
Total equity 229 221

30 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

Notes Projected Actual

31 May 20X7 31 May 20X6
Rs (m) Rs (m)
Non-current liabilities
Debenture loans 3 100 80
Deferred tax 4 10 2
Total non-current liabilities 110 82
Current liabilities 19 25
Total liabilities 129 107
Total equity and liabilities 358 328
Consolidated statement of profit or loss for the year to 31 May
Notes Projected Actual
20X7 20X6
Rs (m) Rs (m)

Revenue 220 195

Operating expenses 5 (185) (158)
Operating profit 35 37
Finance costs (7) (7)
Profit before tax 28 30
Tax expense (3) (3)
Profit for the year 25 27
Notes
(1) Capital expenditure of Rs. 20 m has been recorded so far during the year.
The Group's accounting policy is to recognise assets at cost less depreciation.
During the year, a review of assets' estimated useful lives concluded that
many were too short, and as a result, the projected depreciation charge for
the year is Rs. 5 m less than the comparative figure.
(2) Acquired brand names are held at cost and not amortised on the grounds
that the assets have an indefinite life. Annual impairment reviews are
conducted on all brand names. In December 20X6, the Chico brand name was
determined to be impaired by Rs. 30 m due to allegations made in the press
and by customers that some ingredients used in the Chico perfume range can
cause skin irritations and more serious health problems. The Chico products
have been withdrawn from sale.
(3) A Rs. 20 m loan was taken out in January 20X7, the cash being used to
finance a specific new product development project.
(4) The deferred tax liability relates to timing differences in respect of
accelerated tax depreciation (capital allowances) on the Group's property,
plant and equipment. The liability has increased following changes to the
estimated useful lives of assets discussed in note 1.

CA Sri Lanka 31
Questions

(5) Contracts were signed in February 20X7 for the hire of 5 new machines for
use in production. Contract payments of Rs. 1m have been charged to
operating expenses as they were made, on the basis that the machines are of
low value.
Details of planned acquisition of Azalea Ltd.
Group management is currently negotiating the acquisition of Azalea Ltd, a large
company which develops and sells a range of fine fragrances. It is planned that the
acquisition will take place in early June 20X7, and the Group is hopeful that Azalea
Ltd's products will replace the revenue stream lost from the withdrawal of its
Chico perfume range. Due diligence is taking place currently, and Group
management is hopeful that this will support the consideration of Rs. 130 m
offered for 100% of Azalea Ltd's share capital. The Group's bank has agreed to
provide a loan for this amount.

Required
(a) Evaluate the risks of material misstatement to be considered in planning
the Group audit. Your evaluation should utilise analytical procedures as a
method for identifying relevant risks. (19 marks)
(b) Recommend any additional information which should be requested from
the Group which would allow a more detailed preliminary analytical review
to be performed. (6 marks)
(LO 3.3.1, 3.5.1, 3.7.1) (Total = 25 marks)

18 Silva Group 45 mins

Silva Group (the Group) has a financial year ended on 31 July 20X4. It consists of a
parent company and three subsidiaries – Cooray Ltd, Peires Ltd and Mendis Ltd.
The Group manufactures engines which are then supplied to the car industry. The
consolidated financial statements recognise profit for the year to 31 July 20X4 of
Rs. 23m (20X3 – Rs. 33m) and total assets of Rs. 450m (20X3 – Rs. 455m).
The group accounting team is made up of the newly appointed finance director
and three accounts executives who are currently undertaking their accountancy
qualification. The group instructions were distributed to the components of the
group on 15 August 20X4 with the exception of Mendis Ltd who were not issued
instructions as they are a new component of the group and the team did not want
to overburden their finance manager. The group financial statements have been
delayed as it was not identified that the year end of Mendis was not co-terminus
with the rest of the group.

32 CA Sri Lanka
 SL1 Advanced Business Reporting | Questions

An 80% equity shareholding in Mendis Ltd was acquired on 1 August 20X3.

Goodwill on the acquisition of Rs. 27 m was calculated at that date and remains
recognised as an intangible asset at that value at the year end. The goodwill
calculation performed by the Group's accounting team is shown below:
Rs.'000
Purchase consideration 75,000
Fair value of 20% non-controlling interest 13,000
88,000
Less fair value of Mendis Ltd's identifiable net assets at acquisition (61,000)
Goodwill 27,000
In determining the fair value of identifiable net assets at acquisition, an upwards
fair value adjustment of Rs. 300,000 was made to the book value of a property
recognised in Mendis Ltd's financial statements at a carrying value of Rs. 600,000.
The estimates of fair value and the journal entries for the fair value adjustments
were posted by an accounts executive with the assistance of a second accounts
executive.
A loan of Rs. 60m was taken out on 1 August 20X3 to help finance the acquisition.
The loan carries an annual interest rate of 6%, with interest payments made
annually in arrears. The loan will be repaid in 20 years at a premium of Rs. 5m.
In September 20X4 a natural disaster caused severe damage to the property
complex housing the Group's head office and main manufacturing site. For health
and safety reasons, a decision was made to demolish the property complex. The
demolition took place three weeks after the damage was caused. The property had
a carrying value of Rs. 16 m at 31 July 20X4.
One of the accounts executives posted a journal entry to create a contingent asset
of Rs. 18m, recognised as a current asset and as deferred income in the Group
statement of financial position at 31 July 20X4, representing the amount claimed
under the Group's insurance policy in respect of the disaster.
Cooray Ltd. supplies some of the components used by Peires Ltd. in its
manufacturing process. The group accounting team were unaware of this until a
final review where one of the accounts executives noticed that there were inter-
company transactions in last year's group financial statements.
At the year end, an intercompany receivable of Rs. 20m is recognised in
Cooray Ltd.'s financial statements. Peires Ltd.'s financial statements include a
corresponding intercompany payables balance of Rs. 20m and inventory supplied
from Cooray Ltd. valued at Rs. 50m.

Required
(a) Evaluate the weaknesses in the controls over the preparation of the group
financial statements including suggested improvements. (12 marks)

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(b) Analyse the group financial statements and outline the risks of material
misstatement in (other than those created by the weaknesses in controls
identified in part (a)). (13 marks)
(LO 3.3.1, 3.5.1, 3.9.1, 3.10.1) (Total = 25 marks)

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PART D: CORPORATE GOVERNANCE AND NON-FINANCIAL REPORTING

Questions 19 to 22 cover Corporate Governance and Non-Financial Reporting.

19 Calcula 45 mins
Asha Alexander has recently been appointed as the CEO of Calcula, a public limited
company. The company develops specialist software for use by accountancy
professionals. The specialist software market is particularly dynamic and fast
changing. It is common for competitors to drop out of the market place. The most
successful companies have been particularly focused on enhancing their offering
to customers through creating innovative products and investing heavily in
training and development for their employees.
Turbulent times
Calcula has been through a turbulent time over the last three years. During this
time there have been significant senior management changes, which resulted in
confusion among shareholders and employees as to the strategic direction of the
company. One investor complained that the annual accounts made it hard to know
where the company was headed.
The last CEO introduced an aggressive cost-cutting programme aimed at
improving profitability. At the beginning of the financial year the annual staff
training and development budget was significantly reduced and has not been
reviewed since the change in management.
Future direction
In response to the confusion surrounding the company's strategic direction,
Asha and the board published a new mission, the primary focus of which centres
on making Calcula the market leader of specialist accountancy software. Asha was
appointed as the CEO having undertaken a similar role at a competitor. The board
were keen on her appointment as she is renowned in the industry for her
creativity and willingness to introduce 'fresh ideas'. In her previous role Asha
oversaw the introduction of an integrated approach to reporting performance.
This is something she is particularly keen to introduce at Calcula.
During the company's last board meeting, Asha was dismayed by the finance
director's reaction when she proposed introducing integrated reporting at Calcula.
The Finance Director made it clear that he was not convinced of the need for such
a change, arguing that 'all this talk of integrated reporting in the business press is
just a fad, requiring a lot more work, simply to report on things people do not care
about. Shareholders are only interested in the bottom line'.

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Required
(a) Advise how integrated reporting may help Calcula to communicate its
strategy and improve the company's strategic performance. Your answer
should make reference to the concerns raised by the finance director.
(11 marks)
(b) Outline the likely implications of introducing 'integrated reporting' which
Calcula should consider before deciding to proceed with its adoption.
(6 marks)
(c) Advise the directors of Calcula as to what should be included in the
company's integrated report, referencing the eight key content elements
required by the <IR> Framework. (8 marks)
(LO 4.1.3) (Total = 25 marks)

20 Glowball 45 mins
The directors of Glowball, a public limited company, have discovered that their
main competitors are applying the 'Global Reporting Initiative' (GRI) 'G4'
guidelines and producing sustainability reports alongside their annual reports.
Glowball has a reputation for ensuring the preservation of the environment in its
business activities. It has produced environmental reports in the past and it
wishes to produce a sustainability report for 20X2, but the directors are worried
that any sustainability report produced by the company may detract from its
image if the report does not comply with recognised standards. They are unsure of
the extra requirements of a sustainability report.
Further the directors have collected information in respect of a series of events
which they consider to be important and worthy of note, but are not sure as to
how they would be incorporated in the sustainability report.
The events are as follows.
(a) Glowball is a company that constructs pipelines and pipes gas from offshore
gas installations to major consumers. The company purchased its main
competitor during the year and found that there were environmental
liabilities arising out of the restoration of many miles of farmland that had
been affected by the laying of a pipeline. There was no legal obligation to
carry out the work but the company felt that there would be a cost of around
Rs. 150 million if the farmland was to be restored.
(b) Most of the offshore gas installations are governed by operating licenses,
which specify limits to the substances that can be discharged to the air and
water. These limits vary according to local legislation and tests are carried
out by the regulatory authorities. During the year the company was
prosecuted for infringements of an environmental law in the USA when toxic

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gas escaped into the atmosphere. In 20X2 the company was prosecuted five
times and in 20X1 11 times for infringement of the law. The final amount of
the fine/costs to be imposed by the courts has not been determined but is
expected to be around Rs. 5 million. The gas escape occurred over the sea
and it was considered that there was little threat to human life.
(c) The company produced statistics that measure their improvement in the
handling of emissions of gases that may have an impact on the environment.
The statistics deal with:
(i) Measurement of the release of gases with the potential to form acid
rain. The emissions have been reduced by 84% over five years due to
the closure of old plants.
(ii) Measurement of emissions of substances potentially hazardous to
human health. The emissions are down by 51% on 20W8 levels.
(iii) Measurement of emissions to water that removes dissolved oxygen and
substances that may have an adverse effect on aquatic life.
Accurate measurement of these emissions is not possible but the
company is planning to spend Rs. 70 million on research in this area.
(d) The company tries to reduce the environmental impact associated with the
siting and construction of its gas installations. In particular it aims to
minimise the impact on wildlife and human beings. Additionally, when the
installations are at the end of their life, they are dismantled rather than sunk
into the sea. The current provision for the decommissioning of these
installations is Rs. 215 million.
You are a consultant with Sustainability Matters Co, and the directors have asked
for your advice on the compilation of their first sustainability report.

Required
(a) Contrast the information that might be contained in an environmental
report with that required in a sustainability report. (4 marks)
(b) Recommend disclosures that might be made by Glowball in its
sustainability report in relation to each of the key areas of performance and
impact. Suggest suitable performance measures in each case. (12 marks)
(c) Advise Glowball how the issues above should be addressed in the
sustainability report. (9 marks)
(LO 4.1.2) (Total = 25 marks)

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21 Country A
There has been a debate in Country A for some years about the most appropriate
way to regulate corporate governance. Several years ago, there were a number of
major corporate failures and 'scandals' caused in part by a number of single
powerful individuals dominating their boards. Business leaders and policy-makers
were sceptical about a rules-based approach, and this has led to Country A stock
exchange to issue the following guidance.
'Good corporate governance is not just a matter of prescribing particular
corporate structures and complying with a number of rules. There is a need for
broad principles. All stakeholders should then apply these flexibly to the varying
circumstances of individual companies.'
Given the causes of Country A corporate governance failures, there was a debate
about whether the separation of the roles of Chair and Chief Executive should be
made a legal requirement. This resulted in the stock exchange issuing guidance
that whilst a rules-based or 'box ticking' approach would specify that 'the roles of
Chair and Chief Executive officer should never be combined … We do not think
that there are universally valid answers on such points.'
One company to take advantage of the flexibility in Country A's principles-based
approach was Stark Co. In July 20X0, Stark Co announced that it had combined its
roles of Chair and Chief Executive in a single role carried out by one individual. In
accordance with the Country A listing rules, it made the following 'comply or
explain' statement in its 20X1 annual report.
'Throughout the year the company complied with all Country A Code provisions
with the exception that from 1 July 20X0 the roles of Chair and Chief Executive
have been exercised by the same individual, Mr B. We recognise that this has been
out of line with best practice. We understand the concerns of shareholders but
believe that we have maintained robust governance while at the same time
benefiting from having Mr B in control. On 31 July 20X2 Mr B will step down as
executive Chair, remaining as Chair until we conclude our search for a non-
executive Chair to succeed him, no later than March 20X3.'
Required
(a) Briefly distinguish between rules- and principles-based approaches to
corporate governance. Critically evaluate Country A stock exchange's
guidance that 'all stakeholders should then apply these flexibly to the
varying circumstances of individual companies.' (12 marks)
(b) Explain why a separation of the roles of Chair and Chief Executive is
considered best practice in most jurisdictions. (8 marks)
(c) Assess the 'comply or explain' statement made by Stark Co in its 20X1
annual report. (5 marks)
(LO 4.1, 4.2, 4.3) (Total = 25 marks)

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22 Comfort Hotels
Comfort Hotels Limited (CHL) is a medium size, private company which currently
operates a chain of eighteen medium sized hotels throughout Sri Lanka.
CHL is headed by Isuru Prasad who created the hotel chain in 2008 and acts as
CHL's CEO and Chairman. Given the success of the hotel chain in Sri Lanka, Mr
Isuru Prasad is now considering listing on the Sri Lanka Stock Exchange to raise
capital from new equity investors to fund expansion with new hotels initially in Sri
Lanka, with further long term expansion planned in India and South East Asia.
CHL has a small Board of Directors as follows:

Name Description
Isuru Prasad (male, age 59) The Chairman and Chief Executive Officer (CEO)
of CHL
Kasun Jayawardena CHL's Finance Director
(male, age 56)
Amila Gamage (male, age 51) CHL's Sales, Marketing and Operations Director
Sahan Alwis (male, age 50) Non-Executive Director (NED), who is the owner
of Sri Lanka Fresh Laundry Limited, an
important supplier to CHL
Mahesh Bandara Non-Executive Director (NED) who is CHL's
(male, age 52) previous Finance Director

The CEO and Chairman, Isuru Prasad, believes that only those who have worked
for the company or who are associated with the company have the relevant
knowledge and experience to successfully run the business. The Board of
Directors has never undergone annual performance evaluation of its effectiveness
and none of the directors received any training when they were first appointed, or
subsequently. Mr Prasad believes in learning on the job and doesn't believe there
are any issues with how the Board currently operates and its performance and
effectiveness.
At the last Directors meeting, Mr Prasad commented that he does not fully
understand the purpose of corporate governance and why CHL will need to
comply with all its requirements after the company has listed. Mr Prasad would
also like to understand the key requirements for the formation of a new audit
committee under the code. The Finance Director, Kasun Jayawardena, has
explained to Mr Prasad that full compliance with the Sri Lanka Code of Corporate
Governance will be required by the market should CHL proceed with the proposed
listing.

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Required
(a) Discuss the changes which are required to the composition and
performance of CHL's Board of Directors in order to comply with the 2017
Sri Lanka Code of Corporate Governance. For each change:
(i) Correctly identify the relevant principle or provision and explain why
CHL is currently not compliant with the 2017 Sri Lanka Code of
Corporate Governance;
(ii) Recommend what action CHL must take to become compliant with the
2017 Sri Lanka Code of Corporate Governance; and
(iii) Explain how each recommendation will benefit CHL and its
shareholders. (20 marks)
Note. For this requirement, focus on the main board of directors only.
(b) Explain the role of the audit committee to the CEO. (5 marks)
(LO 4.3, 4.4) (Total = 25 marks)

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PART E: ETHICAL ISSUES IN FINANCIAL REPORTING AND THE REGULATORY

ENVIRONMENT
Questions 23 to 24 cover Ethical Principles and Responding to Ethical Problems.

23 David
David is currently serving as a non-executive director on the board of a
nationalised concern, The Electricity Provision Corporation (EPC), in a country in
Asia. David is also a qualified chartered accountant and a member of his country's
professional accounting body.
EPC operates a number of coal-fired power stations and transmits energy through
a national grid which it controls. The electricity generated is then sold to the
general public by private sector electricity distribution companies.
David is concerned about the ethical implications of a couple of issues that were
discussed at EPC's most recent board meeting which was held yesterday. As a non-
executive director, he believes he has a particular responsibility to consider
ethical issues carefully.
(i) A general election campaign has recently begun in this country. The
governing party has indicated that it intends to maintain EPC as a
nationalised industry if it wins the general election, although it will be
seeking efficiency improvements. The opposition party has indicated that it
intends to privatise all industries that are currently nationalised. Early
yesterday morning before the board meeting, EPC's Managing Director was
suddenly asked by senior civil servants in the Ministry of Energy to provide a
major commitment to cost cutting in the next ten days. The Managing
Director is aware that the Minister of Energy will be making a major election
speech in a fortnight's time.
(ii) A recent United Nations report ranked EPC's home country in the Top 10 of
its worst polluters, as measured by CO2 emissions per head of population.
This report has been seized upon by environmental groups who have called
for a month of action during the general election campaign. They wish to
highlight the environmental damage being caused by the government's
environmental policies and to highlight the need to switch to alternative
technologies such as wind power generation.
In the last few days small groups of protestors have broken through
perimeter fences at two of EPC's power stations and managed to delay
deliveries of coal by chaining themselves across railway tracks. There have
been some reports in the press of heavy handed treatment being meted out
by the security firm hired by EPC to deal with the protests. EPC's Managing
Director has dismissed these reports, saying the protestors' solutions are

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impractical, they have no rights of access, and that EPC is entitled to take
whatever action is required against the protestors to protect its property
and maintain electricity supplies.
Required
(a) Using the American Accounting Association model to support your answer,
recommend to David the course of action the board should take in
responding to the civil servants' request for information. (15 marks)
(b) Evaluate the factors that EPC's board should consider when dealing with the
current protests by environmental groups using Tucker's model for
decision-making. (10 marks)
(LO 5.1) (Total = 25 marks)

24 WWW
WWW is an international company based in Europe which trades principally in
Asia and Europe. In its published Code of Ethics, WWW has committed itself to
'being a company that will trade fairly and sustainably'. WWW has been following
an expansion strategy which has led to the following three situations occurring.
Situation 1
At a recent presentation to investment analysts and financial journalists, WWW's
Chief Executive Officer (CEO) gave a very optimistic forecast for the company's
future, suggesting that revenue would double over the next three years and profits
and dividends would increase by 50%.
However, the CEO had prepared his forecast in a hurry and had not had it
confirmed by anybody else within WWW. He did not mention that WWW's home
Government was considering taking legal action against WWW for underpayment
of excise duties and had made a claim for large damages. If this claim was to be
successful it would materially affect WWW's profit in the next year (20X3).
Situation 2
In connection with the legal case in 1, WWW's home Government had obtained a
court order that all documents relating to WWW's export trade should be made
available to the Government's lawyers.
However, many of the documents covered by the court order were the subject of
confidentiality agreements between WWW and various entrepreneurs. These
documents included details of patents and processes with a high commercial value
and if knowledge of these became public it would destroy some of WWW's
competitive advantage.

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Situation 3
This situation, which is unconnected to Situations 1 and 2, has also occurred.
WWW has a joint venture agreement with a company, ZZZ. Under the terms of the
joint venture agreement each company has to make regular returns of financial
performance to the other. ZZZ is always late in making its returns, which are
usually incomplete and contain many errors. ZZZ's accounting staff are very
reluctant to co-operate with WWW's accounting staff and the working
relationship between the two companies is poor.
WWW's financial controller has been involved in a review of the joint venture with
ZZZ. Due to the many problems that ZZZ has caused her and her staff she has
advised discontinuing the joint venture.

Required
(a) Advise, giving your reasons, whether each of the three situations is in
conflict with CASL's Code of Ethics.
(i) Situation 1 (5 marks)
(ii) Situation 2 (5 marks)
(iii) Situation 3 (5 marks)
(b) Inform WWW of the stages of a procedure it could use to resolve ethical
conflicts. (10 marks)
(LO 5.1) (Total = 25 marks)

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PART F: CASE STUDY QUESTIONS

Questions 25 to 33 are Case Study questions, each one covering a variety of
syllabus areas.

25 Johan 90 mins
Johan, a public limited company, operates in the telecommunications industry.
The industry is capital intensive with heavy investment in licenses and network
infrastructure.
Operations of Johan
The company is operated through three divisions; the Network Division, the Retail
Division and the Dealer Division.
Network Division
The Network Division of Johan operates telephone networks throughout Sri Lanka
and other South-East Asian countries.
The division operates a number of masts and base stations throughout the
countries in which it operates and is continually striving to develop its network
and improve coverage in certain areas through the installation of new masts and
base stations.
The process to install a new mast and base station is as follows.
(a) Johan works with external advisers to identify a general location within a
geographical area for a new base station and masts.
(b) After this the company pays third party consultants to identify an exact
location within the general area where signal quality and coverage will be
optimised.
(c) The company then applies for planning permission and negotiates with the
owner of that land in order to achieve access or acquire the land.
Retail Division
The Retail Division of Johan purchases telephone handsets from a manufacturer
and sells them directly to customers together with call credit.
Dealer Division
The Dealer Division of Johan sells handsets to dealers and invoices the dealers for
those handsets. The dealer can return the handset up to the point when a service
contract in respect of the handset has been signed by a customer. When the
customer signs a service contract, the customer receives the handset free of
charge. Johan allows the dealer a commission on the connection of a customer to
the network. The handset cannot be sold separately by the dealer.

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Hash
Johan purchased the whole of the stated capital of Hash on 1 June 20X6. The whole
of the stated capital of Hash was formerly owned by the five directors of Hash.
This acquisition signaled a diversification of the operations of Johan, as Hash
operates in the construction sector. Hash has a number of commercial building
contracts in place and is currently engaged in the construction of an office block in
Colombo and a hotel complex on the west coast of Sri Lanka. Recently completed
projects include a regional airport, a length of motorway and a multi-story car park.
The management of Johan intend to start using Hash to build new base stations for
the Network Division in the future.
Employees
Johan values its employees highly and its remuneration packages are structured in
order to retain and reward excellent staff.
Cash salaries are competitive and, bonuses are regularly awarded based on the
performance of the individual and the company as a whole. Staff are also entitled
to medical benefits and receive a holiday allowance in excess of the statutory
minimum. They also benefit from in-house childcare facilities and a heavily
subsidised staff canteen and snack bar.
As extra incentive, Johan also operates share-option schemes whereby employees
are awarded options that vest over a three-year period.
Financial statements
Johan prepares consolidated financial statements to a reporting date of 31 May in
accordance with Sri Lankan Financial Reporting Standards.
Financial performance
Johan's recent performance has been described as 'exceptional' by its directors,
with all divisions reporting strong profits and a healthy financial position.
The company has expanded its network substantially and this has translated into
increased revenue and profits.
The company has also seen an increase in the number of handsets sold through
both its Retail and Dealer Divisions.
Hash has reported a strong growth in profits since its acquisition by Johan and
continues to expand.
Recent developments
Johan's Network Division has carried out a feasibility study during the year to
31 May 20X7 to extend its network. The design and planning department of Johan
identified five possible geographical areas for the extension of its network.
The internal costs of this study were Rs. 150,000 and the external costs were
Rs. 100,000 during the year to 31 May 20X7. Following the feasibility study,

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Johan chose a geographical area where it was going to install a base station for the
telephone network. The location of the base station was dependent upon getting
planning permission. A further independent study has been carried out by third
party consultants in an attempt to provide a preferred location in the area.
Johan proposes to build a base station on the recommended site on which
planning permission has been obtained. The third-party consultants have charged
Rs. 50,000 for the study. Additionally, Johan has paid Rs. 300,000 as a single
payment together with Rs. 60,000 a month to the government of the region for
access to the land upon which the base station will be situated. The contract with
the government is for a period of 12 years and commenced on 1 May 20X7.
There is no right of renewal of the contract and legal title to the land remains with
the government. The present value of the future lease payments is Rs. 7.2 million.
Johan's Retail Division purchases telephone handsets from a manufacturer for
Rs. 200 each, and sells the handsets direct to customers for Rs. 150 if they
purchase call credit (call card) in advance on what is called a prepaid phone.
The costs of selling the handset are estimated at Rs. 1 per set. The customers using
a prepaid phone pay Rs. 21 for each call card at the purchase date. Call cards
expire six months from the date of first sale. There is an average unused call credit
of Rs. 3 per card after six months and the card is activated when sold.
The Dealer Division sells handsets (to dealers) for Rs. 150. The dealers act as
agents, selling phone packages, including handsets, on to customers. Johan allows
the dealer a commission of Rs. 280 on the connection of a customer and the
transaction with the dealer is settled net by a payment of Rs. 130 by Johan to the
dealer, being the cost of the handset to the dealer (Rs. 150) deducted from the
commission (Rs. 280). The service contract lasts for a 12-month period with an
average value of Rs. 30 per month. Dealers do not sell prepaid phones, and Johan
receives monthly revenue from the service contract. The stand-alone selling price
of the handsets (without call credit) is Rs. 160. The handsets can only be used with
the Johan service contract and cannot be used with another mobile network.
Under the terms of the purchase agreement for Hash, the five directors of Hash
were to receive a total of three million ordinary shares of Johan on 1 June 20X6
(market value Rs. 6 million) and a further 5,000 shares per director on
31 May 20X7, if they were still employed by Johan on that date. All of the directors
were still employed by Johan at 31 May 20X7.
Johan granted and issued fully paid shares to its own employees on 31 May 20X7.
Normally share options issued to employees would vest over a three-year period,
but these shares were given as a bonus because of the company's exceptional
performance over the period. The shares issued had a market value of
Rs. 3 million (1 million ordinary shares at Rs. 3 per share) on 31 May 20X7 and an
average fair value of Rs. 2.5 million (one million ordinary shares at Rs. 2.50
per share) for the year ended 31 May 20X7. It is expected that Johan's share price
will rise to Rs. 6 per share over the next three years.

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On 31 May 20X7, Johan purchased property, plant and equipment for its fair value
of Rs. 4 million. The supplier has agreed to accept payment for the property,
plant and equipment either in cash or in shares. The supplier can choose to
receive either 1.5 million shares of the company, to be issued in six months, or a
cash payment in three months equivalent to the market value of 1.3 million
shares. It is estimated that the share price will be Rs. 3.50 in three months and
Rs. 4 in six months.
Additionally, at 31 May 20X7, one of the directors recently appointed to the board
has been granted the right to choose either 50,000 shares of Johan or receive a cash
payment equal to the current value of 40,000 shares at the settlement date. This
right has been granted because of the performance of the director during the year
and is unconditional at 31 May 20X7. The settlement date is 1 July 20X8 and the
company estimates the fair value of the share alternative is Rs. 2.50 per share at
31 May 20X7. The share price of Johan at 31 May 20X7 is Rs. 3 per share, and if the
director chooses the share alternative, they must be kept for a period of four years.
One of Hash's building contracts was for a regional airport. During the financial year
to 31 May 20X7, a section of an airport collapsed. Luckily the collapse happened in
the early hours of the morning and the airport was closed at the time, meaning that
no-one was hurt. The accident did, however, result in the closure of the airport
terminal. Investigation into the accident and reconstruction of the section of the
airport damaged is still in progress and no legal action has yet been brought in
connection with the accident. The expert report that is to be presented to the civil
courts, in order to determine the cause of the accident and to assess the respective
responsibilities of the various parties involved, is expected in 20X8. The directors of
Hash feel that at present, there is no requirement to record the impact of the
accident in the financial statements. If any compensation is eventually payable to
the airport operator, this is expected to be covered by Hash's insurance policies.
The directors of Hash feel that the conditions for recognising a provision or
disclosing a contingent liability have not been met. Therefore, Hash does not
intend to recognise a provision in respect of the accident nor disclose any related
contingent liability or a note setting out the nature of the accident and potential
claims in its financial statements for the year ended 31 May 20X7.

Required
(a) Analyse the information provided to determine whether the costs of
extending the network may be recognised as property, plant and equipment,
and critically analyse the amounts to be capitalised. (7 marks)
(b) Analyse the information provided about the payments to the government
and determine how these should be accounted for. (4 marks)
(c) Advise the basis of measurement of the handsets purchased by the
Retail Division. (2 marks)

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(d) Analyse how Johan should recognise revenue on the sale of call cards to
customers and revenue on sales to dealers. (9 marks)
(e) Assess the amounts to be included in Johan's financial statements for the
year ended 31 May 20X7 in respect of share-based payments. (18 marks)
(f) Evaluate the information provided to identify whether a provision needs to
be made in the financial statements of Hash for the year ended 31 May 20X7.
(10 marks)
(LO 1.1.1, 1.1.2, 1.2.1, 1.2.2, 1.3.2) (Total = 50 marks)

26 Carpart 90 mins
Carpart is a public limited company based in Sri Lanka and listed on the
Colombo Stock Exchange. Its core business is twofold:
• It is a vehicle part manufacturer, and
• It sells vehicles purchased from the manufacturer to retail customers.
The business was established 50 years ago by Luis Karava. He initially bought and
sold spare motor parts. Luis had held an interest in motor vehicles since a young
age, and establishing Carpart joined his hobby with his entrepreneurial spirit.
The business gradually grew and was incorporated. After ten years of trading,
Luis realised that he could improve profitability by manufacturing as well as
distributing motor components. Carpart duly acquired its first factory on the
outskirts of Colombo.
Parts were priced competitively, and soon the company built up a reputation for
providing low cost, quality parts. On the back of this reputation, the company
continued to expand, acquiring a further five factories over the next 40 years.
The company still operates from these properties, all of which are owned rather
than leased. Additional storage facilities are acquired as necessary by way of
short-term leases.
Having forged excellent relationships with a number of car manufacturers over
the years, Carpart moved into vehicle sales 15 years ago. The company operates
from four showrooms, all of which are held under lease agreements. Carpart has
agreements with three international car manufacturers to supply their cars to the
general public.
Core operations
Vehicle parts
Carpart makes a number of spare parts that are integral to a motor vehicle.
These include car seats, exhaust pipes, gearboxes and batteries.

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The company has a number of supply contracts in place; the biggest are with the
following companies.
• Vehiclex – for the supply of car seats
• Autoseat – for the supply of car seats
• Venue – for the supply of exhausts
Carpart also supplies goods to a number of mid-size and small customers.
Luis Karava's son, Mikey, now runs the business and is particularly wary of
over-reliance on a few customers.
The vehicle parts division also distributes vehicle-testing systems for use by
car service centres and garages. The customer base for these products is made up
of a large number of customers.
Vehicle sales
Carpart sells vehicles to final customers on two or four-year contracts.
The customer base is broad and there is a high level of repeat business,
which management believes is the result of continually high levels of customer
service.
Carpart also holds a number of demonstration vehicles from each manufacturer
that it represents. These allow customers to 'try out' a variety of cars before
deciding on an appropriate make and model. When the demonstration vehicles
are no longer required, they are sold at a reduced price.
The Carpart Group
Since taking over as the Managing Director of Carpart, Mikey Karava has pursued
an aggressive acquisition strategy. This has resulted in the acquisition of
investments in several companies and the diversification of the business.
The Carpart Group now includes (as well as Carpart itself): four subsidiaries,
an investment in an associate and a number of trade investments.
The subsidiaries operate in a variety of business areas, including health clubs and
fashion retail. These are areas in which Mikey has a personal interest and that he
felt would complement the core Carpart activities in terms of generation of profits.
There is no intragroup trade due to the disparate nature of the subsidiaries.
The associate company is run by Mikey's wife, Luisa. It operates two health and
beauty salons. This acquisition was made as a result of Luisa's business needing a
capital injection and Carpart having funds to invest.
The trade investments are in a number of stock exchange listed companies,
and are held for capital growth.
Financial reporting
Carpart prepares financial statements in accordance with Sri Lanka Financial
Reporting Standards to a reporting date of 30 April.

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Recent developments
Details of Carpart's recent operations are as follows.
Contract with Vehiclex
The contract will last for five years and Carpart will manufacture seats to a certain
specification, which will require the construction of machinery for the purpose.
The price of each car seat has been agreed at Rs. 300 so that it includes an amount
to cover the cost of constructing the machinery but there is no commitment to a
minimum order of seats to guarantee the recovery of the costs of constructing the
machinery. Carpart retains the ownership of the machinery and wishes to
recognise part of the revenue from the contract in its current financial statements
to cover the cost of the machinery that will be constructed over the next year.
Vehicle sales
Carpart sells vehicles on a contract for their market price (approximately
Rs. 20,000 each) at a mark-up of 25% on cost. The expected life of each vehicle is
five years. After four years, the car is repurchased by Carpart at 20% of its original
selling price. This price is expected to be significantly less than its fair value of
30%. The car must be maintained and serviced by the customer in accordance
with certain guidelines and must be in good condition if Carpart is to repurchase
the vehicle. Approximately 5% of cars sold are not returned due to failure to meet
these guidelines.
The same vehicles are also sold with an option that can be exercised by the buyer
two years after sale. Under this option, the customer has the right to ask Carpart
to repurchase the vehicle for 60% of its original purchase price. Historically, 70%
of buyers exercise this option. At the end of two years, the fair value of the vehicle
is expected to be 64% of the original purchase price. If the option is not exercised,
then the buyer keeps the vehicle.
The two year and four year deals are mutually exclusive.
The vehicles that Carpart uses for demonstration purposes are normally used for
this purpose for an 18-month period. After this period, the vehicles are sold at a
reduced price based upon their condition and mileage.
Venue
Carpart also entered into a contract with Venue to provide exhausts at a value of
Rs. 1 million. The terms are that payment is due one month after the sale of the
goods. On the basis of experience with other customers with similar
characteristics, Carpart considers that there is a 5% risk that the customer will not
pay the amount due after the goods have been delivered and the property
transferred. At the reporting date, Venue had not paid the outstanding amount
and Carpart felt that the maximum amount it would receive from the customer
would be Rs. 0.8 million.

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Other sales
Carpart has sold a vehicle testing system to a customer and, because of the current
difficulties in the market, Carpart has agreed to defer receipt of the selling price of
Rs. 2 million until two years after the hardware has been transferred to the
customer.
Carpart has been offering discounts to customers if products were sold with terms
whereby payment was due now but the transfer of the product was made in one
year. A sale has been made under these terms and payment of Rs. 3 million has
been received.
A discount rate of 4% should be used in any calculations.

Required
(a) Analyse the information given and advise the directors of Carpart how they
should account for the contract with Vehiclex. (7 marks)
(b) Analyse the information given so as to determine how revenue should be
recognised on the sale of vehicles. (12 marks)
(c) Analyse the information given and explain the accounting treatment of the
amount outstanding from Venue. (3 marks)
(d) Analyse the other sales made by Carport and explain how revenue should be
recognised with respect to those sales. (6 marks)
Leases
On 1 May 20X4, Carpart entered into a short lease agreement with Elpres to acquire
temporary use of another building. The lease will last for 10 months. Carpart will
make an upfront payment of Rs. 2 million then Rs. 280,000 at the end of each
month. The fair value of the property is Rs. 310 million. Carpart is considering
entering into a three-year lease of a machine from Brooke from 1 May 20X5.
The machine has a total economic life of 20 years. The fair value of the machine at
1 May 20X5 is Rs. 113,600.
The lease payments are Rs. 13,000 per year, paid in advance. The effective rate of
interest is 12.95%. Direct costs of Rs. 6,000 were incurred on commencement of
the lease, and an incentive of Rs. 5,000 was received.
The directors of Carpart have elected to utilise all possible exemptions under
SLFRS 16.

Required
(e) Explain how the lease with Elpres, should be treated. (3 marks)
(f) Analyse how the lease with Brooke should be recorded in the financial
statements for the year ended 30 April 20X6. (15 marks)

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Investments
Carpart has several investments, in subsidiaries, associates and other entities.

Required
(g) Outline the disclosure requirements of SLFRS 12 in relation to such
investments. (4 marks)
(LO 1.2.1, 1.2.2, 1.2.5, 1.3.2) (Total = 50 marks)

27 Mica 90 mins
Background
Mica Industries Limited (Mica) was set up by Andrew Dias and incorporated over
40 years ago, and has subsequently grown both organically and by acquisition to
become a diversified corporation. It has, however, retained its private status and
there are no intentions to obtain a listing for the company. Mica is based in
Colombo and has operations throughout Sri Lanka.
Business operations
Mica's core business was originally property construction, and it still has a strong
presence in this sector. Until recently the company operated only in the
commercial property construction sector, constructing office blocks, retail parks
and hotels to meet customers' specific requirements. In 20X4 the company
appointed a new business strategy consultant in the construction division, and as
a result Mica has, during the year ended 31 December 20X4, begun to develop a
presence in the residential property construction market.
As a natural extension of its commercial property construction operations, and in
response to customer demand, Mica began to offer a property maintenance
service 25 years ago. This proved particularly popular with hotel chains that were
keen to maintain the appearance of their properties in order to attract customers
and gain good reviews from tourist boards. The company now offers maintenance
service contracts to all of its construction customers when their build is complete
and has also extended this service to new maintenance-only customers.
The contracts last for 2 to 5 years and require Mica to attend a property at the
request of the owner in order to perform repairs and maintenance as required.
The company has approximately 120 of these contracts in place.
In 20W2, having constructed a number of hotels for customers, the Board of Mica
took a decision to build a hotel in central Colombo that would be operated by the
company itself. A new hospitality division was developed and an experienced
hotel manager was employed. Unlike many other hotel operators, the company's
focus was on business customers rather than tourists. The hotel proved to be a
success, and as a result a further two hotels were built in Kandy and Jaffna and put
under the control of the hotel manager.

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Most recently, within the last 10 years, the Board of Mica has developed an
investment property division. This division owns a number of office blocks and
retail parks built by the construction division and rents out individual units to
customers under operating leases. As a result, Mica has been able to tap into the
small business market.
Key personnel and ownership
Mica has a main Board with seven executive and three non-executive directors.
The CEO of the company is Luca Dias, the son of the founder Andrew Dias.
Luca Dias also owns, together with his extended family, a majority of shares in the
company. The remainder of the shares are owned by private investors.
Other executive Board members are: Max Boetz, the Managing Director;
Ama Balanchandran, the Finance Director; Tom Amaratunga, the Operations
Director (Construction); Hiruni Amour, the Operations Director
(Diversified Operations); Ravindu Vaduga, the Sales Director; and Lucy Guardia,
the HR Director.
Financial reporting
Mica prepares its financial statements to a reporting date of 31 December in
accordance with Sri Lanka Financial Reporting Standards. It does not prepare
interim statements. The company has always prepared some form of commentary
on its social and environmental impact within the annual report, and Ama
Balanchandran is keen to develop this into a full sustainability report.
Capital structure
Mica pays a modest dividend, with most profits retained and reinvested in the
company. In order to fund diversification and expansion plans, the company has
made new issues of shares and obtained bank funding. The company currently has
two concurrent bank loans outstanding, each with restrictive covenants attached
related to liquidity ratios.
Financial health
Mica has been facing difficult trading conditions for the past few years and its
profits fell in 20X2 and again in 20X3. A slight drop is also expected in the current
year, 20X4. This has been attributed in large part to the hospitality division,
which experienced lower than expected occupancy rates. The Board of Mica
attributed this to two factors: the emergence of new competition, with several
new companies focusing solely on the hotel needs of business people; and the
structure of Mica's operations, meaning that the focus of the company remained
on the core construction and property businesses.
Ama Balanchandran believes that these core businesses of Mica will achieve a
healthy increase in profits in 20X5. A number of new construction contracts have
recently been agreed and it is expected that these, together with projected

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increased tenancy levels in investment properties, will contribute to improved

financial health for the company.
Recent developments
In February 20X4, as a result of continuing poor trading conditions, the hospitality
division was closed down and Mica's business restructured so that only its core
business relating to building and property activities remained.
During the year ended 31 December 20X4 the following occurred.
• On 1 January 20X4 Mica entered into a 5-year contract with Matara Properties
Limited (Matara) to provide a maintenance service for Matara's portfolio of
properties. The fee for the contract was Rs. 1.5 million, to be paid in full on
31 December 20X7. Ama Balachandran wishes to recognise the whole of this
amount in 20X4 as she claims it meets the conditions in SLFRS 15.
• In 20X4, Mica purchased some land on which it will build some houses to be
sold to customers 'off-plan'. These houses will be sold with freehold title and to
a standard design.
The following assets had been used by the hospitality division prior to its closure
and have been retained by Mica.
• Speciality cookery equipment, which had a carrying amount at
31 December 20X4 of Rs. 750,000. This equipment has not been used since the
closure of the hospitality division and at 31 December, Mica was undecided as
to whether to sell it or to lease it to third parties under operating leases. The
fair value less selling costs of the equipment was estimated at Rs. 670,000 and
its value in use was estimated at Rs. 710,000.
• Vans with a carrying amount at 31 December 20X4 of Rs. 310,000 were
retained by Mica on closure of the hospitality division for use in the new
maintenance business. The vans were eventually sold at auction in
January 20X5 for Rs. 270,000 net of auction costs.
• After the closure of the hospitality division, Mica commenced a pre-sale
renovation of its headquarters in June 20X4. Asbestos was, however, discovered
in August 20X4 and the work to remove the asbestos was not completed until
January 20X5. The carrying amount of the property (including renovation and
removal of asbestos) as at 31 December was Rs. 6.7 million and the property was
advertised for sale in February 20X5 at a price of Rs. 8.3 million. Selling costs
were estimated at 2%.
Ama Balachandran has stated that she would like to simplify Mica's reporting and
use the Sri Lankan Financial Reporting Standard for Small and Medium Sized
Entities (SFRS for SMEs) as soon as possible. However, her son, who is an auditor
with a Big Four accounting firm, has told him that there are strict criteria that
must be applied and that some of Mica's accounting policies may need to change.

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Mica's imputed rate of interest according to LKAS 18 is 5%. Income tax is 17%.
Mica's year end is 31 December 20X4.

Required
(a) Analyse the information provided so as to determine how revenue from the
maintenance contract should be recognised. Your answer should include
calculations of the amounts to be recognised. (15 marks)
(b) Assess how revenue should be recognised for the sale of the off-plan
properties in accordance with SLFRS 15 Revenue from Contracts with
Customers (10 marks)
(c) Assess the appropriate classification and measurement of the assets
formerly used by the hospitality business. (11 marks)
(d) Advise Ama Balachandran on whether Mica may adopt SLFRS for SMEs and
outline the differences between the accounting treatments given in SLFRS
for SMEs and full SLFRS in respect of:
• Purchased goodwill
• Owned properties (currently held at valuation)
• Provisions (9 marks)
At the date of the financial statements, 31 December 20X4, Mica's liquidity
position was quite poor, such that the directors described it as 'unsatisfactory' in
the management report. During the first quarter of 20X5, the situation worsened
with the result that Mica was in breach of certain loan covenants at
31 March 20X5. The financial statements were authorised for issue at the end of
April 20X5. The directors' and auditor's reports both emphasised the considerable
risk of not being able to continue as a going concern.
The notes to the financial statements indicated that there was 'ample' compliance
with all loan covenants as at the date of the financial statements. No additional
information about the loan covenants was included in the financial statements.
Mica had been close to breaching the loan covenants in respect of free cash flows
and equity ratio requirements at 31 December 20X4.
Ama Balachandran feels that, given the existing information in the financial
statements, any further disclosure would be excessive and confusing to users.

Required
(e) Assess the adequacy of Mica's disclosures about this matter. (5 marks)
(LO 1.1.1, 1.1.2, 1.1.4, 1.1.7, 1.2.1, 1.3.3) (Total = 50 marks)

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28 Robby 90 mins
Background
Robby PLC ('Robby') is a quoted public company listed on the Colombo Stock
Exchange. Robby and its subsidiaries operate in the energy industry, with
interests in the gas industry and the electrical power industry. Operations include
the extraction of natural gas, the manufacture of coal gas, electricity generation
and distribution, and sales of both gas and electricity.
The company is viewed as one of the most successful energy companies listed on
the Colombo Stock Exchange and has won a number of awards for best practice in
corporate governance.
Development of Robby Group
On 1 June 20X0, Robby acquired 5% of the ordinary shares of Zinc. Zinc operates
in the electricity sector, and owns a hydroelectricity plant. This minority
shareholding was acquired by Robby with the intention that it would be increased
in due course to be a majority shareholding if the performance of Zinc met certain
defined thresholds. Such an acquisition would meet Robby's objectives to increase
its interests in renewable energy sources and generate power through
low-pollution activities.
The defined performance thresholds were met during 20X2 and the Board of
Robby aggressively pursued a further acquisition of shares in Zinc. A deal was
agreed with the previous owners in the summer of 20X2, and a further 55% of
Zinc was eventually acquired by Robby on 1 December 20X2.
On 1 June 20X1, Robby acquired 80% of the equity interests of Hail for cash
consideration of Rs. 50 million. This acquisition furthered Robby's strategy to
pursue renewable and environmentally friendly energy sources. Hail operates in
the areas of solar and wind energy. It has installed solar panels and wind turbines
at 'sun and wind farms' throughout Sri Lanka, which capture energy from sunlight
and the wind and convert it into electricity. This electricity is then distributed
throughout Sri Lanka via the national power grid.
Robby also has a 40% interest in a joint operation, being a natural gas station.
The construction of the station was completed on 1 June 20X2, and is expected to
have a useful life of ten years. The other joint operator (owning 60% of the joint
operation) is Fabian PLC ('Fabian'), another Sri Lankan energy provider.
Robby and Fabian have an agreement whereby any decisions about the joint
operation require a 75% majority, and therefore unanimous consent is required.
The contract between the joint operators also states that revenue generated and
costs incurred by the joint operation are receivable and payable by Fabian.
Any amounts outstanding with Robby are settled after the year end.

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Financial reporting
Robby PLC prepares consolidated financial statements to 31 May in accordance
with Sri Lanka Financial Reporting Standards. The following is an extract of the
accounting policies section of Robby's financial statements.

2. Accounting policies
2.1 Property, plant and equipment
Land and buildings held for use in the production or supply of goods or
services, or for administrative purposes, are stated in the statement of
financial position at their revalued amounts, being the fair value at the date
of revaluation less any subsequent accumulated depreciation and
subsequent accumulated impairment losses. Revaluations are performed
with sufficient regularity such that the carrying amount does not differ
materially from that which would be determined using fair values at the
reporting date.
2.8 Financial assets
Financial assets are classified into the following specified categories: financial
assets at fair value through profit or loss (FVTPL), financial assets at fair value
through other comprehensive income (FVTOCI) and financial assets at
amortised cost. The classification depends on the nature and purpose of the
financial assets and is determined at the time of initial recognition.
2.18 Non-controlling interests
Non-controlling interests in the net assets of consolidated subsidiaries are
identified separately from the Group's equity therein. Non-controlling
interests consist of the amount of those interests at the date of the original
business combination and the non-controlling shareholders' share of changes
in equity since the date of the combination. The interest of non-controlling
shareholders in the acquiree is initially measured at fair value.
In line with Robby's strategy to develop renewable and green energy resources,
and in light of historic bad press about the impact of the energy sector,
the Board of Robby have in recent years started publishing a sustainability report
alongside the financial statements in the annual report. The Board are keen to
develop the annual report to become an integrated report in future years,
however it does not intend to implement this intention immediately and instead
will wait two to three years in order to understand and benefit from the
experiences of other companies adopting integrated reporting.
Cash management
Robby does not maintain high cash balances, instead investing spare cash in
projects and acquisitions. As a result, the company occasionally finds itself
needing short-term injections of cash.

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The Treasury department of Robby has adopted a number of strategies to obtain

these short-term cash injections in the past, including securing bank overdrafts
and short-term bridging loans, factoring receivables balances to banks, and
making sale and leaseback agreements and sale and repurchase agreements.
Recent developments
The following draft statements of financial position relate to Robby, Hail and Zinc,
all public limited companies, as at 31 May 20X3.
Robby Hail Zinc
Rs m Rs m Rs m
Assets
Non-current assets
Property, plant and equipment 112 60 26
Investments in subsidiaries:
Hail 55
Zinc 19
Financial assets 9 6 14
Joint operation 6
Current assets 5 7 12
Total assets 206 73 52
Equity and liabilities
Stated capital 25 20 10
Other components of equity 11 – –
Retained earnings 70 27 19
Total equity 106 47 29
Non-current liabilities: 53 20 21
Current liabilities 47 6 2
Total equity and liabilities 206 73 52
The following information is relevant to the preparation of the group financial
statements of Robby.
(i) Robby categorised the investment in Hail as a financial asset at fair value
through other comprehensive income.
A dividend received from Hail on 1 January 20X3 of Rs. 2 million has
similarly been credited to OCI.
The fair value of the non-controlling interest was Rs. 15 million on
1 June 20X1.
On 1 June 20X1, the fair value of the identifiable net assets of Hail was
Rs. 60 million and the retained earnings of Hail were Rs. 16 million. The excess
of the fair value of the net assets is due to an increase in the value of non-
depreciable land.

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(ii) Robby measured the 5% investment in Zinc at fair value through profit or
loss in the financial statements to 31 May 20X2.
The consideration for the acquisitions was as follows.
Shareholding Consideration
Rs m
1 June 20X0 5% 2
1 December 20X2 55% 16
60% 18
At 31 May 20X3 the carrying amount of the investment in Zinc in Robby's
accounts represents the fair value of the initial 5% shareholding at
31 May 20X2 plus the cost of the additional 55% shareholding.
At 1 December 20X2, the fair value of the equity interest in Zinc held by
Robby before the business combination was Rs. 5 million.
The fair value of the non-controlling interest in Zinc was Rs. 9 million on
1 December 20X2.
The fair value of the identifiable net assets at 1 December 20X2 of Zinc was
Rs. 26 million, and the retained earnings were Rs. 15 million. The excess of the
fair value of the net assets is due to an increase in the value of property, plant
and equipment (PPE), which was provisional pending receipt of the final
valuations. These valuations were received on 1 March 20X3 and resulted in
an additional increase of Rs. 3 million in the fair value of PPE at the date of
acquisition. This increase does not affect the fair value of the non-controlling
interest at acquisition. PPE is to be depreciated on the straight-line basis over
a remaining period of five years.
(iii) The following information relates to the joint arrangement activities with
Fabian.
(1) Assets, liabilities, revenue and costs are apportioned on the basis of
shareholding.
(2) The natural gas station cost Rs. 15 million to construct and is to be
dismantled at the end of its useful life. The present value of this
dismantling cost to the joint arrangement at 1 June 20X2, using a
discount rate of 5%, was Rs. 2 million.
(3) In the year, gas with a direct cost of Rs. 16 million was sold for
Rs. 20 million. Additionally, the joint arrangement incurred operating
costs of Rs. 0.5 million during the year.
Robby has only contributed and accounted for its share of the construction
cost, paying Rs. 6 million.

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(iv) Robby purchased PPE for Rs. 10 million on 1 June 20X0. It has an expected
useful life of twenty years and is depreciated on the straight-line method.
On 31 May 20X2, the PPE was revalued to Rs. 11 million. This was accounted
for in accordance with LKAS 16. At 31 May 20X3, impairment indicators
triggered an impairment review of the PPE. The recoverable amount of the
PPE was Rs. 7.8 million. The only accounting entry posted for the year to
31 May 20X3 was to account for the depreciation based on the revalued
amount as at 31 May 20X2. Robby's accounting policy is to make a transfer of
the excess depreciation arising on the revaluation of PPE.
(v) Robby held a portfolio of trade receivables with a carrying amount of
Rs. 4 million at 31 May 20X3. At that date, the entity entered into a factoring
agreement with a bank, whereby it transfers the receivables in exchange for
Rs. 3.6 million in cash. Robby has agreed to reimburse the factor for any
shortfall between the amount collected and Rs. 3.6 million. Once the
receivables have been collected, any amounts above Rs. 3.6 million,
less interest on this amount, will be repaid to Robby. Robby has
derecognised the receivables and charged Rs. 0.4 million as a loss to profit
or loss.
(vi) Immediately prior to the year end, Robby sold land to a third party at a price
of Rs. 16 million with an option to purchase the land back on 1 July 20X3 for
Rs. 16 million plus a premium of 3%. The market value of the land is
Rs. 25 million on 31 May 20X3 and the carrying amount was Rs. 12 million.
Robby accounted for the sale, consequently eliminating the bank overdraft at
31 May 20X3.

Required
(a) Compile a consolidated statement of financial position of the Robby Group
at 31 May 20X3 in accordance with Sri Lanka Financial Reporting Standards.
(35 marks)
In the above scenario (information point (v)), Robby holds a portfolio of trade
receivables and enters into a factoring agreement with a bank, whereby it
transfers the receivables in exchange for cash. Robby additionally agreed to other
terms with the bank as regards any collection shortfall and repayment of any
monies to Robby. Robby derecognised the receivables. This is an example of the
type of complex transaction that can arise out of normal terms of trade.

Required
(b) Advise when financial assets should be derecognised in accordance with
SLFRS 9 and apply these rules to the portfolio of trade receivables in Robby's
financial statements. (9 marks)

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(c) Assess the legitimacy of Robby selling land just prior to the year end in
order to show a better liquidity position for the group and whether this
transaction is consistent with an accountant's responsibilities to ensure
accurate presentation of financial statements in a given set of circumstances.
(Note. Your answer should include reference to the above scenario.)
(6 marks)
(LO 1.1.1, 2.1.1, 2.1.4, 5.1.1) (Total = 50 marks)

29 Ashanti 90 mins
Background
Ashanti PLC ('Ashanti') is a quoted public company listed on the Colombo Stock
Exchange. Ashanti and its subsidiaries operate in the textiles and apparel
manufacturing industry. This industry employs approximately 15% of Sri Lanka's
workforce and accounts for approximately half of the country's exports.
Within this market, Ashanti operates at the mid-tier; it is not one of the
'Apparel Giants' of Sri Lanka, but it has a significant presence.
The company was established 35 years ago by the Bhaskaran family, just as the
Sri Lankan apparel industry began to grow as a result of the country's open
economic policy and trade and investment friendly environment. The Bhaskaran
family developed Ashanti over the next 20 years, establishing a number of
factories throughout the country. From its inception the company had a good
reputation for treating its workforce well, with good working conditions, fair pay,
medical provision and generous holiday allowances.
In its 25th anniversary year, Ashanti shares were listed on the Colombo Stock
Exchange. As a result, the company raised funds which allowed it to expand
through acquisition. After the listing, the Bhaskaran family retained a minority
shareholding in Ashanti and continued to manage the company.
Development of Ashanti Group
On 1 May 20X3, Ashanti acquired 70% of the equity interests of Bochem, another
public limited company operating in the textiles and apparel industry. This was a
strategic acquisition allowing Ashanti to move into a growth market, being
children's apparel, whilst also achieving a number of cost-cutting strategies.
The remaining 30% of Bochem was owned by a number of disparate investors,
so allowing Ashanti a dominant influence over the company.
Bochem acquired 80% of the equity interests of Ceram, a public limited company,
on 1 May 20X3. Ceram is an apparel retailer which Bochem had supplied with
goods for many years and the acquisition signalled a diversification of operations
for Bochem and the Ashanti Group. Since the acquisition, it has, however become
apparent that Ceram is not a good strategic fit with the rest of the group, and the
Ashanti Board is considering how best to deal with this issue.

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Financial Reporting
Ashanti PLC prepares consolidated financial statements to 30 April in accordance
with Sri Lanka Financial Reporting Standards. The following is an extract of the
accounting policies section of Ashanti's financial statements.
2. Accounting policies
2.1 Property, plant and equipment
Land and buildings held for use in the production or supply of goods or
services, or for administrative purposes, are stated in the statement of
financial position at their revalued amounts, being the fair value at the date of
revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment losses. Revaluations are performed with sufficient
regularity such that the carrying amount does not differ materially from that
which would be determined using fair values at the reporting date.
As a revaluation surplus is realised, it is transferred to retained earnings.
2.4 Financial assets at amortised cost
Trade receivables, loans and other receivables that have fixed or
determinable payments that are not quoted in an active market are classified
as financial assets at 'amortised cost' and are measured using the effective
interest method, less any impairment. Interest income is recognised by
applying the effective interest rate, except for short-term receivables when
the recognition of interest would be immaterial.
2.8 Goodwill
Goodwill represents the excess of the cost of an acquisition (including the
non-controlling interest) over the fair value of the acquiree's identifiable net
assets at the date of acquisition.
Goodwill is tested for impairment at least annually. Any impairment is
recognised immediately in profit or loss. Subsequent reversals of
impairment losses for goodwill are not recognised.
2.15 Non-controlling interests
Non-controlling interests consist of the amount of those interests at the date
of the original business combination and the non-controlling shareholders'
share of changes in equity since the date of the combination. The interest of
non-controlling shareholders in the acquiree is initially measured at fair
value in accordance with SLFRS 3. Non-controlling interests are reported
separately from the equity of the owners of the parent.
Social responsibility
Ashanti, together with the rest of the apparel industry of Sri Lanka, has invested
heavily in achieving a conscientious standpoint in apparel production.
The industry's trade association, Sri Lanka Apparel, runs a campaign called
Garments without Guilt which it uses to draw attention to its adherence to ethical

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considerations. Sri Lanka is also a signatory to 39 conventions of the International

Labour Organisation, and it outlaws child labour. Sri Lankan law requires that an
employer contributes 3% of an employee's salary to a trust fund which the
employee receives after leaving the company.
These factors, together with Ashanti's generous human resources policies,
have led the Board of Ashanti to consider publishing a sustainability report as part
of the company's annual report.
Recent developments
The following financial statements relate to Ashanti.
ASHANTI GROUP:
STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 30 APRIL 20X5
Ashanti Bochem Ceram
Rs m Rs m Rs m
Revenue 810 235 142
Cost of sales (686) (137) (84)
Gross profit 124 98 58
Other income 31 17 12
Distribution costs (30) (21) (26)
Administrative costs (55) (29) (12)
Finance costs (8) (6) (8)
Profit before tax 62 59 24
Income tax expense (21) (23) (10)
Profit for the year 41 36 14

Other comprehensive income for the year,

net of tax –
Items that will not be reclassified to
profit or loss:
AFS financial assets 20 9 6
Gains (net) on PPE revaluation 12 6 –
Actuarial losses on defined benefit plan (14) – –
Other comprehensive income for the
year, net of tax 18 15 6
Total comprehensive income 59 51 20
The following information is relevant to the preparation of the group statement of
profit or loss and other comprehensive income.
(i) The purchase consideration for Bochem comprised cash of Rs. 150 million
and the fair value of the identifiable net assets was Rs. 160 million at that
date. The fair value of the non-controlling interest in Bochem was
Rs. 54 million on 1 May 20X3. The share capital and retained earnings of
Bochem were Rs. 55 million and Rs. 85 million respectively and other
components of equity were Rs. 10 million at the date of acquisition. The

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excess of the fair value of the identifiable net assets at acquisition is due to
an increase in the value of plant, which is depreciated on the straight-line
method and has a five-year remaining life at the date of acquisition. Ashanti
disposed of a 10% equity interest to the non-controlling interests (NCI) of
Bochem on 30 April 20X5 for a cash consideration of Rs. 34 million. The
carrying value of the net assets of Bochem at 30 April 20X5 was
Rs. 210 million before any adjustments on consolidation. Goodwill had
reduced in value by 15% at 30 April 20X4 and at 30 April 20X5 had lost a
further 5% of its original value before the sale of the equity interest to the NCI.
(ii) The purchase consideration for Ceram was cash of Rs. 136 million.
Ceram's identifiable net assets were fair valued at Rs. 115 million and the
NCI of Ceram attributable to Ashanti had a fair value of Rs. 26 million at that
date. On 1 November 20X4, Bochem disposed of 50% of the equity of Ceram
for cash consideration of Rs. 90 million. Ceram's identifiable net assets were
Rs. 160 million and the consolidated value of the NCI of Ceram attributable
to Bochem was Rs. 35 million at the date of disposal. The remaining equity
interest of Ceram held by Bochem was fair valued at Rs. 45 million. After the
disposal, Bochem can still exert significant influence. Goodwill had been
impairment tested and no impairment had occurred. Ceram's profits are
deemed to accrue evenly over the year.
(iii) Ashanti has sold inventory to both Bochem and Ceram in October 20X4.
The sale price of the inventory was Rs. 10 million and Rs. 5 million
respectively. Ashanti sells goods at a gross profit margin of 20% to group
companies and third parties. At the year end, half of the inventory sold to
Bochem remained unsold but the entire inventory sold to Ceram had been
sold to third parties.
(iv) On 1 May 20X2, Ashanti purchased a Rs. 20 million five-year bond with
semi-annual interest of 5% payable on 31 October and 30 April. This was
classified as a financial asset at 'amortised cost'. The purchase price of the
bond was Rs. 21.62 million. The effective annual interest rate is 8% or 4% on
a semi-annual basis. At 1 May 20X4 the amortised cost of the bond was
Rs. 21.046 million and the 12-month expected credit loss was nil. Due to
unexpected issues, issuer of the bond did pay the interest due on
31 October 20X4 and 30 April 20X5, but was in financial trouble at
30 April 20X5. Ashanti feels that as at 30 April 20X5, the bond is impaired
and that the best estimates of total future cash receipts are Rs. 2.34 million
on 30 April 20X6 and Rs. 8 million on 30 April 20X7. The current interest
rate for discounting cash flows as at 30 April 20X5 is 10%. No accounting
entries have been made in the financial statements for the above bond since
30 April 20X4. (You should assume the annual compound rate is 8% for
discounting the cash flows.)

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(v) Ashanti sold Rs. 5 million of goods to a customer who recently made an
announcement that it is restructuring its debts with its suppliers including
Ashanti. It is probable that Ashanti will not recover the amounts outstanding.
The goods were sold after the announcement was made although the order
was placed prior to the announcement. Ashanti wishes to make an additional
allowance of Rs. 8 million against the total receivable balance at the
year- end, of which Rs. 5 million relates to this sale.
(vi) Ashanti owned a piece of property, plant and equipment (PPE) which cost
Rs. 12 million and was purchased on 1 May 20X3. It is being depreciated
over ten years on the straight-line basis with zero residual value.
On 30 April 20X4, it was revalued to Rs. 13 million and on 30 April 20X5,
the PPE was revalued to Rs. 8 million. The whole of the revaluation loss had
been posted to other comprehensive income and depreciation has been
charged for the year. It is Ashanti's company policy to make all necessary
transfers for excess depreciation following revaluation.
(vii) The salaried employees of Ashanti are entitled to 25 days paid leave each
year. The entitlement accrues evenly over the year and unused leave may be
carried forward for one year. The holiday year is the same as the financial
year. At 30 April 20X5, Ashanti has 900 salaried employees and the average
unused holiday entitlement is three days per employee. Five per cent of
employees leave without taking their entitlement and there is no cash
payment when an employee leaves in respect of holiday entitlement.
There are 255 working days in the year and the total annual salary cost is
Rs. 19 million. No adjustment has been made in the financial statements for
the above and there was no opening accrual required for holiday entitlement.
(viii) Investments in equity instruments (excluding shares group entities) have
been categorised as financial assets at fair value through other
comprehensive income.
(ix) Ignore any taxation effects of the above adjustments and the disclosure
requirements of SLFRS 5 Non-current assets held for sale and discontinued
operations.

Required
(a) Compile a consolidated statement of profit or loss and other comprehensive
income for the year ended 30 April 20X5 for the Ashanti Group. (35 marks)
(b) Outline the factors which provide encouragement to companies such as
Ashanti to disclose sustainability information in their financial statements,
briefly discussing whether the content of such disclosure should be at the
company's discretion. (8 marks)

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(c) Discuss the nature of and incentives for 'management of earnings' and
whether such a process can be deemed to be ethically acceptable, given the
requirement for accountants to ensure that financial statements are
accurately presented in a given set of circumstances. (7 marks)
(LO 2.1.1, 4.1.3, 5.1.1) (Total = 50 marks)

30 Rose 90 mins
Background
Rose PLC ('Rose') is a quoted public company listed on the Colombo Stock
Exchange. Rose and its subsidiaries operate in the mining sector, mainly extracting
and selling graphite.
Sri Lanka is the only country in the world that produces super-grade lump and
chippy dust graphite containing between 95% and 99% pure carbon. Lump and
chippy dust graphite products are the highest-value graphite products found
globally, and prices are considerably higher than those for other products such as
flake or amorphous graphite.
Development of Rose Group
Sri Lanka has been mining graphite for 200 years and was a significant graphite
producer and exporter at the start of the last century. Rose was set up almost
100 years ago to take advantage of this available resource. The company grew
steadily until the graphite sector was nationalised almost 50 years ago. At this
stage, Rose transferred its mining expertise to gem mining.
When the private sector was allowed back into the graphite industry,
after 20 years, Rose was quick to re-establish itself, and has since continued to
grow in the graphite sector, whilst retaining interests in gem mining.
On 1 May 20X7, Rose acquired 70% of the equity interests of Petal, a public limited
company. This shareholding was increased to 80% on 30 April 20X8. Petal also
operates in the graphite mining sector, and its acquisition allowed operations to
be streamlined and cost-cutting strategies to be put in place. In addition, it allowed
Rose to access certain advanced mining methods and technologies that Petal had
protected by way of patents.
Rose acquired 52% of the ordinary shares of Stem on 1 May 20X7. Stem is located
in central Africa and operates a gold mine. The acquisition was viewed as a
strategic move to offset the possible negative effects of the Sri Lankan graphite
mining industry being opened up to newer companies.
The income of Stem is denominated and settled in dinars. The output of the mine
is routinely traded in dinars and its price is determined initially by local supply
and demand. Stem pays 40% of its costs and expenses in Sri Lankan Rupees with
the remainder being incurred locally and settled in dinars. Stem's management

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has a considerable degree of authority and autonomy in carrying out the

operations of Stem and is not dependent upon group companies for finance.
Financial reporting
Rose PLC prepares consolidated financial statements to 30 April in accordance
with Sri Lanka Financial Reporting Standards. The following is an extract of the
accounting policies section of Ashanti's financial statements.
2. Accounting policies
2.15 Non-controlling interests
Non-controlling interests consist of the amount of those interests at the date
of the original business combination and the non-controlling shareholders'
share of changes in equity since the date of the combination. The interest of
non-controlling shareholders in the acquiree is initially measured at fair
value in accordance with SLFRS 3. Non-controlling interests are reported
separately from the equity of the owners of the parent.
2.22 Foreign currencies
The individual financial statements of each group company are presented in
its functional currency. For the purposes of the consolidated financial
statements, the results and financial position of each group company are
expressed in Sri Lankan Rupees, which is the functional currency of the
Company and the presentation currency for the consolidated financial
statements.
Financial highlights
The Stem Group has reported healthy profits over recent years, the majority of
which are retained and reinvested in the group's operations. Other funding
requirements are met by way of loan stock issues and long term bank loans.
Future developments
Rose is considering acquiring a service company, MineConsult Co. This company
provides professional technical consultancy services to the mining and metals
sector throughout the world. It is experienced in providing multi-disciplinary
technical studies and due diligence for mineral assets including exploration
through to development, operation and mine closure. Rose, and the other
companies in the Group, have previously used the expertise of MineConsult Co.
The potential acquisition of the company would mark a change in group strategy
as, to date, the group has concentrated on expanding its mining operations.
The directors of Rose have stated that the acquisition is under consideration
because of the value of the human capital involved and the opportunity for
synergies and cross-selling opportunities.

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Recent developments
The draft statements of financial position of Rose, Petal and Stem are as follows,
at 30 April 20X8.
Rose Petal Stem
Rs m Rs m Dinars m
Assets
Non-current assets:
Property, plant and equipment 370 110 380
Investment in subsidiaries
Petal 113 – –
Stem 46 – –
Financial assets 15 7 50
544 117 430
Current assets 118 100 330
Total assets 662 217 760
Equity and liabilities
Stated capital 158 38 200
Retained earnings 256 56 300
Other components of equity 7 4 –
Total equity 421 98 500
Non-current liabilities 56 42 160
Current liabilities 185 77 100
Total liabilities 241 119 260
Total equity and liabilities 662 217 760
The following information is relevant to the preparation of the group financial
statements.
(i) The purchase consideration paid by Rose for Petal comprised cash of
Rs. 94 million. The fair value of the identifiable net assets recognised by Petal
was Rs. 120 million excluding the patent below. The identifiable net assets of
Petal at 1 May 20X7 included a patent which had a fair value of Rs. 4 million.
This had not been recognised in the financial statements of Petal. The patent
had a remaining term of four years to run at that date and is not renewable.
The retained earnings of Petal were Rs. 49 million and other components of
equity were Rs. 3 million at the date of acquisition. The remaining excess of
the fair value of the net assets is due to an increase in the value of land.
The fair value of the non-controlling interest in Petal was Rs. 46 million on
1 May 20X7. There have been no issues of ordinary shares since acquisition
and goodwill on acquisition is not impaired.
Rose paid cash consideration of Rs. 19 million for the further 10% interest in
Petal on 30 April 20X8.

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(ii) On 1 May 20X7 Stem's retained earnings were 220 million dinars. The fair
value of the identifiable net assets of Stem on 1 May 20X7 was 495 million
dinars. The excess of the fair value over the net assets of Stem is due to an
increase in the value of land. The fair value of the non-controlling interest in
Stem at 1 May 20X7 was 250 million dinars.
There have been no issues of ordinary shares of Stem and no impairment of
goodwill in the company since acquisition.
The following exchange rates are relevant to the preparation of the group
financial statements.
Dinars to
Rs.
1 May 20X7 6
30 April 20X8 5
Average for year to 30 April 20X8 5.8
(iii) Rose has a property located in the same country as Stem. The property was
acquired on 1 May 20X7 and is carried at a cost of 30 million dinars.
The property is depreciated over 20 years on the straight-line method. At
30 April 20X8, the property was revalued to 35 million dinars. Depreciation
has been charged for the year, but the revaluation has not been taken into
account in the preparation of the financial statements as at 30 April 20X8.
(iv) Rose commenced a long-term bonus scheme for employees at 1 May 20X7.
Under the scheme employees receive a cumulative bonus on the completion
of five years of service. The bonus is 2% of the total of the annual salary of
the employees. The total salary of employees for the year to 30 April 20X8
was Rs. 40 million and a discount rate of 8% is assumed. Additionally,
at 30 April 20X8, it is assumed that all employees will receive the bonus and
that salaries will rise by 5% per year.
(v) Rose purchased plant for Rs. 20 million on 1 May 20X4 with an estimated
useful life of six years. Its estimated residual value at that date was
Rs. 1.4 million. At 1 May 20X7, the estimated residual value changed to
Rs. 2.6 million. The change in the residual value has not been taken into
account when preparing the financial statements as at 30 April 20X8.

Required
(a) Recommend which currency should be used as the functional currency of
Stem, applying the principles set out in LKAS 21 The effects of changes in
foreign exchange rates. (8 marks)
(b) Compile a consolidated statement of financial position of the Rose Group at
30 April 20X8 in accordance with Sri Lanka Financial Reporting Standards
(SLFRS), showing the exchange difference arising on the translation of
Stem's net assets. Ignore deferred taxation. (35 marks)

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Questions

Rose's accountant has measured the fair value of the assets of MineConsult Co
based on what Rose is prepared to pay for them. The directors of Rose have
further stated that what the company is willing to pay is influenced by its future
plans for the business.
MineConsult Co has contract-based customer relationships with well-known
domestic and international companies and some mining companies.
Rose's accountant has measured the fair value of all of these customer
relationships at zero, because Rose already enjoys relationships with the majority
of these customers.
(c) Evaluate the validity of the accounting treatment for MineConsult Co
proposed by Rose's accountant and whether such a proposed treatment
raises any ethical issues. (7 marks)
(LO 1.2.2, 2.1.1, 5.1.1) (Total = 50 marks)

31 Warrburt 90 mins
Warrburt PLC is listed on the Colombo Stock Exchange and, together with its
subsidiaries, manufactures and distributes beverages. The company was
established over 50 years ago and after an initial period of organic expansion,
achieved speedy growth through acquisitions.
Group structure
The parent company, Warburrt manufactures and distributes milkshake and fruit
juice style shrinks. It currently holds majority shareholdings in four subsidiaries.
The subsidiaries are:
 Fruitz, which makes fruit smoothie drinks which are distributed to
supermarkets and convenience stores throughout Sri Lanka;
 Chillz, which makes non-alcoholic bottled fruit cocktails that are sold to bars
and restaurants throughout Sri Lanka and marketed at older teenagers;
 Elephant Brewery, which brews and bottles a popular brand of lager and
distributes it throughout South East Asia; and
 Any14Tea, which makes canned iced tea drinks that are sold in Sri Lanka and
India.
Both Fruitz and Any14Tea are 100% owned by Warburrt; Chillz is 85% owned
and Elephant Brewery 95% owned. The minority shareholders in Chillz and
Elephant Group are, in both cases, the families that set the companies up.
At the start of December 20X7, Warburrt acquired a 25% interest in H200h,
a private family-run company that adds fruit extracts to mineral water in order to
create a high-end flavoured water product. The 25% shareholding acquired
afforded Warburrt significant influence over H200h.

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Management and employees

Warburrt is managed by a Board consisting of eight members, led by James Dashani,
the CEO. All Board members have extensive experience in the drinks and beverages
sector and are appropriately qualified in their respective fields.
The accounting team is led by Sharmini Cooper, a chartered accountant.
Sharmini has worked for Warburtt group companies for 15 years, progressing from
assistant financial accountant of Chillz to Group Finance Director.
The Group promotes fair employment policies and one of its continuing objectives
is to employ an ethnically diverse workforce with males and females represented
as equally as possible. Employees are encouraged to set personal development
objectives and receive training in order that they can achieve promotion
aspirations. All employees are rewarded with a generous remuneration package,
including holiday pay, paid sick leave, and an annual bonus. Certain employees are
also eligible to join the company's defined benefit pension scheme after an initial
period of employment.
Financial performance and position
Although the Warburrt Group is well-established and a big player in the beverage
market, it suffered a small loss in the year ended 30 November 20X6. A further,
increased loss was reported in the following year and in the year ended
30 November 20X8, the reported operating loss was Rs. 47 million.
Management has attributed the losses to a number of factors, above all the need to
cut selling prices aggressively due to competitor activities and the increase in raw
materials costs as the result of a series of poor fruit and wheat harvests.
These factors have particularly affected Fruitz and Elephant Brewery and as a
result goodwill in both companies has become impaired in the year ended
30 November 20X8.
Related to the continued losses, Warburrt 's cash position is deteriorating.
Despite this, its liquidity position, based on amounts reported in the statement of
financial position at 30 November 20X8 is strong, with a current ratio of 3.3:1
compared to a current ratio at 30 November 20X7 of 3.0.
Future strategy
The strategy of the Warburrt Group remains focused on growth by acquisition,
although the Board feel that the export market should be explored further,
particularly for the Elephant Brewery, as they have heard about the popularity of
unusual beers in Europe and Australia.

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Recent developments
The following draft group financial statements relate to Warrburt:
WARRBURT GROUP:
STATEMENT OF FINANCIAL POSITION AS AT 30 NOVEMBER 20X8
30 Nov 20X8 30 Nov 20X7
Rs m Rs m
Assets
Non-current assets
Property, plant and equipment 350 360
Goodwill 80 100
Other intangible assets 228 240
Investment in associate 100 –
Financial assets 142 150
900 850
Current assets
Inventories 135 198
Trade receivables 92 163
Cash and cash equivalents 288 323
515 684
Total assets 1,415 1,534
Equity and liabilities
Equity attributable to owners of the parent: to
last million
Stated capital 650 595
Retained earnings 371 454
Revaluation surplus 6 4
Other components of equity 39 16
1,066 1,069
Non-controlling interest 46 53
Total equity 1,112 1,122
Non-current liabilities
Long-term borrowing 20 64
Deferred tax 28 26
Long-term provisions 100 96
Total non-current liabilities 148 186
Current liabilities:
Trade payables 115 180
Current tax payable 35 42
Short-term provisions 5 4
Total current liabilities 155 226
Total liabilities 303 412
Total equity and liabilities 1,415 1,534

72 CA Sri Lanka
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WARRBURT GROUP:
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 30 NOVEMBER 20X8
Rs m
Revenue 910
Cost of sales (886)
Gross profit 24
Other income 7
Distribution costs (40)
Administrative expenses (35)
Finance costs (9)
Share of profit of associate 6
Loss before tax (47)
Income tax expense (29)
Loss for the year from continuing operations (76)
Loss for the year (76)
Other comprehensive income for the year (after tax)
Investment in AFS financial assets 27
Gains on property revaluation 2
Remeasurement losses on defined benefit plan (4)
Other comprehensive income for the year (after tax) 25
Total comprehensive income for the year (51)
Loss attributable to:
Owners of the parent (74)
Non-controlling interest (2)
(76)
Total comprehensive income attributable to:
Owners of the parent (49)
Non-controlling interest (2)
(51)

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WARRBURT GROUP:
STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 30 NOVEMBER 20X8
Stated Retained Other Reval'n Total NCI Total
capital earnings comp of surplus equity
equity
Rs m Rs m Rs m Rs m Rs m Rs m Rs m
b/f 595 454 16 4 1,069 53 1,122
Share capital
issued 55 55 55
Dividends (9) (9) (5) (14)
Total
comprehensive
income for
the year (74) 23 2 (49) (2) (51)
Balance at
30.11.X8 650 371 39 6 1,066 46 1,112

NOTE TO STATEMENT OF CHANGES IN EQUITY:

Rs m
Profit/loss attributable to owners of parent (74)
Remeasurement losses on defined benefit plan (4)
Total comprehensive income for year – retained earnings (78)
The following information relates to the financial statements of Warrburt.
(i) Warrburt holds financial assets that are owned by the parent company.
At 1 December 20X7, the total carrying amount of those investments was
Rs 150 m. Rs. 112 m of this Rs. 150 m are classified as financial assets at fair
value through other comprehensive income. The remaining Rs. 38 m related
to an investment in the shares of Alburt, which has been designated as fair
value through profit or loss. During the year, the investment in Alburt was
sold for Rs. 45 m, with the fair value gain shown in 'other income' in the
financial statements. The following schedule summarises the changes.
Alburt Other Total
Rs m Rs m Rs m
Carrying amount at 1 December 20X7 38 112 150
Add gain on derecognition/reval'n 7 30 37
Less sales at fair value (45) – (45)
Carrying amount at 30 November 20X8 – 142 142
Deferred tax of Rs. 3 million arising on the Rs. 30 m revaluation gain above
has been taken into account in other comprehensive income for the year.

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(ii) The retirement benefit liability is shown as a long-term provision in the

statement of financial position and comprises the following.
Rs m
Net defined benefit liability at 1 December 20X7 96
Expense for period 10
Contributions to scheme (paid) (10)
Remeasurement losses 4
Net defined benefit liability at 30 November 20X8 100
Warrburt recognises remeasurement gains and losses in other comprehensive
income in the period in which they occur, in accordance with LKAS 19. The
benefits paid in the period by the trustees of the scheme were Rs. 3 million.
There is no tax impact with regards to the retirement benefit liability.
(iii) The property, plant and equipment (PPE) in the statement of financial
position comprises the following.
Rs m
Carrying amount at 1 December 20X7 360
Additions at cost 78
Gains on property revaluation 4
Disposals (56)
Depreciation (36)
Carrying amount at 30 November 20X8 350
Plant and machinery with a carrying amount of Rs. 1 million had been
destroyed by fire in the year. The asset was replaced by the insurance
company with new plant and machinery, which was valued at Rs. 3 million.
The machines were acquired directly by the insurance company and no cash
payment was made to Warrburt. The company included the net gain on this
transaction in 'additions at cost' and as a deduction from administrative
expenses.
The disposal proceeds were Rs. 63 million. The gain on disposal is included
in administrative expenses. Deferred tax of Rs. 2 million has been deducted
in arriving at the 'gains on property revaluation' figure in other
comprehensive income.
The remaining additions of PPE comprised imported plant and equipment
from an overseas supplier on 30 June 20X8. The cost of the PPE was
380 million dinars with 280 million dinars being paid on 31 October 20X8
and the balance to be paid on 31 December 20X8. The outstanding amount is
included within the trade payables balance in the statement of financial
position.

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The rates of exchange were as follows.

Dinars to Rs. 1
30 June 20X8 5
31 October 20X8 4.9
30 November 20X8 4.8
Exchange gains and losses are included in administrative expenses.
(iv) The interest in H200h was acquired for cash on 1 December 20X7. The net
assets of H200h at the date of acquisition were Rs. 300 million. H200h made a
profit after tax of Rs. 24 million and paid a dividend of Rs. 8 million out of
these profits in the year ended 30 November 20X8.
(v) An impairment test had been carried out at 30 November 20X8 on goodwill
and other intangible assets. The result showed that goodwill was impaired
by Rs. 20 million and other intangible assets by Rs. 12 million.
(vi) The short term provisions relate to finance costs which are payable within
six months.
Warrburt's CEO and Managing Director are concerned about the results for the
year in the statement of profit or loss and other comprehensive income and the
subsequent effect on the statement of cash flows. They have suggested that the
proceeds of the sale of property, plant and equipment and the sale of investments
in equity instruments should be included in 'cash generated from operations'.
The directors are afraid of an adverse market reaction to their results and aware
of the importance of meeting targets in order to ensure job security. They feel that
the adjustments for the proceeds would enhance the 'cash health' of the business.

Required
(a) Compile a group statement of cash flows for Warrburt for the year ended
30 November 20X8 in accordance with LKAS 7 Statement of cash flows, using
the indirect method. (35 marks)
(b) Outline the key issues which the statement of cash flows highlights
regarding the cash flow of the company. (10 marks)
(c) Assess the ethical responsibility of Sharmini Cooper in ensuring that
manipulation of the statement of cash flows, such as that suggested by the
directors, does not occur. (5 marks)
(LO 2.1.1, 3.6.1, 5.1.1) (Total = 50 marks)

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32 Nandasiri Ltd 90 mins

Business background
Nandasiri Ltd. was established over 30 years ago and has become one of the
leaders in the circuit board production industry in Sri Lanka. The business started
as a wholesaler of circuit board components purchased in bulk from
manufacturers. These components would then be separated and sold in smaller
batches to producers of circuit boards. The components would be soldered to the
boards according to the specifications of the ultimate purchaser before shipping
them to that electrical equipment manufacturer.
As the business grew, Nandasiri Ltd. undertook a strategy of vertical integration,
firstly by expansion into the circuit board production industry by the acquisition of
several circuit board production companies that had been customers of the
components that Nandasiri Ltd. was supplying. This enabled Nandasiri Ltd. to
increase their margins whilst securing an avenue of sales for its components.
Likewise, the acquired entities had the advantage of being able to purchase their
supplies at a better price than their competitors in the industry. In this way,
Nandasiri Ltd. was able to consistently grow their market share over several years.
The second phase of growth for Nandasiri Ltd. came through further vertical
integration, this time through the acquisition of their largest upstream supplier of
components. This acquisition meant that Nandasiri Ltd. had the capacity to
produce components that were previously purchased. This enabled Nandasiri Ltd
to again increase the margin that they were able to make throughout the
manufacture and supply process. The components that were previously sold on to
circuit board producers could now be used for in-house production within the
previously acquired producers.
Business Structure
Due the strategy of growth through the acquisition of other entities in the supply
chain, Nandasiri Ltd. has maintained a divisional structure with the divisions being
 Component Manufacturing;
 Circuit Board Production;
 Sales and Distribution.
All of the circuit-board manufacturing and production is carried out in Sri Lanka
and there is one large component manufacturing plant in Colombo which was
purchased as part of the acquisition of the supplier several years ago.
Nandasiri Ltd has two circuit board production facilities, one of which produces
goods for the export market, and the other that produces goods for the domestic
market. About half of its goods are exported, but the export market is suffering
due to competition from cheaper producers overseas. Most domestic sales are
made under contract with approximately 20 customers.

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Current Issues
One of the key materials used in production is copper wiring, all of which is
imported. As a cost cutting measure, in April 20X2 a contract with a new overseas
supplier was signed, and all of the company's copper wiring is now supplied under
this contract. Purchases are denominated in a foreign currency, but the company
does not use forward exchange contracts in relation to its imports of copper
wiring.
In recent years Nandasiri Ltd. has seen pressure from several factors that have
made the business environment challenging. The first factor that has had a major
impact is the entrance of several new Chinese manufacturers into the circuit board
manufacturing industry. Whilst there had always been Chinese businesses in this
market, these manufacturers had previously had a reputation for poor quality
production techniques and a sub-standard product.
However, the new Chinese entrants to the market have begun to produce
significantly improved circuit boards at a much cheaper price than Nandasiri Ltd.
and whilst they are not of the same quality, they are now a realistic alternative for
almost all customers in the market. This factor is compounded by the fact that
many of the electrical products that contain Nandasiri Ltd's circuit boards are also
now manufactured in China and must be shipped to that location whereas the
Chinese competitors are local to these companies.
Another major factor has been the increased raw materials and labour costs. The
cost of copper has increased significantly on the global market and even with the
sourcing of the copper wire from the new overseas supplier, the cost has
continued to increase over the last few years. In addition, the cost of employing
local staff has increased so that the margins that were previously possible are
becoming more and more difficult to attain.
In response, Nandasiri Ltd. has implemented cost cutting measures and is actively
considering strategies to mitigate the factors described above. Possible strategies
involve:
Diversification: Nandasiri Ltd. is considering whether it would be prudent to
diversify away from circuit boards into unrelated business areas such a property
development and was recently offered the opportunity to undertake a joint
venture to re-develop a large site with potential to build 700 luxury homes.
Bespoke Boards: Another potential avenue of strategic change is away from the
traditional business model by creating a website with the facility to enable
customers to design, order and pay for their own circuit boards.
Further Acquisition: The potential to purchase one of the Chinese competitors
and move all production to China has been discussed as an option to solve the
problem of Nandasiri Ltd. being less able to compete on cost.

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At this stage no decision has been made as to which direction should be

undertaken, but a business case has been commissioned on each and the board is
due to draw a conclusion as to the best course of action in the next few months.
Financial reporting
Nandasiri Ltd. prepares financial statements in accordance with Sri Lanka
Financial Reporting Standards to a reporting date of 30 November.
Situation
You are an audit manager in Foo & Co, responsible for the audit of Nandasiri Ltd. It
is the first time that you have managed this audit client, taking over from the
previous audit manager, Kavith Ratwatte, last month. The audit planning for the
year ended 30 November 20X2 is about to commence.
Recent developments
In early November 20X2, production was halted for a week at the production
facility that supplies the domestic market. A number of customers had returned
goods, claiming faults in the circuit boards supplied. On inspection, it was found
that the copper used in the circuit boards was corroded and therefore unsuitable
for use. The corrosion is difficult to spot as it cannot be identified by eye and relies
on electrical testing. All customers were contacted immediately and, where
necessary, products recalled and replaced. The corroded copper remaining in
inventory has been identified and separated from the rest of the copper.
Work has recently started on a new production line which will ensure that
Nandasiri Ltd meets new regulatory requirements prohibiting the use of certain
chemicals, which come into force in March 20X3. In July 20X2, a loan of Rs. 30 m
with an interest rate of 4% was negotiated with Nandasiri Ltd's bank, the main
purpose of the loan being to fund the capital expenditure necessary for the new
production line. Rs. 2.5 m of the loan represents an overdraft which was converted
into long-term finance.
Bespoke Boards
As part of their strategic plan, Nandasiri Ltd started to develop a website for sales
on 1 December 20X1, which was completed and available for use by 31 May 20X2.
The website has facilities for customers to design their own circuit boards, to
choose the products they need and to make a payment. The total cost of website
development in the year ended 30 November 20X2 was Rs. 2,000,000. This was
capitalised and is to be written off over five years.
After initial development, the operation of the website, including collection of
payments from customers, was outsourced to a specialist provider, Khalifa Co.
Khalifa Co pays Nandasiri Ltd each month, after deducting its fee. Nandasiri Ltd's
prices have been reduced by roughly 10% for online sales, which by the end of the
year made up about a quarter of Nandasiri Ltd's total revenue.

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The website initiates the fulfilment process automatically once payment has been
made by the customer, working on the basis of the information entered by the
customer. Nandasiri Ltd has also outsourced the final delivery of goods to a
courier company.
Nandasiri Ltd has experienced some difficulties with the website, including
relatively high rates of returns from customers. There have also been errors in
goods delivered arising from customers' misunderstanding of the website.
Other matters
Several of Nandasiri Ltd's executive directors and the financial controller left in
October 20X2, to set up a company specialising in the recycling of old electronic
equipment. This new company is not considered to be in competition with
Nandasiri Ltd's operations. The directors left on good terms and replacements for
the directors have been recruited.
Financial information
EXTRACT FROM DRAFT STATEMENT OF PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 NOVEMBER 20X2
20X2 20X1
Draft Actual
Rs.'000 Rs.'000
Revenue 12,500 13,800
Operating costs (12,000) (12,800)
Operating profit 500 1,000
Finance costs (800) (800)
Profit/(loss) before tax (300) 200
The draft statement of financial position has not yet been prepared, but Mo states
that the total assets of Nandasiri Ltd at 30 November 20X2 are Rs. 180 m, and cash
at bank is Rs. 130,000. Based on draft figures, the company's current ratio is 1.1,
and the quick ratio is 0.8.

Required
Based on the details in the pre-seen material and the review above:
(a) Evaluate the business risks faced by Nandasiri Ltd.; (18 marks)
(b) Evaluate the risks of material misstatement in the financial statements of
Nandasiri Co. (14 marks)
The external audit for the year ended 30 November 20X2 is now approaching
completion.
The audit team has just discovered that the new loan of Rs. 30m is secured by a
floating charge over the company's inventory. The bank has also taken out
personal guarantees on the domestic residence and other property owned by the

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CEO of Nandasiri Ltd. under the terms of which the bank has the right to take
possession of the property in the event that it cannot recover its debts from the
company. The newly appointed financial controller left after four months citing in
the board minutes that she disagreed with the company's aggressive accounting
treatments.
As part of the going concern review, the audit supervisor, Ayomi Herath, has
scrutinised the management accounts for the first four months of the current
reporting period and has identified that the company is now making significant
losses which she believes to be unsustainable. She has also inspected
correspondence between the company and the bank which indicates that the
company has already breached key loan covenants. The company has recently
changed legal advisors and the newly appointed firm has disagreed with this
assessment.
Ayomi has been informed by the company's procurement manager that Nandasiri
Ltd has recently taken delivery of a large quantity of a new inventory line with a
value of Rs. 14 m which it has purchased on credit from one of its suppliers. At
present the company also has other inventory with a total value of approximately
Rs. 16 m.
Based on a review of the company's bank statements and cash flow forecasts,
Ayomi does not believe that there is any realistic prospect that the company will
be able to pay this supplier for the foreseeable future and is concerned about the
possible implications of this transaction for the directors of the company. Ayomi
has not come across these issues before.

Required
(c) Identify and explain any indicators of potential fraud in the circumstances
outlined above. (10 marks)
(d) Evaluate the possible implications of the circumstances and transactions
noted during the going concern review for the auditor and the actions they
should take as a result. (8 marks)
LO (3.3.1, 3.4.1, 3.7.1) (50 marks)

33 Healthwise 90 mins
An audit manager of Columbus and Co is beginning to plan the audit of Healthwise
Ltd (Healthwise) for the year ended 31 March 20X5.
Healthwise Ltd has recently expanded its operations in the provision of private
healthcare and this will impact on the audit risk and audit strategy for the
upcoming audit. Healthwise Ltd have provided the draft financial statements for
the year ended 31 March 20X5 as follows:

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Healthwise Ltd draft statement of financial position as at 31 March 20X5

20X5 20X4
Rs m Rs m
Non-current assets
Property, plant and equipment 151,477 102,124
Current assets
Inventory 21,118 7,595
Trade and other receivables 19,288 9,920
Cash 6,925 9,625
198,808 129,264
Equity
Share capital 40,000 30,000
Revaluation surplus reserve 46,000 16,000
Retained earnings 35,398 23,457

Non-current liabilities
Loan 30,136 18,113
Provisions 6,136 6,136
Deferred tax 2,450 2,100
Defined benefit plan liability 10,950 9,363
Current liabilities
Trade and other payables 24,938 11,800
Taxation 2,800 2,275
198,808 129,264

Healthwise Ltd draft statement of profit or loss and other comprehensive

income for the year ended 31 March 20X5
20X5 20X4
Rs m Rs m
Revenue 137,410 125,402
Cost of sales (46,719) (48,576)
Gross profit 90,691 77,826
Operating expenses (54,964) (52,111)
Research and development (20,611) (10,463)
Operating profit 15,116 14,252
Profit on disposal 328 -
Finance costs (2,569) (1,267)
Finance income 44 117
Profit before taxation 12,919 13,102
Taxation (2,548) (2,666)
Profit for the year 10,371 10,436

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20X5 20X4
Rs m Rs m
Other comprehensive income:
Remeasurement gains/(losses) on defined
benefit plans 1,570 (437)
Total comprehensive income 41,941 9,999

Healthwise has the following divisions:

Healthwise Care
Healthwise Care provides private medical care from its four medical centres.
Healthwise owns all the properties. Healthwise's accounting policy is to hold
property at fair value and, this year, the properties underwent an independent
revaluation which resulted in a Rs. 20,000 million upward valuation, which has
been credited to total comprehensive income.
Senior Care division
Senior Care provides senior citizens with targeted medical services for this age
group. Each Healthwise care centre has its own wing specifically dedicated to
provide medical care and other services, such as physiotherapy, to senior citizens.
Equipment division
Healthwise Equipment division sells protective medical equipment for healthcare
workers and has expanded during the year by beginning to supply larger medical
equipment to other hospitals.
Aesthetics division
Aesthetics is a relatively new division to diversify into non-surgical facial cosmetic
procedures market. Aesthetics is now a market leader in this area. The Aesthetics
division's predicted profit for the year was Rs. 2,975 million for the year ended
31 March 20X5 and Rs. 4,375 million for the year ended 31 March 20X6.
However, recent performance has been disappointing. The main reason for this is
that Aesthetics division's products have seen sales fall as a result of negative
publicity with some claims for unsatisfactory results.
The management of the Aesthetics division are highly confident that all of the
issues will be resolved and the division will meet its predicted profits for the year
ended 31 March 20X6.
Pharma division
Last year, the Pharma division commenced research and development in the area
of joint pain and arthritis to create a new medical treatment and to save costs by
using a new drug treatment rather than pay another pharmaceutical company for
an existing expensive drug. Last year, it was clear that the feasibility of a new drug
was far from confirmed. However, this year recent results from human trails are

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highly promising and the new drug has now been submitted for approval to the Sri
Lanka government for medical approval, although there is no guarantee approval
will be granted. Recently, Pharma has received commercial offers to buy the
research into joint pain and arthritis; however, these offers were declined. Last
week, Pharma was approached by a global pharmaceutical company who are
interested in purchasing the rights for worldwide distribution outside Sri Lanka,
but further discussions are subject to Sri Lankan Government approval of the new
drug. It is expected that the sale of global rights to the new drug would be highly
profitable for Healthwise Ltd should the drug be approved.
The research and development is currently still ongoing and all costs for the year
have been expensed to profit and loss as the drug has not yet been approved.
Divisional performance
Revenue Profit before tax
20X5 20X4 20X5 20X4
Rs m Rs m Rs m Rs m
Healthwise Care 45,103 43,847 4,356 4,186
Equipment 41,102 32,882 4,640 2,800
Senior Care 21,210 20,708 613 565
Aesthetics 10,293 11,375 980 2,730
Pharma 19.693 16,590 2,330 2,281
Total 137,401 125,402 12,919 13,102
Recent developments
The Finance Director for Healthwise Ltd has provided details of the following
significant transactions which have occurred in the year to 31 March 20X5.
New contract to supply medical equipment to the Equipment division
On 29 March 20X5, Healthwise Ltd signed a contract to supply medical equipment
to a customer for Rs. 1,575 million. The Equipment division would normally sell
the equipment for Rs. 1,750 million
The contract allows the customer to purchase 100,000 units of consumables
specifically for the equipment for a period of 12 months for a discounted price of
Rs. 2,100 per unit. Once they have purchased the 100,000 units or after 12 months
the customer will then pay the normal market price of Rs. 4,000 per unit. The
expectation is that the customer will probably buy around 180,000 units of the
consumables within one year.
The Equipment division has recognised Rs. 1,575 million within revenue on this
new contract in 20X5 which is the sale of the equipment only.
Hedging
In January 20X5, Healthwise Ltd entered into a forward currency contract for the
first time to hedge against the risk of foreign currency rate fluctuations in futures

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purchases with suppliers. The directors are currently proposing not to include any
amounts for this forward contract as the current forward is at a loss. They explain
that this will be matched against the saving when they make the purchases.
Change in pension scheme arrangements.
Healthwise Ltd operates a defined benefit pension plan and the remeasurement
gain in the year has been calculated as follows:
Rs m
Remeasurement gain on fair value of plan assets 615
Loss on transfer to defined contribution scheme (695)
Remeasurement gain on plan obligation 1,650
1,570

During the year, Healthwise Ltd offered some staff members the opportunity to
transfer to a defined contribution scheme and they were offered a significant
payment to transfer. Healthwise Ltd was dissatisfied with its previous actuaries'
work and consequently it has changed them during the year.
Data Analytics
The new audit partner has stated that she would like to use 'data analytics' on the
next audit engagement. She has heard that many large audit firms now make use
of these techniques, but she does not know what the term means.

Required
(a) Using analytical review procedures, identify and evaluate the key audit risks
to Healthwise Ltd's financial statements for the year ended 31 March 20X5.
(15 marks)
(b) Identify and explain, using calculations where relevant, the significant
financial reporting issues for Healthwise Ltd. In each case, explain the
approach required to address the audit risk to the financial statements.
(22 marks)
(c) Explain what the term data analytics means, and discuss current thinking
about its benefits, limitations and anticipated impact on the auditing
profession. (13 marks)
LO (1.2.2, 3.1.1, 3.7.1) Total: 50 marks

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PART A: INTERPRETATION AND APPLICATION OF SRI LANKA ACCOUNTING

STANDARDS AND RECENT DEVELOPMENTS IN FINANCIAL REPORTING
Questions 1 to 11 cover Interpretation and Application of Sri Lanka Accounting
Standards and Recent Developments in Financial Reporting.

1 Pensions
(a) Briefing note for the directors of Joydan
(i) Defined contribution plans and defined benefit plans
With defined contribution plans, the employer (and possibly, as here,
current employees too) pay regular contributions into the plan of a
given or 'defined' amount each year. The contributions are invested,
and the size of the post-employment benefits paid to former employees
depends on how well or how badly the plan's investments perform. If
the investments perform well, the plan will be able to afford higher
benefits than if the investments performed less well.
The B scheme is a defined contribution plan. The employer's
liability is limited to the contributions paid.
With defined benefit plans, the size of the post-employment benefits
is determined in advance, ie the benefits are 'defined'. The employer
(and possibly, as here, current employees too) pay contributions into
the plan, and the contributions are invested. The size of the
contributions is set at an amount that is expected to earn enough
investment returns to meet the obligation to pay the post-employment
benefits. If, however, it becomes apparent that the assets in the fund
are insufficient, the employer will be required to make additional
contributions into the plan to make up the expected shortfall. On the
other hand, if the fund's assets appear to be larger than they need to
be, and in excess of what is required to pay the post-employment
benefits, the employer may be allowed to take a 'contribution holiday'
(ie stop paying in contributions for a while).
The main difference between the two types of plans lies in who bears
the risk: if the employer bears the risk, even in a small way by
guaranteeing or specifying the return, the plan is a defined benefit
plan. A defined contribution scheme must give a benefit formula based
solely on the amount of the contributions.
A defined benefit scheme may be created even if there is no legal
obligation, if an employer has a practice of guaranteeing the benefits
payable.
The A scheme is a defined benefit scheme. Joydan, the employer,
guarantees a pension based on the service lives of the employees in the

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scheme. The company's liability is not limited to the amount of the

contributions. This means that the employer bears the investment risk:
if the return on the investment is not sufficient to meet the liabilities,
the company will need to make good the difference.
(ii) Accounting treatment: B scheme
No assets or liabilities will be recognised for this defined
contribution scheme, other than current liabilities to reflect amounts
due to be paid to the pension scheme at year end. The contributions
paid by the company of Rs. 10 million will be charged to profit or
loss. The contributions paid by the employees will not be a cost to the
company but will be adjusted in calculating employee's net salary.
Accounting treatment: A scheme
The accounting treatment is as follows:
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE
INCOME NOTES
Expense recognised in profit or loss for the year ended 31 October 20X7
Rs. m
Current service cost 20.0
Net interest on the net defined benefit liability (10 – 9.5) 0.5
Net expense 20.5
Other comprehensive income: remeasurement of defined benefit plans
(for the year ended 31 October 20X7)
Rs. m
Remeasurement gains or losses on defined benefit (29.0)
obligation
Remeasurement gains or losses on plan assets (excluding
amounts in net interest) 27.5
(1.5)

STATEMENT OF FINANCIAL POSITION NOTES

Amounts recognised in statement of financial position
31 October 1 November
20X7 20X6
Rs. m Rs. m
Present value of defined benefit obligation 240 200
Fair value of plan assets (225) (190)
Net liability 15 10

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Change in the present value of the defined benefit obligation

Rs. m
Present value of obligation at 1 November 20X6 200
Interest on obligation: 5%  200 10
Current service cost 20
Benefits paid (19)
Loss on remeasurement through OCI (balancing figure) 29
Present value of obligation at 31 October 20X7 240
Change in the fair value of plan assets
Rs. m
Fair value of plan assets at 1 November 20X6 190.0
Interest on plan assets: 5%  190 9.5
Contributions 17.0
Benefits paid (19.0)
Gain on remeasurement through OCI (balancing figure) 27.5
Fair value of plan assets at 31 October 20X7 225.0
(b) Briefing note for directors of Wallace
(i) Reduction to net pension liability
The reduction in the net pension liability as a result of the employees
being made redundant and no longer accruing pension benefits is a
curtailment under LKAS 19 Employee Benefits.
LKAS 19 defines a curtailment as occurring when an entity significantly
reduces the number of employees covered by a plan. It is treated as a
type of past service costs. The past service cost may be negative (as is
the case here) when the benefits are withdrawn so that the present
value of the defined benefit obligation decreases. LKAS 19 requires the
past service cost to be recognised in profit or loss at the earlier of:
 When the plan curtailment occurs; and
 When the entity recognises the related restructuring costs.
Here the restructuring costs (and corresponding provision) are
recognised in the year ended 31 October 20X7 and the plan
curtailment will not take place until after the year end in December
20X7 when the employees are made redundant. Therefore, the
reduction in the net pension liability and corresponding income in
profit or loss should be recognised at the earlier of these two dates, ie
when the restructuring costs are recognised in the year ended 31
October 20X7.
The accounting entry for the reduction in the net pension liability
required at 31 October 20X7 is:
DEBIT present value of defined benefit obligation Rs. 15m
CREDIT profit or loss Rs. 15m

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(ii) Amendments
LKAS 19 was amended in 2018 to clarify that when a net defined
benefit liability is remeasured as a result of a curtailment (or plan
amendment or settlement), updated actuarial assumptions should be
used to determine current service cost and net interest for the
remainder of the reporting period.
Prior to the amendment, the accounting was not clear as LKAS 19
implied that entities should not update the actuarial assumptions for
the calculation of current service cost and net interest during the
period, even if a plan amendment, curtailment or settlement had
resulted in remeasurement of the net defined benefit liability.
The amendment to require updated assumptions to be used should
make the resulting information more useful to users of accounts.
Effect on Wallace
The amendments require updated assumptions to be used for the
calculations of current service cost and net interest for the remainder
of the reporting period. As the curtailment was accounted for on
30 September 20X7, the calculation of current service cost and net
interest for the remaining one month of the reporting period should be
based on the updated actuarial assumptions used to remeasure the net
defined benefit liability.
However, as the updated assumptions will only need to be applied for
one month, it may be that the applying the updated assumptions will
not give a materially different result As clarified by IFRS Practice
Statement 2 Making Materiality Judgements, requirements in SLFRSs
only need to be applied when their effect is material. It may well be
that the use of updated assumptions to calculate current service cost
and net interest for one month will not produce a materially different
result, given that the curtailment is recorded so close to the reporting
date. If so, then this requirement need not be applied.

2 Prochain
Model areas
LKAS 16 Property, plant and equipment is the relevant standard here. The model
areas are held for use in the supply of goods and are used in more than one
accounting period. The company should recognise the costs of setting up the
model areas as tangible non-current assets and should depreciate the costs over
their useful lives. Subsequent measurement should be based on cost. In theory the
company could measure the model areas at fair value if the revaluation model of
LKAS 16 were adopted, but it would be difficult to measure fair value reliably in
this case.

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LKAS 16 states that the initial cost of an asset should include the initial estimate of
the costs of dismantling and removing the item and restoring the site where the
entity has an obligation to do so. A present obligation appears to exist, as defined
by LKAS 37 Provisions, contingent liabilities and contingent assets and therefore
the entity should also recognise a provision for that amount. The provision should
be discounted to its present value, and this amount initially recognised as both
part of the cost of the asset and a separate provision. The subsequent unwinding
of the discount on the provision is recognised in profit or loss.
At 31 May 20X6, the entity should recognise a non-current asset of Rs. 15.7 million
(cost of Rs. 23.6 million (W) less accumulated depreciation of Rs. 7.9 million (W))
and a provision of Rs. 3.7 million (W).
Working
PPE Rs m
Cost of model areas 20.0
Plus provision (20  20%  1 (= 0.898)
3.6
1.0552
Cost on initial recognition 23.6
Less accumulated depreciation (23.6  8/24) (7.9)
Carrying amount at 31 May 20X6 15.7
Provision
Provision: on initial recognition (20  20%  0.898) 3.6
Plus unwinding of discount (3.6  5.5%  8/12) 0.1
Provision at 31 May 20X6 3.7
Purchase of Badex
SLFRS 3 Business Combinations states that the consideration transferred in a
business combination must be measured at fair value at the acquisition date.
The Rs. 100 million cash paid on the acquisition date, 1 June 20X5 is recognised as
purchase consideration. The Rs. 25 million payable on 31 May 20X7 (two years
after acquisition) is split into the Rs. 10 million deferred consideration which
is discounted to its present value by two years (Rs. 10 million  1/1.0552
= Rs. 8.98 million) and the contingent consideration of Rs. 15 million.
The contingent consideration is measured at its acquisition-date fair value.
Here, as the profit forecast targets are unlikely to be met, the fair value would be
significantly less than Rs. 15 million but as the percentage chance of the targets
being met and other relevant information is not given, it is not possible to
establish a fair value.
Prochain should also recognise a corresponding financial liability for the deferred
and contingent consideration as this meets the definition of a financial liability
in LKAS 32 Financial Instruments: Presentation. This is because Prochain has a
contractual obligation to deliver cash on 31 May 20X7 providing the conditions of
the contingent consideration are met. At the year end 31 May 20X6, any changes
in the contingent consideration as a result of changes in expectations of the

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targets being met are recognised in profit or loss (rather than as an adjustment to
goodwill).
Under SLFRS 3, any associated transaction costs are expensed to profit or loss
unless they are the costs of issuing debt or equity, which are accounted for in
accordance with LKAS 32.
A further issue concerns the valuation and treatment of the 'Badex' brand name.
LKAS 38 Intangible Assets prohibits the recognition of internally generated brands
and therefore the brand will not be recognised in Badex's individual statement of
financial position prior to the acquisition. SLFRS 3, however, requires the
intangible assets of an acquiree to be recognised in a business combination if they
meet the identifiability criteria in LKAS 38. For an intangible to be identifiable,
the asset must be separable, or it must arise from contractual or legal rights.
Here, these criteria appear to have been met as the brand could be sold separately
from the entity. Therefore, the 'Badex' brand should be recognised as a separate
intangible asset measured at Rs. 20 million in the consolidated statement of
financial position, rather than subsumed within the measurement of goodwill.
Development of own brand
LKAS 38 Intangible assets divides a project such as this into a research phase and a
development phase. The research phase of a project involves investigation to gain
new scientific or technical knowledge and understanding. At this stage, an entity
cannot demonstrate that any expenditure incurred will generate probable future
economic benefits. Therefore, expenditure on research must be recognised as an
expense when it occurs.
Development expenditure is the application of research findings to a plan or
design for the production of new or improved materials, products and processes
prior to the start of commercial production. Development costs are capitalised
when an entity demonstrates all the following.
(a) The technical feasibility of completing the project
(b) Its intention to complete the asset and use or sell it
(c) Its ability to use or sell the asset
(d) That the asset will generate probable future economic benefits
(e) The availability of adequate technical, financial and other resources to
complete the development and to use or sell it
(f) Its ability to reliably measure the expenditure attributable to the asset.
Once these criteria are met, subsequent development costs must be capitalised;
costs incurred prior to the criteria being met cannot be capitalised retrospectively.
Capitalised development costs should comprise all directly attributable costs
necessary to create the asset and to make it capable of operating in the manner
intended by management. Directly attributable costs do not include selling or
administrative costs, or training costs or market research. The cost of upgrading
existing machinery can be recognised as property, plant and equipment.

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Therefore the expenditure on the 'Pro' project should be treated as follows.

Recognised in statement of financial position
Intangible Property, plant
Expense (P/L) Assets and equipment
Rs m Rs m Rs m
Research 3
Prototype design 4
Employee costs 2
Development work 5
Upgrading machinery 3
Market research 2
Training 1
6 11 3
Prochain should recognise Rs. 11 million as an intangible asset.
Apartments
The apartments are leased to persons who are under contract to the company.
Therefore, they cannot be classified as investment property. LKAS 40
Investment property specifically states that property occupied by employees is
not investment property. This is the case regardless of whether rent is paid at a
market rate or not. The apartments are property, plant and equipment, measured
using the cost or revaluation model and depreciated over their useful lives.
Although the rent is below the market rate the difference between the actual rent
and the market rate is simply income foregone (or an opportunity cost). In order
to recognise the difference as an employee benefit cost it would also be necessary
to gross up rental income to the market rate. The financial statements would not
present fairly the financial performance of the company. Therefore, the company
cannot recognise the difference as an employee benefit cost.

3 Panel
(a) The impact of changes in accounting standards
LKAS 12 Income taxes is based on the idea that all changes in assets and
liabilities have unavoidable tax consequences. Where the recognition criteria
in SLFRS are different from those in tax law, the carrying amount of an asset
or liability in the financial statements is different from the amount at which
it is stated for tax purposes (its 'tax base'). These differences are known as
'temporary differences'. The practical effect of these differences is that a
transaction or event occurs in a different accounting period from its tax
consequences. For example, income from interest receivable is recognised in
the financial statements in one accounting period but it is only taxable when
it is actually received in the following accounting period.

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LKAS 12 requires a company to make full provision for the tax effects of
temporary differences. Where a change in an accounting standard results in
a change to the carrying value of an asset or liability in the financial
statements, the amount of the temporary difference between the carrying
value and the tax base also changes. Therefore, the amount of the deferred
tax liability is affected.
(b) Calculation of deferred tax on first time adoption of SLFRS
SLFRS 1 First time adoption of International Financial Reporting Standards
requires a company to prepare an opening SLFRS statement of financial
position and to apply LKAS 12 to temporary differences between the
carrying amounts of assets and liabilities and their tax bases at that date.
Panel prepares its opening SLFRS statement of financial position sheet at
1 November 20X3. The carrying values of its assets and liabilities are
measured in accordance with SLFRS 1 and other applicable SLFRSs in force
at 31 October 20X5. The deferred tax provision is based on tax rates that
have been enacted or substantially enacted by the end of the reporting
period. Any adjustments to the deferred tax liability under previous GAAP
are recognised directly in equity (retained earnings).
(c) (i) Share options
Under SLFRS 2 Share based payment the company recognises an
expense for the employee services received in return for the share
options granted over the vesting period. The related tax deduction
does not arise until the share options are exercised. Therefore, a
deferred tax asset arises, based on the difference between the intrinsic
value of the options and their carrying amount (normally zero).
At 31 October 20X4 the tax benefit is as follows.
Rs m
Carrying amount of share-based payment –
Less: tax base of share-based payment (16 ÷ 2) (8)
Temporary difference (8)
The deferred tax asset is Rs. 2.4 million (30%  8). This is recognised at
31 October 20X4 provided that taxable profit is available against which
it can be utilised.
Because the remuneration expense of Rs. 20m (Rs. 40/2) is greater
than the tax deduction (Rs. 8m), deferred tax is recognised in profit or
loss.
At 31 October 20X5 there is no longer a deferred tax asset because
the options have been exercised. The tax benefit receivable is
Rs. 13.8 million (30%  Rs. 46 million). Therefore, the deferred tax
asset of Rs. 2.4 million is no longer required.

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(ii) Leased plant

Under SLFRS 16, an asset leased under a lease is recognised for
accounting purposes as:
(1) A right-of-use asset owned by the company, and
(2) A lease liability.
The right-of-use asset is measured at cost which comprises, the
amount of the initial lease liability adjusted for any direct cots or lease
incentives. The right-of-use asset is subsequently measured using the
cost model in LKAS 16 and is depreciated over the shorter of the useful
life or lease term.
The lease liability is measured at present value of future lease
payments, discounted at the interest rate implicit in the lease. The
lease liability is increased for interest charges on the outstanding
liability and reduced for future payments made.
The carrying amount of the lease for accounting purposes is therefore
the net of these two balances:
Rs m Rs m
Carrying amount in financial statements:
Right-of-use asset:
Net present value of future lease payments 12.00
at inception of lease
Less depreciation (12 ÷ 5) (2.40)
9.60
Lease liability:
Liability at inception of lease 12.00
Interest (8%  12) 0.96
Lease payment (3.00)
(9.96)
(0.36)
For tax purposes:
• The tax base of an asset is the amount deductible for tax in future,
which is zero in this case, as capital allowances are not given on
leased assets.
• The tax base of a liability is its' carrying amount less any future tax-
deductible amounts. In this case the carrying amount of the liability
is Rs. 9.96 million and the full amount of this is tax deductible in the
future, giving a tax base of zero.
• The net tax base of the lease arrangement is therefore zero.

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Therefore, at 31 October 20X5 a net temporary difference is calculated

as:
Carrying amount (0.36)
Less tax base 0.00
Temporary difference (0.36)
This is a deductible temporary difference as the tax base is greater than
the carrying amount. Therefore a deferred tax asset of Rs. 108,000
(30%  360,000) arises.
(iii) Intra-group sale
Panel will recognise the goods at cost of Rs. 9 million in its individual
financial statements. The tax base of the goods for Panel is Rs. 9
million, being the amount deductible for tax purposes in the future (the
cost to Panel). This is equal to the goods' carrying amount and
therefore no deferred tax arises in Panel's separate financial
statements
From an accounting point of view, the separate financial statements
of Pins and Panel are consolidated and the unrealised profit of
Rs. 2 million is eliminated. Therefore, the carrying amount of the
goods is Rs. 7 million in the consolidated financial statements. For tax
purposes, however, Pins and Panel remain two separate entities and
each is taxed separately on its reported results. Therefore, the tax base
remains Rs. 7 million. As a result, a deductible temporary difference of
Rs. 2 million arises and an associated deferred tax asset of Rs. 600,000
(30%  Rs. 2 million) is recognised in the consolidated financial
statements.
(iv) Impairment loss
The impairment loss in the financial statements of Nails reduces the
carrying amount of property, plant and equipment, but is not allowable
for tax. Therefore, the tax base of the property, plant and equipment is
different from its carrying amount and there is a temporary difference.
Under LKAS 36 Impairment of assets the impairment loss is allocated
first to goodwill and then to other assets:
Property,
plant and
Goodwill equipment Total
Rs m Rs m Rs m
Carrying amount at 1 6.0 7.0
31 October 20X5
Impairment loss (1) (0.8) (1.8)
– 5.2 5.2
LKAS 12 states that no deferred tax should be recognised on goodwill
and therefore only the impairment loss relating to the property,
plant and equipment affects the deferred tax position.

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The effect of the impairment loss is as follows.

Before After Difference
impairment impairment
Rs m Rs m Rs m
Carrying amount 6 5.2
Tax base (4) (4)
Temporary difference 2 1.2 0.8
Tax liability (30%) 0.6 0.36 0.24
Therefore, the impairment loss reduces deferred the tax liability by
Rs. 240,000.

4 Ambush
(a) Impairment of financial assets
The impairment model in SLFRS 9 Financial Instruments is based on the idea
of providing for expected losses. The financial statements should reflect
the general pattern of deterioration or improvement in the credit
quality of financial instruments within the scope of SLFRS 9. This is a
forward-looking impairment model.
SLFRS 9 requires entities to base their measurement of expected credit
losses on reasonable and supportable information that is available
without undue cost or effort. This will include historical, current and
forecast information.
Expected credit losses are updated at each reporting date for new
information and changes in expectations, even if there has not been a
significant increase in credit risk.
On initial recognition, the entity must create a credit loss
allowance/provision equal to 12 months' expected credit losses. This
is calculated by multiplying the probability of a default occurring in the
next 12 months by the total lifetime expected credit losses that would
result from that default. (This is not the same as the expected cash
shortfalls over the next 12 months.)
In subsequent years, if the credit risk increases significantly since initial
recognition this amount will be replaced by lifetime expected credit
losses. If the credit quality subsequently improves and the lifetime expected
credit losses criterion is no longer met, the 12-month expected credit loss
basis is reinstated.
The amount of the impairment to be recognised on these financial
instruments depends on whether or not they have significantly
deteriorated since their initial recognition.
Stage 1 Financial instruments whose credit quality has not significantly
deteriorated since their initial recognition
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Stage 2 Financial instruments whose credit quality has significantly

deteriorated since their initial recognition
Stage 3 Financial instruments for which there is objective evidence of an
impairment as at the reporting date
For stage 1 financial instruments, the impairment represents the present
value of expected credit losses that will result if a default occurs in the
12 months after the reporting date (12 months expected credit losses).
For financial instruments classified as stage 2 or 3, an impairment is
recognised at the present value of expected credit shortfalls over their
remaining life (lifetime expected credit loss). Entities are required to
reduce the gross carrying amount of a financial asset in the period in which
they no longer have a reasonable expectation of recovery.
Expected credit losses would be recognised in profit or loss and held in a
separate allowance account (although this would not be required to be
shown separately on the face of the statement of financial position).
Assets at fair value are not subject to impairment testing, because
changes in fair value are automatically recognised immediately in profit
or loss (or other comprehensive income for investments in equity
instruments where the election was made to report all gains and losses in
other comprehensive income).
(b) Loan to Bromwich
The financial difficulties and reorganisation of Bromwich are objective
evidence of impairment. The impairment loss is the difference between the
carrying amount of the loan at 30 November 20X5 and the present value of
the estimated future cash flows. As the stated and effective interest rate for
the loan are both 8%, the carrying amount at 30 November 20X5 is
Rs. 200,000. The present value of estimated future cash flows is Rs. 100,000
(on 30 November 20X7), discounted at the original effective interest rate
of 8%.
This is Rs. 85,730 (100,000  1/1.082). Therefore, the impairment loss is
Rs. 114,270 (200,000 – 85,730) and this is recognised immediately in profit
or loss.
(c) Trade receivables
SLFRS 9 classifies trade receivables as financial assets held at amortised cost
as there is a contractual obligation to receive cash.
This method, which spreads the interest income over the life of the financial
asset, may not seem appropriate for short-term trade receivables with no
stated interest rate, as they do not normally bring in any interest income.
It is therefore normally the case that such receivables continue to be
measured at the original invoiced amount.

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As with other financial assets, however, SLFRS 9 requires an annual

impairment test, in order to assess, at each reporting date, whether the
receivable is impaired. SLFRS 9 allows a simplified version of the procedure
detailed in part (a) to be used for trade receivables. The loss allowance is
measured at lifetime expected credit losses from initial recognition.
Many entities perform this calculation using a matrix approach.
Receivables are considered in sub-populations based on their age.
Expected loss allowances (calculated as the expected default rate multiplied
by the gross carrying amount) are calculated for each sub-population at the
period end, depending on how long the receivables have been outstanding.
Increases or decreases in the allowance are taken to profit and loss.
General allowance
Ambush has calculated a general allowance using a formulaic approach.
This is only acceptable if it produces an estimate sufficiently close to that
produced by the SLFRS 9 method. It is not acceptable to use a formula based
on possible trends. The general allowance of two percent is not permitted
under SLFRS 9, because it is not based on past experience and is unlikely to
be an accurate estimate of the cash flows that will be received.
Tray
Where it is probable that payment will not be received in full for an
individually significant balance, an allowance for impairment must be made.
Tray is expected to pay the full amount owed plus a penalty. However,
the payment will be in a year's time, and so discounting should be used to
calculate any impairment.
Milk
Where, as in the case of Milk, there is no objective evidence of impairment,
the individual asset is included in a group of assets with a similar credit risk,
and the group as a whole is assessed for impairment. Milk has a similar
credit risk to 'other receivables' and so will be grouped in with those.
Allowance for impairment
This is calculated as follows.
Cash to be
Balance Received
Rs m Rs m
Tray 4 3.9*
Milk and other receivables 7 6.6
11 10.5
*Rs 4.1 m  1/1.05
Ambush should reduce trade receivables by Rs. 11 m – Rs. 10.5 m =
Rs. 500,000 (or recognise a balance of Rs. 500,000 on the allowance account).

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5 Engina
(a) Sale of goods to the director
 Mr Satay is a director of Engina. As such he is likely to have authority and
responsibility for planning, directing and controlling the activities of
Engina. Therefore, as a member of Engina's key management personnel,
Mr Satay is a related party of the company.
 Mr Satay has purchased Rs. 600,000 (12  Rs. 50,000) worth of goods
from the company and a car for Rs. 45,000, which is just over half its
market value.
 The issue is whether this is a related party transaction requiring
disclosure.
 A related party transaction is a transfer of resources, services or
obligations between a reporting entity and a related party, regardless of
whether a price is charged. Therefore, the sale of goods and the car do
qualify as related party transactions.
 In this case a price is charged, but we must consider whether the
transaction is material; although LKAS 24 does not address the issue of
materiality, accounting standards do not apply to immaterial transactions
and therefore if the sale of goods and the car are deemed immaterial, no
disclosure is required.
 LKAS 1 states that omissions or misstatements are material if they could
individually or collectively influence the economic decisions that users
make on the basis of the financial statements. Materiality depends on the
size or nature of an item or a combination of both.
 The size of the transactions means that they are not material to the
company, and because Mr Satay has considerable personal wealth,
they are unlikely to be material to him either.
 It is, however, normally the case that a transaction with a director (other
than remuneration) is material by nature, and therefore disclosure of the
transactions is required. Disclosure should include the amount of the
transactions and any outstanding balances.
 In addition, LKAS 24 requires disclosure of compensation paid to directors.
Compensation includes subsidised goods and benefits in kind.
Hotel property
 As Managing Director, Mr Soy is a member of the key management
personnel of Engina and so qualifies as a related party. It is not, however,
clear whether Mr Soy's brother is related party or not.

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 LKAS 24 states that close family members of key management personnel

are related parties of an entity, and so the answer depends on whether Mr
Soy's brother qualifies as a close family member.
 LKAS 24 defines close family members as those who may influence or be
influenced by the key personnel in their dealings with the entity. It says
that this includes children and dependants and spouse but does not limit
the definition to these people.
 Whether an individual is under the influence of his brother depends on
their relationship in individual circumstances. In this case the fact that Mr
Soy's brother was given a substantial discount on the property purchase
would appear to suggest that he can influence Mr Soy.
 Therefore, Mr Soy's brother is a related party and the hotel property sold
to the Managing Director's brother should be treated as a related party
transaction.
 LKAS 24 requires disclosure of 'information about the transaction and
outstanding balances necessary for an understanding of the potential
effect of the relationship upon the financial statements'.
 The sale of the property was for Rs. 4 million, and it is this amount that
must be disclosed. This would highlight the nature of the transactions
within the existing property market conditions.
 The question of impairment also needs to be considered. The value of the
hotel has become impaired due to the fall in property prices, so the
carrying amount needs to be adjusted in accordance with LKAS 36
Impairment of assets. The hotel should be measured at the lower of
carrying amount (Rs. 5m) and the recoverable amount. The recoverable
amount is the higher of fair value less costs of disposal (Rs. 4.3m – Rs. 0.2m
= Rs. 4.1m) and value in use (Rs. 3.6m). Therefore, the hotel should be
measured at Rs. 4.1m.
Group structure
 In addition to his role as Finance Director of Engina, Mr Satay controls
Wheel, which owns 100% of Engina. Therefore, Mr Satay has indirect
control of Engina
 LKAS 24 requires disclosure of an entity's 'ultimate controlling party'.
Therefore, in Engina's financial statements, Mr Satay is disclosed as the
ultimate controlling party.
 LKAS 24 requires disclosure of the related party relationship between a
parent and its subsidiary. Therefore, Engina must disclose that Wheel is
its parent company.

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 Engina must also disclose any transactions during the year with related
parties, and any outstanding balances at the period end and provisions
thereon.
 Therefore, sales to Wheel Ltd must be disclosed.
 Engina's transactions with Car Ltd must also be disclosed. LKAS 24 states
that companies under common control are related parties, and the two
companies are under the common control of Mr Satay.
(b) Dividend payment
 This payment is covered by IFRIC 17 Distribution of non-cash assets to
owners.
 IFRIC 17 applies only where all shareholders of the same class of equity
instruments are treated equally. Exhaust Limited is the sole Class B
shareholder in Wheel Limited and therefore it applies in this case.
 IFRIC 17 does not apply where the asset being transferred is controlled by
the same parties before and after the transfer. In this case Exhaust does
not control Wheel and so there is no common control. However, if the
transfer had been to Mr Satay, it would fall outside the scope of IFRIC 17
since Mr Satay controls Wheel.
 IFRIC 17 states that the dividend payment should be recorded at the fair
value of the asset transferred, being Rs. 520,000.
 The difference of Rs. 70,000 between the fair value and the carrying
amount of the asset is recognised in profit and loss and disclosed.

6 Masham
(a) Fair value of assets
Farm machinery
The farm machinery is classified as held for sale and therefore it must be
measured at the lower of carrying amount or fair value less costs to sell.
SLFRS 13 requires that the fair value of an asset is established by reference
to exit, or selling, prices. In establishing the fair value of an asset, it is
assumed that the asset will be sold in its principal market. This is the market
with the greatest volume and level of activity for the asset.
It is made clear that neither India nor Thailand exceeds the other in terms
of sales volume of similar machines. Therefore, neither is the principal
market.
Therefore, fair value is established by reference to the most advantageous
market.

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The most advantageous market is that which maximises the amount that
would be received to sell the asset after taking into account transaction costs
and transport costs. The most advantageous market is therefore Thailand:
India Thailand
Rs. Rs.
Selling price 244,680 237,800
Transaction costs (4,600) (3,900)
Transport costs (29,300) (18,660)
Net receipt 210,780 215,240
SLFRS 13 is clear that transaction costs do not form part of the calculation of
fair value, although they are used in order to establish the most
advantageous market. It is also clear that transport costs are not transaction
costs and therefore they do form part of the calculation of fair value.
The fair value of the machine is therefore equal to the selling price of the
asset less transport costs in the most advantageous market ie Thailand.
Therefore, the fair value of the machine is Rs. 219,140 (237,800 – 18,660).
SLFRS 5 requires measurement of an asset held for sale at the lower of
carrying amount and fair value less costs to sell. Although the transaction
costs do not form part of fair value, they are costs to sell and therefore the
machine has a fair value less costs to sell of Rs. 215,240.
This is greater than the carrying amount of Rs. 220,000 and therefore the
machine must be written down to Rs. 215,240 and an impairment loss
of Rs. 4,760 must be recognised in profit or loss in the year ended
31 December 20X3.
Land
SLFRS 13 requires that measurement of the fair value of non-financial assets
is based on the highest and best use of the asset. It would initially seem that
the highest and best use of the land is for commercial development as this
results in a higher market value.
We must, however, consider the impact of the neighbour's right of way and
the restriction on use. The highest and best use takes into account the use of
the asset that is physically possible, legally permissible and financially
feasible.
The legal right of way is related to the land and as such the neighbour
continues to have this right even if the land is passed on to a purchaser.
The fair value of the land must therefore take this into account.
If the restriction on the use of the land is specific to Masham and would not
pass to a purchaser, it would be permissible to develop the land for
commercial purposes and therefore its fair value at 31 December 20X3
would be based on this use. If the restriction on the use of land is transferred

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with title, the land may not be used for anything other than agricultural
purposes and as such its fair value is lower.
(b) Food processing plants – impairment test
The first step in establishing whether an impairment loss has arisen is to
determine the carrying amount of each CGU.
In order to determine carrying amounts, the shared or 'corporate' assets are
allocated to the cash-generating units to which they relate 'on a reasonable
and consistent basis'. It is therefore not appropriate to allocate the Rs. 4.5
million brand carrying amount to CGU 2 on the basis of its' carrying amount
seeming low otherwise. A common way to allocate corporate assets is based
on the carrying amount of the net assets in each department.
In addition, the issue of the goodwill in CGU 1 must be addressed. As there is
a non-controlling interest and it is measured as a proportion of net assets,
the Rs. 5 million carrying amount of goodwill is parent goodwill only.
Goodwill within the recoverable amount will include all goodwill relevant to
the department and therefore the carrying amount of goodwill is notionally
increased for the non-controlling interest.
The revised carrying amount of each department is therefore as follows.
CGU1 CGU 2 CGU 3
Rs'000 Rs'000 Rs'000
PPE 30,000 46,000 16,000
Goodwill 5,000 – –
Net current assets 16,000 24,000 13,000
51,000 70,000 29,000
Brand
Rs 4.5 m split 1,530 2,100 870
51:70:29
Notional goodwill
20/80  5,000 1,250 – –
Carrying amount 53,780 72,100 29,870
Having established carrying amount, recoverable amount is determined.
Recoverable amount is the higher of fair value less costs of disposal and
value in use.
In the case of fair value less costs of disposal, LKAS 36 is clear that certain
costs do not constitute costs of disposal. Theses excluded costs comprise
termination benefits and restructuring and reorganisation expenses.
Therefore, the recoverable amount of each unit is as follows.
CGU 1 CGU 2 CGU 3
Rs'000 Rs'000 Rs'000
Fair value – costs of disposal 44,900 79,810 33,050
Value in use 43,950 79,500 33,500
Recoverable amount (higher) 44,900 79,810 33,500

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Where carrying amount exceeds recoverable amount, an impairment loss is

recognised in profit or loss. The recoverable amount of CGUs 2 and 3 exceed
their carrying amount and therefore they are not impaired.
The recoverable amount of CGU 1 is less than its carrying amount and
therefore it is impaired. The impairment loss is Rs. 53.78m – Rs. 44.9m =
Rs. 8.88 million.
LKAS 36 requires that the impairment loss is allocated firstly to goodwill,
meaning that Rs. 6.25m is allocated to actual and notional goodwill.
The remaining Rs. 2.63m is allocated on a pro rata basis to the other assets
of the CGU that are within the scope of the standard. Note that the standard
scopes out current assets such as inventories and receivables.
Therefore, the impairment loss is allocated as follows.
Pre Post
impairment Impairment impairment
Rs'000 Rs'000 Rs'000
PPE (2.63  30/31.53) 30,000 (2,502) 27,498
Goodwill – actual 5,000 (5,000) 0
Goodwill – notional 1,250 (1,250) 0
Brand (2.63  1.53/31.53) 1,530 (128) 1,402
Net current assets 16,000 0 16,000
53,780 (8,880) 44,900
Amounts reported in Masham's financial statements for the year ended
31 December 20X3 are therefore as follows.
Statement of financial position
Rs'000
Property, plant and equipment 89,498
(27,498 + 46,000 + 16,000)
Brand (1,402+ 2,100 + 870) 4,372
Net current assets (16,000 + 24,000 + 13,000) 53,000
Statement of profit or loss
Rs'000
Impairment loss (8,880 – 1,250 re notional goodwill) 7,630
(c) Biological assets
A biological asset is defined as a living plant or animal.
LKAS 41 has been updated recently to include a definition of bearer plants.
These are living plants that:
 Are used in the production or supply of agricultural produce;
 Are expected to bear produce for more than one period; and
 Have a remote likelihood of being sold as agricultural produce other than
incidental scrap sales.

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Therefore tea bushes are bearer plant biological assets; dairy cattle are not,
they are biological assets.
Bearer plants are accounted for as property, plant and equipment within the
scope of LKAS 16.
As regards the dairy cattle, LKAS 41 requires that they are measured at fair
value less costs to sell at initial recognition and at each reporting date.
Changes in fair value are recognised as part of profit or loss for the year;
they are not recognised directly in equity.
The tea bushes will be recognised under LKAS 16 at cost less accumulated
depreciation.

7 Complexity
(a) (i) SLFRS 9 Financial Instruments requires an entity to value its financial
liabilities at amortised cost with an option to designate them as
measured at fair value through profit or loss if it reduces or
eliminates an accounting mismatch or because a group of liabilities is
managed and its performance evaluated on a fair value basis. The
accounting treatment applied will impact on how the initial and new
loans are measured and at what carrying amount they are presented
within the financial statements.
The carrying amounts under the amortised cost and fair value methods
are calculated as follows:
Amortised cost
Using amortised cost, both the initial loan and the new loan result in
single payments that are almost identical on 30 November 20X9:
Initial loan: Rs. 470m  1.05 for 5 years = Rs. 599.8m
New loan: Rs. 450m  1.074 for 4 years = Rs. 598.9m
However, the carrying amounts at 30 November 20X5 will be
different:
Initial loan: Rs. 470m + (Rs. 470m  1.05) = Rs. 493.5m
New loan: Rs. 450m
Fair value
If the two loans were carried at fair value, both the initial loan and
the new loan would have the same carrying amount, and be carried
at Rs. 450 million at 30 November 20X5. This is because both loans
result in a single repayment of Rs. 590 million on 30 November 20X9
and so are effectively worth the same amount. As the second
loan was obtained on 30 November 20X5, the fair value of a loan with
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repayment of Rs. 590 million on 30 November 20X9 must be the

amount borrowed at the market rate on that date, ie Rs. 450 million.
There would be a net profit of Rs. 20 million, made up of the interest
expense of Rs. 470m  5% = Rs. 23.5m and the unrealised gain of
Rs. 493.5m – Rs. 450m = Rs. 43.5m.
(ii) Hedge accounting
SLFRS 9 Financial Instruments allows hedge accounting but only if all
of the following conditions are met.
(1) The hedging relationship consists only of eligible hedging
instruments and eligible hedged items.
(2) There must be formal documentation (including identification
of the hedged item, the hedging instrument, the nature of the risk
that is to be hedged and how the entity will assess the hedging
instrument's effectiveness in offsetting the exposure to changes
in the hedged item's fair value or cash flows attributable to the
hedged risk).
(3) The hedging relationship meets all of the SLFRS 9 hedge
effectiveness criteria.
SLFRS 9 defines hedge effectiveness as the degree to which changes
in the fair value or cash flows of the hedged item attributable to a
hedged risk are offset by changes in the fair value or cash flows of the
hedging instrument. The directors of Complexity have asked whether
hedge effectiveness can be calculated. SLFRS 9 uses an objective-
based assessment for hedge effectiveness, under which the following
criteria must be met.
(1) There is an economic relationship between the hedged item
and the hedging instrument, ie the hedging instrument and the
hedged item have values that generally move in the opposite
direction because of the same risk, which is the hedged risk;
(2) The effect of credit risk does not dominate the value changes
that result from that economic relationship, ie the gain or loss
from credit risk does not frustrate the effect of changes in the
underlying item on the value of the hedging instrument or the
hedged item, even if those changes were significant; and
(3) The hedge ratio of the hedging relationship (quantity of
hedging instrument vs quantity of hedged item) is the same as
that resulting from the quantity of the hedged item that the entity
actually hedges and the quantity of the hedging instrument that
the entity actually uses to hedge that quantity of hedged item.

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(b) (i) SLFRS 9 Financial Instruments provides a model for the classification
and measurement of financial instruments that is based on principles
and the entity's underlying business model. Many users find financial
instruments to be complex often due to the nature of the financial
instruments themselves and the many different ways in which they
can be measured. The measurement method depends on:
(1) The applicable financial reporting standard. A variety of
SLFRSs and LKASs apply to the measurement of financial
instruments. For example, financial assets may be measured
using consolidation for subsidiaries (SLFRS 10), the equity
method for associates and joint ventures (LKAS 28 and SLFRS 11)
or SLFRS 9 for most other financial assets.
(2) The categorisation of the financial instrument. SLFRS 9
classifies financial assets as measured at amortised cost, fair
value through profit or loss or fair value through other
comprehensive income A financial asset may only be classified
as measured at amortised cost if the object of the business model
in which it is held is to collect contracted cash flows and its
contractual terms give rise on specified dates to cash flows that
are solely payments of principal and interest. Financial liabilities
are generally accounted for at amortised cost but may be
accounted for under the fair value model as was shown in (a)(i).
(3) Whether hedge accounting has been applied. As was discussed
in (a)(ii), hedge accounting is complex, for example when cash
flow hedge accounting is used, gains and losses may be split
between profit or loss for the year and other comprehensive
income (items that may subsequently be reclassified to profit or
loss). In addition, there may be mismatches when hedge
accounting applies reflecting the underlying mismatches under
the non-hedging rules.
Some measurement methods use an estimate of current value, and
others use historical cost. Some include impairment losses, others
do not.
The different measurement methods for financial instruments creates
a number of problems for preparers and users of accounts:
(1) The treatment of a particular instrument may not be the best,
but may be determined by other factors.
(2) Gains or losses resulting from different measurement methods
may be combined in the same line item in the statement of profit
or loss and other comprehensive income. Comparability is
therefore compromised.

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(3) Comparability is also affected when it is not clear what

measurement method has been used.
(4) It is difficult to apply the criteria for deciding which instrument
is to be measured in which way. As new types of instruments
are created, the criteria may be applied in ways that are not
consistent.
(ii) The accountant's suggestion that information relating to financial
instruments is too complex to disclose is not a good enough reason to
avoid making disclosures in the financial statements. SLFRS 7 Financial
Instruments: Disclosure requires extensive disclosures that will enable
the users of financial statements to better understand the quantitative
effects of financial instruments (the numbers within the financial
statements) and to evaluate the nature and extent of risks that arise
from financial instruments and how Complexity manages those risks.
That is not to say that all information relating to financial instruments
needs to be disclosed and it is important that the accountant focuses on
making material disclosures only.
Practice Statement 2 issued by the International Accounting Standards
Board in 2017 clarifies that if information provided by a disclosure
could not reasonably be expected to influence the decisions users make
based on the financial statements, then that disclosure need not be
made. The assessment of materiality needs to be made from a
quantitative perspective first and then any qualitative factors should
be considered.
The reporting accountant should not view the requirements of SLFRS 7
as a prescriptive list of items that must be disclosed. They must apply
judgement to assess what requires disclosure and present it in a
manner that will be of benefit to the users of the financial statements.

8 Carsoon
(a) Under SLFRS 16 Leases, Carsoon is a lessor and must classify each lease as
an operating or finance lease. A lease is classified as a finance lease if it
transfers substantially all of the risks and rewards incidental to ownership
of the underlying asset. All other leases are classified as operating leases.
Classification is made at the inception of the lease. Whether a lease is a
finance lease or an operating lease depends on the substance of the
transaction rather than the form.
In this case, the leases are operating leases. The lease is unlikely to
transfer ownership of the vehicle to the lessee by the end of the lease term as
the option to purchase the vehicle is at a price which is higher than fair value
at the end of the lease term. The lease term is not for the major part of the

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economic life of the asset as vehicles normally have a length of life of more
than three years and the maximum unpenalised mileage is 10,000 miles per
annum. Additionally, the present value of the minimum lease payments is
unlikely to be substantially all of the fair value of the leased asset as the price
which the customer can purchase the vehicle is above market value, hence
the lessor does not appear to have received an acceptable return by the end
of the lease. Carsoon also stipulates the maximum mileage and maintains the
vehicles. This would appear to indicate that the risks and rewards remain
with Carsoon.
Carsoon should account for the leased vehicles as property, plant and
equipment (PPE) under LKAS 16 Property, Plant and Equipment and
depreciate them taking into account the expected residual value. The rental
payments should go to profit or loss on a straight-line basis over the lease
term. Where an item of PPE ceases to be rented and becomes held for sale, it
should be transferred to inventory at its carrying amount. The proceeds
from the sale of such assets should be recognised as revenue in accordance
with SLFRS 15 Revenue from Contracts with Customers.
LKAS 7 Statement of Cash Flows states that payments from operating
activities are primarily derived from the principal revenue-producing
activities of the entity. Therefore, they generally result from the transactions
and other events which enter into the determination of profit or loss.
Therefore, cash receipts from the disposal of assets formerly held for rental
and subsequently held for sale should be treated as cash flows from
operating activities and not investing activities.
(b) For financial assets which are debt instruments measured at fair value
through other comprehensive income (FVOCI), both amortised cost and fair
value information are relevant because debt instruments in this
measurement category are held for both the collection of contractual cash
flows and the realisation of fair values. Therefore, debt instruments
measured at FVOCI are measured at fair value in the statement of financial
position. In profit or loss, interest revenue is calculated using the effective
interest rate method. The fair value gains and losses on these financial
assets are recognised in other comprehensive income (OCI). As a result, the
difference between the total change in fair value and the amounts recognised
in profit or loss are shown in OCI. When these financial assets are
derecognised, the cumulative gains and losses previously recognised in OCI
are reclassified from equity to profit or loss. Expected credit losses (ECLs) do
not reduce the carrying amount of the financial assets, which remains at fair
value. Instead, an amount equal to the ECL allowance which would arise if
the asset were measured at amortised cost is recognised in OCI.
The fair value of the debt instrument therefore needs to be ascertained at
28 February 20X7. SLFRS 13 Fair Value Measurement states that Level 1

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inputs are unadjusted quoted prices in active markets for identical assets or
liabilities which the entity can access at the measurement date. In-house
models are alternative pricing methods which do not rely exclusively on
quoted prices. It would seem that a Level 1 input is available, based upon
activity in the market and further that, because of the active market, there is
no reason to use the in-house model to value the debt.
Therefore, the accounting for the instrument should be as follows:
Initial measurement
The bonds will be initially recorded at Rs. 60 million and interest of
Rs. 2.4 million (4%  60 million) will be received and credited to profit
or loss.
Subsequent measurement
At 28 February 20X7, the bonds will be valued at Rs. 53 million, which
recognises 12-month credit losses and other reductions in fair value. The
loss of Rs. 7 million will be charged as an impairment loss of Rs. 4 million
to profit or loss, representing the 12-month expected credit losses and
Rs. 3 million to OCI. When the bond is sold for Rs. 53 million on 1 March
20X7, the financial asset is derecognised and the loss in OCI (Rs. 3 million)
is reclassified to profit or loss. Also, the fact that the bond is sold for
Rs. 53 million on 1 March 20X7 illustrates that this should have been the fair
value on 28 February 20X7.
(c) SLFRS 15 Revenue from Contracts with Customers specifies how to account
for costs incurred in fulfilling a contract which are not in the scope of
another standard. Costs to fulfil a contract which is accounted for under
SLFRS 15 are divided into those which give rise to an asset and those which
are expensed as incurred. Entities will recognise an asset when costs
incurred to fulfil a contract meet certain criteria, one of which is that the
costs are expected to be recovered.
For costs to meet the 'expected to be recovered' criterion, they need to be
either explicitly reimbursable under the contract or reflected through
the pricing of the contract and recoverable through the margin.
The penalty and additional costs attributable to the contract should be
considered when they occur and Carsoon should have included them in
the total costs of the contract in the period in which they had been notified.
As regards the counter claim for compensation, Carsoon accounts for the
claim as a contract modification in accordance with SLFRS 15. The
modification does not result in any additional goods and services being
provided to the customer. In addition, all of the remaining goods and
services after the modification are not distinct and form part of a single
performance obligation. Consequently, Carsoon should account for the

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modification by updating the transaction price and the measure of progress

towards complete satisfaction of the performance obligation. However, on
the basis of information available, it is possible to consider that the counter
claim had not reached an advanced stage, so that claims submitted to the
client should not be included in total revenues.
When the contract is modified for the construction of the storage facility, an
additional Rs. 70 million is added to the consideration which Carsoon will
receive. The additional Rs. 70 million reflects the stand-alone selling price of
the contract modification. The construction of the separate storage facility is
a distinct performance obligation and the contract modification for the
additional storage facility is accounted for as a new contract which does not
affect the accounting for the existing contract. Therefore the contract is a
performance obligation which has been satisfied as assets are only
recognised in relation to satisfying future performance obligations. General
and administrative costs cannot be capitalised unless these costs are
specifically chargeable to the customer under the contract. Similarly, wasted
material costs are expensed where they are not chargeable to the customer.
Therefore a total expense of Rs. 150 million will be charged to profit or loss
and not shown as assets.

9 Calendar
(a) (i) Sale of intangible
SLFRS 15 Revenue from Contracts with Customers defines revenue as
income arising from an entity's ordinary activities. Calendar's ordinary
activities do not involve selling development projects. In fact, Calendar
has made no such sales since 20X0. It would seem that Calendar's
business model instead involves developing products for its customers,
who then take over its production, marketing and sale. Stage payments
and royalties are the incomes which arise from Calendar's ordinary
activities and should be treated as revenue.
Based on the above, Calendar is incorrect to recognise the gain as
revenue. In fact, LKAS 38 Intangible Assets explicitly prohibits the
classification of a gain on derecognition of an intangible asset as
revenue.
LKAS 38 defines an intangible asset as an identifiable non-monetary
asset without physical substance. Intangible assets held for sale in the
ordinary course of business are outside the scope of LKAS 38 and are
instead accounted for in accordance with LKAS 2 Inventories. The fact
that the development project was classified as an intangible asset upon
initial recognition further suggests that it was not held for sale in the
ordinary course of business.

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If the development was incorrectly categorised in the prior year

financial statements as an intangible asset, then, as per LKAS 8
Accounting Policies, Changes in Accounting Estimates and Errors, this
should be corrected retrospectively. However, based on the
infrequency of such sales, it seems unlikely that the development was
misclassified.
(ii) Contract
SLFRS 16 Leases says that a contract contains a lease if it conveys the
right to control the use of an identified asset for a period of time in
exchange for consideration. When deciding if a contract involves the
right to control an asset, the customer must assess whether they have:
 The right to substantially all of the identified asset's economic
benefits;
 The right to direct the asset's use.
Calendar has the right to use a specified aircraft for three years in
exchange for annual payments. Although Diary can substitute the
aircraft for an alternative, the costs of doing so would be prohibitive
because of the strict specifications outlined in the contract.
Calendar appears to have control over the aircraft during the three-
year period because no other parties can use the aircraft during this
time, and Calendar makes key decisions about the aircraft's
destinations and the cargo and passengers which it transports. There
are some legal and contractual restrictions which limit the aircraft's
use. These protective rights define the scope of Calendar's right of
use but do not prevent it from having the right to direct the use of the
aircraft.
Based on the above, the contract contains a lease. SLFRS 16 permits
exemptions for leases of less than 12 months or leases of low value.
However, this lease contract is for three years, so is not short term, and
is for a high value asset so a lease liability should have been recognised
at contract inception. The lease liability should equal the present value
of the payments yet to be made, using the discount rate implicit in the
lease. A finance cost accrues over the year, which is charged to profit or
loss and added to the carrying amount of the lease liability. The year-
end cash payment should be removed from profit or loss and deducted
from the carrying amount of the liability.
A right-of-use asset should have been recognised at the contract
inception at an amount equal to the initial value of the lease liability
plus the initial costs to Calendar of negotiating the lease. The right-of-
use asset should be depreciated over the lease term of three years and
so one year's depreciation should be charged to profit or loss.

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(b) Materiality
Calendar's financial statements should help investors, lenders and other
creditors to make economic decisions about providing it with resources. An
item is material if its omission or misstatement might influence the
economic decisions of the users of the financial statements. Materiality is not
a purely quantitative consideration; an item can be material if it triggers
non-compliance with laws and regulations, or bank covenants. Calendar
should consider materiality throughout the process of preparing its financial
statements to ensure that relevant information is not omitted, misstated or
obscured.
Property, plant and equipment (PPE)
LKAS 16 Property, Plant and Equipment states that expenditure on PPE
should be recognised as an asset and initially measured at the cost of
purchase. Writing off such expenditure to profit or loss is therefore not in
accordance with LKAS 16.
According to LKAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors, financial statements do not comply with Sri Lankan Financial
Reporting Standards if they contain material errors, or errors made
intentionally in order to present the entity's financial performance and
position in a particular way. However, assuming that the aggregate impact of
writing off small PPE purchases to profit or loss is not material, then the
financial statements would still comply with Sri Lankan Financial Reporting
Standards. Moreover, this decision seems to be a practical expedient which
will reduce the time and cost involved in producing financial statements,
rather than a decision made to achieve a particular financial statement
presentation.
If implemented, this policy must be regularly reassessed to ensure that PPE
and the statement of profit or loss are not materially misstated.
Disclosure notes
LKAS 1 Presentation of Financial Statements states that application of SLFRSs
in an entity's financial statements will result in a fair presentation. As such,
the use of a checklist may help to ensure that all disclosure requirements
within SLFRSs are fulfilled. However, LKAS 1 and IFRS Practice Statement 2
Making Materiality Judgements both specify that the disclosures required by
SLFRSs are only required if the information presented is material.
The aim of disclosure notes is to further explain items included in the
primary financial statements as well as unrecognised items (such as
contingent liabilities) and other events which might influence the decisions of
financial statement users (such as events after the reporting period). As such,
Calendar should exercise judgement about the disclosures which it prepares,
taking into account the information needs of its specific stakeholders. This is

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because the disclosure of immaterial information clutters the financial

statements and makes relevant information harder to find.
Calendar may also need to disclose information in addition to that specified
in SLFRS if relevant to helping users understand its financial statements.

10 Verge
(a) Maintenance contract
Recognition of revenue from the maintenance contract
Under SLFRS 15, an entity must adjust the promised amount of
consideration for the effects of the time value of money if the contract
contains a significant financing component. A significant financing
component exists even if the financing is only implied by the payment terms.
In effect Verge is providing interest-free credit to the government body.
SLFRS 15 requires the use of the discount rate which would be reflected
in a separate financing transaction between the Verge and its customer
(the government agency), here 6%. This 6% must be used to calculate the
discounted amount of the revenue, and the difference between this and the
cash eventually received recognised as interest income.
The government agency simultaneously receives and consumes the benefits
as the performance takes place so this contract contains a performance
obligation satisfied over time. Verge must therefore recognise revenue
from the contract as the services are provided, that is as work is
performed throughout the contract's life, and not as the cash is received.
The invoices sent by Verge reflect the work performed in each year, but the
amounts must be discounted in order to report the revenue at fair value.
The exception is the Rs. 10 million paid at the beginning of the contract. This
is paid in advance and therefore not discounted, but it is invoiced and
recognised in the year ended 31 March 20X2. The remainder of the amount
invoiced in the year ended 31 March 20X2 (Rs. 28m – Rs. 10m = Rs. 18m) is
discounted at 6% for two years.
In the year ended 31 March 20X3, the invoiced amount of Rs. 12 million will
be discounted at 6% for only one year. There will also be interest income of
Rs. 960,000, which is the unwinding of the discount in 20X2.
Recognised in y/e 31 March 20X2
Rs. m
Initial payment (not discounted) 10
1
Remainder invoiced at 31 March 20X2: 18  2
16
1.06
Revenue recognised 26

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Recognised in y/e 31 March 20X3

1
Revenue: Rs. 12m  = Rs. 11.3m
1.06
Unwinding of the discount on revenue recognised in 20X2 Rs. 16m  6% =
Rs. 960,000
Correction of prior period error
The accounting treatment previously used by Verge was incorrect because it
did not comply with SLFRS 15. Consequently, the change to the new, correct
policy is the correction of an error under LKAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors.
Only including Rs. 10 million of revenue in the financial statements for the
year ended 31 March 20X2 is clearly a mistake on the part of Verge. As a
prior period error, it must be corrected retrospectively. This involves
restating the comparative figures in the financial statements for 20X3
(ie the 20X2 figures) and restating the opening balances for 20X3 so that
the financial statements are presented as if the error had never occurred.
(b) Legal claim
A provision is defined by LKAS 37 Provisions, Contingent Liabilities and
Contingent Assets as a liability of uncertain timing or amount. LKAS 37
states that a provision should only be recognised if:
 There is a present obligation as the result of a past event;
 An outflow of resources embodying economic benefits is probable;
and
 A reliable estimate of the amount can be made.
If these conditions apply, a provision must be recognised.
The past event that gives rise, under LKAS 37, to a present obligation, is
known as the obligating event. The obligation may be legal, or it may be
constructive (as when past practice creates a valid expectation on the part of
a third party). The entity must have no realistic alternative but to settle
the obligation.
Year ended 31 March 20X2
In this case, the obligating event is the damage to the building, and it took
place in the year ended 31 March 20X2. As at that date, no legal proceedings
had been started, and the damage appeared to be superficial. While Verge
should recognise an obligation to pay damages, at 31 March 20X2 the
amount of any provision would be immaterial. It would a best estimate of
the amount required to settle the obligation at that date, taking into account
all relevant risks and uncertainties, and at the year end the amount does not
look as if it will be substantial.

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Year ended 31 March 20X3

LKAS 37 requires that provisions should be reviewed at the end of each
accounting period for any material changes to the best estimate
previously made. The legal action will cause such a material change, and
Verge will be required to reassess the estimate of likely damages. While the
local company is claiming damages of Rs. 12 million, Verge is not obliged to
make a provision for this amount, but rather should base its estimate on
the legal advice it has received and the opinion of the expert, both of which
put the value of the building at Rs. 8 million. This amount should be provided
for as follows.
DEBIT Profit or loss for the year Rs. 8,000,000
CREDIT Provision for damages Rs. 8,000,000
Some or all of the expenditure needed to settle a provision may be
expected to be recovered form a third party, in this case the insurance
company. If so, the reimbursement should be recognised only when it
is virtually certain that reimbursement will be received if the entity
settles the obligation.
 The reimbursement should be treated as a separate asset, and the
amount recognised should not be greater than the provision itself.
 The provision and the amount recognised for reimbursement may be
netted off in profit or loss for the year.
There is no reason to believe that the insurance company will not settle the
claim for the first Rs. 2 million of damages, and so the company should
accrue for the reimbursement as follows.
DEBIT Receivables Rs. 2 million
CREDIT Profit or loss for the year Rs. 2 million
Verge lost the court case and is required to pay Rs. 3 million . This was after
the financial statements were authorised, however, and so it is not an
adjusting event per LKAS 10 Events After the Reporting Period. Accordingly
the amount of the provision as at 31 March 20X3 does not need to be
adjusted.
(c) Gift of building
The applicable standards here are LKAS 16 Property, Plant and Equipment,
and LKAS 20 Accounting for Government Grants and Disclosure of Government
Assistance, within the framework of LKAS 1 Presentation of Financial
Statements. LKAS 1 requires that all items of income and expense recognised
in a period should be included in profit or loss for the period unless a
standard or interpretation requires or permits a different treatment.

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LKAS 16: recognition of building

LKAS 16 states that the cost of an item of property, plant and equipment
should be recognised when two conditions have been fulfilled:
 It is probable that future economic benefits associated with the item will
flow to the entity.
 The cost of the item can be measured reliably.
These conditions are normally fulfilled when the risks and rewards have
transferred to the entity, and they may be assumed to transfer when the
contract is unconditional and irrevocable. As at 31 March 20X2, the
condition of use has not been complied with and Verge has not taken
possession of the building.
The building may, however, be recognised in the year ended 31 March 20X3,
as the conditions of donation were met in February 20X3. The fair value of
the building of Rs. 15 million must be recognised as income in profit or loss
for the year, as it was a gift. The refurbishment and adaptation cost must
also be included as part of the cost of the asset in the statement of financial
position, because, according to LKAS 16, the cost includes directly
attributable costs of bringing the asset to the location and condition
necessary for it to be capable of operating in a manner intended by
management. The transactions should be recorded as follows.
DEBIT Property, plant and equipment Rs. 25m
CREDIT Profit or loss for the year Rs. 15m
CREDIT Cash/payables Rs. 10m
In addition, the building would be depreciated in accordance with the
entity's accounting policy, which could (depending on the policy) involve
time-apportioning over one or two months (February and March 20X3),
depending on when in February the building came into use as a museum.
LKAS 20: Government grant
The principle behind LKAS 20 is that of accruals or matching: the grant
received must be matched with the related costs on a systematic basis.
Grants receivable as compensation for costs already incurred, or for
immediate financial support with no future related costs, should be
recognised as income in the period in which they are receivable.
Government grants are assistance by government in the form of transfers of
resources to an entity in return for past or future compliance with certain
conditions relating to the operating activities of the entity.

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There are two main types of grants:

(i) Grants related to assets: Grants whose primary condition is that an
entity qualifying for them should purchase, construct or otherwise
acquire long-term assets.
(ii) Grants related to income: These are government grants other than
grants related to assets.
It is not always easy to match costs and revenues, but in this case the terms
of the grant are explicit about the expense to which the grant is meant to
contribute. Part of the grant relates to the creation of jobs and this amount
(20  Rs. 50,000 = Rs. 1,000,000) should be taken to income.
The rest of the grant (Rs. 2,500,000 – Rs. 1,000,000 = Rs. 1,500,000) should
be recognised as capital-based grant (grant relating to assets). LKAS 20
would two possible approaches for the capital-based portion of the grant.
(i) Match against the depreciation of the building using a deferred income
approach.
(ii) Deduct from the carrying amount of the building, resulting in a reduced
depreciation charge.
The double entry would be:
DEBIT Cash Rs. 2,500,000
CREDIT Profit or loss Rs. 1,000,000
CREDIT Deferred income/PPE (depending Rs. 1,500,000
on the accounting policy)
If a deferred income approach is adopted, the deferred income would be
released over the life of the building and matched against depreciation.
Depending on the policy, both may be time-apportioned because conditions
were only met in February 20X3.
(d) A change to the measurement of inventory is being proposed from 1 April
20X3 which will impact the interim financial statements prepared to
30 September 20X3. The baseline requirement of LKAS 34 Interim Financial
Reporting is that an entity should make a statement that the interim financial
statements were prepared using the same accounting policies and methods
of computation as the most recent annual financial statements.
If an entity has made a change to their accounting policies since the last full
annual financial statements, then LKAS 34 requires a statement detailing the
nature of the differences in accounting policy and the effect of the difference.
The interim financial statements to 30 September 20X3 will have to include
an explanation of why the method of measuring inventory has been changed,
why it provides more reliable and relevant information and the impact this
change will have on the financial statements.

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As a voluntary change of accounting policy, LKAS 8 requires the change to be

made retrospectively, which will require prior period figures to be amended
as if the new measurement model had always been applied. A change to
inventory will change both the inventories asset on the statement of financial
position and the cost of sales figures in the statement of profit or loss.

11 Moorland
(a) Borrowing costs
LKAS 23 Borrowing Costs requires borrowing costs incurred on acquiring or
constructing an asset to be capitalised if the asset takes a substantial period
of time to be prepared for its intended use or sale. Borrowing costs should
be capitalised during construction and include the costs of general
borrowings which would have been avoided if the expenditure on the asset
had not occurred. The general borrowing costs are determined by applying
the weighted average of the borrowing costs applicable to the general pool
The weighted-average carrying amount of the factory during the period is:
Rs. (200 + 700 + 1,200 + 1,700)m/4, that is Rs. 950 million.
The capitalisation rate of the borrowings of Moorland during the period of
construction is 9% per annum, therefore the total amount of borrowing
costs to be capitalised is the weighted-average carrying amount of the
factory multiplied by the capitalisation rate.
That is (Rs. 950m  9%  4/12) Rs. 28.5 million.
(b) (i) Operating segment
SLFRS 8 Operating Segments describes an operating segment as a
component of an entity:
(1) Which engages in business activities from which it may earn
revenues and incur expenses;
(2) Whose operating results are regularly reviewed by the entity's
chief operating decision-maker to make decisions about resources
to be allocated to the segment and assess its performance;
(3) For which discrete financial information is available.
There is a considerable amount of subjectivity in how an entity may
apply these criteria to its choice of operating segments. Usually an
operating segment would have a segment manager who maintains
regular contact with the chief operating decision-maker to discuss
operating activities, financial results, forecasts or plans for the segment.
Therefore segment managers could have overall responsibility for a
particular product, service line or geographical area and so there could
be considerable overlap in how an entity may apply the criteria. In such
situations the directors of Moorland should consider the core principles
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of the standard. Information should be disclosed to enable users of its

financial statements to evaluate the nature and financial effects of the
business activities in which it engages and the economic environments
in which it operates.
Since Tybull is the only overseas subsidiary, it is likely that separate
disclosure is necessary so that users can better assess the performance
of Tybull and its significance to the group. The directors should consider
whether there are other segments which exhibit similar long-term
financial performance and similar economic characteristics to Tybull. In
such circumstances it is possible to aggregate the operating segments
into a single segment. For example, the segments should have products
of a similar nature and similar methods to distribute their products. The
segments should also have similar types of customer, production
processes and regulatory environment. The directors of Moorland
would need to assess whether such aggregation would limit the
usefulness of the disclosures for the users of the financial statements.
For example, it would no longer be possible to assess the gross margins
and return on capital employed for Tybull on an individual basis,
without referring to its individual financial statements.
Operating segments can be reclassified where an entity changes its
internal organisational structure. As Tybull has not changed its
organisational structure, it is unlikely that it would be able to argue for
a reclassification of its operating segments. Should the directors of
Moorland decide to reclassify the operating segments and combine
Tybull with other segments, LKAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors would need to be applied. A
retrospective adjustment would be required to the disclosures and the
change would need to be justified. An entity should only change its
policy if it enhances the reliability and relevance of the financial
statements. This would appear unlikely given the circumstances.
(ii) Underlying earnings per share
Underlying earnings per share (underling EPS) is an alternative
performance measure (APM) which can be used to enhance the
understanding of users of the accounts.
However, APMs can be misleading. Unlike earnings per share, which is
defined in LKAS 33 Earnings per Share, there is no official definition of
underlying EPS, so management can choose what items to include or
exclude in the underlying earnings. Therefore it is open to bias in its
calculation as management could decide to only adjust for items that
improve the measure. Furthermore, different companies may define
the measure in different ways, which reduces the comparability
between entities.

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The CEO's wish to exclude impairment on goodwill from the calculation

of earnings on the basis that it is unlikely to reoccur is also misleading to
investors. An impairment loss on goodwill could quite feasibly
re-occur in the future as it is at least partly dependent on circumstances
outside of Moorland's control, such as the state of the economy.
Therefore, it could be argued that excluding the impairment loss would
make the measure of underlying earnings per share less useful to
investors.
The CEO wishes to present underlying EPS 'prominently'. It is not clear
what is meant by this comment, however, Moorland should ensure that
it complies with the requirements of LKAS 33 regarding the calculation
and presentation of this alternative EPS. IOSCO's (International
Organisation of Securities Commissions) Statement on Non-GAAP
Financial Measures recommends that APMs are not presented more
prominently than GAAP measures, or in a way that confuses or
obscures GAAP measures.
Ultimately underlying earnings per share will only provide useful
information to Moorland's investors if it is fairly presented.
Moorland could improve the usefulness of underlying EPS by:
 Including an appropriate description of how the measure is
calculated
 Ensuring that the calculation of underlying EPS is consistent year on
year and that comparatives are presented
 Explaining the reasons for presenting the measure, why it is useful
for investors and for what purpose management may use it
 Presenting a reconciliation to the most directly reconcilable
measure in the financial statements, for example EPS calculated
in accordance with LKAS 33
 Not excluding items from underlying EPS that could legitimately
reoccur in the future, such as impairment losses on goodwill
(c) Moorland has been preparing consolidated financial statements under SLFRS
3 Business Combinations which present the results of the parent company
and the subsidiaries as a single group entity. This involves adding together
the income, expenses, assets and liabilities of all entities in the group and
recognising a 'non-controlling interest' share, as well as eliminating
intragroup transactions.
Guidance for parent companies preparing separate financial statements is
given in LKAS 27 Separate Financial Statements. Moorland has a number of
subsidiary companies and must choose how to account for these subsidiaries
in the individual financial statements. LKAS 27 permits the subsidiaries to be

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measured at cost or in accordance with SLFRS 9 as financial assets. All

subsidiaries must be measured in the same way.
If Moorland choose to measure subsidiaries at cost and decides to sell one,
it should be measured as a held-for-sale asset in accordance with SLFRS 5.
If SLFRS 9 is used to measure subsidiaries, Moorland would also need to
decide whether changes in fair value were recognised in the statement of
profit or loss, or in other comprehensive income.
Any dividend income from the subsidiaries should be recognised in the
statement of profit or loss when a right to receive the dividend is
established.

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PART B: PREPARATION AND PRESENTATION OF CONSOLIDATED FINANCIAL

STATEMENTS
Questions 12 to 14 cover the Preparation and Presentation of Consolidated
Financial Statements.

12 Glove
GLOVE GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X7
Rs m
Non-current assets
Property, plant and equipment 320.0
Goodwill 10.1
Other intangibles: trade name 4.0
Investments in equity instruments 10.0
Current assets: 344.1
114.0
Total assets 458.1

Equity and liabilities

Equity attributable to owners of parent
Ordinary shares 150.0
Other reserves 30.7
Retained earnings 150.9
Equity reserve 1.6
333.2
Non-controlling interests 28.9
362.1
Non-current liabilities 49.0
Current liabilities: 47.0
96.0
Total equity and liabilities 458.1

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1 Group structure
Glove
1 June 20X5 80% Retained earnings Rs 10 m
Other reserves Rs 4 m
Body
1 June 20X5 70% Retained earnings Rs 6 m
Other reserves Rs 8 m
Fit
%
Effective interest: 80%  70% 56
Non-controlling interest 44
100
2 Goodwill
Glove in Body Body in Fit
Rs m Rs m Rs m Rs m
Consideration
transferred 60 (30  80%) 24.00
Non-controlling interests (65  20%) 13 (39  44%) 17.16
Fair value of net
assets at acq'n:
Stated capital 40 20
Retained earnings 10 6
Other reserves 4 8
Fair value uplift – land 6 5
Trade name (W6) 5 –
(65) (39.00)
8 2.16

10.16
Note. The trade name is an internally generated intangible asset. While
these are not normally recognised under LKAS 38 Intangible assets, SLFRS 3
Business combinations allows recognition if the fair value can be measured
reliably. Therefore, an intangible asset is recognised on acquisition of
Body (at 1 June 20X5). This will reduce the value of goodwill.
(i) The standing journal to recognise goodwill in Body is therefore (Rs. m):
DEBIT Goodwill 8
DEBIT Stated capital 40
DEBIT Retained earnings 10
DEBIT Other reserves 4
DEBIT PPE 6
DEBIT Intangible assets 5
CREDIT Investment in B 60
CREDIT NCI 13
To recognise the acquisition of Body.

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(ii) The standing journal to recognise goodwill in Fit is therefore (Rs. m):
DEBIT Goodwill 2.16
DEBIT Stated capital 20
DEBIT Retained earnings 6
DEBIT Other reserves 8
DEBIT PPE 5
CREDIT Investment in F 24
CREDIT NCI 17.16
To recognise the acquisition of Fit.
3 Allocation of post-acquisition profits and reserves to the NCI
Body Fit
Retained Other Retained Other
earnings reserves earnings reserves
Rs m Rs m Rs m Rs m
At reporting date 25 5 10 8
At acquisition (10) (4) (6) (8)
Post-acquisition 15 1 4 –
NCI % (20% / 44%) 3 0.2 1.76
(i) These amounts are allocated to the NCI by (Rs m):
DEBIT Retained earnings ( 3 + 1.76) 4.76
DEBIT Other reserves 0.20
CREDIT NCI 4.96
To allocate the NCI its share of retained earnings and reserves since
acquisition
(ii) The carrying amount of the NCI is adjusted for its share of Body's
investment in Fit (Rs. m):
DEBIT NCI (30  20%) 6
CREDIT Investment in F 6
To eliminate the NCI in Body's share of the cost of the investment in Fit
4 Amortisation of intangible assets
The intangible assets recognised at acquisition are amortised over 10 years
therefore at the reporting date cumulative amortisation is Rs. 5 m 
2/10 years = Rs. 1 million.
The amortisation expense is allocated between the group and NCI interests
in Body. Therefore (Rs m)
DEBIT Retained earnings (80%) 0.8
DEBIT NCI (20%) 0.2
CREDIT Intangibles 1
To recognise amortisation of the intangible asset

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5 Defined benefit pension scheme

The amount to be recognised is as follows.
Rs m
Loss on remeasurement through OCI on defined benefit (1.0)
obligation
Gain on remeasurement through OCI on plan assets 0.9
(0.1)
Therefore (Rs m):
DEBIT Other reserves Rs. 0.1 m
CREDIT Net defined benefit liability Rs. 0.1 m
To account for the remeasurement of the net defined benefit liability
6 Convertible loan stock
Under LKAS 32, the loan stock must be split into a liability and an equity
component:
Rs m Rs m
Proceeds: 30,000  Rs. 1,000 30

Present value of principal in three years' time

1
Rs. 30 m  23.815
1.083
Present value of interest annuity
Rs. 30 m  6% = Rs. 1,800,000
 1 1.667
1.08
 1
1.08
2
1.543

 1
1.08
3
1.429

Liability component (28.454)

∴ Equity component 1.546
Rounded to Rs. 1.5m
Balance of liability at 31 May 20X7
Rs'000
Balance b/f at 1 June 20X6 28,454
Effective interest at 8% 2,276
Coupon interest paid at 6% (1,800)
Balance c/f at 31 May 20X7 28,930

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The accounting entries that have been made in respect of the loan stock are
(Rs. m):
DEBIT Cash 30
CREDIT Non-current liability 30
And
DEBIT Finance cost (retained earnings) 1.8
CREDIT Cash 1.8
The accounting entries should have been (Rs m):
DEBIT Cash 30
CREDIT Non-current liability 28.4
CREDIT Equity reserve 1.6
And
DEBIT Finance cost 2.3
CREDIT Cash 1.8
CREDIT Non-current liability 0.5
Therefore a correction journal is (Rs m):
DEBIT Finance cost (retained 0.5
earnings)
DEBIT Non-current liability 1.6
CREDIT Non-current liability 0.5
CREDIT Equity reserve 1.6
7 Exchange of assets
The plant should be measured at initial recognition at its fair value, rather
than the carrying amount of the asset given up. An adjustment must be made
to the value of the plant, and to retained earnings.
Rs.
Fair value of plant 6
Carrying amount of land (4)
∴ Adjustment required (Rs m) 2
DEBIT PPE 2
CREDIT Retained earnings 2

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13 Ejoy
EJOY
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE
INCOME FOR THE YEAR ENDED 31 MAY 20X6
Rs m
Continuing operations
Revenue 4,000
Cost of sales (3,034.4)
Gross profit 965.6
Other income 77
Distribution costs (250)
Administrative expenses (190)
Finance income 5.8
Finance costs (133.9)
Profit before tax 474.5
Income tax expense (226)
Profit for period from continuing operations 248.5
Discontinued operations
Profit for the year from discontinued operations 13
Profit for the year 261.5
Other comprehensive income for the year (not reclassified to P/L):
Gain on property revaluation net of tax: 94
Total comprehensive income for the year 355.5

Profit attributable to:

Owners of the parent 256.9
Non-controlling interest 4.6
261.5
Total comprehensive income for the year attributable to:
Owners of the parent 347.3
Non-controlling interest 8.2
355.5

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1 Group structure

Ejoy

160 72
= 80% = 60% (owned for six months)
200 120
Zbay Tbay
Tbay is a discontinued operation (SLFRS 5).
Timeline
1.6.X5 1.12.X5 31.5.X6

Ejoy

Zbay

Tbay

2 Tbay
Tbay has been classified as a discontinued operation and therefore its profits
must be presented as a single line item in the statement of profit or loss
(Rs. m):
DEBIT Revenue 400
CREDIT Cost of sales 300
CREDIT Distribution costs 35
CREDIT Administrative expenses 30
CREDIT Finance costs 10
CREDIT Tax 10
CREDIT Profit from discontinued 15
operations
To reclassify items of Tbay's income and expenses as profits of discontinued
operations.
3 Re-measurement of Tbay
As Tbay is a disposal group, it is measured in accordance with SLFRS 5 at the
lower of fair value less costs to sell and carrying amount.
When comparing these amounts, care must be taken to ensure that like is
being compared with like; we are given the fair value of the whole of Tbay
and therefore must ensure that costs to sell and carrying amount (including
goodwill) also represent 100% of Tbay.

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Fair value less costs to sell

Rs m
Fair value 344
Costs to sell 100/60%  5 (8.3)
335.7
Carrying amount
Rs m
Fair value of net assets at acquisition (1 December 20X5) 310
Post-acquisition TCI (38  6/12) 19
Notional (unrecognised) NCI goodwill 100/60%  6 (W4) 10
339
Working: Goodwill in Tbay
Rs m
Consideration transferred 192
NCI (310m  40%) 124
Fair value of net assets at acquisition (310)
6
Therefore, an impairment loss of Rs. 339 m – Rs. 335.7 m = Rs. 3.3 m arises.
This is allocated against goodwill. As 60% of total goodwill is recognised in
the consolidated financial statements, 60% of the impairment loss is
recognised (Rs. m):
DEBIT Profits of discontinued 2
operations (60%  Rs. 3.3 m)
CREDIT Assets of disposal group 2
(SOFP)
To recognise the impairment loss in Tbay
The loss is allocated to the owners of the parent company.
4 Investment in joint venture
A gain of Rs. 6 million has been recognised on a disposal to a joint venture.
LKAS 28 requires that only that part of the gain that is attributable to other
investors is recognised. Therefore 50% of the gain (Rs. 3 m) is eliminated
against the cost of investment in the joint venture (Rs. m):
DEBIT Other income 3
CREDIT Investment in joint venture 3
To eliminate the gain attributable to Ejoy against the investment in the joint
venture.
The adjustment is attributable to the owners of the parent company.

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5 Zbay loan asset

The loan asset had a carrying amount of Rs. 60 million at 1 June 20X5, but at
that date, there was objective evidence of impairment, as on Rs. 20 million is
now expected to be received.
The lifetime credit loss at 1 June 20X5 is the difference between the present
value of the contractual cashflows and the present value of expected
cashflows.
Rs m
Present value of contractual cashflows 60.0

Present value of expected future cash flows (20  1/1.062) 17.8

Lifetime credit loss 42.2
(i) The lifetime credit loss is recognised by:
DEBIT Finance costs 42.2
CREDIT Credit loss allowance 42.2
To recognise the impairment of the loan asset in Zbay.
The loan is held by Zbay and therefore the impairment loss is allocated
between the owners of Ejoy and the NCI in Zbay in proportion to their
ownership interests.
(ii) As there is objective evidence of impairment, interest income is
recognised on the loan asset, calculated based on the impaired amount:
Interest income (6%  17.8) 1.1
This is recognised by:
DEBIT Loan asset 1.1
CREDIT Finance income 1.1
To recognise income on the loan asset
The loan is held by Zbay and therefore the income is allocated between
the owners of Ejoy and the NCI in Zbay in proportion to their
ownership interests.
6 Hedged bond
The carrying amount of the hedged bond at the period end is calculated as:
Rs m
1.6.X5 50.0
Interest income (5%  50) 2.5
Interest received (2.5)
Fair value loss (balancing figure) (1.7)
Fair value at 31.5.X6 (per question) 48.3

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(i) The interest income is recognised by (Rs. m):

DEBIT Bond/cash 2.5
CREDIT Finance income 2.5
To recognise income on the bond
(ii) The fair value loss is recognised by (Rs. m):
DEBIT Finance costs 1.7
CREDIT Bond 1.7
To recognise the remeasurement of the bond to fair value
(iii) Since the interest rate swap is 100% effective as a fair value hedge,
it exactly offsets the loss in value of Rs. 1.7 million on the bond.
Therefore finance income of this amount is recognised by (Rs. m):
DEBIT Swap financial asset 1.7
CREDIT Finance income 1.7
To recognise the swap at fair value at the reporting date
(iv) The net settlement of interest is recognised by:
DEBIT Cash 0.5
CREDIT Finance income 0.5
To recognise settlement of interest
All amounts recognised in profit or loss in respect of the bond are
allocated to owners of the parent, since the bond is held by Ejoy.
7 Impairment of Zbay
Zbay is tested for impairment by comparing the carrying amount of the
investment in the consolidated financial statements with its recoverable
amount of Rs. 630 million.
Carrying amount
Rs m
Fair value of net assets at acquisition (1 June 20X4) 600
Post-acquisition TCI (20 + 44) 64
Impairment of loan asset (W5) (42.2)
Interest income on loan asset 1.1
Notional (unrecognised) NCI goodwill 100/80%  40 (W8) 50
672.9

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Therefore, an impairment loss of Rs. 672.9 m – Rs. 630 m = Rs. 42.9 m arises.
This is allocated against goodwill. As 80% of total goodwill is recognised in
the consolidated financial statements, 80% of the impairment loss is
recognised (Rs. m):
DEBIT Cost of sales (80%  Rs 42.9 m) 34.4
CREDIT Goodwill 34.4
To recognise the impairment loss in Zbay
The loss is allocated to the owners of the parent company.
8 Goodwill in Zbay
Rs m
Consideration transferred 520
NCI (310m  40%) 120
Fair value of net assets at acquisition (600)
40

14 Swing
Rs'000 Rs'000
Cash flows from operating activities
Profit before tax 16,500
Adjustments for:
Depreciation 5,800
Impairment losses (W1) 240
22,540
Increase in trade receivables (W4) (1,700)
Increase in inventories (W4) (4,400)
Increase in trade payables (W4) 1,200
Cash generated from operations 17,640
Income taxes paid (W3) (4,200)
Net cash from operating activities 13,440
Cash flows from investing activities
Acquisition of subsidiary net of cash acquired (600)
Purchase of property, plant and equipment (W1) (13,100)
Net cash used in investing activities (13,700)
Cash flows from financing activities
Proceeds from issue of share capital (W2) 2,100
Dividends paid (W2) (900)
Dividends paid to non-controlling interest (W2) (40)
Net cash from financing activities 1,160
Net increase in cash and cash equivalents 900
Cash and cash equivalents at the beginning of the period 1,500
Cash and cash equivalents at the end of the period 2,400

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Workings
1 Assets
Property, plant
and equipment Goodwill
Rs'000 Rs'000
b/f 25,000 –
OCI (revaluation) 500
Depreciation/ Impairment – balancing figure (5,800) (240)
Acquisition of sub/assoc 2,700 (W5) 1,640
Cash paid/(rec'd) – balancing figure 13,100 –
c/f 35,500 1,400
2 Equity
Non-
Share Retained controlling
capital earnings interest
Rs'000 Rs'000 Rs'000
b/f 12,000 21,900 –
SPLOCI 11,100 350
Acquisition of subsidiary 4,000 (W5) 1,440
Cash (paid)/rec'd – balancing 2,100 (900)* (40)
figure
c/f 18,100 32,100 1,750
*Dividend paid is given in question but working shown for clarity.
3 Liabilities
Tax payable
Rs'000
b/f 4,000
SPLOCI 5,200
Acquisition of subsidiary 200
Cash (paid)/rec'd – balancing figure (4,200)
c/f 5,200
4 Working capital changes
Inventories Receivables Payables
Rs'000 Rs'000 Rs'000
Balance b/f 10,000 7,500 6,100
Acquisition of subsidiary 1,600 600 300
11,600 8,100 6,400
Increase/(decrease) – balancing 4,400 1,700 1,200
figure
Balance c/f 16,000 9,800 7,600

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5 Purchase of subsidiary
Rs'000
Cash received on acquisition of subsidiary 400
Less cash consideration (1,000)
Cash outflow (600)
Note. Only the cash consideration is included in the figure reported in the
statement of cash flows. The shares issued as part of the consideration are
reflected in the share capital working (W2) above.
Goodwill on acquisition (before impairment):
Rs'000
Consideration 5,000
Non-controlling interest: 4,800  30% 1,440
Net assets acquired (4,800)
Goodwill 1,640

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PART C: EVALUATING RISK OF MATERIAL MISSTATEMENT IN FINANCIAL

STATEMENTS
Questions 15 to 18 cover Evaluating Risk of Material Misstatement in Financial
Statements.

15 Risk and Going Concern

(a) Jaf Group
Business risks – any four from the following:
 Foreign currency risk: Many of Jaf's supplies are from India and hence cost
would depend on exchange rate with the Indian rupee. Also franchisees
pay 60% of local retail price to Jaf, which passes currency risk to Jaf
where the franchisees are located outside Sri Lanka.
 Cash flow/financing risk: The Group bears an ongoing cash flow risk with
respect to the shop fittings provided to franchisees which are not paid for
until later. Given that most shop fittings will be for new franchisees, this is
coupled with the business risk that those franchisees may fail.
 Leased vs owned properties: Leased properties allows the Group the
flexibility to open, close or move shops, but also subjects the Group to the
risks of the rental market and the potential loss of prime retail sites when
the rental agreements are up for renewal. Owned properties are more
secure, but are less flexible when the retail centre of a town shifts location
over time.
 Fashion: The market in which Jaf operates is a fast-moving one. Success
depends on being at the cutting edge of latest fashions. Given that the
clothes are ordered six months in advance, it is essential that Jaf's
research and buying department calculations are based on accurate
information. Miscalculations of the market could result in large amounts
of unsaleable inventories to customers or indeed to franchisees. Further,
goods unsold by the franchisees can be returned to Jaf, increasing its risk.
 Quality: All clothing is manufactured by third parties. Controls are
necessary to ensure that the quality of goods is adequate across suppliers
and consistent between suppliers and over time.
 Competitors: There are many players in the fashion market which is
becoming more globalised. What in the past may have been a stable
national position could quickly turn sour if a new, but established, foreign
player enters the market. This needs to be regularly monitored.
 Supply issues: Unexpected supply problems could occur for Jaf, a foreign
investor in India through unexpected changes in legislation or local
transport or infrastructure problems.

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 Compliance risk: Operations in various different markets pose risks due to

different regulatory and reporting requirements which must be
researched and complied with.
Risk of material misstatement – any four from the following:
 Overseas transactions: The activities between Jaf and its overseas
suppliers and customers present possible risks of misstatement due to
foreign currency fluctuations under LKAS 21 in terms of statement of
profit or loss items (such as revenues and purchases) and assets (such as
inventory).
 Shop fittings and franchises: Depending on the recoverability of sums due
from franchisees, there may be issues with the recognition and valuation
of items in shops where a franchise may have ceased operating.
 Owned vs leased PPE: There may be a risk of misstatement in shop
premises which are recorded as owned but are leased (and vice versa)
meaning LKAS 16 and/or SLFRS 16 may not be adhered to.
 Inventory: This will be hard to value due to the volatile nature of fashion
goods in general (establishing net realisable value under LKAS 2, for
example, may be difficult). Also, in cases where goods are returned, there
may be a risk of misstatement where ownership of inventory is unclear
and it is either carried incorrectly or omitted from Jaf's financial
statements (this could also affect revenue recognition under SLFRS 15 if
control of inventory is hard to establish).
(b) Karava Ltd –
(i) Going concern indicators
Six of the following indicators with clear explanation are required to
earn the marks available:
Indicator Why indicator impacts on going
concern
90% of Karave's revenue comes The dependence on just two
from just two products in a products in a competitive market
competitive market. means, if competitors develop a
similar or superior product at the
same or lower prices, then Karava
will probably struggle to make
enough sales to cover expenses
(already evidenced by declining
demand).
There has been insufficient Existing products are in decline
investment in product and there are not likely to be
development which would appear sufficient new products to fill the
essential in this competitive cash flow void these declining
product driven market. products will leave.

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Indicator Why indicator impacts on going

concern
Recruitment of suitably trained In the pharmaceutical industry,
staff is proving difficult. specialised staff are needed to
develop the products which will
create cash inflows. Without them,
it will be difficult to see how new
products and related revenue will
be forthcoming.
Rs. 100m of investment in plant Again, this will hold up new
and machinery is needed but the product development and also
company has been unable to suggests the bank consider Karava
secure funding for this. a risky investment and have
reservations about its financial
health.
Trade payables are being paid late The company has to now pay cash
and have withdrawn credit terms. on delivery and this adds further
cash flow strain to Karava which is
already utilising its overdraft
facility. Also some suppliers may
not supply Karava and prevent
them from getting their products
into a saleable condition.
The cash flow forecast shows a The company already seems to
significantly worsening position have significant cash flow
over the next 12 months. problems. A worsening position
suggests further net cash outflows
and the company may not be able
to meet liabilities as they fall due,
particularly given the bank's
cautious stance over providing
finance.

Audit procedures to assess whether the company is a going

concern
 Review correspondence with the bank for indications of the
likelihood of renewal of the overdraft facility.
 Obtain the cash flow forecasts and assess whether the cash inflows
and outflows appear realistic and consistent with knowledge built
up during the audit. Consider the reasonableness of the assumptions
on which the forecasts are based and discuss any findings with
management.
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 Review any post year end management accounts and compare the
cash position they show with that forecast to help assess the
reliability of the forecasts.
 Review any available post year end correspondence with suppliers
to see if the trend of withdrawal of credit terms has continued, or
eased, since the year end date.
 Review board minutes for meetings held after the year end for
issues which indicate further financial difficulties or issues/funding
which will alleviate cash flow problems to some degree.
 Obtain written representations from directors/management that
they consider the company to be a going concern.
Note. There are a number of other procedures that could have been
suggested in place of those stated above, but only four well explained
procedures were required to gain full marks.
(ii) Impact on audit report: going concern appropriate but material
uncertainty exists
The auditor agrees with the directors that the company is a going
concern and this is the basis on which the accounts are drawn up.
However, the directors have agreed to include going concern
disclosures and these disclosures will need to be assessed to see if they
adequately describe the material uncertainty over going concern.
If the disclosure is inadequate the audit opinion will be modified on the
grounds that the financial statements are material misstated.
If the inadequate disclosure is deemed a pervasive material
misstatement, then an adverse opinion will be expressed stating the
accounts are not presented fairly, in all material respects. The reason
for the adverse opinion will be stated in a 'basis for adverse opinion'
paragraph immediately after the opinion paragraph.
If the misstatement is not deemed pervasive, a qualified opinion will be
expressed stating that except for the disclosure over going concern, the
financial statements are presented fairly. The reason for the qualified
opinion will be stated in a 'basis for qualified opinion' paragraph
immediately after the opinion paragraph.
If the disclosure is adequate, then the accounts will be fairly presented
in all material respects and an unmodified opinion will be issued, but
as a material uncertainty exists, a material uncertainty relating to going
concern paragraph will be included after the opinion and basis for
opinion paragraphs and will highlight this and refer to the disclosure
provided by management.

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16 Maleats Plc
(a) Business Risks
Chomping Chimps children's crèches
A child was slightly injured during the year in an incident at one of the
crèches. The media criticism that was received could lead to significant
damage of the Chomping Chimps brand, particularly given that the family-
friendly orientation of the restaurants appears to be an important selling
point. Although revenues from this segment rose 21% compared with 20X8
((120 – 99) / 99 = 21%), this negative publicity probably did result in some
lost revenue.
It is possible that regulatory bodies could take action as a result of this
incident, with the potentially disastrous consequence of the crèches or even
the whole restaurants being shut down.
If it wants to protect the Chomping Chimps brand, Maleats will probably
need to spend money to improve the standard of child care offered in the
crèches. It would be difficult for it to do this given its falling cash balance
(Rs. 17.4m in 20X9; Rs. 52.5m in 20X8). It would therefore have to divert
funds away from other projects, such as the expansion of the Urban Bites
grills.
Revenue derived from Chomping Chimps restaurants makes up 53% of total
revenue (= 120 / 225), so any damage to this revenue stream could have a
significant effect Maleats as a whole.
Chomping Chimps – health and safety
One restaurant was actually closed during the year as a result of significant
breaches in kitchen hygiene standards. Health and safety authorities often
have significant powers, and it is crucial that Maleats Plc's restaurants
comply with them. Moreover, this could cause significant damage to the
Chomping Chimps brand, and even to the other brands that Maleats owns by
way of association with it. If this was to happen revenues could drop sharply,
which would clearly affect Maleats Plc's ability to meet its objective of
maximising market share.
The effect of damage to the Chomping Chimps brand on Maleats as a whole
could be very significant indeed, owing to the fact that it makes up 53% of
Maleats Plc's total revenue in 20X9.
Quick-bite chain
Marketing campaign
A significant marketing campaign was launched to support the Quick-bite
brand, costing Rs. 22.5m in 20X9. This represents 10% of Maleats Plc's total
revenue for the year, and is a significant expense. Indeed, this outlay may

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have been partly responsible for the decrease in cash during the year, and
because of Maleats Plc's poor cash position this level of spending is unlikely
to be sustainable in the future.
Falling revenue
Revenue from this segment fell by 6% in 20X9. The fact that this happened
even though Rs. 22.5m was spent on advertising during the year is a
worrying sign, and may be indicative of a significant reduction in demand.
This is borne out by the pressure exerted by government for the restaurants
to provide nutritional information in its menus, which the company rightly
responded to. It is possible that this highly competitive industry is
experiencing falling demand as a result of increased public awareness of the
importance of eating healthily. This would appear to cast significant doubt
over the wisdom of the company having spent such a large amount on
advertising during the year.
New advertising regulations
50% of Quick-bite's revenue derives from 'chuckle boxes' sold to children.
These sales are likely to be affected by the new advertising regulations
coming into force from September 20X9. Maleats will have to consider how
it is going to tackle this problem going forward.
Urban Bites grills
Expansion plans
Maleats is planning to double the number of Urban Bites grills from 250 to
500 by the end of the current financial year. Given that the restaurants
operate in the higher quality end of the market, this is likely to require
significant expenditure to acquire new prime locations and to refurbish the
locations acquired.
It is possible that Maleats may not be able to afford this level of investment
in the next year, owing to its already declining cash balance. There is a risk
that it will begin to expand the chain, but then run out of cash once it has
started.
There is a possibility that Maleats will have to raise new funds in order to
finance the expansion. Given the scale of its plans, it may struggle to raise the
necessary funds. If it takes on new debt, this will expose the company to
increased liquidity risk if it cannot make the required repayments.
Refurbishment costs
Maleats plans to refurbish each Urban Bites grill every two years. This is
likely to represent a significant and ongoing drain on Maleats Plc's cash
resources, and there is a risk that Maleats will not be able to afford it.
Maleats should therefore consider whether it can reduce the outlay in some
way, perhaps by extending the amount of time between refurbishments from
two to three years.

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Organucopia cafes
Maleats plans to double the number of cafes within the next 12 months. This
would probably be costly, and again there is a question mark over its
affordability to Maleats. The combination of the plans to expand the
Organucopia cafes and the Urban Bites grills, as well as a potential fall in
revenue from the Quick-bite outlets as a result of increased regulatory
pressure, represents a significant risk to the future success of Maleats as a
whole.
This risk is exacerbated by the fact that Maleats financed the expansion in
the Organucopia cafes by taking on short term debt, which may pose a threat
to the company's liquidity if Maleats fails to keep up with the necessary
repayments or is unable to re-finance.
Falling cash balance
Maleats Plc's cash balance fell by Rs. 35.1m from Rs. 52.5m at 31 May 20X8
to Rs. 17.4m at 31 May 20X9, a fall of 69%. At this rate it will run out of
money approximately 180 days into the year (17.4 / 35.1  365). It is vital to
Maleats Plc's ongoing survival that this trend is stemmed.
Falling profits
Maleats Plc's profit after tax fell by 13% from Rs. 23.3m in 20X8 to Rs. 20.3m
in 20X9. This may be a result of some one-off expenses, such as the Rs. 22.5m
advertising expenses in respect of the Quick-bite chain, or any expenses
related to the investment in the Urban Bites grills and the Organucopia cafes.
However, it is crucial that Maleat Plc's management considers its cost-
control procedures in the future. This is particularly pertinent in view of the
impending 15% increase in the minimum wage, which will significantly
increase Maleats Plc's costs, as it will affect a third of employees in the
labour-intensive restaurant industry.
Conclusion
The business risks currently faced by Maleats Plc are not insignificant, and
there is even a risk that it may not survive the next financial year if its
inability to generate sufficient cash inflows is not countered.
(b) Risk of Material Misstatement
Acquisition of Organucopia café chain
The acquisition of the chain of cafes was a mid-year acquisition and there is
a risk that the revenue and costs are not included on a pro-rata basis for the
number of months post-acquisition that the chain was owned by Maleats Plc
As the acquisition was the first to be undertaken by the Group there is a risk
that due to the complex nature of the transaction there may be a material
misstatement due to error. The management team may be inexperienced in
undertaking the adjustments required to include the new component in the
group accounts, again increasing the risk of material misstatement.
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Construction Costs
There is a risk that the capitalisation of the construction costs has been mis-
stated as this is a large and complex series of transactions that is outside the
normal course of business and is therefore difficult to control. In addition,
the inclusion of borrowing costs in the capitalised amount increases the
complexity and the risk that the criteria for capitalising the costs were not
met leading to over-capitalisation. It may also be that the amount of
borrowing costs calculated may be incorrect, for example by not using a
weighted average rate as required when there are general funds borrowed
as appears to be the case here. Lastly the dates of capitalisation could be
incorrectly applied leading to capitalisation too early or beyond the point
that the buildings were ready for use.
Advertising Expenditure
These was a significant amount of expenditure on advertising in relation to
the Quick-bite brand. Rs. 22.5m was spent in 20X9 and this represents 10% of
Maleats Plc's total revenue for the year. There is a risk that this expenditure
could be classified wrongly as capital expenditure and capitalised. LKAS 38
states that advertising expenditure should not be capitalised and should be
written off in the current period. If this expenditure has been capitalised
then intangible assets will be materially overstated.
Segmental Reporting
As a listed company, Maleats Plc. Will be required to disclose it's results
under SLFRS 8 by operating segment. SLFRS requires that business
segments making up more than 10% of total revenue, profit or assets have
their results disclosed separately in a note to the financial statements. There
is a risk that this has not been correctly applied, particularly with respect to
the new acquisition leading to the disclosure being inadequate.
Going Concern
There are several indicators that there could be a going concern issue at
Maleats Plc including the falling profits, falling cash balance and the
commitment to further expansion and construction of new restaurants. In
particular the use of short term debt to finance the current expansion means
that there is a risk that this debt is not renewed. If the loans are due for re-
financing in the current year and Maleats has not confirmed how this debt
would be replaced then this would constitute a material uncertainty around
going concern. Such uncertainties should be disclosed in a note to the
financial statements and there is a risk that this has not been done which
would constitute a material misstatement.

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17 Laurel Group Plc

Evaluation of risk of material misstatement and Additional information to
help in performing analytical review
Selected analytical procedures and associated evaluation of risk of material
misstatement
20X7 20X6
Operating margin 35/220  100 = 15.9% 37/195  100 = 19%
Return on capital (35/229 + 110)  100 = 10.3% (37/221 + 82)  100 =
employed 12.2%
Interest cover 35/7 = 5 37/7 = 5.3

Effective tax rate 3/28  100 = 10.7% 3/30  100 = 10%

Current ratio 143/19 = 7.5 107/25 = 4.3

Gearing ratio (100/100 + 229)  100 = 30.4% (80/80 +221)  100 = 26.6%
Revenue is projected to increase by 12.8% in the year, whereas operating
expenses increase by 17.1%, explaining the reduction in operating margin from
19% in 20X6 to 15.9% in 20X7. The trend in return on capital employed is
consistent, with the return falling from 12.2% to 10.3%.
The notes state that an impairment loss of Rs. 30m has been recognised during the
year. Assuming that this cost has been included in operating expenses, it would be
expected that operating expenses should increase by at least Rs. 30m. However,
operating expenses have increased by only Rs. 27m during the year. If the Rs. 30m
impairment loss is excluded, it would seem that operating expenses have actually
decreased by Rs. 3m, which is not in line with expectations given the substantial
increase in revenue. There is therefore a risk that operating expenses are
understated and consequently profit is overstated.
Conversely, there is also the risk that revenue is overstated given the withdrawal
of the Chico branded products, implying that revenue should decrease due to lost
sales from this revenue stream.
Additional Information
To assist with the analytical review on operating profit, the following additional
information should be obtained:
 A disaggregation of revenue to show the revenue associated with the key
brands of the Group, in particular the level of sales and contribution from the
withdrawn Chico brand.
 A breakdown of revenue month by month, to establish when sales of the Chico
brand cease.
 A disaggregation of the main categories of expenses included in operating
expenses, which would confirm that the impairment loss has been included.
The interest cover is stable and indeed the finance cost recognised is constant at
Rs. 7m each year. Given that the Group took out a Rs. 20m loan in January 20X7, it

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would be expected that finance charges should increase to take account of interest
accruing on the new element of the loan. There is therefore a risk that finance
charges and the associated loan liability are understated.
Additional information
 Details of the loan taken out, including a copy of the new loan agreement to
establish the interest rate payable, repayment terms and whether any
borrowing costs other than interest were incurred.
The Group's effective tax rate also appears stable, increasing from 10% to 10.7%
in the year. However, given the significant movement in the deferred tax liability
there should be a corresponding change in the tax expense, assuming that the
additional deferred tax should be charged to profit or loss. Currently, it is unclear
how this increase in the deferred tax liability has been recorded. The deferred tax
liability itself creates a risk of material misstatement, which will be discussed
separately, and the audit plan must contain detailed responses to ensure that
sufficient and appropriate evidence is obtained in respect of both the current and
deferred tax recognised.
The current ratio has increased sharply in the year from 4.3 to 7.5. This could
indicate that current assets are overstated or current liabilities understated as well
as specific risks such as potential overstatement of inventory included in current
assets, for example, if any Chico inventory is not yet written down in value.
Additional information
 A breakdown of current assets so the individual figures for inventories,
receivables and cash (and any other current assets recognised in the statement
of financial position) can be identified and trends established
 A breakdown of current liabilities to establish the reasons for the decrease of
24% on the prior year
Gearing has increased due to the Rs. 20m loan taken out. It is noted that the Group
is going to take out another significant loan of Rs. 130m should the acquisition of
Azalea Ltd go ahead as planned in early June. Recognition of this loan as a liability
will result in the gearing ratio increasing significantly to 50.1% (230 / 230 + 229).
Several risks arise in respect of this additional loan. First, the timing of its receipt
is important. If the deal is to take place in early June, the finance would need to be
in place in advance, and therefore it is likely that the loan is taken out just prior to
the year end on 31 May. In this case it would need to be recognised and disclosed
in accordance with SLFRS 9 Financial Instruments and SLFRS 7 Financial
Instruments: Disclosures, and there is a risk that the liability is not measured
appropriately or that disclosure is incomplete. Given the potential materiality of
the loan, at 36.3% of existing total assets, this is a significant risk.
There is also a risk that the increase in gearing will breach any existing loan
covenants. While this is a business risk rather than a risk of material
misstatement, the matter may require disclosure in the financial statements.

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Additional information
Copies of any agreements with the bank so that terms can be verified, in particular
the anticipated date of the receipt of the funds, and the impact on the financial
statements and on analytical review procedures confirmed.
According to note 3 to the forecast financial statements, the Rs. 20m loan was
used to finance a specific new product development project. However,
development costs recognised as an intangible asset has increased by only Rs.
15m. The difference of Rs. 5m is not explained by analytical review on the draft
financial statements, and there is a risk that not all the amount spent on
development costs has been capitalised, meaning that the intangible asset could
be understated. Conversely, it could be the case that that Rs. 5m of the amount
spent was not eligible for capitalisation under the recognition rules of LKAS38
Intangible Assets, however, as discussed above the movement in operating
expenses does not suggest that Rs. 5m of research costs has been expensed. It may
also be that the company continues to hold the Rs. 5m in cash and this may be
supported by the significant increase in current assets in the year.`
Additional information
Explanation as to how the Rs. 20m raised from the loan has been utilised, whether
it was all spent on research and development, and the nature of the development
costs which were funded from the loan.
Finally, retained earnings has increased by Rs. 8m. Projected profit for the year is
Rs. 25m, therefore there is an unexplained reconciling item between retained
earnings brought forward and carried forward. The difference could be due to a
dividend paid in the financial year, but additional information including a
statement of changes in equity is required in order to fully assess.
Property, plant and equipment
The change to the estimated useful lives of property, plant and equipment has
increased profit by Rs. 5m, which represents 17.9% of profit before tax and is
therefore material to the financial statements. This change in accounting estimate
is permitted, but the audit team should be sceptical and carefully consider
whether the change is justified. If the change were found to be inappropriate it
would need to be corrected, increasing operating expenses by Rs. 5m, reducing
operating profit to Rs. 30m and the operating margin would fall to only 13.6%.
This would be a significant reduction in profit and it could be that management
bias is a risk factor, especially given the sizeable loan which is about to be agreed
meaning that the projected financial statements may have already been
scrutinised by the Group's bank.
Chico brand name and associated issues
The Group finance director states that the Chico brand name has been impaired by
Rs. 30m. However, the brand name intangible asset has fallen by Rs. 35m in the

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year, so there is an unexplained reduction of Rs. 5m. This may have been caused
by the impairment or sale of another brand, and additional information should be
sought to explain the movement in the year.
The management team will need to verify whether the Rs. 30m impairment
recognised in relation to the Chico brand name is a full impairment of the amount
recognised in relation to that specific brand within intangible assets. Given that
the branded products have been withdrawn from sale, it should be fully written
off, and if any amount remains recognised, then intangible assets and operating
profit will be overstated. The amount written off amounts to 8.4% of Group assets
and 107% of profit before tax. It is a highly material issue which may warrant
separate disclosure under LKAS 1 Presentation of Financial Statements. It is a risk
that the necessary disclosures are not made in relation to the discontinuance
and/or the impairment of assets.
There is also a risk that other brands could be impaired, for example, if the
harmful ingredients used in the Chico brand are used in other perfume ranges.
The impairment recognised in the financial statements could therefore be
understated, if management has not considered the wider implications on other
product ranges.
There is also a risk that inventories are overstated if there are any Chico items
included in the amount recognised within current assets. Any Chico products
should be written down to the lower of cost and net realisable value in accordance
with LKAS 2 Inventories, and presumably the net realisable value would be zero.
There is a possibility that some non-current assets used in the production of the
Chico fragrance may need to be measured and disclosed in accordance with LKAS
36 Impairment of Assets and/or SLFRS 5 Assets Held for Sale and Discontinued
Operations. This would depend on whether the assets are impaired or meet the
criteria to be classified as held for sale, for example, whether they constitute a
separate major line of business.
There may also be an issue relating to the health issues caused by use of the Chico
products. It is likely that customers may have already brought legal claims against
the Group if they have suffered skin problems after using the products. If claims
have not yet arisen, they may occur in the future. There is a risk that necessary
provisions have not been made, or that contingent liabilities have not been
disclosed in the notes to the financial statements in accordance with LKAS 37
Provisions, Contingent Liabilities and Contingent Assets. This would mean that
potentially liabilities are potentially understated and operating profit is
overstated, or that disclosures are incomplete.
Goodwill
Goodwill has not been impaired this year; we shall need to carry out a review of
management's annual impairment test to assess its appropriateness and whether
any of the goodwill has been impaired by the media coverage of the Chico product

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allegations. This means that goodwill and operating profit could be overstated if
any necessary impairment has not been recognised.
Deferred tax liability
The finance director states that the change in the deferred tax liability relates to
the changes in estimated useful lives of assets and associated accelerated tax
depreciation (capital allowances). However, the impact on profit of the change to
estimated useful lives amounts to Rs. 5m, so the Rs. 8m increase in deferred tax
seems inappropriate and it is likely that the liability is overstated.
The deferred tax liability has increased by five times, and the Rs. 10m recognised
in the year-end projection is material at 2.8% of total assets. The changes in
deferred tax and the related property, plant and equipment therefore do not
appear to be proportionate and the amount recognised could be incorrect.
Machine hire
The payments are 3.5% of profit before tax (=Rs. 1m/Rs. 28m), and are thus not
material by themselves. They may of course become material once aggregated
with any other misstatements.
The contracts may qualify as leases in line with SLFRS 16 Leases, if the Group has
the right to control the use of specific identified assets. If this is the case then the
machines should be recognised as right-of-use assets within non-current assets,
and a lease liability for the present value of lease payments. The assets should
then be treated in line with LKAS 16 Property, Plant and Equipment. Not
recognising these leases may mean that both non-current assets and liabilities are
understated.
SLFRS 16 does allow an exemption from recognition for low-value assets that
are held on short-term leases. If the machines met these criteria then the Group
could elect merely to recognise the lease payments as an expense on a straight-
line basis over the lease term. This does not apply in this case, because payments
of Rs. 200,000 per machine (= Rs. 1m ÷ 5) indicate that the machines are not
low-value assets.
Additional information needed would be the contracts, so that the present value of
any lease liability can be determined. This could have an effect on the preliminary
analytical review. Although the payments recognised this year are not material, it
is quite possible that any right-of-use assets (and lease liabilities) not recognised
would be material.
Acquisition of Azalea Co
The acquisition is planned to take place in early June and assuming it takes place,
it will be a significant event to be disclosed in accordance with LKAS 10 Events
after the Reporting Period. Details of the acquisition will also need to be disclosed
to comply with SLFRS 3 Business Combinations which requires disclosure of
information about a business combination whose acquisition date is after the end

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of the reporting period but before the financial statements are authorised for
issue. There is a risk that the necessary disclosures are not made which would be
a significant risk of material misstatement given the materiality of the acquisition.

18 Silva Group
(a) Weaknesses in internal controls
Knowledge and experience of staff
It would appear that the staff members responsible for the preparation of
the group financial statements lack the knowledge and experience required
to undertake this complex accounting process.
The finance director is newly appointed which means that they will not have
been through the process of consolidating this particular group set of
accounts even if they are experienced in a previous position. Some of the
decisions being made by the finance director would suggest that they are
insufficiently experienced, such as the decision not to send the group
instructions to the new component of the group, the late issue of
instructions, the lack of review processes and allocation of work (see below).
In addition, the other members of staff are not qualified accountants
resulting in the finance director being supported by part-qualified staff only.
Again, this leads to an increased risk of error as these members of staff may
not have the accounting knowledge required to undertake the preparation of
the group financial statements. This is evidenced by some of the decisions
made by the executives such as the recognition of the contingent asset (see
below).
In order to rectify this situation, the group should review it's recruitment
policy to ensure that they are recruiting members of staff that are suitably
qualified for the role that they are expected to undertake. The human
resources policies should also be reviewed to assess whether there is a
problem with the progression of the part-qualified members of staff through
the qualification and whether additional support or incentives need to be
provided to encourage these members of staff to become qualified.
Group instructions issued late
The fact that the group instructions were circulated on 15 August leads is a
weakness in the internal control system as it is 15 days after the year end of
the group. The instructions will include such matters as:
 What financial information from the component will be included in the
group financial statements.
 Financial reporting procedures manual and a reporting package including
standard formats for providing financial information that will be included
in the group financial statements.

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 The accounting policies to be applied.

 Disclosure requirements around operating segments, related parties and
intra-group transactions and balances.
 Reporting timetable.
These matters need to be brought to the attention of the finance teams of the
components of the group well before the year end to enable them to prepare
for the year end close off of their financial statements. If there are items or
policies that the component teams were unaware of then it may be difficult
or impossible for them to provide that information post year end once the
system procedures have been run to close-off that year.
Group instructions not issued to new component
The non-provision of the group instructions to the new component is a
fundamental problem in preparing the group financial statements. The new
component has been a member of the group for the full 12 months and it is
unlikely that the provision of group instructions would have the impact of
over-burdening the finance manager as suggested.
The non-provision of instructions may also have led directly to the team not
identifying that the year end of the group and the new component were not
co-terminus and this has in turn led to the group accounts being delayed.
This type of information will be requested in the group instructions along
with the information outlined above.
Without the instructions the new component will be unaware of group
accounting policies, may not identify related party transactions and may
prepare their financial statements in a way that makes it difficult to integrate
with the rest of the group as they are unaware of the standard format.
The group instructions should therefore be issued on a timely basis, before
the year end and any changes from previous years highlighted to ensure
sufficient understanding. The instructions should be provided to all
components of the group regardless of when they were acquired.
Work allocation and lack of review processes
It would appear that the work allocation within the group accounting team is
questionable with the unqualified accounts executives making complex
judgements such as fair value determinations and the decision to create a
contingent asset. These decisions should be made by a more senior member
of staff with sufficient qualifications and experience to make such
judgements.
In an accounts team such as this where there is a lack of qualified staff it may
be difficult to allocate the work in this way as there is only one qualified
member of staff and they would quickly become overburdened in making
the majority of the decisions. This could be considered by the group and they
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should review their recruitment policy as mentioned above to ensure that

the accounts department has a sufficient spread of suitably qualified
members of staff.
It would also appear that there is no review process in place where such
judgemental areas could be reviewed by a suitably qualified member of staff.
With the current staffing situation, the finance director should ensure that
there are suitable controls in place such as:
 Sequentially pre-numbered proforma used (paper/electronic and subject
to regular sequence check), including comments section to describe
nature and requirement for journal entry;
 Restricted access to proforma (physical/logical). In automated systems
authorisation tables can be used to restrict who can read, edit and
authorise journal entries; and
 Monthly review of journal entries posted to ensure no unauthorised
transactions entered. Where there are a large number of journals this
may involve programmed editing identifying unusual journals for review
(eg large round-sum amounts, postings to unusual accounts, posting by
particular individuals).
(b) Risks of material misstatement
Goodwill
Goodwill is 6% of total assets, and is therefore material.
Impairment
Management should review goodwill for impairment at the end of the year.
No impairment loss has been recognised, and there is a risk that this is
because no impairment review was conducted.
Group profit has declined by 30.3% (Rs. 10m/Rs. 33m) and assets have
declined by 1.1% (Rs. 5m/Rs. 455m). These are both impairment indicators,
although it is possible that the downward trends do not relate to
Mendis Ltd's ('Mendis') activities. In any case there is a risk that assets and
profit are both overstated.
Consideration
Consideration should be measured at its fair value. There is a risk that the
calculation is incomplete, eg if there is any deferred or contingent
consideration not included.
Non-controlling interest (NCI)
SLFRS 3 Business Combinations permits NCI to be measured at fair value, so
this is acceptable (SLFRS 3). However, there is a risk in relation to the
estimation of fair value. If Mendis is listed then this is just the market price

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of the shares and is reliable; however, if it is not listed then the estimation
must be done in line with SLFRS 13 Fair value measurement. This involves an
element of judgement, the basis of which must be clearly understood by the
auditor.
Net assets
There is a risk that not all net assets will be identified, or that the estimation
of their fair values is not reliable. Some form of due diligence should have
been performed as part of the acquisition, which may have valued the
business and identified its assets and liabilities.
Fair value adjustment
The adjustment of Rs. 300,000 is not material, at less than 1% of total assets.
However, additional depreciation should be charged at group level on these
assets (also not material).
Loan
The loan is 13.3% of total assets, and is material.
Under SLFRS 9 Financial Instruments it is measured at its fair value when
initially recognised, and then subsequently at amortised cost as it is not held
for trading (although there is a fair value option). An effective interest rate
should thus be used to allocate the premium over the 20-year life of the loan.
There is a risk that the finance charge is not calculated using the effective
rate, or that the premium is recognised incorrectly (for example, it may be
recognised as a liability at its present value, which is incorrect).
SLFRS 7 Financial Instruments: Disclosure contains extensive disclosure
requirements, and there is a risk of misstatement in respect of inadequate
disclosures in relation to the loan (eg of its significance for Mendis Co's
financial position and performance).
Evidence
Property
The carrying value is material, at 3.6% of total assets (= Rs. 16m / Rs. 450m).
Under LKAS 10 Events after the Reporting Period, the natural disaster is a
non-adjusting event because it relates to conditions which did not exist until
two months after the year end (LKAS 10: para. 3). Therefore, the value of the
property complex should not be written off in the 20X4 financial statements.
The event should be disclosed in a note describing its impact, and
quantifying its anticipated effect on next year's financial statements.
Consideration should be given to any other effects, eg other damage
sustained in the disaster, and the costs of the demolition itself.

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Contingent asset
The contingent asset is material, at 4.0% of total assets (= Rs. 18m /
Rs. 450m).
This should not have been recognised, as it also relates to a non-adjusting
event deriving from conditions which did not exist at the end of the
reporting period. This fact is saliently admitted by the recognition as
'deferred income', which is itself incorrect because the amount has not yet
been received.
Intercompany trading
Intercompany receivables and payables are 4.4% of Group assets and are
material. The inventory is 11% of Group assets and is also material.
Intercompany balances should be eliminated on consolidation. There is a
risk that this has not been done correctly, overstating Group assets and
liabilities.
If these transactions included a profit element, then Group inventory needs
to be reduced in value by an adjustment for unrealised profit. If this is not
made, then Group assets and profits will be overstated.
Individual companies
It is not clear why Peires Ltd. has recognised inventory at Rs. 50m but a
payable at Rs. 20m, or where the remaining Rs. 30m (Credit) has been
entered in its books. If it is because the goods were sold at a mark-up of Rs.
30m, then the inventory can continue to be recognised at the cost of Rs. 50m,
but the payable must also be Rs. 50m. These amounts need to be recognised,
and more information is needed on why there is a mismatch within Peires
Ltd.'s own records.
The transaction should be disclosed in the financial statements of each
individual company in line with LKAS 24 Related Party Disclosures.

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PART D: CORPORATE GOVERNANCE AND NON-FINANCIAL REPORTING

Questions 19 to 22 cover Corporate Governance and Non-Financial Reporting.

19 Calcula
(a) Benefits of integrated reporting at Calcula
Confusion
As a result of the recent management changes at Calcula, the company has
struggled to communicate its 'strategic direction' to key stakeholders.
The company's annual accounts have made it hard for shareholders to
understand Calcula's strategy, which in turn has led to confusion.
Uncertainty among shareholders and employees is likely to increase the risk
of investors selling their shares and talented IT developers seeking
employment with competitors.
Communicating strategy
The introduction of integrated reporting may help Calcula to overcome these
issues as it places a strong focus on the organisation's future orientation.
An integrated report should detail the company's mission and values, the
nature of its operations, along with features on how it differentiates itself
from its competitors.
Including Calcula's new mission to become the market leader in the
specialist accountancy software industry would instantly convey what the
organisation stands for.
In line with best practice in integrated reporting, Calcula could supplement
its mission with how the board intend to achieve this strategy. Such detail
could focus on resource allocations over the short to medium term.
For example, plans to improve the company's human capital through hiring
innovative software developers working at competing firms would help to
support the company's long-term mission. To assist users in appraising the
company's performance, Calcula should provide details on how it will
measure value creation in each 'capital'. 'Human capital' could be measured
by the net movement in new joiners to the organisation compared to the
previous year.
A key feature of integrated reporting focuses on the need for organisations
to use non-financial customer-oriented key performance measures (KPIs)
to help communicate the entity's strategy. The most successful companies in
Calcula's industry are committed to enhancing their offering to customers
through producing innovative products. Calcula could report through the use
of KPIs how it is delivering on this objective, measures could be set which for
example measure the number of new software programs developed in the

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last two years or report on the number of customer complaints concerning

newly released software programs over the period.
Improving long term performance
The introduction of integrated reporting may also help Calcula to enhance its
performance. Historically, the company has not given consideration to how
decisions in one area have impacted on other areas. This is clearly indicated
by former CEO's cost cutting programme, which served to reduce the staff
training budget. Although, this move may have enhanced the company's
short-term profitability, boosting financial capital, it has damaged long term
value creation.
The nature of the software industry requires successful organisations to
invest in staff training to ensure that the products they develop remain
innovative in order to attract customers. The decision to reduce the training
budget will most likely impact on future profitability if Calcula is unable to
produce what software customers' demand.
Finance Director's comments
As illustrated in the scenario, the Finance Director's comments indicate a
very narrow understanding of how the company's activities and 'capitals'
interact with each other in delivering value. To dismiss developments in
integrated reporting as simply being a 'fad', suggest that the Finance
Director is unaware of the commitment of many accounting bodies in
promoting its introduction.
However, some critics refute this and argue that the voluntary nature of
integrated reporting increases the likelihood that companies will choose not
to pursue its adoption. Such individuals highlight that until companies are
legally required to comply with integrated reporting guidelines, many will
simply regard it as an unnecessary effort and cost.
The Finance Director's assertion regarding shareholders is likely to some
degree to be correct. Investors looking for short-term results from an
investment might assess Calcula's performance based on improvements in
profitability. However, many shareholders will also be interested in how the
board propose to create value in the future. Ultimately, Calcula's aim to
appease both groups is its focus on maximising shareholder value, the
achievement of which requires the successful implementation of both short
and long term strategies.
Furthermore, unlike traditional annual reports, integrated reports highlight
the importance of considering a wider range of users. Key stakeholder
groups such as Calcula's customers and suppliers are likely to be interested
in assessing how the company has met or not met their needs beyond the
'bottom line'. Integrated reporting encourages companies to report
performance measures that are closely aligned to the concepts of

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sustainability and corporate social responsibility. This is implied by the

different capitals used: consideration of social relationships and natural
capitals do not focus on financial performance but instead are concerned,
for example, with the impact an organisation's activities have on the natural
environment.
Ultimately, as integrated reporting provides senior management with a
greater quantity of organisational performance data this should help in
identifying previously unrecognised areas which are in need of
improvement.
Clearly, a major downside to generating extensive additional data concerns
determining which areas to report on. This is made especially difficult as
there is no recognised criterion for determining the level of importance of
each 'capital'. As we shall explore in part (2), the Finance Director's remark
regarding the increase in the Calcula's employee workload to comply with
integrated reporting practices may have some merit.
It is debatable as to whether the production of an integrated report
necessarily leads to an improvement in organisational performance or
whether it simply leads to an improvement in the reporting of performance.
However, focusing management's attention on the non-financial aspects of
Calcula's performance as well as its purely financial performance, could be
expected to lead to performance improvements in those areas. For example,
if innovation is highlighted as a key factor in sustaining Calcula's long-term
value, a focus on innovation could help to encourage innovation within the
company.
(b) Implications of implementing integrated reporting
IT and IS costs
The introduction of integrated reporting at Calcula will most likely require
significant upgrades to be made to the company's IT and information system
infrastructure. Such developments will be needed to assist Calcula in
capturing both financial and non-financial KPI data. Due to the broad range
of business activities reported on using integrated reporting (customer,
finance and human resources) the associated costs in improving the
infrastructure to deliver relevant data about each area is likely to be
significant. It may, however, be the case that Calcula's existing information
systems are already capable of producing the required non-financial
performance data needed in which case it is likely that the focus here will be
on investigating which data sets should be included in the integrated report.
Time implications
The process of gathering and collating the data to include in an integrated
report is likely to require a significant amount of staff time. This may serve
to decrease staff morale especially if staff are expected to undertake this

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work in addition to completing existing duties. In some cases, this may

require Calcula to pay employees overtime to ensure all required
information is published in the report on time.
Staff costs
To avoid overburdening existing staff the board may decide to appoint
additional staff to undertake the work of analysing data for inclusion in the
integrated report. This will invariably lead to an increase in staff costs.
Consultancy costs
As this will be Calcula's first integrated report the board may seek external
guidance from an organisation that provides specialist consultancy on
reporting. Any advice is likely to focus on the contents of the report.
The consultant's fees are likely to be significant and will increase the
associated implementation costs of introducing integrated reporting.
Disclosure
A potential downside of adopting integrated reporting centres on Calcula
potentially volunteering more information about its operations than was
actually needed. In the event that Calcula fully disclosed the company's
planned strategies it is likely that this could be used by competitors. Such a
move is likely to undermine any future moves to out-manoeuvre other
industry players. In the event that Calcula have hired an external consultant
to support the introduction of integrated reporting it is likely that the advice
given by the consultant will stress the need to avoid disclosure of
commercially sensitive information.
(c) Content of the integrated report
The <IR> Framework prescribes the eight key content elements of an
integrated report:
(i) Organisational overview and external environment: what Calcula
does and the circumstances under which it operates. Calcula could
explain that it develops specialist accounting software and give
information about its customer types.
(ii) Governance: how Calcula's governance structure supports its ability
to create value in the short, medium and long term. Calcula could
explain, for example, the composition of its board of directors and how
directors are selected on the basis of their experience and expertise.
It could explain how their remuneration is linked to value added within
the company.
(iii) Business model: the organisation's business model should be
explained. Calcula could explain how it identifies the need for and
develops its programs.

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(iv) Risks and opportunities: the specific risks facing Calcula should be
identified and its risk management approach explained. Calcula could
discuss the intense competition in the market and how it responds by
investing in its employees.
(v) Strategy and resource allocation: how Calcula intends to achieve its
strategic objectives. Calcula has stated that its mission is to become the
market leader of specialist accounting software so it should provide
information as to how it plans to achieve this.
(vi) Performance: whether Calcula achieved its strategic objectives for the
period and what its outcomes are in terms of effects on its different
types of capitals. For example, Calcula could mention its increased
intellectual capital due to new products patented and human capital in
terms of employee knowledge.
(vii) Outlook: the challenges and uncertainties that Calcula is likely to
encounter in pursuing its strategy. Calcula could discuss the challenges
faced from lower cost competitors and the problems of protecting its
intellectual property.
(viii) Basis of preparation and presentation: how Calcula determines
what matters to include in the report and how these matters are
quantified or evaluated. Calcula could explain the process by which
Asha Alexander and (presumably) other directors compile the report.

20 Glowball
(a) Environmental and sustainability reports
Environmental reports typically only contain information about an entity's
impact on the environment ie air, water and land. Glowball, for example,
could disclose information about the effect of toxic gases in the air,
chemicals leaking into the sea, or damage to land caused by construction
works.
Sustainability reports also provide information on economic, social and
governance issues.
Economic issues might include disclosure of economic performance
(ie profit, value added), market share and procurement practices.
Social issues can be considered in terms of a number of areas according to
the GRI G4 guidelines:
 Labour practices and decent work disclosures might include details of
health and safety, training and education and diversity and equal
opportunity practices.
 Human rights disclosures might include details of policies on child labour,
indigenous rights and supplier human rights.

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 Society disclosures might detail the impact of the business and its
suppliers' businesses on society and anti-corruption policies
 Product responsibility might include disclosure of customer health and
safety practices, product labelling and compliance procedures.
Governance issues might include disclosure of directors' recruitment and
remuneration policies.
(b) Issues that could be considered in the sustainability report
Note. In each case, performance should be compared to previous years and
against targets. Any unexpected performance should be explained.
Economic
 Market presence: Glowball could measure its market share in each of its
key markets. Market share would have increased in the current period
due to the acquisition of a competitor, so that should be explained.
 New pipelines installed: Since this is a driver of revenue, a measure would
be useful. Glowball could measure the number of kilometres of pipe laid,
volume of gas transported in the new lines or the number of new
installations served. A distinction should be made between organic
growth and growth due to acquisition.
 Economic impacts: Glowball could discuss the impact of climate change
on the demand for its services, and how it tries to predict future demand
under conditions of uncertainty.
Environmental
 Supplier environmental assessment: Glowball could discuss the number
and type of assessments of its suppliers' environmental practices it has
performed, for example of the suppliers of materials that are used to
construct the pipelines.
 Biodiversity: Glowball could provide detail of the impact of its pipe laying
on ocean biodiversity and the practices it adopts to try to minimise that
impact.
 Energy: Glowball could detail its energy usage and measures taken to
establish energy efficient alternatives.
Social
 Training and education: Glowball could detail the amount spent on
training, any education support given to employees (eg paying for MBAs)
and measures taken to retain well-trained staff.
 Occupational health and safety: Glowball could detail accidents, perhaps
distinguishing between fatal and non-fatal, and lost days due to accidents.

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 Security practices: As it may operate in dangerous parts of the world,

Glowball could detail the type and cost of security measures it has in place
to protect its assets and employees.
Governance
 Director selection: Glowball could detail how directors are recruited and
selected and could provide data on educational qualifications and years of
experience.
 Directors' remuneration: Glowball could explain how directors'
remuneration is determined and could provide data on and explanations
for remuneration compared to performance.
 Risk assessment process: Glowball could provide information on how the
directors assess risks facing the company and the adequacy of internal
controls.
(c) Comments on 'environmental events'
(i) Glowball could explain how this issue arose. It could explain that,
although there is no legal obligation to restore the farmland, its policy
is to be environmentally responsible (the question refers to Glowball's
reputation for preserving the environment). The report could mention
the cost of Rs. 150 million and the fact that a provision has been made
in the financial statements, assuming that it has been made on the basis
of the constructive obligation. Specific examples of other restorations
of land could be included in the sustainability report.
(ii) The LKAS 37 criteria to recognise a provision are met: there is a legal
obligation as a result of a past event, an outflow of economic resources
is probable, and the amount can be estimated reliably. A provision
should therefore be recognised in the financial statements for the
estimated fine of Rs. 5 million. This should be mentioned in the
sustainability report. The report might also put the fines into context
by stating how many tests have been carried out and how many times
the company has passed the tests. The directors may wish to point out
the fact that the number of prosecutions has been falling from year to
year.
(iii) These statistics are good news and need to be covered in the
sustainability report. However, the emphasis should be on accurate
factual reporting rather than boasting. It would be useful to provide
target levels for comparison, or an industry average if available.
The emissions statistics should be split into three categories:
 Acidity to air and water
 Hazardous substances
 Harmful emissions to water

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As regards the aquatic emissions, the Rs. 70 million planned

expenditure on research should be mentioned in the sustainability
report as it shows a commitment to benefiting the environment.
(iv) The environmental report should mention the steps that the company
is taking to minimise the harmful impact on the environment in the
way it sites and constructs its gas installations. The report should also
explain the policy of dismantling the installations rather than sinking
them at the end of their useful life.
The sustainability should be referenced to the financial statements,
where an explanation of the accounting treatment and detail of the
decommissioning provision can be found.

21 Country A
(a) Rules-based approach
A rules-based approach requires companies to comply with regulations.
There are no exceptions apart from those allowed for in the regulations. A
rules-based approach is generally underpinned by law. Companies which do
not comply will face legal sanctions.
Principles-based approach
A principles-based approach is likely to be underpinned by some company
law, but the principles will also cover areas not included in legislation.
Principles-based approaches emphasise the objectives of governance,
rather than good governance being achieved by taking a number of
prescribed actions. Companies operating under a principles-based code
cannot, however, just ignore it. The code will often be incorporated into
listing rules. They have to state that they have complied in their accounts or
identify and explain the areas where they have not complied. Investors will
then decide whether they accept the company's justification for non-
compliance and may take action that impacts upon share price.
Country A's approach
The guidance in the Country A code clearly identifies that the code is
principles-based, as it states that there is more to governance than
complying with rules. Good governance requires broad principles which
should be applied flexibly to individual companies.
Arguments in favour
Areas of application
A principles-based approach can extend more widely than a rules-based
approach and can focus on areas where it would be unrealistic to apply
rules. For example, a principles-based approach can require directors to

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undertake professional development to extend their knowledge and skills

without laying down how many courses they should go on each year. A
principles-based approach can require boards to maintain good relations
with major (institutional) shareholders without laying down how much
contact there should be each year.
Cost to companies
A principles-based approach is also less costly in terms of time and
expenditure. Companies in a rules-based jurisdiction may have to invest
considerable time and monies in developing information and reporting
systems that evidence compliance. There is evidence that companies have
turned away from US stock markets, where they would be under the rules-
based, Sarbanes-Oxley (2002) regime on the grounds of cost of compliance. To
be effective, a rules-based regime also has to have bodies to monitor and
enforce compliance. The costs of maintaining these bodies are often passed
on to companies in the form of listing costs.
Flexibility of approach
A principles-based approach can require companies to maintain adequate
structures, for example effective risk management systems, but allow what is
adequate to vary by company or industry. For example, in some industries
companies will avoid hazardous activities and will not therefore require
elaborate health and safety control systems. Other industries, for
example extractive industries, inevitably involve hazardous activities and so
require complex risk management systems to ensure that risks are reduced
to levels that are as low as reasonably practicable.
Flexibility in application
Principles-based codes can allow for flexibility in application of provisions in
circumstances where non-compliance can be justified. Companies may have
to deal with a period of transition, for example where a Chair leaves the
board suddenly and it takes time to recruit a permanent successor. In these
circumstances having the same person act as Chair and Chief Executive on a
temporary basis may be felt to be the most practical solution. Provided the
non-compliance is explained clearly, investors may accept the justification.
Arguments against
Consistency of approach
A rules-based approach means all companies are complying with the same
standards. It should be easy for investors to see that compliance has been
achieved. Comparison between companies should be straightforward.
Some investors may have more confidence in a rules-based approach as a
result. It is also therefore easier to enforce a rules-based approach on
companies.

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Broad principles
The principles in a principles-based code may be so broad as to mean that
companies have excessive leeway in following the code. Some companies
may therefore try to do as little as possible to comply with the code, and
therefore gain cost and competitive advantage over other companies that
have been more conscientious.
Compulsory requirements
Where principles-based codes include specific recommendations, for
example that the role of Chair and Chief Executive be split, there may be
confusion over whether these recommendations are compulsory or not.
Recommendations that are underpinned by company law requirements will
be compulsory, but the status of recommendations that are not underpinned
may be unclear. In some countries, the adoption of governance codes by
stock exchanges means that specific recommendations in codes have been
seen as listing rules requiring compliance. Companies that lack
compliance expertise may find it difficult to judge whether and how they
should comply.
Explanations
Explanations for non-compliance may not be adequate for shareholders.
Shareholders may not understand the reasons for, and consequences of,
non-compliance. Accounts may provide unclear explanations, with
directors knowing that, even if some shareholders are unhappy, their
positions are guaranteed by having the support of sufficient large
shareholders.
(b) Power
Having the same person in both roles means that power is concentrated in
one person. A common feature of governance scandals that have prompted
the development of guidance has been an individual exercising excessive
power. The board may be ineffective in controlling the Chief Executive if
it is led by the Chief Executive. For example, the Chair is responsible for
providing information that the other directors require to manage the
company. If the Chair is also Chief Executive, the directors cannot be sure
that the information they are getting is sufficient and accurate. Separation
of the role also means that the board can express its concerns more
effectively by providing a point of reporting for the non-executive directors.
Accountability
The board cannot make the Chief Executive truly accountable for
management if it is chaired and led by the Chief Executive. The Chair carries
the authority of the board and the Chief Executive carries authority
delegated by the board. Separating the roles emphasises the Chief

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Executive's accountability to the board's leader, the Chair, and also the
shareholders whose interests the Chair represents. Separation should
reduce the risk of conflicts of interest where the Chair/Chief Executive
focuses on his own self-interest.
Demands of roles
Splitting the posts between different people reflects the reality that both jobs
are demanding roles and no-one person will have the skills and the time
to do both jobs well. The Chief Executive can concentrate on running the
company's operations, developing business and risk management strategy,
reviewing investment policy and managing the executive team. The Chair
can concentrate on running the board effectively and ensuring that directors
develop an understanding of the views of major investors.
Under governance best practice, the Chair should be an independent non-
executive director, and hence well placed to adopt a supervisory and
monitoring role.
Governance requirements
Splitting the roles ensures compliance with governance requirements
and reassures shareholders. Investor confidence is important in
maintaining company value and being seen to comply with governance best
practice should contribute to investor confidence about the way a company
is being run.
(c) Comply or explain
Compliance with governance requirements
Stark Co has fulfilled the requirements of the listing rules to identify areas of
non-compliance. The statement clearly highlights the area where Stark Co
has not complied. It unambiguously states that it is not in accordance with
governance best practice. It specifies as well that Mr B is the individual
concerned. This may be significant for shareholders who may be less
concerned about the breach because they have confidence in Mr B.
Why it has happened
However, the statement does not state clearly why Stark Co has not
complied. It does not explain the reasons for the company benefiting from
having Mr B in control. The statement that the company has maintained
robust corporate governance is also vague. Stating the company understands
the concerns of shareholders is not the same as saying that the company has
responded to them.
Time limit to non-compliance
However, shareholders will be reassured by the fact that Stark Co is planning
to comply with governance requirements in future and the company has
made a clear commitment to separate the roles and has set a time limit on this.

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22 Comfort Hotels
(a) Separation of roles of the CEO and Chairman
The 2017 Sri Lanka Code of Corporate Governance requires that the role of
Chairman and CEO are performed by separate people and CHL is currently
not compliant with this provision. Where both roles are undertaken by one
person, this a justification will need to be disclosed in the annual report.
Currently, Isuru Prasad performs the role of Chairman and Chief Executive
Officer. When the company lists, Mr Prasad can remain as CEO, however, the
Board must externally appoint a new, and independent non-executive
director (NED) as Chairman, as currently CHL has no independent NED's. If
the desired new Chairman is not independent than a lead independent
director should be appointed. Alternatively, CHL can disclose the reason why
both roles are performed Mr Prasad in the annual report.
This provision aims to ensure no one individual has decision making powers
which can remain unchallenged. The Chairman has the power to challenge
decisions made by the CEO as both share equal rank which lowers the risk
that poor decisions made solely by the Mr Prasad are actioned as they
remain unchallenged.
Lack of independent management oversight by the executive board.
The code requires Directors to act objectively in the best interests of the
company and hold management accountable for performance. This requires
separation between strategic oversight by the board and management of the
company's operations.
Currently, the Board of Directors essentially take an operational role, other
than restaurant managers, and therefore are accountable for their own
performance, which means the Executive Board currently lacks independent
scrutiny. Therefore, SPDL should appoint a management team to run the
company, who are not Board Directors, who can be held accountable by the
Board for company performance.
Without sufficient time committed to strategic oversight, it is possible the
board of directors will be distracted by operational challenges and strategic
planning will may harm stakeholder interests once listed.
Insufficient non-executive directors
The Sri Lanka Code of Corporate Governance requires the higher of either
three non-executive directors (NEDs), or NEDs make up a third of board, as
whole. Currently, CHL has two NED's so is currently not compliant with this
provision.
To comply with this requirement, CHL need to appoint at least one new non-
executive director. As the executive board grows, CHL will need to appoint

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further NED's to ensure at least a third of the board made up of NEDs, to

remain compliant.
Increasing the number of NEDs increases their voting capacity, which means
NEDs have the power to block decisions which they judge to be detrimental
to the shareholders they represent. NEDs cannot be dismissed by the
executive directors which strengthens NED influence.
Both existing NEDs are not independent
The Sri Lanka Code of Corporate Governance requires that there are three
independent NED's or at least two thirds of non-executive directors are
independent, whichever is higher. CHL is currently not compliant with this
provision as both NEDs are not independent.
One NED is a key supplier who is not independent as will have access to
confidence procurement information (ie purchase, material information etc)
which creates a conflict of interest in price negotiations between the
supplier, which is a NED, and CHL. The other NED is the previous finance
director of CHL so is deemed too familiar with the executive board to fully
exercise objectivity and independence. The company will need to replace
both existing NEDs with independent NED directors.
Currently, there is a self-interest threat from the supplier and a familiarity
threat with the CEO's wife and ex-finance director. A lack of independence
on the CHL Board means shareholder interests may not be prioritised.
Board performance is not assessed
The 2017 Sri Lanka Code of Corporate Governance requires the board
undertakes a formal and rigorous annual assessment of the effectiveness of
the board and CHL is currently not compliant with this provision.
CHL has never undertaken a board assessment and therefore the Board of
CHL may be unaware of where improvement can be made. Once listed, the
Board are advised to hire an independent and external qualified consultant
to assess the effectiveness of board operations and each individual board
member.
Board performance will be enhanced once recommendations made by a
formal independent assessment are actioned. This is likely to improve
strategic decision making, internal control and risk management procedures,
which will enhance the sustainability of CHL.
Lack of director training
The Sri Lanka Code stresses the need for every director to receive
appropriate training when first appointed to a board and subsequently as
necessary. Training should include the general responsibilities of being a
director and managing industry-specific issues, which in the hotel industry
will include compliance with health and safety and food hygiene regulations.
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As none of the directors have ever received training either when first
appointed as a director, or subsequently in fulfilling their stewardship of the
company, then CHL is not yet compliant with this requirement of the code.
CHL need to consider the individual training needs of its directors,
dependent on each role. This should be done annually as part of the board
evaluation.
Without sufficient training, there is risk that the directors are not able to
fully oversee the management of the company and adequately respond to
commercial, compliance, financial or operational risks as they arise.
Lack of board diversity
Whilst the Sri Lanka Code of Corporate Governance doesn't provide specific
requirements for a board of director to show diversity in gender, age and
experience, the foreword to the code acknowledges diversity amongst board
members to be a key requirement in running a successful corporation.
Currently, the CHL Board is all male and there is no one under the age of 50.
The CHL Board will need to appoint new executive and non-executive
directors, and these appointments should address the current age and
gender imbalance.
Similar groups of people can be quick to form consensus by drawing on a
narrow range of options arising from similar experiences. By widening
diversity, this will inject new experience, insight and perspective into
problem solving and creative discussions.
(b) Emphasises the importance of governance and control
The audit committee can help create a culture that emphasises discipline
and control in governance. The audit committee can also contribute to
improving significantly the culture of transparency. The committee's role
will be strengthened if it consists of independent trustees or non-executive
directors, at least some of whom have financial knowledge. Directors with
these qualities should be able to act independently from the CEO and
executive board of directors.
Review of financial statements
The audit committee can play a particularly important role in CHL by
reviewing the quality of financial information. The committee can put
pressure on the other directors to increase the level of detail of financial
reporting towards the full disclosure made by similar listed companies. It
can also review the accounting systems that provide information for key
stakeholders and press for improvements in these.

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Review of internal controls

The audit committee can also look at aspects of internal control and focus on
areas of specific risk, such as cash management and property valuation,
which are particular risk areas in the hotel industry. The audit committee
also needs to assess whether adequate controls are in place to limit the risk
of fraud and non-compliance with regulations.
Compliance and ethics
The audit committee should obtain evidence that CHL is fully complying with
the regulations and codes that apply to the hotel industry in Sri Lanka.
Fraud
The audit committee should also consider the risk of fraud and consider
establishing a whistleblowing channel, enabling staff to report suspicions of
fraud directly to the audit committee. The audit committee should also be
able to instigate an investigation into fraud itself, without the approval of
executive directors being required.

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PART E: ETHICAL ISSUES IN FINANCIAL REPORTING AND THE REGULATORY

ENVIRONMENT
Questions 23 to 24 cover Ethical Principles and Responding to Ethical Problems.

23 David
(a) What are the facts of the case?
The facts are that the civil servants have made what is an apparently
legitimate request for information. However the circumstances suggest that
if the board supplies this information, it may be used by the governing party
to support its bid for re-election.
What are the ethical issues in the case?
Independence. The main ethical issue is independence. The corporation
exists to serve the interests of the country as a whole and should not be
seen to be supporting one political party, even if the board believes that
party's policies are best for EPC. The fact that the request has come via the
civil servants will not be a defence, since the civil servants also have a
(possibly stronger) duty of independence.
Obedience. The board also however owes a duty of obedience to the
Ministry of Energy, which is its employer, and has a right to make legitimate
business requests. Confidentiality may also be an issue, that the board may
be instructed to treat the request and its response as confidential.
What are the norms, principles and values related to the case?
Objectives. The board must act in accordance with the corporation's
objectives, which will be to supply electricity as economically and
efficiently as possible. The board is entitled to consider whether major
cost-cutting may increase the risk of the electricity supply failing.
Governance. As EPC is a nationalised entity, the directors are expected to
act in accordance with the wishes of the properly elected government,
since the democratic process confers legitimacy upon the government's
wishes. This means accepting major changes such as privatisation if they
wish to remain on the board, also accepting other obligations such as
keeping certain information confidential if necessary.
Independence. The duty of independence means that the board cannot
actively intervene in the political process, an issue of most relevance
during a general election campaign.
Transparency. Ultimately also the board owes a duty of transparency
about its policies to the public and consumers, as they are primary
stakeholders. However the duty of transparency is not normally regarded

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as absolute; strategic business discussions may legitimately be kept

confidential in the short-term for various reasons.
What are the alternative courses of actions for the board?
Supply the information on the grounds that the board is not empowered
to refuse a legitimate request from the Ministry of Energy.
Supply the information provided that the board receives prior assurance,
certainly from the civil servants and preferably from the Minister of Energy,
that the information will not be used for political purposes during the
election campaign.
Refuse to supply the information on the grounds that the board must be
seen to be neutral when its future is a significant issue in the election
campaign.
Refuse to supply the information on the grounds that it cannot be
expected to make a major commitment to cost reduction instantly;
review and discussion of possible options will be required and this will take
time.
What is the best course of action that is consistent with the norms,
principles and values?
The board seems to have legitimate business reasons for asking for more
time to consider cost reductions. It is also entitled to be sensitive to
independence issues and seek assurances before it supplies any
information that could help the governing party.
What are the consequences of each course of action?
If the information is supplied and then kept confidential, the board's
independence is unlikely to be questioned, although a hastily drawn up
plan may later be criticised for business reasons. If detailed information is
not supplied until the board has had the chance to consider its plans
carefully, the decisions are more likely to be in accordance with the
corporation's objectives.
If the board supplies the information and it is used for political
purposes, then the board's independence will be questioned. If the
opposition party then wins the election, some or all of the board may well be
replaced and EPC may suffer disruption to board decision-making and
monitoring. Similarly if the board refuses, the current government takes
offence and wins the election, the board may also be replaced.
What is the decision?
The board may feel able to supply some indications of how it might cut
costs. It should refuse to supply detailed information until it has had time
to consider future planning carefully, even if this means the information is

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not available until after polling day. Before it supplies any information it
should seek guarantees from the governing party that it will not use the
information to forward its political platform. It should not reveal the request
has been made unless the information is used for political purposes and the
board therefore needs to demonstrate that it has acted independently.
(b) The stages of Tucker's five question model are in the decision:
Profitable
Although the nationalised corporation will be a non-profit making body, it
has the duty to control its costs. The costs of combating the protestors will
include:
 The costs of security
 The costs of taking action to counter the bad publicity that may be a
consequence of the treatment of the protestors
 The costs of legal action brought by the protestors as a result of the
actions of the security guards
The other issue however is whether there is any alternative to incurring
these costs. If the protestors are determined to protest, the alternative may
be disruption to the country's power supply, which is likely to be regarded
as being much more important.
Legal
The legality of the security guards' action depends upon local legislation,
in particular the rights to protest, to protect property and use
reasonable force. There is also the issue of how far EPC will be held
responsible for the actions of its agent, the security firm. Because of the
issues of poor publicity and also the costs described above, EPC's board
should be wary if it appears that excessive force may be being used, since
this is likely to be a legally grey area.
Fair
The pressure groups may claim that they have a legitimate right to protest.
Their case may be weakened by the fact that they can currently take political
action in the general election campaign, although perhaps they might argue
that none of the major parties fairly represents their views. However even if
the board was to accept that the pressure groups are legitimate
stakeholders, it also has a duty to consumers, who are undoubtedly also
legitimate stakeholders, to preserve the continuity of electricity supplies.
These include consumers whose livelihoods and indeed lives may be
threatened by power cuts (hospital patients for example).
Right
The main ethical issues are whether it is right for the pressure group to take
potentially life-threatening action in order to advance a cause that has
fundamental long-term consequences (action against global warming). From

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EPC's point of view the ethical issue is whether force should be used against
the pressure group if its actions are life-threatening; if it can be, how much
force would be right; ultimately would it be legitimate to take action that
might jeopardise the lives of the protestors.
Sustainable
Because of the general election campaign and a possible change of
government, the board cannot be expected at present to make long-term
decisions about switching to a more environmentally friendly method of
electricity generation. However if the managing director's attitude is
typical of the board, then the viewpoint is not sustainable; continued use of
coal will mean supplies are eventually exhausted and there is strong
scientific evidence that the emissions are having adverse climatic effects.
Many countries are investigating alternative sources of power. Whatever the
result of the general election, EPC's board has a duty to ask the new
government to review energy policies.

24 WWW
(a) Situation 1
Integrity – This situation could be in conflict with the fundamental principle
of integrity.
CASL's Code of Ethics highlights that the principle of integrity requires
accountants to be 'honest, straightforward and truthful' in all business
relationships. The principle of integrity also implies that accountants should
not be associated with any information which they believe contains a
materially false or misleading statement, or which is misleading by
omissions.
Contain a materially false or misleading statement – The CEO has
presented a very optimistic forecast for WWW's profits, but this could be
misleading if the government's claim for damages against the company is
successful.
Omits information where such omission would be misleading –
Although the government's claim for damages would 'materially affect'
WWW's profit for 20X3 if it were successful, the CEO did not mention the
claim in his presentation to the analysts and journalists. This omission is
therefore misleading, because it prevents his audience from being aware
that WWW's profit for 20X3 might be materially lower than the figure given
in the forecast.
Note: The principle of integrity also requires professional accountants to
disassociate themselves from statements or information which have been
'furnished recklessly'.

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Contain statements or information furnished recklessly – The CEO

prepared his forecast in a hurry, and did not check the figures with anyone
else in WWW. Given that WWW is an international company, the CEO could
be seen as reckless for presenting a forecast without asking anybody else in
the company to confirm it. Such actions suggest the CEO has perfect
knowledge of the company and its prospects, but that seems very unlikely.
Advice:
The CEO's forecast and presentation demonstrate the characteristics of
communications which conflict with the principle of integrity. The CEO has
not been honest in his dealings with the analysts and the journalists, and
therefore Situation 1 represents a conflict with the principle of integrity.
Situation 2
Confidentiality – The principle which could be jeopardised here is
confidentiality. The Code requires accountants and firms to refrain from
disclosing, outside a firm, confidential information which has been acquired
as a result of business relationships with that firm.
Many of the documents which the Government's lawyers have requested
contain confidential information, which suggests there could be a conflict
with the principle of confidentiality if they are handed over.
Exception: Legal proceedings – However, the Code makes an exception to
the principle of confidentiality in the context of legal proceedings. In other
words, the principle of confidentiality is not breached if confidential
information is disclosed when it is required in the course of legal
proceedings.
This is the case in Situation 2. WWW has been required to produce the
documents as a result of the court order obtained by the Government.
Advice:
Although the documents contain confidential information, Situation 2 does
not represent a conflict with the Code.
Situation 3
Objectivity – The principle which could be at stake in this situation is
objectivity.
The principle of objectivity requires accountants not to allow bias, conflict of
interest, or the undue influence of others to override their professional or
business judgements.
Reasons for financial controller's decision – The financial controller's
advice about discontinuing the joint venture appears to have been driven by
the poor working relationship between the accounting staff in the two

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companies, and the problems which ZZZ has caused the financial controller
and his staff.
By contrast, the financial controller does not appear to have considered the
profitability of the joint venture, or the commercial benefits to WWW of
continuing with it.
Conflict – In this respect, it appears that financial controller's decision has
been biased as a result of the problems which she and her staff have
encountered in working with ZZZ.
Advice:
This situation represents a conflict with the Code, and specifically with the
principle of objectivity.
(b) WWW could use the following stages for resolving ethical conflicts:
Establish the all relevant facts and information
Identify the ethical issues which are involved, and identify the
fundamental ethical principles related to the matter in question. These
principles should be identified in WWW's published Code of Ethics, but
alternatively WWW could refer to a Code published by a professional body
such as CASL or IFAC (in its Code of Ethics).
Follow procedures – Where possible, WWW should follow its internal
procedures when enquiring into the ethical conflict.
Identify potential courses of action – WWW should investigate possible
courses of action which it could use to resolve the conflict, and should
consider the potential consequences of each possible course of action.
The following questions could be relevant here:
 Can the conflict be resolved?
 What are the consequences if the conflict is not resolved?
 What stakeholders are affected by the conflict, or will be affected if it is
not resolved?
Consultation – In order to help answer these questions, WWW needs to
consult all the stakeholders who are affected by the conflict.
Resolution – Once WWW has established all the relevant facts, and
considered the consequences of each possible course of action, it should then
determine the appropriate course of action to resolve the conflict.
External advice – If WWW is not able to resolve the matter internally, it
may need to seek external advice, either from its legal advisors, or from a
relevant professional body (such as CASL).

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Compromise – However, it is important for WWW to recognise that, in some

ethical conflicts, there may not be a way of resolving the conflict which is
entirely wholly acceptable to all stakeholders. The resolution is likely to
involving trading off the interests of one stakeholder group against those of
another. Therefore, it is almost inevitable that there will need to be a degree
of compromise in resolving the conflict.

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PART F: CASE STUDY QUESTIONS

Questions 25 to 33 are Case Study questions, each one covering a variety of
syllabus areas.

25 Johan
(a) Costs incurred in extending the network
LKAS 16 states that the cost of an item of property, plant and equipment
should be recognised when two conditions have been fulfilled:
 It is probable that future economic benefits associated with the item will
flow to the entity.
 The cost of the item can be measured reliably.
The cost, according to LKAS 16, includes directly attributable costs of
bringing the asset to the location and condition necessary for it to be capable
of operating in a manner intended by management. Examples of such
directly attributable costs are site preparation costs and installation and
assembly costs.
The feasibility study relates to general site selection, ie selecting a general
geographical area in which the base station may be installed. Applying the
first criterion (probability of economic benefits) would exclude the
feasibility study costs, both internal and external, because (by definition) the
economic benefits of a feasibility study are uncertain. These costs,
Rs. 250,000 in total, should be expensed as incurred.
The costs incurred to select a specific site within the chosen geographical
area are treated differently. Applying the LKAS 16 definition of directly
attributable costs, the selection of a base station site that meets the technical
conditions required for the optimal operation of the network is an inherent
part of the process of bringing the network assets to the location and
condition necessary for operation. The Rs. 50,000 paid to third party
consultants to find a suitable site is part of the cost of constructing the
network, and may therefore be capitalised.
(b) Lease
The other costs – a payment of Rs. 300,000 followed by Rs. 60,000 a month
for twelve years – is a lease and is governed by SLFRS 16. SLFRS 16 defines a
lease as an agreement whereby the lessor conveys to the lessee, in return for
a payment or series of payments, the right to use an asset for an agreed
period of time.
Johan must recognise a lease liability and a right-of-use asset in relation to
this land. The lease liability is the present value of future lease payments,
which is Rs. 7.2 million.

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The right-of-use asset to be capitalised, includes the initial lease payment of

Rs. 300,000 and the value of the lease liability. Therefore Rs. 7.23 million will
be capitalised. This right-of-use asset will be depreciated over the 12-year
lease term. One month of depreciation or Rs. 50,208 (7.23m / 12 years 
1/12) will be charged for the year ended 31 March 20X7.
(c) Inventory of handsets
LKAS 2 states that inventories must be valued at the lower of cost and net
realisable value. The handsets cost Rs. 200, and the net realisable value is
selling price of Rs. 150 less costs to sell of Rs. 1, which is Rs. 149.
All handsets held in inventory by the Retail Division must be written down
to Rs. 149 per handset.
(d) Revenue recognition
Call cards
Under SLFRS 15, revenue is recognised to depict the transfer of goods or
services to customers in an amount that reflects the consideration to which
the entity expects to be entitled in exchange for those goods or services.
In the case of the call cards, the performance obligation is the provision of
services over a six month period, not the provision of the card itself,
and accordingly revenue should be recognised as the services are provided.
Rs. 21 per call card is received in advance of the services being provided, and
therefore should be recognised as deferred revenue at the point of sale.
The transaction price that should be recognised as revenue is the amount of
consideration which the entity expects to receive. Based on prior experience,
Rs. 18 of credit is used (21 – 3 unused) and so Rs. 18 should be recognised as
income over the six month period from the date of the sale.
The Rs. 3 of unused credit – an average figure may be used rather than the
figure for each card – is recognised as revenue when the card expires, that is
when Johan has no further obligation to the customer.
Sales to dealers
Johan sells handsets to the dealer division which the dealer then sells on to
customers. Any unsold handset can be returned.
Under SLFRS 15, an entity is a principal if it controls the specified good or
service before that good or service is transferred to a customer. Johan bears
the risk of loss in value of the handset, as the dealer may return any handsets
before a service contract is signed with a customer. In addition, Johan sets
the price of the handset. Therefore, Johan is the principal in this transaction
and the dealer is acting as an agent for the sale of the handset and service
contract.

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There are two performance obligations: the sale of the handset and the
12-month service contract. However, SLFRS 15 states that an entity should
combine two or more contracts entered into at the same time with the same
customer and account for the contracts as a single contract if the contracts
are negotiated as a package with a single commercial objective. As the
handsets cannot be used with another mobile network, these contracts
should be accounted for together.
SLFRS 15 states that when entity is a principal, it should recognise the gross
amount of consideration when the performance objective is satisfied.
The performance obligation is satisfied over the 12-month contract period,
so the Rs. 150 revenue should be recognised over that period, in addition to
the monthly service contract income.
The standard states that the incremental costs of obtaining a contract are the
costs that would not have been incurred if the contract had not been
obtained, such as sales commission. Incremental costs can sometimes be
recognised as an asset but permits the costs to be recognised as an expense,
when the amortisation period of the asset would be one year or less, as is the
case here.
(e) Shares issued to the directors
The three million shares issued to the directors on 1 June 20X6 as part of the
purchase consideration for Hash are accounted for by Johann in accordance
with SLFRS 3 Business combinations rather than SLFRS 2 Share-based
payment. This is because the shares issued are not remuneration or
compensation, but simply part of the purchase price of the company.
The cost of the business combination is the total of the fair values of the
consideration given by Johan. The total fair value here is the market value of
the shares, being Rs. 6 million.
The contingent consideration – 5,000 shares per director, to be received on
31 May 20X7 if the directors are still employed by Leigh – may, however, be
seen as compensation accounted for in accordance with SLFRS 2. The fact
that the additional payment of shares is linked to continuing employment
suggests that it is a compensation arrangement, and therefore SLFRS 2 does
apply.
SLFRS 2 requires that the transaction is measured at the fair value of the
instruments granted at the grant date. The market value of each share at that
date is Rs. 2. (Three million shares are valued at Rs. 6 million.) Therefore,
the total value of the compensation is 5 directors  5,000 shares  Rs. 2 =
Rs. 50,000.
In the year ended 31 May 20X7, Rs. 50,000 is recognised in profit or loss as
part of staff costs with a corresponding increase in equity recognised in the
statement of financial position.

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Shares issued to employees

These shares are remuneration and are accounted for under SLFRS 2.
The transaction is measured at the fair value of the instruments issued at the
date on which they are granted. Here, the grant date and issue date are the
same, and the fair value of each instrument at that date is Rs. 3 per share.
Therefore, the transaction is measured at Rs. 3 million. As the shares are
given as a bonus they vest immediately and are presumed to be
consideration for past services.
Therefore, the total of Rs. 3 m is recognised in profit or loss as a staff cost
when the shares are issued with a corresponding increase to equity.
Purchase of property, plant and equipment
In accordance with SLFRS 2, the purchase of property, plant and equipment
is treated as a share-based payment in which the counterparty has a choice
of settlement, in shares or in cash.
Such transactions are treated as the issue of a compound financial
instrument, with a debt and an equity element.
The fair value of the equity element is the fair value of the goods or services
(in this case the property) less the fair value of the debt element of the
instrument. The fair value of the property is Rs. 4m. The fair value of the
liability component at 31 May 20X7, based on the share price at that date,
is 1.3 million  Rs. 3 = Rs. 3.9 million.
The journal entries are:
DEBIT Property, plant and equipment Rs. 4 m
CREDIT Liability Rs. 3.9 m
CREDIT Equity Rs. 0.1 m
To recognise the acquisition of PPE and the share-based transaction
In three months' time, the debt component is remeasured to its fair value.
Assuming the estimate of the future share price was correct at Rs. 3.50,
the liability at that date will be 1.3 million  Rs. 3.5 = Rs. 4.55. An adjustment
is recognised as follows.
DEBIT Expense (4.55 – 3.9) Rs. 0.65 m
CREDIT Liability Rs. 0.65 m
To re-measure the liability to fair value
Choice of share or cash settlement
The share-based payment to the new director, which offers a choice of cash
or share settlement, is also treated as the issue of a compound instrument.
In this case, the fair value of the services is determined by the fair value of
the equity instruments given.

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The fair value of the equity alternative is Rs. 2.50  50,000 = Rs. 125,000.
The cash alternative is valued at 40,000  Rs. 3 = Rs. 120,000. The difference
between these two values – Rs. 5,000 – is deemed to be the fair value of the
equity component. At the settlement date, the liability element is measured
at fair value and the method of settlement chosen by the director determines
the final accounting treatment.
At 31 May 20X7, the accounting entries are:
DEBIT Profit or loss – directors' Rs. 125,000
remuneration
CREDIT Liability Rs. 120,000
CREDIT Equity Rs. 5,000
To recognise the share-based transaction.
In effect, the director surrenders the right to Rs. 120,000 cash in order to
obtain equity worth Rs. 125,000.
(f) Provision
A provision is defined by LKAS 37 Provisions, contingent liabilities and
contingent assets as a liability of uncertain timing or amount. LKAS 37 states
that a provision should only be recognised if:
 There is a present obligation as the result of a past event;
 An outflow of resources embodying economic benefits is probable; and
 A reliable estimate of the amount can be made.
If these conditions apply, a provision must be recognised.
The past event that gives rise, under LKAS 37, to a present obligation,
is known as the obligating event. The obligation may be legal, or it may be
constructive (as when past practice creates a valid expectation on the part of
a third party). The entity must have no realistic alternative but to settle the
obligation.
As at 31 May 20X7, Hash has no legal obligation to pay compensation to third
parties. No legal action has been brought in respect of the accident. Nor can
Hash be said to have a constructive obligation at the year end, because the
investigation has not been concluded, and the expert report will not be
presented to the civil courts until 20X8. Therefore, under LKAS 37 Provisions,
contingent liabilities and contingent assets no provision is recognised.
The possible payment does, however, fall within the LKAS 37 definition of a
contingent liability, which is:
 A possible obligation depending on whether some uncertain future event
occurs; or
 A present obligation for which payment is not probable or the amount
cannot be measured reliably.

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There is uncertainty as to the outcome of the investigation and findings of

the report, and the extent of the damages and any compensation arising
remain to be confirmed. However, the uncertainty over these details is not
so great that the possibility of an outflow of economic benefits is remote.
Therefore, in respect of the contingent liability, the details and, if possible an
estimate of the amount payable, must be disclosed in the notes to the
financial statements.
The question arises as to whether the possible recovery of the compensation
costs from the insurance company should be disclosed as a contingent asset
under LKAS 37.
LKAS 37 provides specific guidance on reimbursements ie where some or all
of the expenditure required to settle a provision is expected to be
reimbursed by another party. In this case, the standard states that the
reimbursement is recognised only when it is virtually certain that
reimbursement will be received if the entity settles the obligation.
As no provision has been recognised at the reporting date in respect of costs
associated with the airport's collapse, it follows that no reimbursement asset
can be recognised either.

26 Carpart
(a) Vehiclex
SLFRS 15 takes a five-step approach to recognising revenue:
(i) Identify the contract with a customer
(ii) Identify the performance obligations in the contract
(iii) Determine the transaction price
(iv) Allocate the transaction price to the performance obligations in the
contract
(v) Recognise revenue when (or as) the entity satisfies a performance
obligation.
A five-year contract has been agreed with Vehiclex. The performance
obligation is the provision of car seats, manufactured to a particular
specification. SLFRS 15 states that the transaction price is the amount of
consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer. The transaction price
is therefore the agreed price of Rs. 300 per seat. The fact that this agreed
amount includes an amount to cover the cost of machinery is irrelevant to
the amount of revenue to be recorded.

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The performance obligation is satisfied when the customer obtains control

of the promised asset. Indicators of control include:
(i) The entity has a present right to payment for the asset.
(ii) The customer has legal title to the asset.
(iii) The entity has transferred physical possession of the asset.
(iv) The significant risks and rewards of ownership have been transferred
to the customer.
(v) The customer has accepted the asset.
In this case, the performance obligation is the transfer of the car seat to
Vehiclex and it is only at this point that the revenue of Rs. 300 per seat can
be recognised. It is not possible to recognise revenue in the current year
financial statements, if the contract doesn't commence until the next
financial year.
The machinery should be capitalised and depreciated in line with LKAS 16.
(b) Vehicle sales
Sale with a right of return
SLFRS 15 states that a right of return means that a customer can return
goods to the seller and receive in exchange a full or partial refund, a credit
note, another product or any combination of these.
Where goods are sold with a right of return, an entity should not recognise
revenue for goods that it expects to be returned. It can calculate the level of
returns using the expected value method or simply estimate the most likely
amount. This is recognised as a refund liability rather than revenue.
The entity also recognises an asset (adjusted against cost of sales) for its right
to recover products from customers on settlement of the refund liability.
The asset is measured at the previous carrying amount of the goods less
expected decreases in value and costs to recover the product. It should be
presented separately from the refund liability.
When Carpart makes a vehicle sale experience has shown that there is an
70% chance that the buyer will exercise the two-year option, a 25% chance
that the buyer will keep the car for four years and a 5% chance that they
won't return it.
Based on a market value of Rs. 20,000, the expected level of returns payable
would be:
Likelihood Return Weighted average
Two-year option 70% 60%  20,000 = 12,000 Rs. 8,400
Four-year contract 25% 20%  20,000 = 4,000 Rs. 1,000
Not returned 5% 0 –
Rs. 9,400

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The revenue that would therefore be recognised on the sale of a vehicles is

Rs. 10,600 with Rs. 9,400 recorded as a refund liability.
An asset should be recognised for the right to recover the vehicles.
The vehicles are sold at a 25% mark-up on cost, so a vehicle with a selling
price of Rs. 20,000 has a cost of Rs. 16,000 (20,000 / 1.25). This initial cost
would need to be adjusted for any expected decreased in value and any costs
to recover the product. As there are three possible options, a weighted
average is likely to the produce the best estimate for the asset:
Likelihood FV Cost (assuming Weighted
25% mark up) average
Two-year option 70% 64%  20,000 12,800 / 1.25 Rs. 7,168
= 12,800 = 10,240
Four-year contract 25% 30%  20,000 6,000 / 1.25 Rs. 1,200
= 6,000 = 4,800
Not returned 5% – – –
Rs. 8,368
This asset would be created upon the sale of the car, with the corresponding
credit to cost of sales.
Demonstration vehicles
These are not conventional inventory, but have the characteristics of
property, plant and equipment, because they are held for use in the
business (demonstrations) and are expected to be used in more than one
accounting period. They should be capitalised as property, plant and
equipment and depreciated over the 18-month period during which they
are being used as demonstration vehicles. At the end of the 18-month
period, the vehicles are reclassified back into inventories and are no longer
depreciated. When the SLFRS 15 recognition criteria for the sale of goods
are met, revenue is recognised and the carrying amount of the cars is
transferred to cost of sales.
(c) Venue
Carpart believes that there is a 5% risk, based on experience with other
customers, that Venue will default. SLFRS 15 states that the transaction price
should be the amount which an entity expects to receive. In this case
consideration is expected to either by Rs. 1 million (95% chance) or
nil (5% chance). SLFRS 15 permits either a weighted average or the most
likely amount to be received. An entity must apply the chosen method
consistently throughout the contract. Depending on the method selected,
either Rs. 1 million or Rs. 950,000 could be recognised as revenue with a
corresponding trade receivable.
The trade receivable is a financial asset within the scope of SLFRS 9 and
therefore Carpart must assess at the end of each reporting period whether

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there is objective evidence of an impairment. The deteriorating financial

situation of the customer is identified as an indicator of impairment by
SLFRS 9.
The impairment loss is measured as the difference between the carrying
amount of the receivable (Rs. 1 m or Rs. 950,000) and the present value
of estimated future cash flows that it will give rise to (Rs. 0.8 million).
The impairment will be recognised in profit or loss.
(d) Other sales
SLFRS 15 requires the transaction price to equal the cash price of the goods
or services at the time that control of them passes to the customer.
The vehicle testing systems are being sold with payment receivable two years
after the systems are transferred. The present value of the Rs. 2 million must
be recorded as revenue and interest income should be recorded to reflect the
financing provided by Carpart to the customer.
Using the 4% discount rate given, the present value of the consideration is
Rs. 2 m/1.042 = Rs. 1.85 m.
This is recognised by:
DEBIT Receivable Rs 1.85 m
CREDIT Revenue Rs 1.85 m
To recognise the revenue receivable at the discounted amount
The unwinding of the discount is credited to profit or loss as finance income
over the two-year period as follows.
Year 1 Year 2
DEBIT Receivable (1.85  0.04/(1.85  1.04)  0.04) Rs. 74,000 Rs. 76,960
CREDIT Finance income Rs. 74,000 Rs. 76,960
The sales made in advance of payment are also covered by SLFRS 15.
Where sales are made in advance of payment, as finance cost is recorded.
However, the standard states that no adjustment is required if payment is
received 12 months or less before the goods are transferred, so a finance
cost is not required for the Rs. 3 million of sales as the goods will be
transferred in one year.
The Rs. 3 m payment cannot be initially recognised as revenue as the
performance obligation, the transfer of goods, has not yet been satisfied.
Instead a deferred income liability is recognised:
DEBIT Cash Rs 3 m
CREDIT Deferred income Rs 3 m
When the goods are transferred and the performance obligations are satisfied
DEBIT Deferred income Rs 3 m
CREDIT Revenue Rs 3 m

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(e) Lease with Elpres

SLFRS 16 includes an exemption for short term leases, which are defined as
leases with a term of 12 months or less. As the directors of Carpart take all
possible exemptions, this accounting for this lease will be simplified.
Rather than recording a lease liability and a corresponding right-of-use
asset, the lease payments will be recognised on a straight-line basis over the
lease term.
Total payments made are: 2 million + (10  280,000) = Rs. 4.8 million
It is a ten month lease, so Rs. 480,000 should be recognised each month.
(f) Lease with Brooke
The basic principle of SLFRS 16 is that all leases are recognised in the
statement of financial position.
A lessee is required to recognise a right-of-use asset and a lease liability for
all leases of more than 12 months, as the lease with Brooke is.
Carpart would initially recognise a 'right-of-use' asset and a lease liability at
the present value of the future lease payments. The first lease payment is
made at the start of the lease, so the future payments are the payments at
the start of year 2 and year 3.
The present value is:
= (13,000 / 1.1295) + (13,000 / 1.12952)
= 11,510 + 10,190
= 21,700
This is value of the lease liability, but the right-of-use asset would be
recorded as:
lease liability + direct costs + initial payment – lease incentives
= 21,700 + 6,000 + 13,000 – 5,000
= 35,700
The lease is therefore initially recorded on 1 May 20X5 as:
DEBIT Right-of-use asset 35,700
CREDIT Lease liability 21,700
CREDIT Cash (13,000 + 6,000 – 5,000) 14,000
Interest on the lease for the year ended 30 April 20X6 would be 21,700 
12.95% = Rs. 2,810 and this would increase the lease liability and be
recorded as a finance cost.
DEBIT Lease liability 2,810
CREDIT Finance costs 2,810

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The lease liability at the year end of Rs. 24,510 (21,700 + 2,8100) would be
shown in the financial statements split into a current liability of Rs. 13,000
(the year 2 payment due on 1 May 20X6) with the balance of Rs. 11,510 as a
non-current liability.
The right-of-use asset would be depreciated over the lease term on a
straight-line basis unless another systematic basis were more representative
of the consumption of the asset. The annual depreciation charge would be
Rs. 11,900 (35,700 / 3).
(g) Disclosure
In order to meet the objective of SLFRS 12 Disclosure of interests in other
entities, entities are required to make the following disclosures.
(i) Significant judgements and assumptions made in determining control,
joint control or significant influence and type of joint arrangement
(ii) Information on interests in subsidiaries such that the composition of
the group and non-controlling interest is understood and restrictions,
risks and changes in ownership can be evaluated
(iii) Information on interests in associates and joint arrangements such that
the nature and extent of the interests, financial effects and associated
risks can be evaluated
(iv) Information on interests in unconsolidated structured entities such
that the nature and extent of the interests and associated risks can be
evaluated

27 Mica
(a) Maintenance contract
SLFRS 15 requires revenue to be recognised when the performance
obligations in the contract are met.
Mica has entered into a five-year maintenance contract. When a performance
obligation is satisfied over time, an entity shall recognise revenue over time
by measuring the progress towards complete satisfaction of that
performance obligation.
Progress can be measured by either input or output methods, an entity must
determine what it thinks is most appropriate.
Based on the information available, it would appear to be appropriate to use
the output method of time elapsed, and therefore the revenue would be
recognised over the five-year period of the contract.
Ama Balachandran is wrong to believe that the whole of this revenue can be
recognised in 20X4, as the service will be provided over a five-year term
from 1 January 20X4 to 31 December 20X8. Whether Mica chooses to use

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time elapsed, or another method to determine progress towards completion,

only a proportion of the revenue will be recognised in year 1.
Assuming that Mica recognises the revenue on a straight-line basis according
to the stage of completion, the amount of revenue would be Rs. 300,000 per
year.
However, there is also a significant financing component to the contract,
because the contract starts on 1 January 20X4, but payment is to be made in
full on 31 December 20X7.
SLFRS 15 requires the payment to be discounted to present value and the
discounted amount must be recorded as finance income in the periods
preceding 20X7, and the discount unwound each year.
When payment is received on 31 December 20X7, there is still one year
remaining in the contract. Therefore, the Rs. 300,000 relating to that final
year will be recorded as deferred income, then released as revenue during
the year ended 31 December 20X8.
Entries will be as follows.
Debit Credit
Rs. Rs.
31 December 20X4
Receivable 259,151
Revenue (300k/1.053) 259,151
To record the revenue for 20X4

31 December 20X5
Receivable 12,958
Interest income (259,151  5%) 12,958
To unwind the discount in respect of the receivable
Receivable 272,109
Revenue (300k/1.052) 272,109
To record the revenue for 20X5

31 December 20X6
Receivable 27,211
Interest income ((259,151 + 12,958 + 272,109)  27,211
5%)
To unwind the discount in respect of the receivable
Receivable 285,714
Revenue (300k/1.05) 285,714
To record the revenue for 20X6

31 December 20X7
Receivables 42,857
Interest income 42,857
((259,151 + 12,958 + 272,109 + 27,211 + 285,714)
 5%)

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Debit Credit
Rs. Rs.
To unwind the discount in respect of the receivable
Cash 1,500,000
Receivables 900,000
Revenue 300,000
Deferred income 300,000
To recognise receipt of cash, revenue for the year and
deferred income

20X8
Deferred income 300,000
Revenue 300,000
To recognise revenue for 2018
(b) Off-plan sales
Although Mica's previous construction contracts would have been accounted
for in accordance with SLFRS 15, the nature of these contracts may be
different.
Each sale represents a sale of land plus an agreement for the construction of
real estate and
Mica will need to determine whether under SLFRS 15, the two components
must be treated separately or can be combined.
SLFRS 15 identifies the sale of goods as being distinct from the construction
of an asset which suggests that the two components should be treated
separately.
There is a performance obligation to transfer the land at a point in time
(when construction is complete) and a performance obligation to construct
the property on the land over the build period.
The total fair value of consideration received or receivable must be allocated
to each component based on their relative stand alone selling prices ie the
selling price of the land and the selling price of the house.
(c) Former hospitality division
SLFRS 5 states that an entity shall classify a non-current asset as held for
sale if its' carrying amount will be recovered principally through a sale
transaction rather than through continuing use.
For this to be the case:
(i) The asset must be available for immediate sale in its present condition
(ii) Its sale must be highly probable, meaning:
(1) An appropriate level of management must be committed to a plan
to sell the asset
(2) There must be an active programme to locate a buyer

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(3) The asset (or disposal group) must be actively marketed for sale
at a price that is reasonable in relation to its current fair value
(4) The sale should be expected to qualify for recognition as a
completed sale within one year from the date of classification
(5) It must be unlikely that significant changes to the plan will be
made
Cookery equipment
Since the decision has not fully been made as to whether to sell the
equipment or retain it and lease it, it cannot be categorised as held for sale.
The asset therefore continues to be classified as PPE and must be tested for
impairment at each period end, if indicators of impairment exist. According
to LKAS 36, an indicator of possible impairment is a change in operations
resulting in a change in use of the asset. The cookery equipment is currently
idle and therefore an impairment test must be performed.
The carrying amount of the equipment is Rs. 750,000. The recoverable
amount, being the higher of fair value less costs of disposal and value in use,
is the value in use of Rs. 710,000. Therefore, the equipment is impaired.
An impairment loss of Rs. 40,000 must be recognised in profit or loss, and
depreciation should continue to be charged on the written down amount
over the remaining useful life. If the decision is made to sell the equipment, it
will be transferred to be an asset held for sale when the SLFRS 5 criteria are
met and will be measured and presented in accordance with that standard.
Vans
Although the vans were in fact sold in January 20X5, there is no indication
that they were intended to be sold as at 31 December 20X4.
SLFRS 5 states that if the criteria for assets to be classified as held for sale are
met after the reporting period, an entity must not classify a non-current asset
as held for sale in those financial statements ie it is a non-adjusting event.
When those criteria are met after the reporting period but before the
authorisation of the financial statements for issue, the entity must make
additional disclosures. Therefore, Mica shall disclose:
• A description of the vans
• A description of the facts and circumstances of their sale, and
• If relevant, the reportable segment in which the vans are presented in
accordance with SLFRS 8
The vans are therefore presented in the statement of financial position as at
31 December 20X4 within property, plant and equipment rather than assets
held for sale.
The sale so soon after the year end at a price lower than carrying amount
could be an indicator that the vans were actually impaired at the year end.
If the sale at less than carrying amount was due to conditions that existed at

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the reporting date, then this is an adjusting event and the value of the vans
should be written down to Rs. 270,000 as at 31 December 20X4. If the loss of
value is due to events occurring after the year end, then this is a
non-adjusting event, and should be disclosed if material.
Headquarters
Although Mica have clearly intended to sell the property since June 20X4,
the company decided to renovate the property prior to the sale. As a result of
the discovery of asbestos, the renovations are ongoing at the reporting date.
Therefore, at no stage has the property been available for immediate sale in
its present condition. Furthermore, it was not advertised for sale until
February 20X5, meaning there was (understandably) not an active
programme to find a buyer.
Accordingly the property may not be designated as held for sale at
31 December 20X4, and should be recorded at carrying amount of Rs. 6.7 m.
(d) SLFRS for SMEs
The SLFRS for SMEs may be applied by any company that meets the
definition of a Small or Medium Sized Entity (SME) and is not a
Specified Business Entity (SBE).
An SME is an entity that does not have public accountability and publishes
general purpose financial statements for external users.
Mica has retained its private status rather than seek a listing and therefore
does not have public accountability; equally it does produce general purpose
financial statements for external users.
An SBE is a company such as a bank or insurance company; it does not
include a property construction and management company.
Therefore, Mica is eligible to apply the SLFRS for SMEs.
Purchased goodwill
SLFRS 3 requires that the NCI is measured as a proportion of the net assets
of the acquiree; there is no option to measure it at fair value.
Therefore, recognised goodwill always represents the parent share of
goodwill only.
SLFRS 3 requires that transaction costs on an acquisition are recognised in
profit or loss; the SLFRS for SMEs requires that these costs form part of the
acquisition cost. As a result, goodwill calculated in accordance with the
SLFRS for SMEs may be greater than that calculated in accordance with
SLFRS 3.
Full SLFRS require that recognised goodwill is not amortised, but instead is
tested for impairment annually. The SLFRS for SMEs simplifies this
treatment in a practical sense by requiring that goodwill is amortised over a

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finite life (presumed to be ten years) and is tested for impairment only if
there is an indicator of impairment.
Goodwill is therefore measured at cost less accumulated amortisation
charges less accumulated impairment losses.
Owned properties held at revalued amount
Both full SLFRS and the SLFRS for SMEs permit the choice of measuring
properties under either the revaluation or cost model.
Provisions
The guidance contained within the SLFRS for SMEs on accounting for
provisions is identical to that contained within LKAS 37.
(e) Adequacy of disclosures
The applicable standards here are SLFRS 7 Financial instruments: Disclosures
and LKAS 10 Events after the reporting period.
According to SLFRS 7, Mica should have included additional information
about the loan covenants sufficient to enable the users of its financial
statements to evaluate the nature and extent of risks arising from financial
instruments to which the entity is exposed at the end of the reporting period.
Such disclosure is particularly important in Mica's case because there was
considerable risk at the year end (31 December 20X4) that the loan
covenants would be breached in the near future, as indicated by the
directors' and auditor's doubts about the company continuing as a going
concern. Information should have been given about the conditions attached
to the loans and how close the entity was at the year-end to breaching the
covenants.
SLFRS 7 requires disclosure of additional information about the covenants
relating to each loan or group of loans, including headroom (the difference
between the amount of the loan facility and the amount required).
The actual breach of the loan covenants at 31 March 20X4 is a material event
after the reporting period as defined in LKAS 10. The breach, after the date
of the financial statements but before those statements were authorised, is a
non-adjusting event, as it does not provide additional information
concerning year-end conditions. Therefore, the event should have been
disclosed in accordance with LKAS 10.
Although the breach is a non-adjusting event, where such an event means
that an entity is no longer a going concern, LKAS 10 requires that the
financial statements are not prepared on a going concern basis. Here both
the directors' and auditor's reports express going-concern doubts however
the information in the financial statements is prepared on a going-concern
basis. The directors should therefore assess the going concern status of the
company.
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28 Robby
(a) ROBBY GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X3
Rs m
Assets
Non-current assets
Property, plant and equipment: + 12 (W13) 241.13
Goodwill 6.00
Financial assets 29.00
276.13
Current assets + 4 (W12) 36.00
Total assets 312.13

Equity and liabilities

Equity attributable to owners of the parent
Ordinary shares 25.00
Other components of equity 2.00
Retained earnings 81.45
108.45
Non-controlling interests 27.64
136.09
Non-current liabilities 94.84
Current liabilities + 3.6 (W12) +16 (W13) 81.20
Total equity and liabilities 312.13

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1 Group structure
1 June Robby 1 June 1 Dec X2
X1 X2
80% 5% + 55% = 60%
(sub) (IEI)
Pre- Pre-
acquisition acquisition
Rs. 16 m Hail Zinc N/A Rs. 15 m
retained retained
earnings earnings
2 (i) Carrying amount of Hail
Hail was initially recognised at purchase consideration of
Rs. 55 million and is subsequently classified as FVTOCI and
measured at fair value with changes recognised in other
comprehensive income. At the reporting date it is measured at its
fair value of Rs. 55 m and therefore a cumulative revaluation gain
of Rs. 55 m – Rs. 50 m = Rs. 5 m is represented in other
components of equity. This must be eliminated on consolidation.
In addition, Robby has recognised a dividend from Hail in other
comprehensive income (and so accumulated in other components
of equity). This must be transferred to retained earnings.
These are achieved by (Rs. m):
DEBIT Other components of 7 million
equity (%m + 2m)
CREDIT Investment in H 5 million
CREDIT Retained earnings 2 million
To eliminate the fair value gain on Hail in Robby's separate
financial statements and transfer the dividend to retained
earnings
(ii) Carrying amount of Zinc
Total consideration for the 60% investment in Zinc was
Rs. 18 million. Whilst the second investment is carried at cost of
Rs. 16 million, the initial investment was measured at FVTPL and
a re-measurement of Rs. 1 m was recognised at 31 May 20X2.
This is reversed by (Rs. m):
DEBIT Retained earnings 1m
CREDIT Investment in Zinc 1m
To eliminate the fair value gain on Zinc in Robby's separate
financial statements

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3 Goodwill (Hail)
Rs m Rs m
Consideration transferred 50
Non-controlling interest (fair value per q) 15
FV of identifiable net assets at acq'n:
Stated capital 20
Retained earnings 16
Fair value adjustment – land 24
(60)
5
The standing journal to recognise this is (Rs. m):
DEBIT Goodwill 5 million
DEBIT Stated capital 20 million
DEBIT Retained earnings 16 million
DEBIT PPE 24 million
CREDIT Investment in H 50 million
CREDIT NCI 15 million
To recognise the acquisition of Hail and resulting goodwill
4 Goodwill (Zinc)
(i) The previously held interest in Zinc has a carrying amount of
Rs. 2 million; on the acquisition date it is remeasured to its fair
value of Rs. 5 million and a gain of Rs. 3 million is recognised in
profit or loss and accumulated in retained earnings (Rs. m):
DEBIT Investment in Z 3 million
CREDIT Retained earnings 3 million
To recognise the remeasurement to fair value of the existing
interest
(ii) Goodwill is calculated as follows.
Rs m Rs m
Consideration transferred (55%) 16
Non-controlling interest at fair value (per question) 9
Fair value of previously held interest (5%) 5
FV of identifiable net assets at acq'n:
Stated capital 10
Retained earnings 15
Fair value adjustment (1 + 3) * 4
(29)
1

*The fair value adjustment is provisionally Rs. 1 million at the

acquisition date, however it is determined to be Rs. 3 million

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higher when the final valuations are received three months later.
This adjustment takes place in the measurement period and
SLFRS 3 requires that goodwill is retrospectively adjusted.
The standing journal to recognise this is (Rs. m):
DEBIT Goodwill 1 million
DEBIT Stated capital 10 million
DEBIT Retained earnings 15 million
DEBIT PPE 4 million
CREDIT Investment in Z (16 + 5) 21 million
CREDIT NCI 9 million
To recognise the acquisition of Hail and resulting goodwill
5 Allocation of post-acquisition retained earnings to the NCI
Hail Zinc
Rs m Rs m
Retained earnings at reporting date 27 19
Retained earnings at acquisition (16) (15)
Post-acquisition 11 4
NCI share (20%/40%) 2.2 1.6
Therefore, a total Rs 3.8 million (2.2 million + 1.6 million) of profits are
allocated to the NCI by (Rs. m):
DEBIT Retained earnings 3.8 million
CREDIT NCI 3.8 million
To allocate profits since acquisition to the NCI
6 Depreciation of fair value adjustment in Zinc
(Note the fair value adjustment in Hail was to non-depreciable land.)
The fair value uplift of Rs. 4 million in Zinc is depreciated over a
remaining useful life of five years. Therefore, the charge from
acquisition to the period end is Rs. 4 million/5 years  6/12 million =
Rs. 400,000. This additional expense is attributable to the group and
NCI in their ownership proportions and is recognised by:
DEBIT Retained earnings (60%) 0.24 million
DEBIT NCI (40%) 0.16 million
CREDIT PPE 0.4 million
To recognise depreciation on the fair value uplift
7 Joint operation (in Robby's books)
The accounting treatment of a joint operation is prescribed by
SLFRS 11 Joint arrangements. Robby must recognise on a line-by-line
basis its assets, liabilities, revenues and expenses plus its share (40%)

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of the joint assets, liabilities, revenue and expenses. The figures are
calculated as follows.
Profit or loss for the year
Rs m
Revenue: 20  40% 8.00
Cost of sales: 16  40% (6.40)
Operating costs: 0.5  40% (0.20)
Depreciation (0.68)
Finance cost (unwinding of discount) (0.04)
Profit from joint operation (to retained earnings (W10) 0.68
Statement of financial position
Rs m
Property, plant and equipment:
1 June 20X2 cost: gas station (15  40%) 6.00
dismantling provision (2  40%) 0.80
6.80
Accumulated depreciation: 6.8/10 (0.68)
31 May 20X3 carrying amount 6.12
Trade receivables (from other joint operator): 8.00
20 (revenue)  40%
Trade payables (to other joint operator): 6.60
16 + 0.5 (costs)  40%
Dismantling provision:
At 1 June 20X2 (as above) 0.80
Finance cost (unwinding of discount): 0.8  5% 0.04
At 31 May 20X3 0.84
Robby has accounted only for its share of the construction cost of
Rs. 6 m. The journal to correct this is therefore as follows (Rs. m):
DEBIT Property, plant and equipment 6.12
DEBIT Trade receivables 8.00
CREDIT Joint operation 6.00
CREDIT Trade payables 6.60
CREDIT Provision 0.84
CREDIT Retained earnings (Robby) 0.68
To recognise the joint operation in accordance with SLFRS 11

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8 Property, plant and equipment

Carrying Reval.
amount surplus
Rs m Rs m
1 June 20X0 Cost 10.00
Acc. depreciation 2/20  10 (1.00)
9.00
Revaluation gain (balancing figure ) 2.00 2.00
31 May 20X2 Revalued PPE c/d 11.00
Depreciation for year 1/18  11 (0.61)
Transfer to retained earnings: 0.61 – 0.50 (0.11)
31 May 20X3 Balance 10.39 1.89
Impairment loss (2.59)
(balancing figure)
Recoverable amount 7.80
The impairment loss is charged to other comprehensive income and
therefore to other components of equity to the extent of the
revaluation surplus. The remainder is taken to profit or loss and
therefore to retained earnings. Therefore Rs. 1.89 is recognised as a
reduction in other components of equity and Rs. 2.59 – Rs. 1.89 =
Rs. 0.7 as a reduction in retained earnings.
The reserve transfer for excess depreciation is recorded by (Rs m):
DEBIT Other components of equity 0.11
CREDIT Retained earnings 0.11
To transfer the excess depreciation charge from OCE to retained
earnings
The impairment loss is recognised by (Rs. m):
DEBIT Other components of equity 1.89
DEBIT Retained earnings 0.70
CREDIT Property, plant and equipment 2.59
To recognise the impairment loss
The net journal is therefore (Rs. m):
DEBIT Other components of equity 2.00
DEBIT Retained earnings 0.59
CREDIT Property, plant and equipment 2.59
To recognise the impairment and excess depreciation transfer
9 Debt factoring
Robby should not have derecognised the receivables because the risks
and rewards of ownership have not been transferred. The receivables
must therefore be reinstated, the loss reversed, and the proceeds
recognised as a liability (Rs. m):

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DEBIT Trade receivables 4.0

CREDIT Current liabilities 3.6
CREDIT Retained earnings (to reverse loss) 0.4
To reverse the incorrect entry and recognise the factoring
arrangement correctly
10 Sale and repurchase of land
Robby should not have derecognised the land from the financial
statements because the risks and rewards of ownership have not been
transferred. The substance of the transaction is a loan of Rs. 16 m,
and the 5% 'premium' on repurchase is effectively an interest
payment. This is an attempt to manipulate the financial statements in
order to show a more favourable cash position. The sale must be
reversed, and the land reinstated at its carrying amount before the
transaction. The repurchase, ie the repayment of the loan takes place
one month after the year end, and so this is a current liability (Rs. m):
DEBIT Property, plant and equipment 12
DEBIT Retained earnings (to reverse profit on
disposal) (16 – 12) 4
CREDIT Current liabilities 16
To reverse the incorrect entry and recognise the sale and repurchase
arrangement correctly
(b) Derecognition of a financial asset
Derecognition is the removal of a previously recognised financial instrument
from an entity's statement of financial position.
An entity should derecognise a financial asset when:
(i) The contractual rights to the cash flows from the financial asset expire;
or
(ii) The entity transfers the financial asset or substantially all the risks and
rewards of ownership of the financial asset to another party.
SLFRS 9 gives examples of where an entity has transferred substantially all
the risks and rewards of ownership. These include:
(i) An unconditional sale of a financial asset
(ii) A sale of a financial asset together with an option to repurchase the
financial asset at its fair value at the time of repurchase.
The standard also provides examples of situations where the risks and
rewards of ownership have not been transferred:
(i) A sale and repurchase transaction where the repurchase price is a fixed
price or the sale price plus a lender's return
(ii) A sale of a financial asset together with a total return swap that
transfers the market risk exposure back to the entity

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(iii) A sale of short-term receivables in which the entity guarantees to

compensate the transferee for credit losses that are likely to occur.
It is possible for only part of a financial asset or liability to be derecognised.
This is allowed if the part comprises:
(i) Only specifically identified cash flows; or
(ii) Only a fully proportionate (pro rata) share of the total cash flows.
For example, if an entity holds a bond it has the right to two separate sets of
cash inflows: those relating to the principal and those relating to the interest.
It could sell the right to receive the interest to another party while retaining
the right to receive the principal.
In the case of Robby, the substance of the transaction needs to be considered
rather than its legal form. Robby has transferred the receivables to the factor
in exchange for Rs. 3.6m cash, but it is liable for any shortfall between
Rs. 3.6m and the amount collected. In principle, Robby is liable for the whole
Rs. 3.6m, although it is unlikely that the default would be as much as this.
Robby therefore retains the credit risk. In addition, Robby is entitled to
receive the benefit (less interest) of repayments in excess of Rs. 3.6m once
the Rs. 3.6 million has been collected. Therefore, for amounts in excess of
Rs. 3.6m Robby also retains the late payment risk. Substantially all the risks
and rewards of the financial asset therefore remain with Robby, and the
receivables should continue to be recognised.
(c) Sale of land
Ethical behaviour in the preparation of financial statements, and in other
areas, is of paramount importance. This applies equally to preparers of
accounts, to auditors and to accountants giving advice to directors.
Financial statements may be manipulated for all kinds of reasons, for
example to enhance a profit-linked bonus. In this case, the purpose of the
sale and repurchase is to present a misleadingly favourable picture of the
cash position, which hides the fact that the Robby Group has severe liquidity
problems. The extent of the liquidity problems can be seen in the current
ratio of Rs. 36m/Rs. 81.2m = 0.44:1, and the gearing ratio of 0.83, calculated
as follows.
53 + 20 + 21  non –current liabilities  + 3.6  factored receivables  + 16  land option 
Equity interest  including NCI 
113.60
= = 0.83
136.09
The effect of the sale just before the year-end was intended to eliminate the
bank overdraft and improve these ratios, although when the sale of land is
correctly accounted for as a loan, there is no improvement to gearing.
The sale as originally accounted for might forestall proceedings by the bank,
but as the substance of the transaction is a loan, it does not alter the true
position and gives a misleading impression of it.
CA Sri Lanka 205
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Company accountants act unethically if they use 'creative' accounting in

accounts preparation to make the figures look better. To act ethically, the
directors must put the interests of the company and its shareholders first,
and must also have regard to other stakeholders such as potential investors
or lenders. If a treatment does not conform to acceptable accounting
practice, it is not ethical. Acceptable accounting practice includes conformity
with the qualitative characteristics set out in the Conceptual Framework
particularly fair presentation and verifiability. Conformity with the
Conceptual Framework precludes window-dressing transactions such as this,
and so the land needs to be reinstated in the accounts and a current liability
recognised for the repurchase.

29 Ashanti
(a) ASHANTI GROUP
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 30 APRIL 20X5
Rs m
Revenue 1,096.00
Cost of sales (851.00)
Gross profit 245.00
Other income 57.80
Distribution costs (64.00)
Administrative costs (96.01)
Finance income 1.68
Finance costs (32.70)
Share of profit of associate 2.10
Profit before tax 113.87
Income tax expense (49.00)
Profit for the year 64.87
Other comprehensive income (items that will not be reclassified
to profit or loss)
Gain on AFS financial assets 32.00
Gain/loss on property revaluation 19.60
Remeasurement of defined benefit plan (14.00)
Share of other comprehensive income of associate 0.90
Other comprehensive income for the year net of tax 38.50
Total comprehensive income for the year 103.37

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Rs m
Profit attributable to:
Owners of the parent 50.48
Non-controlling interests 14.39
64.87
Total comprehensive income attributable to:
Owners of the parent 82.89
Non-controlling interests 20.48
103.37

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1 Group structure
Ashanti
1 May 20X3 30 April 20X5
70% – 10% = 60%
Bochem
1 May 20X3 1 Nov 20X4
80% – 50% = 30%
Effective interest to
1 Nov 20X4 56%
NCI (bal) 44%
Ceram 100%
Ashanti
Bochem Subsidiary with 30% NCI for whole year

Ceram

Subsidiary with 44% NCI  6 12 30% associate (with 30% NCI by

Ashanti)

1.5.X4
1.11.X4 30.4.X5
2 Goodwill in Bochem
Rs m
Consideration transferred: per 150.0
question/136  70%
Fair value of non-controlling interest 54.0
Fair value of net assets (160.0)
44.0
Impairment loss to 30.4. 20X4: 44  15% (6.6)
37.4
Impairment loss to 30.4.20X5: 44  5% (2.2)
35.2
The impairment loss in the year is recognised by (Rs. m):
DEBIT Administrative costs 2.2
CREDIT Goodwill (SOFP) 2.2
To recognise the impairment of goodwill in the year
As the goodwill is attributable to both the group and the NCI, the loss is
allocated between the owners of Ashanti and the NCI in proportion to
their ownership interests.

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3 Fair value adjustment

Rs m
Fair value of net asset at acquisition 160
Book value of net assets at acquisition (55 + 85 + 10) (150)
Fair value upift 10
The fair value uplift is depreciated over five years, therefore (Rs m):
DEBIT Administrative costs 2
(10 million/5 years)
CREDIT PPE (SOFP) 2
To recognise additional depreciation in the year
4 Disposal of 10% of Bochem
As control is not lost, there is no effect on the consolidated statement of
profit or loss and other comprehensive income.
The sale is, in effect, a transfer between owners (Ashanti and the
non-controlling interest). It is accounted for as an equity transaction
directly in equity, and only reflected in the statement of changes in
equity.
Although no adjustment is required, the disposal journal is shown for
completeness (Rs. m):
DEBIT Cash 34
CREDIT Non-controlling interest (251.2 *  10%) 25.12
CREDIT Adjustment directly to parent's equity 8.88
* Net assets of Bochem at date of sale:
Rs m
Net assets at 30 April 20X5 210.0
FV adjustments (W3) 6.0
216.0
Goodwill (W2) 35.2
251.2
5 Disposal of Ceram
Rs m Rs m
Fair value of consideration received 90.0
Fair value of equity interest retained 45.0
Carrying amount of Ceram at
date of disposal
Net assets 160.0
Goodwill (W6) 6.2
166.2
Less NCI per question (35.0)
(131.2)
3.8

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(i) The disposal is recognised by (Rs m):

DEBIT Cash (SOFP) 90
DEBIT NCI (SOFP) 35
DEBIT Interest in associate (SOFP) 45
CREDIT Net assets (SOFP) 160
CREDIT Goodwill (SOFP) 6.2
CREDIT Other income 3.8
To recognise the gain on the part-disposal of Ceram
The gain is attributable between the owners of the parent and the
NCI in Bochem in proportion to their ownership interests.
(ii) Ceram is now an associate and therefore after the disposal,
the group share of its profit after tax and OCI is recognised as
income from an associate (Rs. m):
DEBIT Investment in associate 3
(SOFP)
CREDIT Share of profit of 2.1
associate (Rs 14m  30%
 6/12 million)
CREDIT Share of OCI of associate 0.9
(Rs 10m  30% 
6/12 million)
To recognise income from Ceram as an associate
This income is attributable to the owners of Ashanti and the NCI in
Bochem in proportion to their ownership interests.
6 Goodwill on acquisition of Ceram
Rs m
Consideration transferred (136m  70%) 95.2
Fair value of non-controlling interest 26.0
Fair value of net assets (115.0)
Goodwill on acquisition 6.2
7 Intragroup sales
(i) Intragroup sales/purchases must be eliminated by (Rs. m):
DEBIT Revenue (10m + 5m) 15
CREDIT Cost of sales 15
To eliminate intragroup sales

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(ii) The unrealised profit on sales from Ashanti to Bochem is

cancelled by (Rs. m):
DEBIT Cost of sales (10  ½  20%) 1
CREDIT Inventory (SOFP) 1
To eliminate the unrealised profit in inventory
As the selling company was Ashanti, the adjustment is attributable to
the owners of Ashanti only.
8 Bond impairment
SLFRS 9 adopted an expected credit loss model to impairment. In order
to calculate the impairment, the carrying amount of the bond at
30 April 20X5 is compared with the present value of future cash flows
associated with the bond. Therefore, the carrying amount at
30 April 20X5 needs to be calculated and adjusted:
Carrying amount Rs m
1 May 20X4 amortised cost 21.046
Effective interest @ 4% 0.842
31 October 20X4 cash received (20  5%) (1.000)
20.888
Effective interest @ 4% 0.836
30 April 20X5 cash received (1.000)
30 April 20X5 carrying amount 20.724
As no accounting entries have been made in the year, the amortisation
of the bond must be recognised by (Rs. m):
DEBIT Cash 2
CREDIT Financial asset (SOFP) (21,046 – 20,724) 0.32
CREDIT Finance income (0.842 + 0.836) 1.68
To recognise amortisation of the bond for the year
There is a significant increase in credit risk since future cash receipts
are less than expected. Therefore, a lifetime expected credit loss should
be recognised.
Present value of future cash flows Rs m
30 April 20X6 Rs 2.34 m  1/1.08 2.167
30 April 20X7 Rs 8 m  1/1.082 6.859
9.026
Therefore a lifetime expected credit loss of Rs. 11.698m (Rs. 20.724m –
Rs. 9.026m) arises. This is rounded and recognised by (Rs. m):
DEBIT Finance costs 11.70
CREDIT Loss allowance 11.70
To recognise the impairment loss on the bond
All amounts are attributable to the owners of Ashanti.

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9 Allowance for receivables

The revenue of Rs. 5 million should not have been recorded, as it is not
probable that future economic benefits from the sale will flow to
Ashanti. The revenue should only be recorded when the customer pays
for the goods.
It is not appropriate to include the Rs. 5 m in the allowance for doubtful
debts of Rs. 8 m, and so the allowance must be limited to Rs. 3 m.
The required adjustments are recorded by (Rs. m):
DEBIT Revenue 5
CREDIT Receivables (SOFP) 5
DEBIT Finance costs (impairment of receivable) 3
CREDIT Allowance for receivables (SOFP) 3
To reverse the recorded revenue and recognise the increase in
allowance for receivables
The costs are allocated to the owners of Ashanti.
10 Property, plant and equipment
Reval'n
SOFP surplus
Rs m Rs m
1 May 20X3 Cost 12.000
Depreciation (12 million/10 years) (1.200)
Revaluation (balancing figure) 2.200 2.200
30 April 20X4 Revalued PPE c/f 13.000
Depreciation for year (13 million/9 years) (1.444)
Transfer to retained earnings: 1.444 – 1.2 (0.244)
1.956
Revaluation loss (balancing figure) (3.556) (1.956)
30 April 20X5 Revalued PPE c/f 8.000 0.000
Ashanti has recorded the revaluation loss by (Rs. m):
DEBIT Other comprehensive income 3.56
CREDIT Property, plant and equipment 3.56
It should have (Rs. m):
DEBIT Other comprehensive income 1.96
DEBIT Profit or loss (balancing figure) 1.6
CREDIT Property, plant and equipment 3.56
Therefore, the journal required to correct the entry is (Rs. m):
DEBIT Administrative costs Rs 1.6 m
CREDIT Other comprehensive income Rs 1.6 m
To correctly recognise the downwards revaluation
The PPE is owned by Ashanti and therefore the loss is attributable to
the owners of the parent only.

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11 Holiday pay accrual

LKAS 19 Employee benefits requires that an accrual be made for holiday
entitlement carried forward to next year.
Number of days c/f: 900  3  95% = 2,565 days
Number of working days: 900  255 = 229,500
2,565
Accrual =  Rs. 19 m = Rs. 0.21 m
229,500
Therefore (Rs. m):
DEBIT Administrative costs 0.21
CREDIT Accruals 0.21
To recognise the holiday accrual
This is attributable to the owners of Ashanti.
(b) Sustainability reporting
Sustainability may also be known as corporate citizenship or social
responsibility. It includes anything from environmental awareness to
involvement in local community issues to modifying business processes to
reduce the operational use of energy resources.
A sustainability report is an organisational report that provides information
about a company's economic, social and environmental performance and
impact. Such reports are becoming increasingly important to stakeholders
who use them to evaluate the long-term viability of a company.
There are a number of factors that encourage companies to provide a
sustainability report with their financial statements.
As stated, public interest in corporate social responsibility is steadily
increasing. Although financial statements are primarily intended for
investors and their advisers, there is growing recognition that companies
actually have a number of different stakeholders. These include customers,
employees and the general public, all of whom are potentially interested in
the way in which a company's operations affect the natural environment and
the wider community.
These stakeholders can have a considerable effect on a company's
performance. As a result, many companies now deliberately attempt to build
a reputation for social, economic and environmental responsibility.
Therefore, the disclosure of sustainability information is essential. There is
also growing recognition that corporate social responsibility is actually an
important part of an entity's overall performance. Responsible practice in
areas such as reduction of damage to the environment and the promotion of
good employee relations increase shareholder value. Companies that act
responsibly and provide sustainability reports are perceived as better
investments than those that do not.
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In the Sri Lanka textiles and apparel industry, and particularly in Ashanti,
it is also the case that excellent practice in employee recruitment and
relations has already been established. This is, in itself, an incentive to
promote sustainability reporting, in that there exists good practice to report
upon.
Another factor is growing interest by governments and professional bodies.
Although there are no SLFRSs that specifically require sustainability
reporting, it may be required by company legislation. There are now a
number of awards for high quality sustainability disclosure in financial
statements. These provide further encouragement to disclose information.
At present companies are normally able to disclose as much or as little
information as they wish in whatever manner that they wish. This causes a
number of problems. Companies tend to disclose information selectively and
it is difficult for users of the financial statements to compare the
performance of different companies. However, there are good arguments for
continuing to allow companies a certain amount of freedom to determine the
information that they disclose. If detailed rules are imposed, companies are
likely to adopt a 'checklist' approach and will present information in a very
general and standardised way, so that it is of very little use to stakeholders.
(c) Management of earnings
'Earnings management' involves exercising judgement with regard to
financial reporting, and structuring transactions so as to achieve stable and
predictable result, and in some cases, give a misleadingly optimistic picture
of a company's performance. This is done with the intention, whether
consciously or not, of influencing outcomes that depend on stakeholders'
assessments. For example, a bank, or a supplier or customer may decide to
do business with a company on the basis of a favourable performance or
position. A director may wish to delay a hit to profit or loss for the year in
order to secure a bonus that depends on profit. Indeed earnings
management, sometimes called 'creative accounting' may be described as
manipulation of the financial reporting process for private gain.
A director may also wish to present the company favourably in order to
maintain a strong position within the market. The motive is not directly
private gain – he or she may be thinking of the company's stakeholders, such
as employees, suppliers or customers – but in the long-term earnings
management is not a substitute for sound and profitable business,
and cannot be sustained.
'Aggressive' earnings management is a form of fraud and differs from
reporting error. Nevertheless, all forms of earnings management may be
ethically questionable, even if not illegal.

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A more positive way of looking at earnings management is to consider the

benefits of not manipulating earnings:
(i) Stakeholders can rely on the data. Word gets around that the company
'tells it like it is' and does not try to bury bad news.
(ii) It encourages management to safeguard the assets and exercise
prudence.
(iii) Management set an example to employees to work harder to make
genuine profits, not arising from the manipulation of accruals.
(iv) Focus on cash flow rather than accounting profits keeps management
anchored in reality.
Earnings management goes against the principle of corporate social
responsibility. Companies have duty not to mislead stakeholders, whether
their own shareholders, suppliers, employees or the government.
Because the temptation to indulge in earnings management may be strong,
particularly in times of financial crisis, it is important to have ethical
frameworks and guidelines in place. The letter of the law may not be enough.

30 Rose
(a) Factors to consider in determining functional currency of Stem
LKAS 21 The effects of changes in foreign exchange rates defines functional
currency as 'the currency of the primary economic environment in which the
entity operates'. Each entity, whether an individual company, a parent of a
group or an operation within a group, should determine its functional
currency and measure its results and financial position in that currency.
An entity should consider the following factors:
(i) What is the currency that mainly influences sales prices for goods and
services (this will often be the currency in which sales prices for its
goods and services are denominated and settled)?
(ii) What is the currency of the country whose competitive forces and
regulations mainly determine the sales prices of its goods and services?
(iii) What is the currency that mainly influences labour, material and other
costs of providing goods or services? (This will often be the currency in
which such costs are denominated and settled.)
Applying the first of these, it appears that Stem's functional currency is the
dinar. The price it charges is denominated and settled in dinars and is
determined by local supply and demand. However, when it comes to costs
and expenses, Stem pays in a mixture of dollars, dinars and the local
currency, so that aspect is less clear-cut.

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Other factors may also provide evidence of an entity's functional currency:

(i) It is the currency in which funds from financing activities are
generated.
(ii) It is the currency in which receipts from operating activities are usually
retained.
Stem does not depend on group companies for finance. Furthermore, Stem
operates with a considerable degree of autonomy, and is not under the
control of the parent as regards finance or management. It also generates
sufficient cash flows to meet its cash needs. These aspects point away from
the dollar as the functional currency.
The position is not clear cut, and there are arguments on both sides.
However, on balance it is the dinar that should be considered as the
functional currency, since this most faithfully represents the economic
reality of the transactions, both operating and financing, and the autonomy
of Stem in relation to the parent company.
(b) ROSE GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT
30 APRIL 20X8
Rs m
Non-current assets
Property, plant and equipment 603.65
Goodwill 22.20
Intangible assets 3.00
Financial assets 32.00
660.85
Current assets 284.00
944.85
Equity and liabilities
Share capital 158.00
Retained earnings 277.39
Other components of equity 6.98
442.37
Non-controlling interests 89.83
532.20

Non-current liabilities 130.65

Current liabilities 282.00
412.65
944.85

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1 Group structure
Rose

1 May 20X7 30 April 20X8 1 May 20X7

70% 10% = 80% 52%

Cost Rs. 94m + Rs. 19m Cost Rs. 46m

FV NCI Rs. 46m 80% 52% FV NCI 250m dinars
FV NA Rs. 120m FV NA 495m dinars
RE Rs. 49m RE 220m dinars
OCE Rs. 3m Petal Stem OCE
2 Translation of SOFP of Stem at 30 April 20X8
Dinars (m) Rate Rs m
Property, plant and equipment 380 5 76.00
Financial assets 50 5 10.00
Current assets 330 5 66.00
760 152.00
Share capital 200 6 33.33
Retained earnings
Pre-acqn 220 6
36.67
Post-acqn 80 5.8 13.79
FX Reserve – (W3) 16.21
500 100.00
Non-current liabilities 160 5 32.00
Current liabilities 100 5 20.00
760 152.00
3 Exchange difference arising on translation
Rs m Rs m
Opening net assets (200m + 220m)
At opening rate of 6 70
At closing rate of 5 84
Gain 14
Retained profit for the year (80m)
At average rate of 5.8 13.79
At closing rate of 5 16
Gain 2.21
Gain recognised as OCI of Stem and 16.21
accumulated in foreign exchange reserve

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4 Acquisition of Petal
(i) Goodwill Rs m
Consideration transferred 94
Fair value of non-controlling interests 46
Fair value of identifiable net assets at acquisition:
Stated capital (38)
Retained earnings (49)
Other components of equity (3)
Patent (4)
Fair value adjustment – land (120 – 38 – 49 – 3) (30)
16
This is recognised by (Rs. m):
DEBIT Goodwill 16
DEBIT Stated capital 38
DEBIT Retained earnings 49
DEBIT Other components of equity 3
DEBIT Intangible assets 4
DEBIT PPE 30
CREDIT Investment in P 94
CREDIT NCI 46
To recognise the acquisition of Petal and resulting goodwill
(ii) The intangible asset is amortised over four years. Amortisation to
date is Rs. 1 million (4 million/4 years). It is recognised by
(Rs. m):
DEBIT Retained earnings 0.7
(70%  1 million)
DEBIT NCI (30%  1 million) 0.3
CREDIT Intangible assets 1
To recognise amortisation on the intangible asset recognised on
consolidation
5 Acquisition of Stem
(i) Goodwill is calculated as:
Dinars Rate Rs m
(m)
Consideration transferred
(Rs 46m  6) 276 6 46.00
Non-controlling interests 250 6 41.67
Less fair value of net assets at acq'n
Stated capital (200) 6 (33.33)
Retained earnings (220) 6 (36.67)
FV adjustment to land (75) 6 (12.5)
At 1 May 20X7 31 6 5.17

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This is recognised by (Rs. m):

DEBIT Goodwill 5.17
DEBIT Stated capital 33.33
DEBIT Retained earnings 36.67
DEBIT PPE 12.5
CREDIT Investment in P 46
CREDIT NCI 41.67
To recognise the acquisition of Stem and resulting goodwill
(ii) Goodwill is retranslated at the year-end using the closing rate to
Rs. 6.2 m (31 million/5). Therefore, a gain of Rs. 1.03 m is
recognised. This is allocated between the owners of Rose and the
NCI in Stem by (Rs. m):
DEBIT Goodwill 1.03
CREDIT NCI (48%  1.03m) 0.49
CREDIT FX reserve 0.54
(52%  1.03m)
To recognise the retranslation of goodwill using the closing rate
(iii) The fair value adjustment is also retranslated at the year-end
using the closing rate to Rs. 15 m (75 million/5). The Rs. 2.5 m
gain is allocated between the owners of Rose and the NCI. It is
recognised by (Rs. m):
DEBIT PPE 2.5
CREDIT FX Reserve (52%  2.5) 1.3
CREDIT NCI (48%  2.5) 1.2
To recognise the retranslation of the fair value adjustment using
the closing rate
6 Allocation of post-acquisition reserves movements to the NCI
Petal Stem
Retained Retained FX
earnings OCE earnings reserve
Rs m Rs m Rs m Rs m
At reporting date 56 4 50.46 16.21
At acquisition (49) (3) (36.67) –
Post-acquisition 7 1 13.79 16.21
NCI share 2.1 0.3 6.62 7.78
(30%/48%)

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The NCI share of reserves movements are allocated by:

DEBIT Retained earnings 8.72
(2.1 + 6.62)
DEBIT Other components of equity 0.3
DEBIT FX reserve 7.78
CREDIT NCI 16.8
To allocate the NCI its share of post-acquisition profits and OCI
7 Rose – property
Dinars m Rs m
Cost at 1 May 20X7 30 @ 6 dinars: Rs. 1 5.00
Depreciation (30 million/20) (1.5) 5 million/ 20yrs (0.25)
Carrying amount
at 30 April 20X8 28.5 4.75
Revaluation (balancing figure) 6.5 2.25
Revalued amount
at 30 April 20X8 35 @ 5 dinars: Rs. 1 7.00
The revaluation surplus of Rs. 2.25 m is recognised in other
components of equity by (Rs. m):
DEBIT PPE 2.25
CREDIT OCE 2.25
To recognise the revaluation surplus
8 Bonus scheme
The cumulative bonus payable is Rs. 4.42 m, calculated as follows,
with a 5% annual increase:
Bonus as at: Rs m
30 April 20X8 Rs 40 m  2% 0.800
30 April 20X9 Rs 0.8 m  1.05 0.840
30 April 20Y0 Rs 0.8 m  1.052 0.882
30 April 20Y1 Rs 0.8 m  1.053 0.926
30 April 20Y2 Rs 0.8 m  1.054 0.972
4.420
This is Rs. 884,000 (Rs. 4.42/5 years) per year. The current service cost
is the present value of Rs. 884,000 at 30 April 20X8: Rs. 884,000 
1/1.084 = Rs. 0.65 m.
This is recorded by (Rs. m):
DEBIT Retained earnings 0.65
CREDIT Non-current liabilities 0.65
To recognise the long-term bonus scheme

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9 Rose – plant
The change in residual value is a change in accounting estimate and is
applied prospectively from the date of change (1 May 20X7):
Rs m Rs m
Depreciation for the year based on (20 – 1.4) ÷ 6 3.10
original residual value
Depreciation for the year based on (20 – (3.1  3 years) 2.70
revised amount – 2.6) ÷ 3 years
Adjustment 0.40

The adjustment is recognised by (Rs. m):

DEBIT PPE 0.4
CREDIT Retained earnings 0.4
To record depreciation correctly based on the revised residual value
10 Increased shareholding in Petal
The subsequent acquisition of a 10% holding in Petal for Rs. 19 million
has been recognised by Rose by:
DEBIT Investment in P 19
CREDIT Cash 19
In the consolidated accounts this acquisition is dealt with as a
transaction between shareholders and is accounted for by adjusting
the carrying amount of the NCI from 30% to 20%. The amount of the
decrease is calculated in W5 as Rs. 16.03m. The adjustment to parent's
equity, which is recognised in other components of equity is calculated
as follows.
Rs m
NCI at acquisition (W4(i)) 46.00
NCI share of amortisation of intangible (W4(ii)) (0.3)
NCI share of post-acq. retained earnings (W6) 2.1

NCI share of post-acquisition OCE (W6) 0.3

48.10
Adjustment 10%/30%  Rs 48.1 million 16.03

The adjustment to NCI is recognised in the parent's equity by (Rs m):

DEBIT Non-controlling interest 16.03
DEBIT Other components of equity 2.97
(balancing figure)
CREDIT Investment in P 19
To eliminate the cost of the 10% investment in Petal and adjust equity
to reflect the acquisition

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(c) Acquisition of MineConsult Co

Rose's proposed valuation of MineConsult Co's assets (based on what it is
prepared to pay for them, which is, in turn, influenced by future plans for the
business) does not comply with SLFRS.
Such a valuation needs to be based on the following SLFRS.
(i) SLFRS 3 Business combinations. Under SLFRS 3, an acquirer must
allocate the cost of a business combination by recognising the
acquiree's identifiable assets, liabilities and contingent liabilities that
satisfy the recognition criteria at their fair values at the date of the
acquisition.
(ii) SLFRS 13 Fair value measurement defines fair value as as 'the price that
would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement
date.' This is also known as 'exit price'.
(iii) LKAS 38 Intangible assets states that intangible assets acquired in
business combinations can normally be measured sufficiently reliably
to be recognised separately from goodwill.
Measuring MineConsult Co's assets on the basis of their value to Rose does
not accord with the above standards. First, the standards may recognise as
assets items that Rose does not identify. Secondly, there has been no attempt
to apply the SLFRS 13 definition of fair value, which specifies the price that
would be paid by market participants and implies that Rose's judgement
alone would not be sufficient.
With respect to the contract-based customer relationships that MineConsult
Co has, in proposing to value these at zero on the grounds that Rose already
has good relationships with customers, Rose is failing to apply LKAS 38.
Under LKAS 38, part of the cost of the acquisition should be allocated to
these relationships, which will have a value separate from goodwill at the
date of the acquisition. The fair value of the customer relationships should
not be based on Rose's judgement of their worth but on that of a market
participant such as a well-informed buyer.
Ethical behaviour in the preparation of financial statements, and in other
areas, is of paramount importance. Directors and company accountants act
unethically if they use 'creative' accounting in accounts preparation to make
the figures look better, in particular if their treatment would mislead users,
as here. Motivation for misleading treatments can include market
expectations, market position or expectation of a bonus.
To act ethically, the directors must put the interests of the company and its
shareholders first and must also have regard to other stakeholders such as
potential investors or lenders. If a treatment does not conform to acceptable
accounting practice, it is not ethical.

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If the aim of the proposed treatment is to deliberately mislead users of

financial statements, then it is unethical, and should not be put into practice.
It is possible that non-compliance with SLFRS 3, SLFRS 13 and LKAS 38 is a
genuine mistake. If so, the mistake needs to be corrected in order to act
ethically. There is, in any case a duty of professional competence in the
preparation of financial statements, which would entail keeping up to date
with SLFRS and local legislation.

31 Warrburt
(a) WARRBURT GROUP
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 NOVEMBER 20X8
Rs m Rs m
Operating activities
Net loss before tax (47)
Adjustments for
Gain on revaluation of investment in equity
instruments (7)
(Alburt – fair value on disposal less FV at 1.12.X7 (W1)
Retirement benefit expense 10
Depreciation 36
Profit on sale of property plant and equipment: (7)
Rs. 63m – Rs. 56m
Profit on insurance claim: Rs. 3m – Rs. 1m (2)
Foreign exchange loss (W6) Rs. 1.1m + Rs. 0.83m 2
Share of profit of associate (6)
Impairment losses: Rs. 20m + Rs. 12 m 32
Interest expense 9
20
Decrease in trade receivables (W4) 71
Decrease in inventories (W4) 63
Decrease in trade payables (W4) (86)
Cash generated from operations 68
Retirement benefit contributions* (10)
Interest paid (W5) (8)
Income taxes paid (W3) (39)
Net cash from operating activities 11
Investing activities
Purchase of PPE: Rs. 56m (W1) + Rs. 1.1m (W6) (57)
Proceeds from sale of property, plant and equipment 63
Proceeds from sale of financial asset investments 45
Acquisition of associate (W1) (96)
Dividend received from associate: (W1) 2
Net cash used in investing activities (43)

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Rs m Rs m
Financing activities
Proceeds from issue of ordinary shares (W2) 55
Repayment of long-term borrowings (W3) (44)
Dividends paid (9)
Dividends paid to non-controlling shareholders (W3) (5)
Net cash used in financing activities (3)
Net decrease in cash and cash equivalents (35)
Cash and cash equivalents at beginning of year 323
Cash and cash equivalents at end of year 288
*Note. Only the contributions paid are reported in the cash flow, because
this is the only movement of cash. The amounts paid by the trustees are not
included, because they are not paid by the company.
Workings
1 Assets
Intan. Financial
PPE Goodwill assets Associate assets
Rs m Rs m Rs m Rs m Rs m
b/f 360 100 240 0 150
P/L 6
OCI (revaluation) 4 30**
FV gain on investment 7
in Alburt
Dep'n/Impairment/ (36) (20) β (12) β
Acquisition of 96
associate
Asset destroyed (1)
Replacement from ins. 3
company (at FV)
Disposals (56)
Non-cash additions (on 20
credit)*
8  25%
Cash paid/(rec'd) 56 0 0 (2) (45)
c/f 350 80 228 100 142
Bold figures in the table above are calculated as balancing figures.
Notes
*The additions are translated at the historic rate. Adjustment for
exchange rate differences are dealt with in (W9).

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Rs m
280 56
Additions (cash)
5
100 20
Additions (credit)
5
Total (excluding destroyed assets replaced): 78 – (3 – 1) 76
**This is the gain on revaluation, which is shown in the statement of
profit or loss and other comprehensive income net of deferred tax of
Rs. 3m (W3), that is at Rs. 27m. The gross gain is therefore Rs. 30m and
is the amount reflected in this working.
2 Equity
Stated Retained Reval
capital earnings Surplus OCE NCI
Rs m Rs m Rs m Rs m Rs m
b/f 595 454 4 16 53
P/L (74) (2)
OCI 2 23
Cash (paid)/rec'd 55 (9) ** (5) **
c/f 650 371 6 39 46

**Cash flow given in question, but working shown for clarity

3 Liabilities
Long-term Retirement benefit
borrowings Tax payable liability
Rs m Rs m Rs m
b/f 64 (26 + 42) 68 96
P/L 29 10
OCI (3 + 2) * 4
5
Cash (paid)/rec'd (44) (39) (10)**
c/f 20 63 100
(28+ 35)
Bold figures in the table above are calculated as balancing figures.
*On revaluation gain on PPE + revaluation gain on AFS financial assets
**Only the contributions paid are reported in the cash flow, because
this is the only movement of cash. The amounts paid by the trustees
are not included, because they are not paid by the company.

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4 Working capital changes

Inventories Trade receivables Trade payables
Rs m Rs m Rs m
b/f 198 163 180.00
Exchange loss (W6) 20.83
Increase/(decrease) (63) (71) (85.83)
c/f 135 92 115
Bold figures in the table above are calculated as balancing figures.
5 Interest payable
Rs m
Balance b/f (short-term provisions) 4
Profit or loss for year 9
Cash paid (balancing figure) (8)
Balance c/f (short-term provisions) 5
6 Exchange loss
At 30 June 20X8:
DEBIT 380 Rs. 76 m
Property, plant and equipment (W1)
5
CREDIT 380 Rs. 76 m
Payables
5
To record purchase of property, plant and equipment
At 31 October 20X8:
DEBIT 280 Rs. 56 m
Payables
5
DEBIT Profit/loss (loss) Rs. 1.1 m
CREDIT 280 Rs. 57.1 m
Cash
4.9
To record payment of 280 million dinars
At 30 November 20X8:
DEBIT P/L (loss) Rs. 0.83 m
CREDIT Rs. 0.83 m
Payables  100 = 20.83  –  100 = 20 
   
 4.8   5 

To record loss on re-translation of payable at the year end

Notes
1 The Rs. 20.83 million was wrongly included in trade payables, so
must be removed from the decrease in trade payables in the SOCF.
2 The unrealised loss on retranslation of the payable (Rs. 0.83 m)
must always be adjusted. The realised loss on the cash payment
of Rs. 1.1 would not normally be adjusted, but it relates to a non-
operating item, so is transferred to 'purchase of PPE'.

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(b) Key issues arising from the statement of cash flows

Cash is the lifeblood of business, and is less able to be manipulated than
profit. It is particularly important to look at where the cash has come from
and what it has been spent on.
If cash coming into a business is from trading activity, rather than,
for example, a share issue, this is sustainable and is likely to continue into
the future.
If cash has been spent on, for example, acquiring non-current assets, this is
investment in the future of the company and is likely to increase or maintain
revenue levels in coming years. Conversely, cash spent on the payment of
dividends, although it provides a necessary return to investors, is lost to the
company.
Although Warrburt has made a loss before tax of Rs. 47 million, net cash
generated by operations is Rs. 68m. This indicates that the loss is in some
part due to the effect of accounting policies and conventions. In the case of
Warburrt, for example, the non-cash expenses of depreciation and
impairment total Rs. 68 million.
Having taken account of these and other items, but before adjusting for
changes in working capital, the loss before tax becomes a positive cash
inflow of Rs. 20 million.
The question arises, however, as to whether this cash generation can
continue if profitability does not improve.
The cash inflow from operations further benefits from decreasing the levels
of cash tied up in receivables and inventories. The Rs. 134 million cash
released by this action more than offsets the cash used to achieve a
reduction in the level of trade payables.
Although the effect of working capital management on the cash flows of
Warburrt is beneficial, the effect on the business should also be considered. A
decrease in trade receivables and inventories in this case may be related to a
fall in trading levels; the reduction of trade receivables, whilst releasing cash,
may be the result of aggressively chasing (and so alienating) customers; the
reduction of inventories may result in future supply problems.
The Rs. 68 million cash generated by operations adequately covers the
mandatory operating cash outflows to meet interest and tax commitments,
as well as the defined benefit pension contribution. This leaves a 'free cash
flow' of Rs. 11 million.
Other than those arising from operating activities, further cash inflows arise
from the sale of PPE and financial asset investments, and the proceeds of
share issues. None of these are sustainable sources of cash in the long term,
however they are acceptable where 'matched' with a cash outflow.

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The proceeds from sale of PPE, for example, is offset to some extent by
expenditure on new PPE, indicating that Warburrt has not decreased its
non-current asset base and continues to invest in PPE for the future good of
the group.
The proceeds from sale of financial asset investments have clearly been used
to invest in H200h, which will provide dividend income as well as capital
growth in the future.
Equally, the proceeds of the share issue appear to have been used in part to
fund the repayment of long-term borrowings. This is encouraging because
gearing will reduce, which is particularly important in the light of possible
problems sustaining profitability and cash flows from trading activities.
The level of dividends is modest given other cash flows, and appears to
provide shareholders with an acceptable return on their investment.
Overall, there is a net cash outflow of Rs. 35 million. It can be concluded that
this is largely due to the high cost of the investment in H200h, which is not
wholly covered by the cash raised from the sale of other assets; in other
words, cash is tied up in long-term rather than short-term investment.
It will be the intention of the directors of Warburrt that this investment
should generate future profits that will sustain and increase the operating
cash flow of the group, however whether this is achieved remains to be seen.
(c) Ethical responsibility of Sharmini Cooper
Directors may, particularly in times of falling profit and cash flow, wish to
present a company's results in a favourable light. This may involve
manipulation by creative accounting techniques such as window dressing,
or, as is proposed here, an inaccurate classification.
If the proceeds of the sale of financial asset investments and property,
plant and equipment are presented in the statement of cash flows as part of
'cash generated from operations', the picture is misleading. Operating cash
flow is crucial, in the long term, for the survival of the company, because it
derives from trading activities, which is the purpose of the company's
existence. Sales of assets generate short term cash flows that cannot be
repeated year-on-year, unless there are to be no assets left to generate
trading profits with.
As a professional, Ms Cooper has a duty, not only to the company she works
for, but to CASL, stakeholders in the company, and to the principles of
independence and fair presentation of financial statements. It is essential that
Ms Cooper tries to persuade the CEO and Managing Director not to proceed
with the adjustments, which she must know violates LKAS 7, and may well go
against the requirements of local legislation. If, despite Sharmini Cooper's
protests, the two directors insist on the misleading presentation, then Ms
Cooper has a duty to bring this to the attention of the auditors.

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32 Nandasiri Ltd.
(a) Evaluation of business risks
Overseas supplier
Copper wiring is a key production material and is imported from overseas.
There is therefore a risk of unstable supply as a result of it being transported
over a long distance, across borders. Any of the following could pose
problems:
 A rise in fuel prices could affect the cost of materials.
 Political instability could lead to difficulties transporting across borders.
 Goods may not be subject to the same regulatory standards as those in
Nandasiri's own jurisdiction and could be of poor quality.
 Environmental disruption could affect eg shipping or aviation, and lead to
disruption of the supply of materials.
If there were a stock-out of this key material, then this would severely affect
Nandasiri Ltd's production and its ability to supply its customers. This could
lead to a loss of revenue and of customer goodwill.
Exchange rate risk
Purchases are made in a foreign currency, and fluctuations are not hedged
against. This leaves Nandasiri Ltd exposed to the risk of price rises, which
could affect both its cash position and its short-term profitability. It may be
advisable for the company to use forward contracts to help mitigate this risk.
Key supplier
Nandasiri Ltd is reliant on just one supplier for all its copper wiring. It is
thus exposed to any risks resulting from problems with this supplier, eg
price rises, problems with supply, quality control.
Nandasiri Ltd also moved all of its copper purchases to just one new
supplier, before first using the supplier for a trial period. It was therefore
highly exposed to any problems with the new supplier.
Competitive pressure
Nandasiri Ltd operates in a competitive industry and is subject to price
competition from overseas. There is a risk that Nandasiri will be unable to
keep its prices low enough to compete on this basis. It may need to consider
alternative strategies.
The industry is dynamic and subject to rapid change, so in order to remain
competitive Nandasiri Ltd must adapt quickly to any changes. It may not
have sufficient resources to do this.

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Quality control
Quality problems with the new copper supply have led to goods being
returned by customers. This seems likely to be related to the use of a new,
cheaper supplier. There is a risk of losing customers as a result of poor-quality
products, which may be particularly dangerous in this competitive market.
It may be necessary in future for Nandasiri Ltd to test the quality of copper
purchased. This would incur costs, which would in turn put further pressure
on Nandasiri Ltd's already tight operating margins.
New regulations
New regulations come into force after the year end. There is a risk that these
may not be complied with, which could lead to significant penalties. These
could be fines, or could result in suspending production.
New loan
The new Rs. 30m loan is significant at 1/6 (16.7%) of total assets. It is not
known what proportion of net assets this constitutes. Annual interest on the
loan is 4%  Rs. 30m = Rs. 1.2m, which is a significant amount in the context
of a loss of Rs. 300,000 before tax and a cash balance of only Rs. 130,000.
The fact that Nandasiri Ltd has a Rs. 2.5m overdraft may be indicative of a
cash shortage, a view that is borne out by low current and quick ratios.
There is a risk that Nandasiri Ltd may not be a going concern for the next
year.
Management change
The loss of several executive directors means that key business expertise has
been lost, which might have been especially important given Nandasiri Ltd's
current financial position.
Website sales
The introduction of website sales brings with it several risks. These include
the risk of non-compliance with taxation, legal and other regulatory issues.
There is a risk of technological failure (crashes) resulting in business
interruption and possible brand damage.
There is a significant security risk from virus attacks, which could result in
loss of company or customer data. This may in turn have legal ramifications.
The high rate of returns from the website is a concern, as this may indicate a
flaw in the design of the website.
On balance the website is likely to help improve Nandasiri Ltd's sales, but it
is notable that prices have been reduced by 10%. There is a risk of lost
revenue if this reduction has not been given adequate consideration.

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Outsourcing
Nandasiri Ltd has outsourced both its new website and the delivery service
from it, which brings a risk that the services provided may not be of
sufficient quality. Nandasiri Ltd is now reliant on two external entities for
key elements of its business, over which it has now relinquished control.
There is also a cost risk with outsourced services, as they may be more
expensive than performing the service in-house.
Profitability
Draft revenue is down by Rs. 1.3m from 20X1, or 9.4%. Operating profit has
fallen by Rs. 500,000, or 50%, and the operating margin has fallen from 7.2%
to 4%, a fall of 44%. Nandasiri Ltd has made a pre-tax loss of Rs. 300,000,
although this does not appear to include the finance costs from the new loan
(finance costs for 20X2 are the same as 20X1). If these were included, then
the loss would be about Rs. 0.5m higher, at Rs. 0.8m. This is a large loss and
may again indicate going concern problems.
(b) Risks of material misstatement
Foreign exchange
There is a risk of non-compliance with LKAS 21 The Effects of Changes in
Foreign Exchange Rates. LKAS 21 requires that non-monetary items are
recognised at the historical rate, which is the rate at the date of the
transaction. This would include income and expenses in the statement of
profit or loss. There is a risk that non-monetary items are not recognised at
the correct historical rate, leading to under- or over-statement of these items.
LKAS 21 requires monetary items to be measured at the closing rate. Thus
any foreign currency payables and receivables must be retranslated at the
year end, with any exchange gain or loss being recognised in the statement
of profit or loss. There is a risk that the wrong rate is used, or that items are
translated using the wrong date. There is also a risk that no exchange gain or
loss is recognised in relation to payables and receivables settled during the
year.
Product recall
Nandasiri Ltd may be liable to customers in relation to faulty goods supplied.
Although the issue appears to be resolved, it is possible that there may be
further liabilities which should be recognised in line with LKAS 37
Provisions, Contingent Liabilities and Contingent Assets. There is thus a risk
that provisions are understated.
There is a risk that the accounting treatment of the product recall was
incorrect. Any revenue recognised on recalled items should be cancelled
against the corresponding receivables balance. The risk is therefore that
revenue and receivables may be overstated.
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New production line

The construction of the new production line is likely to result in new non-
current assets which should be recognised in line with LKAS 16 Property,
Plant and Equipment. There is a risk that this has not been done correctly,
leading to either under or over statement of assets.
The production line is likely to be a qualifying asset in line with LKAS 23
Borrowing Costs, so all directly attributable borrowing costs should be
capitalised. It is not clear how much of the Rs. 0.5m finance cost from the
new loan would be capitalised, as the loan appears to have been used only
'mainly' for the new production line.
Old production line – impairment
The new regulations coming into force after the year end indicate that the
existing production may be impaired. LKAS 36 Impairment of Assets requires
management to conduct an impairment review. If this is not done
adequately, then non-current assets and profit may be overstated.
Inventory obsolescence
There is a risk that some inventory may have been rendered un-useable by
the use of corroded copper. The matter is complicated by the fact that testing
is required to determine whether an item has been affected.
LKAS 2 Inventories requires inventory to be carried at the lower of cost and
net realisable value. There is a danger that obsolete inventory has been
included in the financial statements without being reviewed for impairment,
resulting in an overstatement of inventory.
Website development costs
Website development costs may be treated as an internally generated
intangible asset according to LKAS 38 Intangible Assets, provided that the
appropriate conditions are satisfied.
LKAS 38 requires the website to be feasible, which seems to be the case
since it is operational. Similarly, the costs appear to be able to be measured
reliably at Rs. 2,000,000. There is a risk, however, that subsequent costs
have been included within this figure, which could result in assets being
overstated and expenses understated.
Website sales
A key risk is the use of an outsourced service provider. The website sales are
likely to be material to Nandasiri Ltd as they make up around a quarter of
revenue, even though they have only been launched for half a year. The
outsourced service therefore constitutes a key element of Nandasiri Ltd's
internal control systems, so it will need to be assessed carefully.

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Going concern
As indicated in the evaluation of business risks, there may be going concern
problems at Nandasiri Ltd. The risk is either that the financial statements are
prepared on the going concern basis when they should not be, or that
appropriate disclosures are not made regarding any significant doubts over
going concern.
(c) Indicators of potential fraud
SLAuS 240 sets out risk indicators that an auditor should be aware of when
assessing the risk of material misstatement due to fraud and there are
several of these indicators apparent in Nandasiri Ltd.
Pressure on management related to performance of the company
The recent poor performance of the company means that management will
be under pressure to improve results and show the company in a good light.
The losses suffered in the 20X2 financial statements combined with the
ongoing losses now apparent in the first few months of the current reporting
period are sufficient to indicate a risk that management may attempt to
manipulate the financial statements or make decisions that would otherwise
not be considered and could constitute fraud as evidenced by the decisions
regarding the loan (see below).
There is a significant personal incentive to ensure the success of the
company for management, not least because their jobs will rely on the
continuation of it and this factor is one that contributes to the increased risk
of fraud through such pressure.
Personal guarantee taken out by the CEO
The CEO has personally guaranteed the company loan on personal assets.
This is a significant risk as the CEO now stands to lose not only their job in
the event of the insolvency of the company, but their personal assets as well.
It would appear that this is what has incentivised the potentially fraudulent
behaviour related to the bank loan outlined below. The fact that the CEO has
the personal wealth to be able to place such guarantees should also be
considered a risk factor as this may be indicative of a lifestyle that is
inconsistent with the known income of the CEO. In such circumstances the
auditor should determine whether there is the potential for the wealth to
have been obtained through the company by illegal means and could be
indicative of a longer-term fraud.
Financial controller leaving
The financial controller was appointed recently as a result of the previous
financial controller leaving with other directors to set up their own
company. This is a high level of turnover of staff, and particularly staff in
very senior positions within the organisation. This again is a fraud risk factor

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as the staff who have resigned may have done so or been forced to do so as a
result of discovering or suspecting fraudulent activity.
The most recent departure of the financial controller due to a disagreement
with the aggressive accounting treatments could be a reference to potential
fraud or suspicions of fraud that meant that they did not want to be
employed by the company. The ramifications of an accountant being
involved with a company involved in fraudulent trading or fraudulent
financial reporting mean that once they become aware of irregularities they
may simply leave.
Change in legal advisor
Frequent changes of legal advisor is a fraud risk factor. The company may
have changed their advisor if the original provider did not give the advice
they wanted in relation to potential fraud or the legality of the company to
continue trade if it could be considered to be insolvent. In such a case the
directors may have decided to appoint a legal advisor who did not know all
the facts or to whom all the facts were not disclosed by the directors. In such
a case the directors could obtain the advice that suited their needs by
revealing only what supported their own position to the new legal advisor.
Complexity and lack of transparency related to the loan arrangements.
Nandasiri Ltd. seem to have bought a substantial quantity of goods on credit
in order to ensure that the bank will have sufficient secured assets to cover
its debt without having to call in the personal guarantee on the directors'
house. The amounts involved in this transaction may be grounds for
additional suspicion that the directors' actions were intended to defraud
creditors – the inventory balance is now Rs30m (14m + 16m) which is just
enough to cover the bank's secured loan. The transaction will thereby
effectively transfer the losses which the directors would otherwise suffer
under their personal guarantees to the bank onto the company's unsecured
creditors. If the transaction has been intentionally designed to achieve this
outcome this would constitute fraud.
(d) Possible Implications
Going Concern Status
The auditor must consider whether the going concern assumption is valid in
the current circumstances. There would appear to be sufficient evidence to
suggest that the going concern assumption may not be appropriate as even
prior to the current information there was a doubt as to whether Nandasiri
Ltd constituted a going concern.
The auditor has already come to the conclusion that the company has no
realistic prospect of paying the supplier from whom they purchased the
inventory for the foreseeable future. All of this would suggest that the

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auditor may have to disagree with management's assessment of going

concern.
The auditor will need to discuss the situation with the directors of Nandasiri
Ltd. and determine whether they have plans for the future that will improve
the situation over the coming months. This is complicated by the fact that
the auditor may well now suspect that the directors have undertaken a
transaction designed to defraud creditors and may cast doubt on any
assertions that the management team make.
Assuming that the transaction can be shown by the directors not to be of
fraudulent intention and that there is only the issue of a potential inability
to pay the creditors on time then it will be for the directors to convince the
auditor that they have sufficient plans to address the issue. If the auditor
does not agree with the going concern assumption, they should ask
management to prepare the financial statements on the break-up basis and,
if management refuse, should issue an adverse audit opinion.
If the auditor agrees that the company is a going concern and that the
assumption is appropriate, the situation is at the very least one that
constitutes a material uncertainty or several uncertainties in relation to
going concern and as such will require adequate disclosure by management
in the financial statements. An appropriate disclosure note should be drafted
by management and the auditor should review it to determine whether the
level of disclosure is adequate.
If the disclosure is adequate, then the auditor should draw the attention of
the users to the disclosure note in the going concern paragraph of the audit
report. If the disclosure is inadequate the auditor should issue a qualified or
adverse opinion.
If the auditor comes to the conclusion that there has been an attempt to
defraud the creditors of Nandasiri Ltd. then they should disclose the matter
to those charged with governance. However, the fact that the CEO is part of
the fraudulent transaction means that it may be the audit committee (if one
exists) that would be informed of the matter. The auditor would also
consider whether it would be appropriate to disclose this information to
parties outside the entity such as the legal authorities.

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33 Healthwise
(a) Statement of profit and loss
Overall, Healthwise Ltd revenue has risen by 9.6% to Rs. 137,410 million.
However, profit before taxation has actually decreased by 0.6% to 10,372
million. Procedures to confirm correct revenue recognition are required the
contract nature of some of Healthwise's revenue activities.
Cost of sales has fallen by 3.8% despite divisional growth. Whilst measures
to control costs have been made this year, the extent of the reduction in cost
creates an audit risk that costs may be understated and procedures to test
understatement should be included in the audit plan.
As both revenue and cost results are not within expectation then analysis of
performance by division is required.
Divisional performance analysis
Profit
before
Revenue tax Margin
20X5 20X4 20X5 20X4 20X5 20X4
% %
Rs m Rs m Rs m Rs m Margin Margin
Healthwise
45,103 43,847 4,356 4,186 9.7% 9.5%
Care
Equipment 41,102 32,882 4,640 2,800 11.3% 8.5%

Senior Care 21,210 20,708 613 565 2.9% 2.7%

Aesthetics 10,302 1,375 980 2,730 9.5% 24.0%

Pharma 19,693 16,590 2,330 2,821 11.8% 17.0%

Total 137,410 125,402 12,919 13,102 9.4% 10.4%

Revenue and profit before tax for Healthwise Care and Senior Care divisions
have both increased in line with expectations. The low margin in Senior Care
is low compared with the rest of the company. The reasons for this need to
be explained by management as part of the audit.
Equipment division revenue has increased by 25% from 20X4 and profit
before tax has increased by a significant amount of 66%. The profit before
tax margin has increased to 11.3%.The equipment division has expanded
and secured a new contract to supply medical equipment this year which
could explain some of this change. The one contract we have details of has
revenue of Rs. 1,575 million which only explains 19% of the increase in
revenue in 20X5. Additional information and breakdowns will be required to

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help our risk assessment. In particular the profit margin on the supply of
new equipment would be required to understand the impact they have had.
Aesthetics division revenue has fallen by 10% but more of a concern is that
profit before tax has fallen by 64% with the profit margin falling significantly
from 24% to 9.5%. This is a significant concern especially as this year's
profit figure is much lower than forecast. We need to ensure we understand
the reasons for the changes and that these relate to changes in the business.
Pharma revenue has increased by 19% which contrasts with the decline in
profit before tax of 17%. The Pharma division is intended to save costs by
other divisions sourcing pharmaceuticals products from them and they could
have been transferring these to other divisions at a reduced price. An
additional reason could be high research costs which have decreased profit.
For research and development costs, the audit must establish if capitalisation
criteria set out in LKAS 38 has now been met given the new drug is now with
the Sri Lanka Government for approval. Therefore, there is a risk that 20X5
research expenditure will require adjustment as capitalisation would require
this cost to be recognised as an intangible asset in the statement of financial
position.
Statement of financial position
The value of non-current assets have increased significantly by 48.3%. The
majority of the increase is due to a revaluation of property to current value,
however, the increase is significant, and increases risk of misstatement if
this is not supported by an independent valuation. Also, LKAS 16 requires
impairment testing as an item of property, plant, or equipment shall not be
carried at more than recoverable amount. Gaining assurance that the
recoverable amount is higher than the fair value less costs to sell and its
value in use will be required.
Inventory has risen by 178.1% which may be due to expansion in certain
divisions and the new contract to supply equipment. However, the size of the
increase in inventory increases audit risk. Evidence to confirm existence,
valuation and cut-off of inventory will need to be particular areas of focus.
Receivables have risen by 94.4% which is significantly higher than the
overall revenue increase of 9.6%. This highlights a potential recovery issue.
If there has been a rise in unsatisfied customers of the Aesthetics division
who are refusing to pay then this raises the risk of material overstatement.
Payables have risen by 111.3% despite overall cost of sales falling by 3.8%.
This suggests a possible going concern risk, given cash has fallen and new
loans have been taken on this year. A going concern review will be required
as part of the audit then may require further disclosures in the financial
statement related to going concern.

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The value for provisions of Rs. 6,136 million has remained unchanged which
suggests this balance has not been reappraised by management and
updated. Given the changes in business activity noted, and the rise in
dissatisfied customers in the Aesthetics division, then there is significant risk
that this balance in the financial statements is misstated.
(b) Equipment sale
The Equipment division has currently recognised all of the revenue on the
sale of medical equipment and has not considered whether there are
separate performance obligations within the contract.
The clause that allows the customer to purchase consumables for a discount
needs to be considered to assess whether this represents a separate
performance obligation. As the consumable are offered at a discount this is
considered to represent a material right and therefore is a separate
performance obligation.
The Equipment division needs to allocate the total amount of Rs. 1,020
million payable under the contract to the equipment and consumables in
relation to their relative standalone price.
This will be calculated as follows:
Standalone price Allocation Allocation
Rs m % Rs m
Equipment 1,750 81 1,453
Consumables 400 * 19 194
Total 2,150 100 1,785 **
* 100,000 units @ Rs. 4,000 = Rs. 400m
** (100,000 units @ Rs. 2,100) + Rs. 1,575m = Rs. 1,785m
Revenue for the equipment should be recognised of Rs. 1,453 million when
control of the equipment is transferred to the customer. If this has happened
before the year end, then this is a decrease of Rs. 122m (1,575 – 1,453).
The revenue for the consumables should be recognised as the units are
purchased. This is when the performance obligations are satisfied in
accordance with SLFRS 15 Revenue from Contracts with Customers.
The key audit risk is that Healthwise has overstated revenue for this
contract as they have recognised all of the revenue (Rs. 1,575 million) as one
performance obligation. The audit approach for this area would be to focus
on the details of the contract to confirm the terms, in particular that the
consumables are offered at a discount as this is key to the assessment of
whether a separate performance obligation exists.
The contract was signed on 29 March 20X5 but there is no information on
the date that the equipment is delivered to the customer or whether any
consumables have been supplied under the contract.

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The potential adjustment to revenue will depend on the delivery date and if
this is after the year end revenue should be adjusted by Rs. 1,575 million if
control of the equipment has not passed. This represents 3.5% of
Equipment division's revenue and 1% of Healthwise Ltd revenue so is
material to the company.
Alternatively, if the adjustment is just to remove the Rs. 122 million of
revenue this is likely to be immaterial to the company. Whichever adjustment
is required the impact on profit will need to be considered as a corresponding
adjustment to cost may also be required.
Additionally, as we are aware that Healthwise has recently expanded in to
this area, there could also be other contracts with similar clauses in them so
consequently other areas where revenue may be overstated. This is a
technical area of financial reporting and as this is a new business area for
Healthwise Ltd the client may lack the necessary skills to properly account
for this transaction, which increases the risk of material misstatement in the
financial statements.
Revaluation of property
Healthwise uses the revaluation model allowed under LKAS16. This year a
revaluation has been performed which is correct as revaluations should be
carried out regularly so that the carrying amount of an asset does not differ
materially from its fair value at the balance sheet date.
However, it is noted that the increase in the revaluation surplus reserve of
Rs. 30,000 million has not been recorded in the other comprehensive
income. This must be added to correct the noted misstatement.
It is unclear the entire class of property has been revalued. It is also unclear
if property has been depreciated since the date of the revaluation. If this is
not the case then the balance for property, plant and equipment may have
been misstated, so further adjustment may be required based on the results
of audit testing.
Research and development expenditure
Under LKAS 38, an intangible asset arising from development must be
capitalised if an entity can demonstrate all of the following criteria:
• The technical feasibility of completing the intangible asset (so that it will
be available for use or sale).
• Intention to complete and use or sell the asset.
• Ability to use or sell the asset.
• Existence of a market or, if to be used internally, the usefulness of the
asset.

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• Availability of adequate technical, financial, and other resources to

complete the asset.
• The cost of the asset can be measured reliably.
LKAS 38 states that 'If any of the recognition criteria are not met then the
expenditure must be charged to the profit and loss statement as incurred'.
Currently, Healthwise are assuming the recognition criteria has not been
met as research and development costs have been charged in the profit and
loss statement.
However, there is now the possibility that bringing a new medicine is now
feasible. Healthwise has the intention to market the drug if it passes final
drug trials, Also, Healthwise may sell the rights to license the drug
worldwide. A market for this drug will exist as joint pain is a common
ailment in the elderly and the company appears to be have the resources to
complete the final stages of research and product development.
Therefore, it is possible that the criteria set out by LKAS 28 is now met. If so
then costs of Rs. 20,611 million must be capitalised. This will increase profit
and increase the value of assets with new intangible assets disclosures in the
financial statement. Prior year costs do not need to be adjusted as it is clear
that the technical feasibility of the new drug was not confirmed in 20X4.
Reclassification of research costs as an intangible asset will depend on
management's assessment of the likelihood that technical feasibility is
confirmed. If there is doubt that the drug will be approved by the Sri Lanka
Government then no adjustment will be required. However, an adjusting
post balance sheet event will arise if the drug is approved by the government
before the financial statements are signed by the auditor.
Forward currency
SLFRS 9 Financial Instruments requires that derivatives are recognised at
their fair value and any gains or losses should be reflected in profit or loss.
The directors of Healthwise Ltd are therefore incorrect in the proposed
treatment as they must always include the derivative as a financial asset or
financial liability in the statement of financial position.
In order to comply with the hedging requirements of SLFRS 9 they would
have had to designate it as a hedge at inception and have full documentation
of the hedging strategy. The arrangement would need to comply with the
SLFRS 9 hedging criteria. This would still require the derivative to be shown
on the statement of financial position, but any gain or loss could go to other
comprehensive income.
Additionally, SLFRS 7 requires extensive disclosure requirements for
financial instruments that the directors must comply with.

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This is a risky area as it involves complex accounting transactions and the

directors would appear to lack sufficient technical expertise in this area of
financial reporting. Our audit approach needs to focus on obtaining
independent evidence over the valuation of the derivative and to be sure if
they do hedge account, that the documentation was created at inception.
Pension
Healthwise Ltd have currently recognised the loss arising on the transfer to
the defined contribution scheme within other comprehensive income. This
accounting treatment is incorrect as the difference between compensation
paid and the reduction in obligation should be recognised in profit or loss.
Our audit approach to this needs to ensure that we review this calculation in
detail and ensure the loss is correctly included within profit or loss. A further
audit issue may arise due to the fact that Healthwise Ltd has changed its
actuary during the year. We need to understand the reasons for the change
in case they cause concern over the reliability of the information provided.
Given the significant remeasurement gain this year compared to the loss in
the previous year, we need to approach this area with scepticism and to
ensure that the actuaries are independently and appropriately qualified. We
may need to consider using our own actuary if we are not confident that they
are independent.
(c) Data analytics is the examination of data to try to identify patterns, trends or
correlations. As the quantity of data has increased, it has become more
necessary to evolve ways of processing and making sense of it. Data analytics
is part of the 'Big data' movement, namely the qualitative shift in the amount
of data that can be held and analysed by modern computers.
This development in technology processing and data transfer and storage
has made it increasingly possible for auditors to examine and to manipulate
a complete data set, ie 100% of the transactions. This has the potential to
change the way audit testing works; rather than eg performing controls
testing on a sample of items, it is possible to perform risk analysis on a
whole population.
The benefits of the using of data analytics as part of the audit strategy
include:
(i) Analysing the whole data set through data analytics to enhance a
broader and deeper auditor insight of the entity and the business
environment in which it operates which will improve the application of
professional scepticism and professional judgment.
(ii) Enhancing the auditor's ability to gather audit evidence from the
analysis of larger populations, including enabling better audit risk
identification and audit strategic responses and allow further testing to
be performed from the entire transaction population.

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Data analysis has introduced audit techniques such as real time auditing and
predictive audit techniques as tools which auditors can use as part of a risk
based audit strategy.
Real time auditing is where an auditor is assigned throughout the year to
audit individual transactions as they happen. For significant, unusual
transactions, supporting documentation can be reviewed as soon as the
document is generated and the application of controls, such as authorisation
and segregation of duties, can be observed happening as part of normal
business procedures. If risk is highlighted, or controls are absent, then
auditor intervention at this early stage is likely to correct this, and limit
further audit risk on these types of transactions.
Predictive audit techniques using a business's complete data set can
highlight trends which can then be extrapolated to predict likely future
balances or transaction types, which can then be compared with audit
transactional data. A comparison of actual transactions and balances with
auditor generated predicted balances provides an effective source of audit
evidence. Significant deviations can systematically be identified by
technology for investigation by the auditor and substantiated with
corroborating evidence.
Additionally, the quality of the audit of financial statements can be improved
using data analytics as patterns, deviations and inconsistencies are more
likely to be identified and therefore investigated.
In an audit environment so saturated with data about a client, one of the key
challenges for auditors is knowing how to make the best use of the data. To
help avoid the phenomenon of 'drowning in data', audit data analytics tools
allow auditors to visualise trends graphically, and to develop new ways of
interrogating data to find trends and relationships. Graphical representation
allows auditors to more clearly spot unexpected deviations. For example, an
unusually high volume of transactions in a particular month, or higher than
expected sales or costs for a particular product.
Current auditing standards, such as SLAuSs, are based on techniques of
identifying audit risk and focusing on controls which mitigate these audit
risks, supported by substantive procedures which replaced the fully
substantive approaches that had preceded it. It has been claimed in some
quarters that data analytics techniques, such as trend analysis, will bring
about changes of this magnitude to the audit profession.
The sheer scale of the work that can be performed using data analytics
techniques makes such a difference to auditors that new auditing standards
are likely to be needed due to the change whilst others have claimed that
auditing standards are fundamentally sound, but are in need of
modernisation to reflect these techniques.

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There are also limitations of using data analytics as part of the audit strategy.
Auditors need to have a clear understanding of the data they are analysing,
particularly the relevance of the data to the audit. Furthermore, data
analytics will not provide everything the auditor will needs to know or
provide all the audit evidence required to sign off the audit report. Also,
financial statements have significant amounts and disclosures that are
accounting estimates (or that are based on accounting estimates) or that
contain qualitative information. Professional judgment is necessary to assess
the reasonableness of the entity's estimated value and disclosures of those
items. While the data analytics technology of today is able to unlock valuable
insights for the auditor to consider, its use in a financial statement audit will
not replace the need for professional judgement and professional scepticism.
Finally, the auditor's should be mindful of potential "overconfidence" in
technology and data analytics. This is tool to enhance audit quality, and not a
replacement of the auditors judgements, data analytics can lead to false
results, so it is important that auditors continue to corroborate audit risks
with traditional audit evidence as well as technology generated audit
evidence.

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SECTION A
There are 2 questions of 25 marks each. Both questions are compulsory.
This section has 50 marks in total.
Recommended time for this section is 90 minutes.

Question 1
(a) Havanna owns a chain of health clubs and has entered into binding contracts
with sports organisations, which earn income over given periods.
The services rendered in return for such income include access to Havanna's
database of members, and admission to health clubs, including the provision
of coaching and other benefits. These contracts are for periods of between
nine and 18 months. The directors decided that because Havanna only
assumes limited obligations under the contract mainly relating to the
provision of coaching, this could not be seen as the rendering of services for
accounting purposes. As a result, Havanna's accounting policy for revenue
recognition is to recognise the contract income in full at the date when the
contract was signed. (7 marks)
(b) In May 20X3, Havanna decided to sell one of its regional business divisions
through a mixed asset and share deal. The decision to sell the division at a
price of Rs. 40 million (net of costs to sell) was made public in
November 20X3 and gained shareholder approval in December 20X3. It was
decided that the payment of any agreed sale price could be deferred until
30 November 20X5. The business division was presented as a disposal group
in the statement of financial position as at 30 November 20X3. At the initial
classification of the division as held for sale, its net carrying amount was
Rs. 90 million. In writing down the disposal group's carrying amount,
Havanna accounted for an impairment loss of Rs. 30 million which
represented the difference between the carrying amount and value of the
assets measured in accordance with applicable Sri Lanka Financial Reporting
Standards (SLFRS).
In the financial statements at 30 November 20X3, Havanna showed the
following costs as provisions relating to the continuing operations.
These costs were related to the business division being sold and were as
follows.
(i) A loss relating to a potential write-off of a trade receivable owed by
Cuba Sport, which had gone into liquidation. Cuba Sport had sold the
goods to a third party and the division had guaranteed the receipt of
the sale proceeds to the Head Office of Havanna

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(ii) A provision was recognised relating to the expected transaction costs

of the sale including legal advice and lawyer fees
(9 marks)
(c) (i) Havanna has decided to sell its main office building to a third party for
Rs. 350 million and lease it back on a ten-year lease. The current fair
value of the property is Rs. 350 million and the carrying amount of the
asset is Rs. 294 million. The present value of the future lease payments
has been calculated as Rs. 269.5 million. The remaining useful life of
the building is 15 years. The transaction constitutes a sale in
accordance with SLFRS 15 Revenue from Contracts with Customers.
No accounting adjustment has been made for this sale. (5 marks)
(ii) The market for property is uncertain in the jurisdiction, and Havanna
therefore requires guidance on the consequences of selling the office
building at prices other than the Rs. 350 million fair value. Havanna
would like a brief statement of the difference it would make if the sale
price were:
(1) Rs. 420 million
(2) Rs. 280 million (4 marks)

Required
Advise Havanna on how the above transactions should be dealt with in its
financial statements with reference to Sri Lanka Financial Reporting Standards
where appropriate. (Note. The mark allocation is shown against each of the four
issues above.)
(Total = 25 marks)

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Question 2
(a) Bental, a listed bank, has a subsidiary, Hexal, which has two classes of shares,
A and B. A-shares carry voting powers and B-shares are issued to meet
Hexal's regulatory requirements. Under the terms of a shareholders'
agreement, each B shareholder is obliged to capitalise any dividends in the
form of additional investment in B-shares. The shareholder agreement also
stipulates that Bental agrees to buy the B-shares of the minority
shareholders through a put option under the following conditions.
(i) The minority shareholders can exercise their put options when their
ownership in B-shares exceeds the regulatory requirement, or
(ii) The minority shareholders can exercise their put options every three
years. The exercise price is the original cost paid by the shareholders.
In Bental's consolidated financial statements, the B-shares owned by
minority shareholders are to be reported as a non-controlling interest.
(8 marks)
(b) Bental entered into a number of swap arrangements during 20X3. Some of
these transactions qualified for cash flow hedge accounting in accordance
with SLFRS 9 Financial instruments. The hedges were considered to be
effective. At 30 November 20X3, Bental decided to cancel the hedging
relationships and had to pay compensation. The forecast hedged
transactions were still expected to occur and Bental recognised the entire
amount of the compensation in profit or loss.
Additionally, Bental also has an investment in a foreign entity over which it
has significant influence and therefore accounts for the entity as an
associate. The entity's functional currency differs from Bental's and in the
consolidated financial statements, the associate's results fluctuate with
changes in the exchange rate. Bental wishes to designate the investment as a
hedged item in a fair value hedge in its individual and consolidated financial
statements.
(7 marks)
(c) On 1 September 20X3, Bental entered into a business combination with
another listed bank, Lental. The business combination has taken place in two
stages, which were contingent upon each other. On 1 September 20X3,
Bental acquired 45% of the share capital and voting rights of Lental for cash.
On 1 November 20X3, Lental merged with Bental and Bental issued new
A-shares to Lental's shareholders for their 55% interest.
On 31 August 20X3, Bental had a market value of Rs. 70 million and Lental a
market value of Rs. 90 million. Bental's business represents 45% and
Lental's business 55% of the total value of the combined businesses.

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After the transaction, the former shareholders of Bental excluding those of

Lental owned 51% and the former shareholders of Lental owned 49% of the
votes of the combined entity. The Chief Operating Officer (COO) of Lental is
the biggest individual owner of the combined entity with a 25% interest.
The purchase agreement provides for a board of six directors for the
combined entity, five of whom will be former board members of Bental with
one seat reserved for a former board member of Lental. The board of
directors nominates the members of the management team.
The management comprised the COO and four other members, two from
Bental and two from Lental. Under the terms of the purchase agreement, the
COO of Lental is the COO of the combined entity.
Bental proposes to account for the transaction as a business combination
and identify Lental as the acquirer. (10 marks)

Required
Evaluate the accounting practices and policies outlined above and consider
whether they are acceptable under Sri Lanka Financial Reporting Standards.
(Note. The mark allocation is shown against each of the three issues above.)
(Total = 25 marks)

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SECTION B
This section has one question which is compulsory.
This section has 50 marks.
Recommended time for this section is 90 minutes.

Question 3
Preseen
Minny is a public limited company that operates in the pharmaceuticals sector,
producing and distributing pharmaceuticals, biologics, vaccines and consumer
healthcare. The company was formed 60 years ago and has since grown
significantly. Its head office is in Kandy, Sri Lanka.
Operations
Minny is operated as four distinct divisions: Drugs and Vaccines,
Healthcare Products, Consumer Products and Home Consumables.
Minny manufactures drugs and vaccines for major diseases including diabetes,
asthma and cancer. These drugs and vaccines take years to develop, with only a
small proportion of candidate vaccines progressing to be licensed for clinical use
by the authorities. The drugs developed by Minny's Drugs and Vaccines division
are protected by patent; these patents allow only Minny to sell the drugs that it
has developed. During this period Minny is normally able to generate sufficient
profit to recoup the cost of developing a particular drug or vaccine. After the
expiry of a patent (between 10 and 15 years), competitors can produce and sell
generic versions of the drug.
The company's over-the-counter health-care products, manufactured and sold by
the Healthcare Products division include generic cold and flu remedies,
nicotine replacements and pain relief products.
The Consumer Products division of Minny manufactures and sells oral healthcare
products (toothpastes, mouthwashes etc) and nutritional products (such as high
fibre bars, protein shakes, energy drinks and weight loss shakes). The company
invests a considerable amount of money in developing new nutritional products,
as the route to market is more straightforward than that for regulated drugs and
vaccines, and as a result returns arise more quickly.
Minny also manufactures and sells a small number of cleaning products for
consumers through its Home Consumables division. These include anti-bacterial
sprays, bleach products and furniture and floor polishes.

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Development of the group

Minny acquired 70% of the equity shares in Bower (a public limited company) on
1 December 20X0 for a cash price of Rs. 730 million. This was a strategic
acquisition, made with the intention of acquiring know-how and patents owned by
Bower. As a result of the acquisition, Minny was able to develop its product base
and access the market for drugs for blood disorders such as anaemia, lymphoma
and myeloma (blood cancers).
An 80% share in the equity of Heeny (a public limited company) was acquired on
1 December 20X1 at a cost of Rs. 320 million, paid in cash. This acquisition was
made in order that Minny could achieve rapid market expansion. Heeny has a
well-established sales and distribution network in Africa, a market that Minny had
not previously entered.
Minny acquired a 14% interest in Puttin, a public limited company,
on 1 December 20X0 for a cash consideration of Rs. 21 million. The investment
was accounted for at cost. On 1 June 20X2, Minny acquired an additional
16% interest in Puttin for a cash consideration of Rs. 27 million and achieved
significant influence. Puttin operates in consumer healthcare products such as
shampoos, conditioners and toothpastes. As such this investment was seen to be a
good strategic fit for Minny's Consumer Products division. In time it is expected
that the investment may be increased and control over Puttin achieved.
Financial reporting and accounting policies
The financial statements of Minny are prepared to a reporting date of
30 November. Financial statements are prepared in accordance with SLFRS and
Colombo Stock Exchange regulations. They are presented in an annual report
together with a social and environmental impact report, which the Board of Minny
intends to develop into a full sustainability report.
The Board of Minny is aware that SLFRS 3 allows a choice of method to measure
the non-controlling interest on an acquisition-by-acquisition basis. In order to
maximise reported goodwill, it has elected to measure the non-controlling interest
in both subsidiaries at fair value at the acquisition date.
Goodwill arising from the acquisitions is not amortised, but is tested for
impairment at each reporting date in accordance with the requirements of SLFRS.
Development costs are capitalised when the LKAS 38 criteria are met. They are
amortised over a relevant period. In the case of drugs and vaccines, this is the
period for which the product is patent protected; for nutritional products it is
usually ten years.
The company adopts the LKAS 16 revaluation model for its properties, and
revaluation exercises are performed with sufficient frequency that carrying
amounts are in line with fair values at each reporting date.

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Financial performance
Analysis of the recent financial performance of Minny Group indicates strong
performance from the Drugs and Vaccines division. This is largely due to the
launch to market of a drug to treat the effects of a new strain of flu. This drug has
been licensed for use by a number of healthcare authorities throughout Asia and
as a result has generated significant revenues since its launch.
The Healthcare Products division is considered to be a 'cash cow' by the Board of
Minny; it continues to require little investment in comparison to other divisions
and returns steady profits.
The Consumer Products division has shown steady growth in revenue over the
past year, which can be attributed to the continued consumer trend towards
exercise and weight loss plans, and Minny's ability to respond to consumer
demand in these areas.
In recent years the Home Consumables division has not performed as well as the
other divisions of Minny, contributing the lowest profit margins of the group.
Revenue is relatively stagnant, and the Board consider that there are two viable
routes for this division: either dispose of it or commit to invest in it and develop it.
Unseen
(a) The draft statements of financial position of Minny, Bower and Heeny are as
follows at 30 November 20X2.
Minny Bower Heeny
Rs m Rs m Rs m
Assets
Non-current assets
Property, plant and equipment 920 300 310
Investment in subsidiaries
Bower 730
Heeny 320
Investment in Puttin 48
Intangible assets 198 30 35
1,896 650 345
Current assets 895 480 250
Total assets 2,791 1,130 595

Equity and liabilities

Stated capital 920 400 200
Other components of equity 73 37 25
Retained earnings 895 442 139
Total equity 1,888 879 364
Non-current liabilities 495 123 93
Current liabilities 408 128 138
Total liabilities 903 251 231
Total equity and liabilities 2,791 1,130 595

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The following information is relevant to the preparation of the group

financial statements.
(i) At acquisition, the fair value of the non-controlling interest in Bower
was Rs. 295 million. On 1 December 20X0, the fair value of the
identifiable net assets acquired was Rs. 835 million and retained
earnings of Bower were Rs. 319 million and other components of
equity were Rs. 27 million. The excess in fair value is due to non-
depreciable land.
(ii) The fair value of a 20% non-controlling interest in Heeny at
1 December 20X1 was Rs. 72 million; a 30% holding was
Rs. 108 million and a 44% holding was Rs. 161 million. At the date of
acquisition, the identifiable net assets of Heeny had a fair value of
Rs. 362 million, retained earnings were Rs. 106 million and other
components of equity were Rs. 20 million. The excess in fair value is
due to non-depreciable land.
(iii) Both Bower and Heeny were tested for impairment at 30 November 20X2.
The recoverable amounts of both cash generating units as stated in the
individual financial statements at 30 November 20X2 were Bower,
Rs. 1,425 million, and Heeny, Rs. 604 million, respectively. The directors of
Minny felt that any impairment of assets was due to the poor performance
of the intangible assets. The recoverable amount has been determined
without consideration of liabilities which all relate to the financing of
operations.
(iv) Puttin made profits after tax of Rs. 20 million and Rs. 30 million for the
years to 30 November 20X1 and 30 November 20X2 respectively.
On 30 November 20X2, Minny received a dividend from Puttin of
Rs. 2 million, which has been credited to other components of equity.
(v) Minny purchased patents of Rs. 10 million to use in a project to develop
a new weight loss shake product on 1 December 20X1. Minny has
completed the investigative phase of the project, incurring an
additional cost of Rs. 7 million, and has determined that the product
can be developed profitably. An effective test batch was created at a
cost of Rs. 4 million and in order to put the shake into a condition for
sale, a further Rs. 3 million was spent. Finally, marketing costs of
Rs. 2 million were incurred. All of the above costs are included in the
intangible assets of Minny.
(vi) Minny intends to dispose of the Home Consumables division. At the
date the held for sale criteria were met, the carrying amount of the
assets and liabilities comprising the division were:

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Rs m
Property, plant and equipment (PPE) 49
Inventory 18
Current liabilities 3
It is anticipated that Minny will realise Rs. 30 million for the business.
No adjustments have been made in the financial statements in relation
to the above decision.

Required
Prepare the consolidated statement of financial position for the
Minny Group as at 30 November 20X2. (35 marks)
(b) Minny intends to dispose of the Home Consumables division and has stated
that the held for sale criteria were met under SLFRS 5 Non-current assets
held for sale and discontinued operations. The criteria in SLFRS 5 are very
strict and regulators have been known to question entities on the application
of the standard. The two criteria which must be met before an asset or
disposal group will be defined as recovered principally through sale are: that
it must be available for immediate sale in its present condition, and the sale
must be highly probable.

Required
Outline what is meant in SLFRS 5 by 'available for immediate sale in its
present condition' and 'the sale must be highly probable', setting out briefly
why regulators may question entities on the application of the standard.
(7 marks)
(c) Bower has a property which has a carrying amount of Rs. 2 million at
30 November 20X2. This property had been revalued at the year end and a
revaluation surplus of Rs. 400,000 had been recorded in other components
of equity. The directors intended to sell the property to Minny for
Rs. 1 million shortly after the year-end. Bower previously used the historical
cost basis for measuring property.

Required
Evaluate the ethical and accounting implications of the above intended sale
of assets to Minny by Bower. You are not required to adjust your answer to
part (a). (8 marks)
(Total = 50 marks)

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SECTION A

Question 1
(a) Contracts with sports organisations
The applicable standard relating to the contracts is SLFRS 15 Revenue from
Contracts with Customers. This standard has a five-step process for
recognising revenue.
(i) Identify the contract with the customer.
(ii) Identify the separate performance obligations.
(iii) Determine the transaction price.
(iv) Allocate the transaction price to the performance obligations.
(v) Recognise revenue when (or as) a performance obligation is satisfied.
It is assumed that (i) and (iii) are satisfied – the contracts are binding, and
there is no indication in the question that the transaction price is
undetermined. Step (ii) 'identify the separate performance obligations'
needs to be considered. Despite Havanna's claims, the performance
obligation under SLFRS 15 is the provision of services. Revenue should be
recognised as the services are provided (step (v)). Step (v) would treat this
as a performance obligation satisfied over time because the customer
simultaneously receives and consumes the benefits as the performance takes
place.
A performance obligation satisfied over time meets the criteria in Step (v)
above and, if it is entered into more than one accounting period, as here for
some of the contracts, would previously have been described as a long-term
contract.
In this type of contract an entity has an enforceable right to payment for
performance completed to date. The standard describes this as an amount
that approximates the selling price of the goods or services transferred to
date (for example recovery of the costs incurred by the entity in satisfying
the performance plus a reasonable profit margin).
Methods of measuring the amount of performance completed to date
encompass output methods and input methods.
(i) Output methods recognise revenue on the basis of the value to the
customer of the goods or services transferred. They include surveys of
performance completed, appraisal of units produced or delivered etc.
(ii) Input methods recognise revenue on the basis of the entity's inputs,
such as labour hours, resources consumed, costs incurred. If using a
cost-based method, the costs incurred must contribute to the entity's
progress in satisfying the performance obligation.

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Havanna argues that the 'limited obligations' under the contracts

(coaching and access to its membership database) do not constitute
rendering of services, and that it is therefore acceptable to recognise the
contract revenue in full. However, this treatment contravenes SLFRS 15.
In the case of these contracts, the services are performed by an indeterminate
number of acts over a specified period of time. Under SLFRS 15, the best
measure of progress towards complete satisfaction of the performance
obligation over time is a time-based measure and Havanna should recognise
revenue on a straight-line basis over the specified period.
There is no justification for Havanna's treatment, that is recognising the
contract income in full when the contract is signed. The 'limited obligations'
argument is not supported by SLFRS 15. Accordingly, Havanna must
apportion the income arising from the contracts over the period of the
contracts, as required by the standard.
(b) Sale of division
Impairment loss
A division (or disposal group) is classified as held for sale when it is available
for immediate sale in its present condition and the sale is highly probable.
For a sale to be probable, management must be committed to a sale plan,
and the plan must have been announced or its implementation begun.
Here the plan has been announced and so the division to be sold meets the
criteria in SLFRS 5 to be classified as held for sale. It has therefore been
correctly classified as a disposal group under SLFRS 5.
Measurement of a disposal group on classification as held for sale is
determined in two steps:
Step 1
Immediately before classification as held for sale, the assets and liabilities of
a disposal group are re-measured in accordance with applicable SLFRS.
Any impairment loss is generally recognised in profit or loss, but if the asset
has been measured at a revalued amount under LKAS 16 Property, plant and
equipment or LKAS 38 Intangible assets, the impairment is treated as a
revaluation decrease.
Step 2
On classification as held for sale, a disposal group is measured at the lower of
its carrying amount and fair value less costs to sell.
At this stage an impairment loss will arise if the adjusted carrying amount of
the disposal group exceeds its fair value less costs to sell. The impairment
loss (if any) is recognised in profit or loss.

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For assets carried at fair value prior to initial classification, the requirement
to deduct costs to sell from fair value will result in an immediate charge to
profit or loss.
Havanna has calculated the Step 1 impairment as Rs. 30 million, being the
difference between the carrying amount at initial classification and the value
of the assets measured in accordance with SLFRS.
Step 1
Calculate carrying amount under applicable SLFRS: Rs. 90 million – Rs. 30
million = Rs. 60 million
Step 2
Classified as held for sale. Compare the adjusted carrying amount under
applicable SLFRS (Rs. 60 million) with fair value less costs to sell (Rs. 40
million). Measure at the lower of carrying amount and fair value less costs to
sell, here Rs. 40 million. Recognise a Rs. 20 million impairment loss in profit
or loss.
Other costs
Certain other costs relating to the division being sold are currently
recognised as provisions relating to continuing operations. This treatment is
not correct:
(i) The trade receivable from Cuba Sports should have been tested for
impairment immediately before classification of the division as held for
sale.
An impairment loss equal to the amount of the trade receivable should
have been recognised; this would have reduced the carrying amount of
the division prior to its initial classification as held for sale. The write
down of the receivable balance replaces the provision recognised in the
books of the continuing operations.
In addition, the division has guaranteed the sale proceeds to Havanna's
Head Office.
As the amount owing has not been collected and the receivable is
impaired, the regional business division must bear the cost of making
good the guarantee.
Therefore, a liability should be recognised for the disposal group.
Additionally, the sales price of the division (and hence the fair value
less costs to sell) should be adjusted to reflect this amount.
(ii) The provision for transaction costs should not have been recognised in
continuing operations. The costs (legal advice and lawyers' fees)
should be considered as part of 'costs to sell' when calculating fair
value less costs to sell.

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Both items affect fair value less costs to sell, and item (i), the trade
receivable, also affects the carrying amount of the division on classification
as held for sale.
(c) Sale and leaseback
(i) SLFRS 16 Leases requires an initial assessment to be made regarding
whether or not the transfer constitutes a sale. This is done by
determining when the performance obligation is satisfied in
accordance with SLFRS 15 Revenue from Contracts with Customers
(para. 99). In this case, we are told in the question that the SLFRS 15
criteria have been met. SLFRS 16 therefore requires that, at the start of
the lease, Havanna should measure the right-of-use asset arising from
the leaseback of the building at the proportion of the previous carrying
amount of the building that relates to the right-of-use retained. This is
calculated as carrying amount × discounted lease payments/fair value.
The discounted lease payments were given in the question as Rs. 269.5
million.
For Havanna, the right of use asset is therefore: 294m  269.5m/350m
= Rs. 226.38 million
Havanna only recognises the amount of gain that relates to the rights
transferred. The gain on sale of the building is Rs. 56 million (350m –
294m), of which:
(56m  269.5m/350m) = Rs. 43.12 million relates to the rights retained.
The balance, (56m – 43.12m) = Rs. 12.88 million, relates to the rights
transferred to the buyer.
At the commencement date the lessee accounts for the transaction as
follows:
Debit Credit
Rs'000 Rs'000
Cash 350,000
Right-of-use asset 226,380
Building 294,000
Financial liability 269,500
Gain on rights transferred __________ 12,880
576,380 576,380
The right-of-use asset will be depreciated over ten years, the gain will
be recognised in profit or loss and the financial liability will be
increased each year by the interest charge and reduced by the lease
payments.

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(ii) (1) Sales price Rs. 420 million

Here the sales price would be above fair value. SLFRS 16 states
that the excess over fair value should be accounted for as
additional finance provided by the lessor, so the RS. 70 million
(420m – 350m) above the fair value would be treated as an
additional liability, not as a gain on the sale.
(2) Sales price Rs. 280 million
Here the sales price is below fair value. SLFRS 16 requires that
'below market terms' should be accounted for as a prepayment
of lease payments. In other words, the shortfall in consideration
received from the lessor is treated as a lease payment by the
lessee.

Question 2
(a) Classification of B-shares
It is not always easy to distinguish between debt and equity in an entity's
statement of financial position, partly because many financial instruments
have elements of both.
The distinction is important, since the classification of a financial instrument
as either debt or equity can have a significant impact on the entity's reported
earnings and gearing ratio, which in turn can affect debt covenants.
Companies may wish to classify a financial instrument as equity, in order to
give a favourable impression of gearing, but this may in turn have a negative
effect on the perceptions of existing shareholders if it is seen as diluting
existing equity interests.
LKAS 32 Financial instruments: presentation brings clarity and consistency to
this matter, so that the classification is based on principles rather than
driven by perceptions of users.
Bental has classified the B-shares as non-controlling interest (equity) but
this does not comply with LKAS 32. LKAS 32 defines an equity instrument as:
'any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities'. It must first be established that an instrument
is not a financial liability, before it can be classified as equity.
A key feature of the LKAS 32 definition of a financial liability is that it is a
contractual obligation to deliver cash or another financial asset to another
entity.
A financial instrument is an equity instrument if there is an unconditional
right to avoid delivering cash or another financial asset to another entity.

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An instrument may be classified as an equity instrument if it contains a

contingent settlement provision requiring settlement in cash or a variable
number of the entity's own shares only on the occurrence of an event which
is very unlikely to occur – such a provision is not considered to be genuine.
If the contingent payment condition is beyond the control of both the entity
and the holder of the instrument, then the instrument is classified as a
financial liability.
The shareholders' agreement imposes on Bental a clear contractual
obligation to buy B-shares from the non-controlling shareholders on the
terms set out in the agreement.
It does not have an unconditional right to avoid delivering cash or another
financial asset to settle the obligation. The circumstance above, where the
contingent settlement provision is not considered genuine because an event
is unlikely to occur, does not apply here: the minority shareholders' can
exercise their put option at least every three years, and more frequently if
their ownership in B-shares exceeds the regulatory requirement.
Accordingly, the minority shareholders' holdings of B shares should be
treated as a financial liability in the consolidated financial statements of
Bental.
(b) Hedging
Swap arrangements
SLFRS 9 sets out requirements for when hedge accounting is discontinued.
Cash flow hedge accounting should be discontinued if the hedging
instrument expires or is sold, terminated or exercised, if the criteria for
hedge accounting are no longer met, a forecast transaction is no longer
expected to occur or if the entity revokes the designation.
If hedge accounting ceases for a cash flow hedge relationship because the
forecast transaction is no longer expected to occur, gains and losses deferred
in other components of equity are recognised in profit or loss immediately.
If the transaction is still expected to occur and the hedge relationship ceases,
the amounts accumulated in equity are retained in equity until the hedged
item affects profit or loss.
In the case of Bental, the forecast hedged transactions are still expected to
occur. Bental should recognise the cash payments of compensation against
the fair value of the swaps, so there is no immediate effect on profit or loss.
The amounts accumulated in equity are reclassified to profit or loss in the
period when the item that was hedged affects profit or loss.

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Investment in foreign entity

The foreign entity is an associate and Bental therefore accounts for it using
the equity method in its consolidated accounts.
Under SLFRS 9, an equity method investment cannot be a hedged item in a
fair value hedge because the equity method recognises in profit or loss the
investor's share of the associate's profit or loss, rather than changes in the
investment's fair value.
A hedge of a net investment in a foreign operation is different because it is a
hedge of the foreign currency exposure, not a fair value hedge of the
change in the value of the investment.
Bental may, however, be able to designate the investment as a hedged item
in a fair value hedge in its individual financial statements, provided its fair
value can be measured reliably.
(c) Business combination
SLFRS 3 Business Combinations requires an acquirer to be identified in all
business combinations, even where the business combination looks like a
merger of equals. The acquirer is the combining entity that obtains control of
the entity with which it is combined.
It is not always easy to determine which party is the acquirer, and SLFRS 3
defers to SLFRS 10 in respect of guidance on the matter. The key point is
control, rather than mere ownership, but this may not be easy to assess.
Arguments in favour of Bental being the acquirer:
(i) Bental is the entity giving up cash amounting to 45% of the purchase
price, which is a significant share of the total purchase consideration.
(ii) In a business combination effected primarily by exchanging equity
interests, as here, the acquirer is usually the entity that issues its equity
interests. Thus, Bental appears to be the acquirer.
(iii) Other factors need to be taken into consideration in determining which
of the combining entities has the power to govern the financial and
operating policies of the other entity. Per SLFRS 10, that is usually the
one whose shareholders retain or receive the largest proportion of the
voting rights in the combined entity, here Bental which has 51%
immediately after the transaction.
(iv) A controlling share does not always mean that the party that has it has
the power to govern the combined entity's financial and operating
policies so as to obtain benefits from its activities. Power may also be
given by rights to appoint, reassign or remove key management
personnel who can direct the relevant activities of the combined entity.
Five out of the six directors of the combined entity are former board
members of Bental, which points to Bental being the acquirer.

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Arguments in favour of Lental being the acquirer:

(i) Despite the above, arguably the former management of Lental has
greater representation on the management team. The management
team consists of the Chief Operating Officer and two former employees
of Lental, while Bental has only two former employees on the
management team.
(ii) The Chief Operating Officer of Lental has, as an individual, the largest
share of the combined entity, which at 25%, gives him a great deal of
influence over the team, especially taking into account the composition
of the team. Although the board nominates the team, this individual
influence points towards Lental being the acquirer.
(iii) Lental may also be seen as the acquirer when the relative size of the
combining entities is taken into account, for example in terms of assets,
revenue or profit. The fair value of Lental is Rs. 90 million, which is
significantly greater than that of Bental, (Rs. 70 million) and this is an
indication of control.
Conclusion
Identifying the acquirer is not easy, and there are arguments on both sides.
In the case of Lental, the Chief Operating Officer of Lental is the source of
much of Lental's power, whereas Bental has a balance of other factors in its
favour, the most important of which are:
(i) Bental is the entity transferring the cash
(ii) Bental issued the equity interest
(iii) Bental has the marginal controlling interest
It is possible to conclude that Bental is the acquirer, but this is not a clear-cut
case.

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SECTION B

Question 3
(a) MINNY GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30.11.20X2
Rs m
Non-current assets
Property, plant and equipment 1,606.0
Goodwill 190.0
Intangible assets 227.0
Investment in associate: 48 + 4.5 – 2 50.5
2,073.5
Current assets 1,607.0
Disposal group held for sale 33.0
Total assets 3,713.5

Equity and liabilities

Equity attributable to owners of the parent
Stated capital 920.00
Retained earnings 936.08
Other components of equity 77.80
1,933.88
Non-controlling interests 394.62
2,328.50
Non-current liabilities 711.00
Current liabilities 671.00
Current liabilities associated with disposal group 3.00
Total equity and liabilities 3,713.50

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Workings
1 Group structure – Minny group
Bower (70%) Heeny (80%)
Rs. million Rs. million
Consideration 730 320
FV of net assets at date of acquisition 835 362

Consisting of:
Stated capital 400 200
Retained earnings at date of acquisition 319 106
OCE at date of acquisition 27 20
Excess FV due to non-depreciable land (missing 89 36
figure)
835 362

FV of NCI at date of acquisition 295 161

%
Effective interest in Heeny: 70%  80% 56
... Non-controlling interest 44
100
2 Goodwill
Bower Heeny
Rs m Rs m

Consideration transferred 730 320  70% 224

Non-controlling interests 295 (44%) 161

FV of identifiable net assets at acq'n:

Stated capital (400) (200)
Retained earnings (319) (106)
OCE (27) (20)
FV uplift – land (89) (36)
190 23
Impairment losses (W4) (–) (23)
190 –

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(i) The acquisition of Bower is recognised by (Rs. m):

DEBIT Goodwill 190
DEBIT Stated capital 400
DEBIT Retained earnings 319
DEBIT OCE 27
DEBIT PPE 89
CREDIT Investment in B 730
CREDIT NCI 295
(ii) The acquisition of Heeny is recognised by (Rs. m):
DEBIT Goodwill 23
DEBIT Stated capital 200
DEBIT Retained earnings 106
DEBIT OCE 20
DEBIT PPE 36
CREDIT Investment in Heeny 224
CREDIT NCI 161
3 Allocation of profits to the NCI
The increase in retained earnings and OCE since acquisition in both
companies is calculated as follows (Rs. m).
Bower Heeny
Retained OCE Retained OCE
earnings earnings
At reporting date 442 37 139 25
At acquisition (319) (27) (106) (20)
Increase 123 10 33 5
NCI share 36.9 3 14.52 2.2
(30%/44%)
(i) The allocation of these amounts to the NCI is recognised by
(Rs. m):
DEBIT Retained earnings 51.42
(36.9 + 14.52)
DEBIT OCE (3 + 2.2) 5.2
CREDIT NCI 56.62
(ii) The NCI cost of Bower's investment in Heeny is eliminated
against the NCI by (Rs. m):
DEBIT NCI (30%  320) 96
CREDIT Investment in Heeny 96

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4 Impairment
Bower Heeny
Rs m Rs m
Carrying amount
Assets (separate SOFP) 1,130 595
Fair value adjustments (W2) 89 36
Goodwill (W2) 190 23
1,409 654
Recoverable amount (1,425) (604)
Impairment loss – 50

Allocated to: goodwill 23

Intangible assets (balancing figure) 27
50
Bower is not impaired as the carrying amount is below the recoverable
amount, but Heeny's assets are impaired.
The impairment loss is allocated first to goodwill and then to the
intangible assets, because the directors believe that it is the poor
performance of the intangible assets that is responsible for the
reduction in the recoverable amount.
The impairment loss is recognised by (Rs. m):
DEBIT Retained earnings (56%) 28
DEBIT NCI (44%) 22
CREDIT Goodwill 23
CREDIT Intangible assets 27
Note that the loss is allocated to the NCI as well as group retained
earnings. This includes the impairment loss in respect of goodwill
because goodwill is 'full goodwill' i.e. it includes NCI goodwill.
5 Investment in associate
The associate is already measured at cost in the financial statements of
Minny. In order to apply equity accounting, the group share of Puttin's
profits since gaining significant influence are recognised by (Rs. m):
DEBIT Investment in associate 4.5
(30%  Rs 30 m  6/12m)
CREDIT Retained earnings 4.5
In addition, the dividend received and credited to OCE is transferred to
reduce the carrying amount of the investment in the associate (Rs. m):
DEBIT OCE 2
CREDIT Investment in associate 2

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6 Disposal group
Assets and liabilities of the disposal group are re-classified as current
and shown as separate line items in the statement of financial position.
The disposal group is impaired, and the impairment loss is calculated
as follows.
Rs m
Property, plant and equipment 49
Inventory 18
Current liabilities (3)
Carrying amount 64
Anticipated proceeds (FV less costs to sell) (30)
Impairment loss 34
This is recognised by (Rs m):
DEBIT Current liabilities 3
DEBIT Assets of disposal group 33
(49 + 18 – 34)
DEBIT Retained earnings 34
CREDIT PPE 49
CREDIT Inventory 18
CREDIT Liabilities of disposal group 3
7 Development costs
Rs m
Patent 10 Intangible asset
Investigation phase 7 Profit or loss
Prototype 4 Intangible asset: development costs
Preparation for sale 3 Intangible asset: development costs
Marketing 2 Profit or loss
The adjustment required to eliminate the items which should be
recognised in profit or loss is (Rs m):
DEBIT Profit or loss (retained earnings) 9
CREDIT Intangible assets 9
(b) Held for sale criteria under SLFRS 5 Non-current assets held for sale and
discontinued operations
The held for sale criteria in SLFRS 5 Non-current assets held for sale and
discontinued operations are very strict, and often decision to sell an asset or
disposal group is made well before they are met. It may be difficult for
regulators, auditors or users of accounts to determine whether an entity
genuinely intends to dispose of the asset or group of assets.
SLFRS 5 requires an asset or disposal group to be classified as held for sale
where it is available for immediate sale in its present condition subject only
to terms that are usual and customary, and the sale is highly probable.

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The standard does not give guidance on terms that are usual and customary
but the guidance notes give examples. Such terms may include, for example,
a specified period of time for the seller to vacate a headquarters building
that is to be sold, or it may include contracts or surveys. However, they
would not include terms imposed by the seller that are not customary,
for example, a seller could not continue to use its headquarters building until
construction of a new headquarters building had taken place.
For a sale to be highly probable:
• Management must be committed to the sale.
• An active programme to locate a buyer must have been initiated.
• The asset must be marketed at a price that is reasonable in relation to its
own fair value.
• Completion of the sale must be expected within one year from the date of
classification.
• It is unlikely that significant changes will be made to the plan or the plan
withdrawn.
Regulators may question entities' application of this standard because the
definition of highly probable as 'significantly more likely than probable'
is subjective. Entities may wish to separate out an unprofitable/impaired
part of the business in order to show a more favourable view of continuing
operations, and so regulators have reason look very closely at whether the
classification as held for sale is genuine.
(c) Transfer of property
The proposed transfer of property from Bower to its parent Minny is not a
normal sale. The property's carrying amount of Rs. 2m reflects the current
value as it was revalued at the year end, but the 'sale' price is only Rs. 1m.
In effect, this is a distribution of profits of Rs. 1m, the shortfall on the
transfer.
Distributions of this kind are not necessarily wrong or illegal. Bower's
retained earnings of Rs. 442 million, plus the 'realised' revaluation surplus of
Rs. 400,000 more than cover the distribution, so, depending on the
distributable profits rules in the jurisdiction in which it operates, it is likely
to be legal.
Certain SLFRS may apply to the transfer.
(i) If the asset meets the held for sale criteria under SLFRS 5 Non-current
assets held for sale and discontinued operations, it will continue to be
included in the consolidated financial statements, but it will be
presented separately from other assets in the consolidated statement
of financial position. An asset that is held for sale should be measured

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at the lower of its carrying amount and fair value less costs to sell.
Immediately before classification of the asset as held for sale, the entity
must update any impairment test carried out.
(ii) As the transfer is from a subsidiary to its parent, LKAS 24 Related party
disclosures will apply and in the individual financial statements of
Bower and Minny, although it would be eliminated on consolidation.
Knowledge of related party relationships and transactions affects the
way in which users assess a company's operations and the risks and
opportunities that it faces. Even if the company's transactions and
operations have not been affected by a related party relationship,
disclosure puts users on notice that they may be affected in future,
but in this case the related party relationship clearly has affected the
price of the transfer.
Even though the transfer is likely to be legal, and even if it is correctly
accounted for and disclosed in accordance with LKAS 24 and SLFRS 5
(or LKAS 16 if the SLFRS 5 criteria are not met) the transaction raises ethical
issues. The non-controlling interest shareholders who hold the other 30% of
Bower shares have been disadvantaged by this sale at far less than market
value. The impact of financial transactions on all affected parties should be
considered by the directors and auditors/advising accountants have the
responsibility to identify transactions such as this which may raise ethical
concerns and discuss these with the directors.
Financial statements may be manipulated for all kinds of reasons,
for example to enhance a profit-linked bonus or to disguise an unfavourable
liquidity position. In this case, suspicion might be aroused by the fact that
the transfer of the property between group companies at half the current
value has no obvious logical purpose, and looks like a cosmetic exercise of
some kind, although its motives are unclear. As outlined in the Conceptual
Framework, accounting information should be relevant and should faithfully
represent the underlying economic substance. While the transaction is
probably permissible, the directors need to explain why they are doing it.

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