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(a) Gasnature is a publicly traded entity involved in the production and trading of natural gas and oil. Gasnature jointly owns an underground storage facility with another entity, Gogas. Both parties extract gas from offshore gas fields, which they own and operate independently from each other. Gasnature owns 55% of the underground facility and Gogas owns 45%. They have agreed to share services and costs accordingly, with decisions regarding the storage facility requiring unanimous agreement of the parties. The underground facility is pressurised so that the gas is pushed out when extracted. When the gas pressure is reduced to a certain level, the remaining gas is irrecoverable and remains in the underground storage facility until it is decommissioned. Local legislation requires the decommissioning of the storage facility at the end of its useful life. Gasnature wishes to know how to treat the agreement with Gogas including any obligation or possible obligation arising on the underground storage facility and the accounting for the irrecoverable gas. (9 marks)<br>(b) Gasnature has entered into a 10-year contract with Agas for the purchase of natural gas. Gasnature has made an advance payment to Agas for an amount equal to the total quantity of gas contracted for 10 years which has been calculated using the forecasted price of gas. The advance carries interest of 6% per annum, which is settled by way of the supply of extra gas. Fixed quantities of gas have to be supplied each month and there is a price adjustment mechanism in the contract whereby the difference between the forecasted price of gas and the prevailing market price is settled in cash monthly. If Agas does not deliver gas as agreed, Gasnature has the right to claim compensation at the current market price of gas. Gasnature wishes to know whether the contract with Agas should be accounted for under IFRS 9 Financial Instruments. (6 marks)<br>(c) Additionally, Gasnature is finalising its financial statements for the year ended 31 August 2015 and has the following issues:<br>(i) Gasnature purchased a major refinery on 1 January 2015 and the directors estimate that a major overhaul is required every two years. The costs of the overhaul are approximately $5 million which comprises $3 million for parts and equipment and $2 million for labour. The directors proposed to accrue the cost of the overhaul over the two years of operations up to that date and create a provision for the expenditure. (4 marks)<br>(ii) From October 2014, Gasnature had undertaken exploratory drilling to find gas and up to 31 August 2015 costs of $5 million had been incurred. At 31 August 2015, the results to date indicated that it was probable that there were sufficient economic benefits to carry on drilling and there were no indicators of impairment. During September 2015, additional drilling costs of $2 million were incurred and there was significant evidence that no commercial deposits existed and the drilling was abandoned. (4 marks)<br>Required:<br>Discuss, with reference to International Financial Reporting Standards, how Gasnature should account for the above agreement and contract, and the issues raised by the directors.<br>Note: The mark allocation is shown against each of the items above.<br>Professional marks will be awarded in question 3 for clarity and quality of presentation. (2 marks)
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There has been significant divergence in practice over recognition of revenue mainly because International Financial Reporting Standards (IFRS) have contained limited guidance in certain areas. The International Accounting Standards Board (IASB) as a result of the joint project with the US Financial Accounting Standards Board (FASB) has issued IFRS 15 Revenue from Contracts with Customers. IFRS 15 sets out a five-step model, which applies to revenue earned from a contract with a customer with limited exceptions, regardless of the type of revenue transaction or the industry. Step one in the five-step model requires the identification of the contract with the customer and is critical for the purpose of applying the standard. The remaining four steps in the standard’s revenue recognition model are irrelevant if the contract does not fall within the scope of IFRS 15.<br>Required:<br>(a) (i) Discuss the criteria which must be met for a contract with a customer to fall within the scope of IFRS 15. (5 marks)<br>(ii) Discuss the four remaining steps which lead to revenue recognition after a contract has been identified as falling within the scope of IFRS 15. (8 marks)<br>(b) (i) Tang enters into a contract with a customer to sell an existing printing machine such that control of the printing machine vests with the customer in two years’ time. The contract has two payment options. The customer can pay $240,000 when the contract is signed or $300,000 in two years’ time when the customer gains control of the printing machine. The interest rate implicit in the contract is 11·8% in order to adjust for the risk involved in the delay in payment. However, Tang’s incremental borrowing rate is 5%. The customer paid $240,000 on 1 December 2014 when the contract was signed. (4 marks)<br>(ii) Tang enters into a contract on 1 December 2014 to construct a printing machine on a customer’s premises for a promised consideration of $1,500,000 with a bonus of $100,000 if the machine is completed within 24 months. At the inception of the contract, Tang correctly accounts for the promised bundle of goods and services as a single performance obligation in accordance with IFRS 15. At the inception of the contract, Tang expects the costs to be $800,000 and concludes that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will occur. Completion of the printing machine is highly susceptible to factors outside of Tang’s influence, mainly issues with the supply of components.<br>At 30 November 2015, Tang has satisfied 65% of its performance obligation on the basis of costs incurred to date and concludes that the variable consideration is still constrained in accordance with IFRS 15. However, on 4 December 2015, the contract is modified with the result that the fixed consideration and expected costs increase by $110,000 and $60,000 respectively. The time allowable for achieving the bonus is extended by six months with the result that Tang concludes that it is highly probable that the bonus will be achieved and that the contract still remains a single performance obligation. Tang has an accounting year end of 30 November. (6 marks)<br>Required:<br>Discuss how the above two contracts should be accounted for under IFRS 15. (In the case of (b)(i), the discussion should include the accounting treatment up to 30 November 2016 and in the case of (b)(ii), the accounting treatment up to 4 December 2015.)<br>Note: The mark allocation is shown against each of the items above.<br>Professional marks will be awarded in question 4 for clarity and quality of presentation. (2 marks)
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(a) Kayte operates in the shipping industry and owns vessels for transportation. In June 2014, Kayte acquired Ceemone whose assets were entirely investments in small companies. The small companies each owned and operated one or two shipping vessels. There were no employees in Ceemone or the small companies. At the acquisition date, there were only limited activities related to managing the small companies as most activities were outsourced. All the personnel in Ceemone were employed by a separate management company. The companies owning the vessels had an agreement with the management company concerning assistance with chartering, purchase and sale of vessels and any technical management. The management company used a shipbroker to assist with some of these tasks.<br>Kayte accounted for the investment in Ceemone as an asset acquisition. The consideration paid and related transaction costs were recognised as the acquisition price of the vessels. Kayte argued that the vessels were only passive investments and that Ceemone did not own a business consisting of processes, since all activities regarding commercial and technical management were outsourced to the management company. As a result, the acquisition was accounted for as if the vessels were acquired on a stand-alone basis.<br>Additionally, Kayte had borrowed heavily to purchase some vessels and was struggling to meet its debt obligations. Kayte had sold some of these vessels but in some cases, the bank did not wish Kayte to sell the vessel. In these cases, the vessel was transferred to a new entity, in which the bank retained a variable interest based upon the level of the indebtedness. Kayte’s directors felt that the entity was a subsidiary of the bank and are uncertain as to whether they have complied with the requirements of IFRS 3 Business Combinations and IFRS 10 Consolidated Financial Statements as regards the above transactions. (12 marks)<br>(b) Kayte’s vessels constitute a material part of its total assets. The economic life of the vessels is estimated to be 30 years, but the useful life of some of the vessels is only 10 years because Kayte’s policy is to sell these vessels when they are 10 years old. Kayte estimated the residual value of these vessels at sale to be half of acquisition cost and this value was assumed to be constant during their useful life. Kayte argued that the estimates of residual value used were conservative in view of an immature market with a high degree of uncertainty and presented documentation which indicated some vessels were being sold for a price considerably above carrying value. Broker valuations of the residual value were considerably higher than those used by Kayte. Kayte argued against broker valuations on the grounds that it would result in greater volatility in reporting.<br>Kayte keeps some of the vessels for the whole 30 years and these vessels are required to undergo an engine overhaul in dry dock every 10 years to restore their service potential, hence the reason why some of the vessels are sold. The residual value of the vessels kept for 30 years is based upon the steel value of the vessel at the end of its economic life. At the time of purchase, the service potential which will be required to be restored by the engine overhaul is measured based on the cost as if it had been performed at the time of the purchase of the vessel. In the current period, one of the vessels had to have its engine totally replaced after only eight years. Normally, engines last for the 30-year economic life if overhauled every 10 years. Additionally, one type of vessel was having its funnels replaced after 15 years but the funnels had not been depreciated separately. (11 marks)<br>Required:<br>Discuss the accounting treatment of the above transactions in the financial statements of Kayte.<br>Note: The mark allocation is shown against each of the elements above.<br>Professional marks will be awarded in question 3 for clarity and quality of presentation. (2 marks)
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Section B – TWO questions ONLY to be attempted<br>(a) Chemclean trades in the chemical industry. The entity has development and production operations in various countries. It has entered into an agreement with Jomaster under which Chemclean will licence Jomaster’s knowhow and technology to manufacture a chemical compound, Volut. The know-how and technology has a fair value of $4 million. Chemclean cannot use the know-how and technology for manufacturing any other compound than Volut. Chemclean has not concluded that economic benefits are likely to flow from this compound but will use Jomaster’s technology for a period of three years. Chemclean will have to keep updating the technology in accordance with Jomaster’s requirements. The agreement stipulates that Chemclean will make a non-refundable payment of $4 million to Jomaster for access to the technology. Additionally, Jomaster will also receive a 10% royalty from sales of the chemical compound.<br>Additionally, Chemclean is interested in another compound, Yacton, which is being developed by Jomaster. The compound is in the second phase of development. The intellectual property of compound Yacton has been put into a newly formed shell company, Conew, which has no employees. The compound is the only asset of Conew. Chemclean is intending to acquire a 65% interest in Conew, which will give it control over the entity and the compound. Chemclean will provide the necessary resources to develop the compound. (8 marks)<br>(b) In the year to 30 June 2015, Chemclean acquired a major subsidiary. The inventory acquired in this business combination was valued at its fair value at the acquisition date in accordance with IFRS 3 Business Combinations. The inventory increased in value as a result of the fair value exercise. A significant part of the acquired inventory was sold in the post acquisition period but before 30 June 2015, the year end.<br>In the consolidated statement of profit or loss and other comprehensive income, the cost of inventories acquired in the business combination and sold by the acquirer after the business combination was disclosed on two different lines. The inventory was partly shown as cost of goods sold and partly as a ‘non-recurring item’ within operating income. The part presented under cost of goods sold corresponded to the inventory’s carrying amount in the subsidiary’s financial statements. The part presented as a ‘non-recurring item’ corresponded to the fair value increase recognised on the business combination. The ‘non-recurring item’ amounted to 25% of Chemclean’s earnings before interest and tax (EBIT). Chemclean disclosed the accounting policy and explained in the notes to the financial statements that showing the inventory at fair value would result in a fall in the gross margin due to the fair value increase. Further, Chemclean argued that isolating this part of the margin in the ‘non-recurring items’, whose nature is transparently presented in the notes, enabled the user to evaluate the structural evolution of its gross margin. (6 marks)<br>(c) In the consolidated financial statements for 2015, Chemclean recognised a net deferred tax asset of $16 million, which represented 18% of its total equity. This asset was made up of $3 million taxable temporary differences and $19 million relating to the carry-forward of unused tax losses. The local tax regulation allows unused tax losses to be carried forward indefinitely. Chemclean expects that within five years, future taxable profits before tax would be available against which the unused tax losses could be offset. This view was based on the budgets for the years 2015-2020. The budgets were primarily based on general assumptions about the development of key products and economic improvement indicators. Additionally, the entity expected a substantial reduction in the future impairment of trade receivables and property which the entity had recently suffered and this would result in a substantial increase in future taxable profit.<br>Chemclean had recognised material losses during the previous five years, with an average annual loss of $19 million. A comparison of Chemclean’s budgeted results for the previous two years to its actual results indicated material differences relating principally to impairment losses. In the interim financial statements for the first half of the year to 30 June 2015, Chemclean recognised impairment losses equal to budgeted impairment losses for the whole year. In its financial statements for the year ended 30 June 2015, Chemclean disclosed a material uncertainty about its ability to continue as a going concern. The current tax rate in the jurisdiction is 30%. (9 marks)<br>Required:<br>Discuss how the above items should be dealt with in the financial statements of Chemclean under International Financial Reporting Standards.<br>Note: The mark allocation is shown against each of the three issues above.<br>Professional marks will be awarded in question 2 for clarity and quality of presentation. (2 marks)
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Carpart, a public limited company, is a vehicle part manufacturer, and sells vehicles purchased from the manufacturer.<br>Carpart has entered into supply arrangements for the supply of car seats to two local companies, Vehiclex and Autoseat.<br>(i) Vehiclex<br>This 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 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 which will be constructed over the next year. (4 marks)<br>(ii) Autoseat<br>Autoseat is purchasing car seats from Carpart. The contract is to last for three years and Carpart is to design, develop and manufacture the car seats. Carpart will construct machinery for this purpose but the machineryis so specific that it cannot be used on other contracts. Carpart maintains the machinery but the know-how has been granted royalty free to Autoseat. The price of each car seat includes a fixed price to cover the cost of the machinery. If Autoseat decides not to purchase a minimum number of seats to cover the cost of the machinery, then Autoseat has to repay Carpart for the cost of the machinery including any interest incurred.<br>Autoseat can purchase the machinery at any time in order to safeguard against the cessation of production by Carpart. The purchase price would be the cost of the machinery not yet recovered by Carpart. The machinery has a life of three years and the seats are only sold to Autoseat who sets the levels of production for a period.<br>Autoseat can perform. a pre-delivery inspection on each seat and can reject defective seats. (9 marks)<br>(iii) Vehicle sales<br>Carpart sells vehicles on a contract for their market price (approximately $20,000 each) at a mark-up of 25%<br>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. 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.<br>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 70% of its original purchase price. It is thought that the buyers will exercise the option. At the end of two years, the fair value of the vehicle is expected to be 55% of the original purchase price. If the option is not exercised, then the buyer keeps the vehicle.<br>Carpart also uses some of its vehicles for demonstration purposes. These vehicles are normally used for this<br>purpose for an eighteen-month period. After this period, the vehicles are sold at a reduced price based upon their condition and mileage. (10 marks)<br>Professional marks will be awarded in question 3 for clarity and quality of discussion. (2 marks)<br>Required:<br>Discuss how the above transactions would be accounted for under International Financial Reporting Standards in the financial statements of Carpart.<br>Note. The mark allocation is shown against each of the arrangements above.
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3 Ashlee, a public limited company, is preparing its group financial statements for the year ended 31 March 2005. The<br>company applies newly issued IFRSs at the earliest opportunity. The group comprises three companies, Ashlee, the<br>holding company, and its 100% owned subsidiaries Pilot and Gibson, both public limited companies. The group<br>financial statements at first appeared to indicate that the group was solvent and in a good financial position. However,<br>after the year end, but prior to the approval of the financial statements mistakes have been found which affect the<br>financial position of the group to the extent that loan covenant agreements have been breached.<br>As a result the loan creditors require Ashlee to cut its costs, reduce its operations and reorganise its activities.<br>Therefore, redundancies are planned and the subsidiary, Pilot, is to be reorganised. The carrying value of Pilot’s net<br>assets, including allocated goodwill, was $85 million at 31 March 2005, before taking account of reorganisation<br>costs. The directors of Ashlee wish to include $4 million of reorganisation costs in the financial statements of Pilot for<br>the year ended 31 March 2005. The directors of Ashlee have prepared cash flow projections which indicate that the<br>net present value of future net cash flows from Pilot is expected to be $84 million if the reorganisation takes place<br>and $82 million if the reorganisation does not take place.<br>Ashlee had already decided prior to the year end to sell the other subsidiary, Gibson. Gibson will be sold after the<br>financial statements have been signed. The contract for the sale of Gibson was being negotiated at the time of the<br>preparation of the financial statements and it is expected that Gibson will be sold in June 2005.<br>The carrying amounts of Gibson and Pilot including allocated goodwill were as follows at the year end:<br>The fair value of the net assets of Gibson at the year end was $415 million and the estimated costs of selling the<br>company were $5 million.<br>Part of the business activity of Ashlee is to buy and sell property. The directors of Ashlee had signed a contract on<br>1 March 2005 to sell two of its development properties which are carried at the lower of cost and net realisable value<br>under IAS 2 ‘Inventories’. The sale was agreed at a figure of $40 million (carrying value $30 million). A receivable of<br>$40 million and profit of $10 million were recognised in the financial statements for the year ended 31 March 2005.<br>The sale of the properties was completed on 1 May 2005 when the legal title passed. The policy used in the prior<br>year was to recognise revenue when the sale of such properties had been completed.<br>Additionally, Ashlee had purchased, on 1 April 2004, 150,000 shares of a public limited company, Race, at a price<br>of $20 per share. Ashlee had incurred transaction costs of $100,000 to acquire the shares. The company is unsure<br>as to whether to classify this investment as ‘available for sale’ or ‘at fair value through profit and loss’ in the financial<br>statements for the year ended 31 March 2005. The quoted price of the shares at 31 March 2005 was $25 per share.<br>The shares purchased represent approximately 1% of the issued share capital of Race and are not classified as ‘held<br>for trading’.<br>There is no goodwill arising in the group financial statements other than that set out above.<br>Required:<br>Discuss the implications, with suitable computations, of the above events for the group financial statements of<br>Ashlee for the year ended 31 March 2005.<br>(25 marks)
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3 On 1 June 2005, Egin, a public limited company, was formed out of the re-organisation of a group of companies with<br>foreign operations. The directors require advice on the disclosure of related party information but are reluctant to<br>disclose information as they feel that such transactions are a normal feature of business and need not be disclosed.<br>Under the new group structure, Egin owns 80% of Briars, 60% of Doye, and 30% of Eye. Egin exercises significant<br>influence over Eye. The directors of Egin are also directors of Briars and Doye but only one director of Egin sits on the<br>management board of Eye. The management board of Eye comprises five directors. Originally the group comprised<br>five companies but the fifth company, Tang, which was a 70% subsidiary of Egin, was sold on 31 January 2006.<br>There were no transactions between Tang and the Egin Group during the year to 31 May 2006. 30% of the shares<br>of Egin are owned by another company, Atomic, which exerts significant influence over Egin. The remaining 40% ofthe shares of Doye are owned by Spade.<br>During the current financial year to 31 May 2006, Doye has sold a significant amount of plant and equipment to<br>Spade at the normal selling price for such items. The directors of Egin have proposed that where related party<br>relationships are determined and sales are at normal selling price, any disclosures will state that prices charged to<br>related parties are made on an arm’s length basis.<br>The directors are unsure how to treat certain transactions relating to their foreign subsidiary, Briars. Egin purchased<br>80% of the ordinary share capital of Briars on 1 June 2005 for 50 million euros when its net assets were fair valued<br>at 45 million euros. At 31 May 2006, it is established that goodwill is impaired by 3 million euros. Additionally, at<br>the date of acquisition, Egin had made an interest free loan to Briars of $10 million. The loan is to be repaid on<br>31 May 2007. An equivalent loan would normally carry an interest rate of 6% taking into account Briars’ credit rating.<br>The exchange rates were as follows:<br>Euros to $<br>1 June 2005 2<br>31 May 2006 2·5<br>Average rate for year 2·3<br>Financial liabilities of the Group are normally measured at amortised cost.<br>One of the directors of Briars who is not on the management board of Egin owns the whole of the share capital of a<br>company, Blue, that sells goods at market price to Briars. The director is in charge of the production at Briars and<br>also acts as a consultant to the management board of the group.<br>Required:<br>(a) (i) Discuss why it is important to disclose related party transactions, explaining the criteria which determine<br>a related party relationship. (5 marks)<br>(ii) Describe the nature of any related party relationships and transactions which exists:<br>– within the Egin Group including Tang (5 marks)<br>– between Spade and the Egin Group (3 marks)<br>– between Atomic and the Egin Group (3 marks)<br>commenting on whether transactions should be described as being at ‘arm’s length’.
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