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Answer the following ONE compulsory question which relates to the Case below. Marks
will be awarded for logical argumentation and appropriate presentation of the answers.
CASE
Assume that you are the accounting manager of Forever Prosperity Limited (“FPL”),
Mr. Raymond Chan. FPL is a listed company in Hong Kong. It is principally engaged in
the manufacture of electronic products in Hong Kong.
In order to achieve vertical integration, FPL acquired 20 per cent of the issued share capital
of Unending Achievement Limited (“UAL”), a retail company incorporated in Hong Kong, on
1 April 2005. The cost of investment was three million Foreign Currency Dollars
(FC3,000,000), converted into six million Hong Kong Dollars (HKD6,000,000) on 1 April 2005.
This 20 per cent shareholding enables FPL to exercise significant influence on UAL. The
book values of UAL’s net identifiable assets approximate to their fair values at the acquisition
date.
On the same date, i.e. 1 April 2005, FPL acquired 80 per cent of the issued share capital of
Everlasting Success Limited (“ESL”), also a retail company incorporated in Hong Kong.
The cost of investment was also six million Hong Kong Dollars (HKD6,000,000). The book
values of ESL’s net identifiable assets approximate to their fair values at the acquisition date.
The difference between the cost of investment and FPL’s share of the book values of ESL’s
net identifiable assets is attributed to the goodwill.
ESL UAL
HKD'000 HKD'000 HKD'000 HKD'000
Cost of investment 6,000 6,000
Fair value of net assets acquired
Property, plant and equipment 5,000 24,300
Inventories 1,000 4,400
Accounts receivable 1,400 4,000
Cash and cash equivalents 200 800
Accounts payable (1,000) (3,500)
6,600 30,000
% acquired 80% 5,280 20% 6,000
Goodwill 720 --
To partly finance the acquisition of the 80% interest in ESL, FPL raised HKD4,000,000 by
issuing new ordinary shares to an investor.
FPL paid FC500,000 (HKD1,000,000) at 1 April 2005 to the vendor of the 20% interest in
UAL. The vendor allowed FPL to settle the remaining balance of FC2,500,000
(HKD5,000,000 at the exchange rate at 1 April 2005), on 31 March 2008, on condition that
FPL pays the market rate of interest for the loan.
Consolidated income statement (extract) for the year ended 31 March 2006
HKD'000
Revenue 35,700
Cost of sales (Note 1) (19,200)
Depreciation expenses (4,000)
Other expenses (Note 2) (3,400)
Interest expenses (400)
Share of profit of an associate (Note 3) 1,000
Profit before tax 9,700
Income tax expenses (1,400)
Profit for the period 8,300
Attributable to:
Equity holders of the parent company 7,700
Minority interests 600
8,300
2006 2005
HKD’000 HKD’000
Assets
Property, plant and equipment (Note 4) 48,000 33,000
Goodwill 720 --
Investment in an associate (Note 5) 6,400 --
Inventories 5,300 3,900
Accounts receivable 2,700 2,600
Cash and cash equivalents (Note 6) 200 6,300
63,320 45,800
Equity and Liabilities
Ordinary shares 14,000 12,000
Share premium 2,000 --
Accumulated profits (Note 7) 35,920 31,220
Minority interests (Note 8) 2,600 1,200
Non-current borrowings (Note 9) 5,300 --
Accounts payable 1,200 380
Interests payable 200 --
Tax payable 2,100 1,000
63,320 45,800
The functional currency and presentation currency for FPL, UAL and ESL are the Hong Kong
Dollar (HKD).
(3) This represents the share of UAL’s post-tax profit for the year ended
31 March 2006.
(4) During the year, the group has purchased certain property, plant and equipment
but has not disposed of any property, plant and equipment.
(5) At 1 March 2006, FPL received interim dividends for the six months ended
30 September 2005 of HK$300,000 from UAL.
(7) During the year, FPL paid dividends of HK$3,000,000 to its shareholders.
Proposed dividends at 31 March 2006 were HK$2,400,000
(2005: HK$3,000,000).
(8) Certain subsidiaries of FPL, some of them non-wholly owned, have paid
dividends during the year.
(9) This represents the amount due to the vendor of the 20% interest in UAL at
amortised cost.
After you have sent the draft consolidated financial statements to the directors for review,
one of the directors, who is not a certified public accountant, sends you an e-mail as follows:
Consolidated financial statements of FPL for the year ended 31 March 2006
Could you please clarify the following points relating to FPL’s draft consolidated financial
statements which I have just reviewed.
(A) I noticed that the dividends received from UAL have been reported as an item of cash
inflows in the consolidated cash flow statement for the year ended 31 March 2006.
However, the dividends received from ESL have not been reported in the
consolidated cash flow statement accordingly. Why is there such an inconsistency?
Moreover, should the dividends be a kind of revenue? Why do they not appear as
such in the income statement?
Best regards,
Ryan
Required:
(i) the different accounting treatments generally applied to UAL and ESL
in FPL’s consolidated financial statements (ignore the dividends for
this part);
(8 marks)
(7 marks)
(10 marks)
(b) Prepare the consolidated cash flow statement of FPL as at 31 March 2006,
including all the required notes. You may use either the direct method or the
indirect method to present the operating cash flows.
(25 marks)
* * * END OF SECTION A * * *
(QUESTIONS)
Answer all of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.
“An overseas incorporated company with an annual turnover of less than HK$50 million is no
longer required to prepare financial statements that present a true and fair view.”
Required:
Apes Investment Inc. (“APES”) has the following investments as at 31 December 2005:
(2) On 1 July 2005, APES acquired 250,000 ordinary shares of Top Trend Limited (“TTL”), a
privately owned enterprise, at a cost of HK$18 per share from the sole shareholder.
TTL has 5,000,000 ordinary shares in issue. APES considers itself a passive investor
and has not participated in TTL’s financing and operating policy decisions. APES has
not designated this investment as at fair value through profit or loss from the acquisition
date. Although TTL has reported a profit and declared dividends continuously in the
past year, it is considered that the fair value of these shares cannot be reliably
measured as at 31 December 2005.
Required:
Determine and explain how APES should recognise and measure these investments
in the consolidated balance sheet as at 31 December 2005 in accordance with relevant
Hong Kong Financial Reporting Standards.
(12 marks)
High Tech Toys Group (“HTT Group”) is engaged in the manufacture and trading of
electronic toys with two production plants in Hong Kong and Shenzhen respectively. On
18 November 2005, the board of HTT Group decided to close down the production plant in
Hong Kong. On 14 December 2005, a detailed plan for closing down the Hong Kong plant
(including the disposal of the leasehold property in which the plant situated) was approved
by the board. Prior to the balance sheet of 31 December 2005, redundancy notices were
sent to the workers for termination of the employment contract on 28 February 2006 and a
property agent was engaged for the disposal of the leasehold property. Also, a
transportation contract of HK$800,000 was entered into with a logistics company to ship the
machinery acquired after 2002 from Hong Kong to Shenzhen in early February 2006. A
deposit of HK$100,000 was paid on 30 December 2005. All the other machinery,
equipment and furniture and fixtures will be abandoned.
Required:
(a) leasehold property (HTT Group acquired the leasehold property in lump sum ten
years ago. The consideration cannot be allocated reliably between the land
element and the building element. Accordingly, the leasehold property has
been accounted for as property, plant and equipment and measured at cost
model. The property agent has advised you that the market price of the
leasehold property is higher than the original cost);
(d) unused entitlement of annual leave of workers (Each worker is entitled to fifteen
working days of paid leave annually. Unused entitlement of paid leave can be
carried forward to a future period. Workers are entitled to a cash payment for
unused entitlements on leaving the company); and
(e) severance payment under the Employment Ordinance for the redundant
workers.
(15 marks)
On 1 January 2005, Excellent Holding Limited (“EHL”) acquired a 100% equity interest of
Super Return Limited (“SRL”) at a cash consideration of HK$10,600,000. SRL has four
subsidiaries, W, X, Y and Z, each operates independently. The fair values of the assets of
W, X, Y and Z acquired by EHL were HK$800,000, HK$1,800,000, HK$2,800,000 and
HK$3,800,000 respectively. EHL recognised goodwill of HK$1,400,000 that relates to the
acquisition of SRL. SRL is an investment holding company with no assets other than
investments in W, X, Y and Z.
At the acquisition date, there was no reasonable way to allocate the goodwill arising on the
acquisition of SRL to W, X, Y and Z or other cash-generating units of EHL. The whole
goodwill was allocated to the group of cash-generating units consisting of W, X, Y and Z.
At 31 December 2005, the carrying amounts of the assets of W, X, Y and Z in EHL’s draft
consolidated accounts were HK$900,000, HK$1,900,000, HK$2,500,000 and HK$4,400,000
respectively.
At 31 December 2005, EHL conducted a review of the carrying amounts of the assets of W,
X, Y and Z and the recoverable amounts at 31 December 2005 were estimated to be
HK$1,100,000, HK$2,300,000, HK$2,400,000 and HK$5,000,000 respectively.
Required:
(4 marks)
(b) Determine any impairment loss that should be recognised in EHL’s consolidated
financial statements for the year ended 31 December 2005.
(9 marks)