F7 MOCK TEST – ANSWER

SECTION A
1. Indicate, by clicking on the relevant boxes, whether the following statements describe the
advantages/disadvantages of IFRS Accounting Standards are correct or incorrect.

IFRS Accounting Standards improve comparability

because they must be used by all listed companies CORRECT INCORRECT
worldwide.

IFRS Accounting Standards facilitate cross-border

CORRECT INCORRECT
investment.

IFRS Accounting Standards are suitable for

CORRECT INCORRECT
reporting entities of any size and type.

IFRS Accounting Standards they may be costly to

CORRECT INCORRECT
implement.

Explain:
The requirement to use IFRS accounting standards is dependent on the jurisdiction/country of the
entity. Not all countries have opted to adopt IFRS Accounting Standards Therefore, they are not
applied by all listed companies worldwide.
IFRS Accounting Standards are designed for large companies with a profit-motive. They are less
suitable for small, private companies and organisations that do not have a profit motive.

2. The IASB follows a standard-setting process when developing a new standard.

What is the correct order of this standard-setting process?
Arrange the tokens below in order from steps 1-4 of the process

Step 1 Consultation with the IFRS advisory council about adding the topic to the IASB’s work plan

Step 2 Issue a discussion paper, if relevant

Step 3 Issue an exposure draft

Step 4 Conduct a post-implementation review

1
Tokens

Conduct a post-implementation review

Issue a discussion paper, if relevant

Issue an exposure draft

Consultation with the IFRS advisory council about adding the topic to the IASB’s work plan

3. Which TWO of the following criteria must be met for an asset to be recognised in the financial
statements according to the Conceptual Framework for Financial Reporting?
A. Recognition of the asset provides verifiable information
B. Recognition of the asset provides relevant information
C. The cost of the asset is capable of reliable measurement
D. Recognition of the asset provides users with a faithful representation of the asset
E. It is probable that the asset will generate future economic benefits
Explain:

• Recognition of the asset provides relevant information

• Recognition of the asset provides users with a faithful representation of the asset.
An asset is recognised only if:

• it meets the definition of an asset, and

• recognition of the asset (and any resulting income, expenses or changes in equity) provides
information that is useful – i.e. relevant information that faithfully represents the asset.
Verifiability is an enhancing qualitative characteristic of useful information but does not form part of
the recognition criteria for assets.
The recognition criteria in the Conceptual Framework do not refer to reliable measurement of an
asset or the probability of future economic benefits.

4. Greek Co, a company with a 31 December financial year end, decided to sell one of its buildings
on 1 October 20X8 and immediately started to market it for sale at its fair value. A potential buyer
has been found to purchase the building in its current condition. The building is ready for immediate

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transfer to the buyer as soon as price negotiations are complete and the sale is expected to take
place in early 20X9. The following information is relevant to the building at 31 December 20X8.

Carrying amount at 1 October 20X8 $500,000

Fair value at 1 October 20X8 $525,000

Fair value at 31 December 20X8 $505,000

Costs to sell $70,000

At what amount should the building be measured in Greek Co’s statement of financial position at
31 December 20X8?
A. $500,000
B. $435,000
C. $505,000
D. $450,000
Explain:
Held for sale non-current assets are carried at the lower of:

• carrying amount; and

• fair value less costs to sell.

The building is initially measured at $455,000 ($525,000 - $70,000) on 1 October 20X8
This is reassessed at the year end and the fair value less costs to sell has fallen further to $435,000
($505,000 - $70,000).

5. Indicate, for each of the items listed below, whether the expenditure should be included in the
cost of inventory or recognised in profit or loss, in accordance with IAS 2 Inventories.

An allocation of fixed production overheads RECOGNISED IN

INCLUDED IN COST
based on normal capacity PROFIT OR LOSS

RECOGNISED IN
Abnormal amounts of wasted materials INCLUDED IN COST
PROFIT OR LOSS

Costs of storage after completion of RECOGNISED IN

INCLUDED IN COST
inventories and before sale PROFIT OR LOSS

3
Explain:
The cost of inventories includes all costs involved in bringing the inventories to their present location
and condition. This includes purchase costs, cost of conversion, and other cost. Production
overheads are a cost of conversion. Fixed production overheads should be allocated based on
normal capacity (and variable production overheads based on actual output). Abnormal losses are
specifically excluded from the cost of inventories and should be recognised as an expense in profit
and loss. Storage costs are only part of the cost of inventory if the storage is a necessary part of the
production process.

6. Tea Co grows tea bushes on its tea plantation When the leaves from the bushes have reached
maturity, they are picked and then dried using drying equipment.
Select the appropriate IFRS Accounting Standard that should be used to account for each of the
components of Tea Co’s tea plantation by matching the correct token to the correct component.

IFRS Accounting Standard

Tea bushes IAS 16 Property, Plant and Equipment
Tea leaves at the time of picking IAS 41 Agriculture
Drying equipment IAS 16 Property, Plant and Equipment

Tokens

IAS 16 Property, Plant and Equipment

IAS 2 Inventories

IAS 41 Agriculture

Explain:
Tea bushes are bearer plants since they bear tea leaves for more than one period. Bearer plants are
within the scope of IAS 16 rather than IAS 41.
The tea leaves at the time of harvest are agricultural produce and thus at this point should be
recognised and measured in accordance with IAS 41. After harvest, they are inventories and IAS 2
applies.
The drying equipment is an item of property, plant and equipment since it is used in the production
of tea leaves and is expected to be used in more than one period.

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7. Teach Co received a $3 m loan from its local government to assist with expanding its business
operations to build a private college. The loan has an interest rate of 1% and is repayable after 3
years. The prevailing market interest rate for similar loans is 6%.
Select the correct answer to describe the nature of the loan received and the value of the benefit
received in accordance with IAS 20 Accounting for Government Grants and Disclosure of
Government Assistance.
Government grant
The loan received from the local government is considered to be

5% interest expense on the loan

The value of the benefit received from the government
amount over 3 years

A. Government assistance
B. Government grant
C. $3m
D. 5% interest expense on the loan amount over 3 years

8. Golden Co has purchased land for its mining operations. The purchase date was 1 August 20X8.
Government legislation requires that Golden Co restores the land after a period of 5 years. At 1
August 20X8 the cost to restore the land, based on an environmental expert’s advice, is $180 000.
An appropriate discount rate is 6%. Golden Co has a 31 December year-end.
Which of the following statements is correct according to IAS 37 Provisions, Contingent Liabilities
and Contingent Assets?
A. On 1 August 20X8 Golden Co should recognise a provision equal to the present value of the
restoration costs and a corresponding expense in profit and loss. The carrying amount of the
environmental provision at 31 December 20X8 is $190,800.
B. On 1 August 20X8 Golden Co should recognise a provision equal to the present value of the
restoration costs and a corresponding debit entry to land. The carrying amount of the environmental
provision at 31 December 20X8 is $190,800.
C. On 1 August 20X8 Golden Co should recognise a provision equal to the present value of the
restoration costs and a corresponding debit entry to land. The carrying amount of the
environmental provision at 31 December 20X8 is $184,500.
D. On 1 August 20X8 Golden Co should recognise a provision equal to the present value of the
restoration costs and a corresponding expense in profit and loss. The carrying amount of the
environmental provision at 31 December 20X8 is $184,500.

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Explain:
As time passes, the present value of the provision will increase. This "unwinding of the discount" is
similar to interest and recognised as an interest expense in the statement of profit or loss for the
period. In this scenario, since the provision was only recognised on 1 August. Interest should only be
accounted for 5/12 months.
Value provision of at 31 December X8
Present value on 1 Aug 20X8: 180,000
Interest expense in year ended 31 December 20X8: (180,000 x 6% x 5/12m) = $4,500
Carrying amount at year-end: 180,000+4,500=184,500

9. Indebt Co issued $20 million convertible loan notes on 1 July 20X3. In five years’, time, on 30 June
20X8, the holders can choose to redeem the loan notes for cash of $20 million or to convert them
into a fixed number of ordinary shares.
At 1 July the present value of loan notes with similar terms but without a conversion option was
$18.97million.
Which statement is correct in accordance with IAS 32 Financial Instruments: Presentation?
A. At 1 July 20X3 Indebt Co should recognise a liability of $18.97million. If the loan notes are
converted on 30 June 20X98, $18.97 is transferred to equity from the liability account.
B. At 1 July 20X3 Indebt Co should recognise an equity balance of $1.03million. This balance is
subsequently increased to $20 million by 30 June 20X8.
C. At 1 July 20X3 Indebt Co should recognise a liability of $18.97million. A finance cost of $1.03
million is recognised over the five years to 30 June 20X8.
D. At 1 July 20X3 Indebt Co should recognise an equity balance of $ 20 million. This is eliminated if
the loan notes are redeemed for cash.
Explain:
The initial entry to recognise the issue of the loan notes is:
Cr Equity $1,030,000
Cr Loan notes (liability) $18,970,000
The equity component is the residual amount after deduction of the more easily measurable debt
component from the value of the instrument as a whole
The liability is measured by discounting the stream of future payments at the prevailing market rate
for a similar liability without the conversion option.

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Over the five years to maturity the liability is wound up to the $ 20 million redemption value and $
1.03 million is recognised as an interest expense. The equity balance remains at $1.03 million
throughout the five years.

10. Parent owns 35% of Kid Co which gives it significant influence. During the current financial
reporting period Parent Co. sold inventory to Kid Co for $8,000 at a margin of 30%. At year-end, the
inventory remained unsold. Parent Co has recognised a receivables balance of $8,000 for this sale
and Kid Co has recognised a corresponding payables balance.
Which statement is correct?
A. The unrealised profit is $2,400 and the receivable and payable balances are cancelled in the
consolidated financial statements.
B. The unrealised profit is $840 and the receivable and payable balances are cancelled in the
consolidated financial statements. C. $7.3 million
C. The unrealised profit is $2,400 and the receivable and payable balances are not cancelled in the
consolidated financial statements.
D. The unrealised profit is $840 and the receivable and payable balances are not cancelled in the
consolidated financial statements.
Explain:
The unrealised profit is: $840 = (30% x $8,000)) x 35%
Balances between a group company and an associate are not cancelled in the consolidated financial
statements.

11. Fit Co owns a 40% shareholding in Dot Co. which gives it significant influence During the year, Fit
Co sold goods to Dot Co. At the year-end Dot still holds some of these goods.
Select the correct tokens to reflect the consolidation adjustment required in relation to the
unrealised profit in inventory.
Tokens
Dr Cost of sales
Share of profit of associate
Cr Investment in associate
Cost of sales

Inventories

Investment in associate

7
Explain:
A sale of goods from a parent to an associate is a “downstream” transaction. The group share of the
unrealised profit must be eliminated from the selling company’s cost of sales and the acquiring
company’s inventory balance. Since the inventory balance of the associate is not reflected in the
group statements, the investment in associate line item must reflect this elimination.

12. Beaver Co has a year-end of 31 December 20X6. It entered into the following foreign currency
transactions in the current year:

• Transaction 1: On 25 October 20X6, Beaver Co bought inventory denominated in a foreign

currency. At year-end, the inventory has been sold however the supplier has not been paid.

• Transaction 2: On 1 July 20X6, Beaver Co purchased equipment to be used in its operations,

paying in a foreign currency. The equipment is measured using the cost model and
depreciated over a useful life of five years.
Indicate which of the options are correct in accordance with IAS 21 Foreign Currency Transactions.

The trade payable is A monetary asset A non-monetary asset

The trade payable is Not retranslated at 31 December 20X6 Retranslated at 31 December 20X6

The equipment is A monetary asset A non-monetary asset

The equipment is Not retranslated at 31 December Retranslated at 31 December 20X6

13. Freddy Co purchased a building, paying for it in a foreign currency. The building was classified
as investment property and Freddy Co adopts the IAS 40 fair value model for such properties.
Since the building was purchased, its fair value has increased and an exchange gain has arisen.
Which of the following options is correct, in accordance with IAS 21 Foreign Currency Transactions?
A. The increase in fair value and the exchange gain should be recognised in profit and loss
B. The increase in fair value and the exchange gain should be recognised in OCI
C. The exchange gain should be recognised in profit and loss and the fair value gain should be
recognised in OCI
D. The fair value gain should be recognised in profit and loss and the exchange gain should be
recognised in OCI

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Explain:
The exchange gain or loss on non-monetary items measured at fair value is recognised in the same
way as the fair value gain or loss. Since the building is an investment property, measured using the
fair value model, the fair value gain will be recognised in profit and loss, and therefore so will the
exchange gain.

14. Thirsty Co manufactures ‘Quench’ branded soft drinks. The brand was purchased from a
competitor during the current year. Thirsty Co-management believes that the ‘Quench’ brand will
contribute to the net cash flows of the entity indefinitely.
Which of the following requirements reflects the correct accounting treatment for the brand IAS 38
Intangible assets?
A. Amortise the brand over a maximum useful life of 10 years and test for impairment if indicators
exist
B. Do not amortise the brand but review the useful life if there is evidence that it has changed and
test for impairment if indicators exist
C. Amortise the brand over a maximum useful life of 10 years and review this life annually
D. Do not amortise the brand but test for impairment annually and whenever indicators exist
Explain:
IAS 38 permits an intangible asset to have an indefinite useful life and in this case, it is not amortised,
but instead tested for impairment annually; and whenever there is an indication of impairment.
The useful life is reviewed each period to determine whether events and circumstances continue to
support an indefinite useful life assessment.

15. The following information relates to Profit Co at 31 December 20X8

20X8 ($000) 20X7 ($000)

Equity shares $2 each 200,000 50,000

Profit for the year 160,000 95,000

During 20X8 there was a bonus issue of equity shares. No other shares were issued in 20X7 and
20X8.
Complete the sentence below by filling in the blank
In accordance with IAS 33 Earnings Per Share, the basic EPS in 20X7, presented as a comparative in
the 20X8 financial statements, is ___95______________ cents

9
Explain:
The bonus shares are treated as if they had always been in issue. The number of shares in issue in
20X8 is 100 million ($200m/$2) and the 20X7 EPS is recalculated based on this number of shares.
$95m/100m = 95 cents

SECTION B
The following scenario relates to questions 16-20
Osborn Co purchased two properties on 1 July 20X7.

• Property 1 cost $900,000 and was used by Osborne as a head office. Legal costs relating to
the purchase were $30,000. During the course of the year ended 31 December 20X7, Osborn
Co had to repair part of the roof at a cost of $2,000.

• Property 2 cost $300,000 and was immediately rented to corporate tenants for $1,000 per
month. On 1 September 20X8 Osborn Co converted this property into a sales office for its
own use.
The fair value of the buildings was as follows:

Date Property 1 ($) Property 2 ($)

31 December 20X7 925,000 320,000

1 September 20X8 - 337,000

31 December 20X8 895,000 340,000

Extracts from Osborn Co’s accounting policies note are provided below:

• Osborn Co measured owner-occupied property using the revaluation model and depreciates
it over a 20-year useful life.

• Osborn Co measures investment properties using the fair value model.

16. According to relevant IFRS Accounting Standards, how will the legal costs relating to the
purchase of Property 1 and its subsequent roof repair costs be recognised?
A. The legal costs should be included as part of the initial measurement of the building and the roof
repair costs should be recognised as an expense in profit or loss.
B. The legal costs should be included as part of the initial measurement of the building and the roof
repair costs should be added to the carrying amount of the building.
C. The legal costs and the roof repair costs should both be recognised as an expense in profit or
loss.

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D. The legal costs should be recognised as an expense in profit or loss and the roof repair costs
should be added to the carrying amount of the building.
Explain:
An investment property is measured initially at its cost, which is the fair value of the consideration
given for it, including any transaction costs.
Roof repair costs do not meet the definition of an asset and should be recognised as an expense as
incurred.

17. What is the total amount that should be recognised in the statement of profit or loss in the year
ended 31 December 20X7 in relation to Property 2?
A. An expense of $1,50
B. An expense of $7,500
C. Income of $20,000
D. Income of $26,000
Explain:
The property is investment property measured using the fair value model. It is initially recognised at
a cost of $300,000 and then remeasured to its fair value of $320,000 at the year's end. The $20,000
gain is recognised in profit or loss. A rental income of $6,000 ($1,000 x 6 months) is also recognised.

18. According to relevant IFRS Accounting Standards, what are the accounting steps that should be
taken to correctly recognise the account conversion Property 2 into a sales office on 1 September
20X8?
Arrange the tokens below in the correct order.

Step 1 Measure the property at its fair value of $337,000

Step 2 Transfer the property between non-current asset classifications in the statement of
financial position

Step 3 Depreciate the property

Tokens

Transfer the property between non-current asset classifications in the statement of financial position

Measure the property at its fair value of $337,000

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Depreciate the property

Explain:
1. Measure the property at its fair value
2. Transfer the property between non-current asset classifications in the statement of financial
position.
3. Depreciate the building
When an investment property at fair value is transferred to owner-occupied property, its fair value at
the date of transfer is deemed cost for the subsequent application of IAS 16.

19. Which statement best describes the accounting treatment that should be applied to the
decrease in the fair value of Property 1 in the year ended 31 December 20X8?
A. The decrease is recognised in profit or loss.
B. The decrease is recognised in other comprehensive income.
C. The decrease is recognised in other comprehensive income to the extent that a revaluation
surplus exists for Property 1 and thereafter in profit or loss.
D. The decrease is recognised in profit or loss to the extent of any previous increase in fair value and
thereafter in other comprehensive income.
Explain:
Property 1 is an owner-occupied property measured using the revaluation model. Any decrease in
fair value is initially recognised as a reversal of the previous revaluation.

20. Which of the following properties which are also held by Osborn Co should not be recognised as
an investment property?
A. Red House, which is an apartment block occupied by Osborn Co employees, all of whom pay
market rents
B. Blue Tower, which Osborn Co rents from an unrelated party and sublets to corporate tenants
C. Green Place, which is land held for an undetermined future use
D. Black Centre, which is a shopping centre let to retailers. Osborn Co provides maintenance and
security services to tenants

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Explain:
Where property is occupied by employees it is not investment property, regardless of whether the
employees pay market rents.
Property that is held as a right-of-use asset can be investment property.
The provision of ancillary services (such as security and maintenance) does not affect classification
as an investment property if these services are insignificant.

The following scenario relates to questions 21-25

Britely Co acquired 85% of Dimely Co’s 250,000 shares on 1 January 20X7 for $1.45 million cash
payable immediately, and a share-for-share exchange in which one Britely Co share was exchanged
for every two acquired in Dimely Co. The market price of a Britely Co share on 1 January 20X7 was
$15 and the price of a Dimely Co share was $8. Britely Co has elected to measure non-controlling
interests in Dimely Co at fair value. The share price of Dimely Co at the acquisition date is used to
calculate fair value.
The following information related to Dimely Co at 1 January 20X7.

Retained earnings 1,200,000

Share capital 650,000

The carrying amounts of all the recognised assets and liabilities of Dimely Co were considered to be
equal to their fair value at this date, with the exception of land whose fair value was $200,000 greater
than it carrying amount. In its separate financial statements, Dimely Co had not recognised a
provision for a present obligation of $140,000 that had only a 30% likelihood of being settled. This
had a fair value of $90,000. At 31 December 20X8 the matter to which the present obligation was
related had not been resolved.
In the year ended 31 December 20X7, Dimely Co made profits of $75,000 and reported other
comprehensive income related to financial asset investments of $54,000.
At 31 December 20X7, goodwill in Dimely Co was considered to be impaired by 20%
Britely Co also holds 75% of the equity shares in Grimly Co. During the year ended 31 December 20X8,
Grimly Co sold goods to Britely Co for $120,000, charging a mark-up on cost of 20%. A quarter of
these goods were still held by Britely Co at the reporting date.
21. In accordance with IFRS 3 Business Combinations, the consideration transferred to acquire the
85% equity shareholding in Dimely Co is $_______3,043,750___________
Explain:

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Consideration:
Cash component: $1,450,000
Share exchange: $1,593,750 = ((85% x 250,000 x 1/2) x $15)
Total consideration: $3,043,750

22. In accordance with IFRS 3 Business Combinations, what is the fair value of the identifiable
assets acquired and liabilities assumed on the acquisition of Dimely Co?
A. $1,850,000
B. $1,910,000
C. $1,960,000
D. $2,050,000
Explain:

Retained earnings 1,200,000

Share capital 650,000

FV on land 200,000

Contingent liability (90,000)

1,960,000

The contingent liability is recognised as a provision on acquisition at its fair value because it
represents a present obligation (rather than a possible obligation). The fact that it is not probable to
be paid is irrelevant.

23. What is the carrying amount of the non-controlling interest in Dimely Co reported in the
consolidated statement of financial position at 31 December 20X7?
A. $296,850
B. $300,000
C. $311,250
D. $319,350
Explain:

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$

FV of NCI at acquisition: 15% x 250,000 x $8 300,000

Share of post-acquisition profits: 15% x $75,000 11,250

Share of post-acquisition OCI: 15% x $54,000 8,100

24. Match the tokens below to that correctly reflect the consolidation adjustment required, when
preparing the consolidated statement of financial position at 31 December 20X8, in respect of the
sales made between Grimly Co and Britely Co.

Inventory Non-controlling interest

Cr $5,000 Dr $1,250

Tokens

Dr $1,250 Cr $1,250

Dr $1,500 Cr $1,500

Dr $5,000 Cr $5,000

Dr $6,000 Cr $6,000

Explain:
Unrealised profit = $5,000 (20/120 x $120,000 x 1/4)
NCI share = $1,250 (25% x $5,000)
In the consolidated financial statements, the carrying amount of inventory must reflect its cost to the
group by eliminating any profit that has not yet been realised:

• Reduce (credit) inventory in the consolidated statement of financial position.

• In the statement of profit or loss increase the cost of sales of the selling company. If this is
the subsidiary, the relevant percentage of the adjustment is allocated to the NCI.

25. Which one of the following statements relating to the subsequent measurement of goodwill in
Dimely Co does NOT correctly reflect the requirements of IFRS Accounting Standards?
A. The non-controlling interest is allocated a proportion of the impairment loss in Dimely Co’s
goodwill
B. The goodwill arising on the acquisition of Dimely Co is not amortised
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C. The goodwill in Dimely Co must be tested for impairment annually
D. After the impairment the goodwill in Dimely Co is measured in the consolidated statement of
financial position at its initial measurement less the group share of the impairment loss
Explain:
The carrying amount of goodwill at the reporting date is its cost less the total impairment loss since
the acquisition. Impairment will be allocated:

• between the owners of the parent and the NCI according to their shareholdings, if the NCI is
measured at fair value which it is in this case and;

• entirely to the owners of the parent if the NCI is measured using the proportionate method.
Furthermore, Goodwill must be tested annually for impairment. The test must be carried out at the
same time each year, but not necessarily at the year-end despite an indicator of impairment existing
or nor.

The following scenario relates to questions 26-30.

Dorothy Co is a car dealership and provides maintenance services. The following information is
relevant to the year ended 31 July 20X8.
Agreement with Lucy Co
Dorothy Co has an agreement with another car dealership, Lucy Co. Lucy Co keeps some of Dorothy
Co’s cars in its showroom. If Lucy Co sells one of Dorothy Co’s cars, Dorothy Co pays it a
commission. However, if Dorothy finds a suitable buyer for a car provided to Lucy Co, it, can
immediately request the return of that car from Lucy Co.
Sale of electric car
Dorothy Co sold an electric car to a customer on 1 May 20X8. The contract states that the customer
must pay Dorothy Co $28,000 in two years’ time. An appropriate discount rate is 8%.
Sale of car and maintenance services
Dorothy Co entered into an agreement with another customer on 1 April 20X8 to provide a new car
for $28,800 and one maintenance service free of charge. Similar maintenance services are provided
by several of Dorothy Co’s competitors. The service will be performed when the car has been driven
20,000km. By 31 July 20X8 the customer had driven 8,000km in the car. Ordinarily, a maintenance
service costs $3,200.
Fleet maintenance contract
On 1 July 20X8 Dorothy Co won a lucrative $120,000 contract to provide maintenance services for a
fleet of cars owned by a corporate customer, starting immediately. The contract lasts 2 years. The
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customer paid 50% of the transaction price when the contract began and will pay the balance at the
end of the contract.
In bidding for the contract, the company incurred $18,000 in costs that would not have arisen
otherwise. It also spent $9,600 of management time on the bid.

26. According to IFRS 15 Revenue from Contract with Customers, which TWO of the following
statements are true regarding the agreement between Dorothy Co and Lucy Co?
A. Dorothy Co should recognise revenue in respect of all the cars when they are delivered to Lucy Co
B. Dorothy Co should recognise revenue from cars delivered to Lucy Co when Lucy Co has sold the
car to an external party
C. Lucy Co controls the cars located in its showroom
D. Cars located in Lucy’s showroom are the inventory of Dorothy Co
E. Dorothy Co should recognise revenue in relation to a proportion of the cars when they are delivered
to Lucy Co. The proportion should be based on the expected number of cars that will be returned
Explain:
Since Dorothy Co can require the return of the cars and transfer them to another party, this is a
consignment arrangement. Dorothy Co controls the cars until they are sold to a third party and should
not recognise revenue until then. The cars remain inventory of Dorothy Co until this time.

27. According to IFRS 15 Revenue from Contract with Customers, which of the following
statements is correct in relation to the sale of the electric car?
A. Dorothy Co should recognise an interest expense of $480 in the year ended 31 July 20X8
B. Dorothy Co should recognise income of $24,485 in the year ended 31 July 20X8
C. Dorothy Co should not recognise any revenue in the year ended 31 July 20X8
D. Dorothy Co should recognise a receivable of $28,000 on 1 May 20X8
Explain:
The agreement constitutes both the sale of a car and a finance component. The sale of the vehicle
must be recognised on 1 May 20X8 at a discounted amount of $24,005 ($28,000/1.082) and a
corresponding receivable is also recognised at this time. The discount on the receivable is
subsequently unwound resulting in finance income of $480 ($24,005 x 8% x 3/12m) in the year ended
31 July 20X8.

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28. What revenue should Dorothy Co recognise in respect of the sale of car and maintenance
services in the year ended 31 July 20X8?
$ 25,920
Explain:
The total transaction prices of $28,800 should be allocated between the provision of the car and the
service based on standalone selling prices:
Car $25,920 ($28,800 x 28,800/ (28,800+3,200))
Service $2,880 ($28,800 - $25,920)
The service has not been provided in the year and therefore no related revenue should be recognised.

29. In relation to the fleet maintenance contract select the correct answer to indicate what balance
Dorothy Co should recognise in its statement of financial position.
Dorothy Co should recognise a contract asset/ receivable/contract liability measured at
$5,000/$55,000/$60,000.
Explain:
Dorothy Co should recognise a contract liability measured at $55,000.
In the year ended 31 July 20X8 Dorothy Co’s accounting entries should be :
Dr Bank $60,000
Cr Revenue (1/24 x $120,000) $5,000
Cr Contract liability $55,000

30. In relation to the costs to win the fleet maintenance contract what expense should Dorothy Co
recognise in profit or loss in the year ended 31 July 20X8?
A. $1,150
B. $10,350
C. $18,400
D. $27,600
Explain:
Incremental costs of obtaining a contract should be recognised as an asset and amortised on a basis
that is consistent with the transfer of goods or services to the customer. Other, non-incremental
costs should be recognised as an expense when incurred. The expense recognised in the year
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includes non-incremental costs of $9,600 and amortisation of incremental costs of $750 ($18,000 x
1/24).

SECTION C
Question 31:
The following scenario relates to three requirements.
Mervin Co has prepared a draft trial balance at 31 December 20X8.

DR ($000) CR ($000)

Property, plant and equipment- carrying amount at 36,000

31 December 20X8 (note (i))

Factory costs (note (i)) 7,500

Share capital 10,000

Revaluation reserve note(ii) 1,600

Retained earnings at 1 January 20X8 55,740

Draft profit for the year ended 31 December 20X8 4,500

Provision for warranties (note (iii)) 5,000

Dividends paid 7,240

Current tax payable 2,800

Inventories at 31 December 20X8 (note (iv)) 8,620

Trade receivables 11,020

Cash 33,030

Loan (note (i)) 19,890

Trade payables 3,880

103,410 103,410

The following notes are relevant:

(i) Mervin Co has been constructing a second factory since 1 January 20X7. On 31 August 20X8, the
construction of the factory was completed and at this date, it was ready for immediate use. At 31
December 20X7, the carrying amount of the factory under construction was correctly calculated at
$8,000,000. The costs incurred in the current year were as follows:

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$000
Materials, labour and sub-contractors 5,000

Other directly attributable overhead costs 2,000

Administrative overheads 500

All the above costs has been recorded in the factory costs account in the above trial balance.
A specific loan of $18 million was obtained in 20X7 to fund the construction of the factory and it
carries an annual rate of interest rate of 10.5%. The loan was still outstanding at 31 December 20X8.
All interest on the loan has been recorded as an interest expense in profit or loss for the period.
Mervin Co depreciates factory buildings over 20 years. No entries have been made in respect of the
factory in the year ended 31 December 20X8.
(ii) The revaluation reserve relates to Mervin Co’s head office. At 1 December 20X8, it was discovered
that the head office had been damaged due to a storm, resulting in an impairment loss of $2 million.
This has been included in the calculation of the draft profit before tax and is reflected in the carrying
amount of property, plant and equipment. Depreciation on the head office has been calculated and
recorded correctly. Mervin Co does not make a transfer from revaluation surplus to retained earnings
in relation to revalued assets.
(iii) Mervin Co estimates its provision for warranties based on past experience. The provision for the
current period has not yet been calculated or recognised. The information below has been compiled
by management for the purpose of calculating the required provision at 31 December 20X8:

Product Unit sold Probability of defect Expected cost to remedy

Product A 25,000 15% $32

Product B 1,100,000 30% $18

(iv) In February 20X9, prior to the financial statements being authorised for issue, Mervin Co
determined that some of its inventory, produced in December 20X8, had manufacturing defaults.
Taking this into account the total net realisable value of inventory at 31 December 20X8 was
determined to be $6 million. None of the damaged inventory had been sold.
Requirements:
(a) Explain how the discovery of the inventory defects would affect the financial statements of
Mervin Co for the 20X8 financial year-end. (3 marks)
(b) Prepare a schedule of adjustments to the draft profit listed in the trial balance, taking into
account the additional information in notes (i) to (iv). (8 marks)

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(c) Prepare the Statement of Financial Position of Mervin Co at 31 December 20X8. (9 marks)
(20 marks)

Answer
(a) Events after the reporting period – are events, both favourable and unfavourable, that occur
between the reporting date and the date on which the financial statements are authorised for issue.
There are two types of events after the reporting period:
1. Those which provide further evidence of conditions which existed at the reporting date
(“adjusting” events).
2. Those which are indicative of conditions which arose after the reporting date (“non-adjusting”
events).
The effects of adjusting events after the reporting date must be recognised in the financial
statements (i.e. the financial statements must be adjusted).
Mervin Co established in February 20X9 that inventory produced before the year's end had
manufacturing defects.
This is regarded as an adjusting event because it provides information of conditions that existed at
the year's end.
Therefore, inventory should be written down to its net realisable value of $ 6 million in the 20X8
financial statements.
(b)

$000

Draft profit for the period 4,500

Admin costs-factory (500)

Capitalised borrowing costs (W1) 1,260

Depreciation on factory (W2) (271)

Reversal of impairment loss (recognised in OCI) 1,600

Movement in provision for warranties (W3) (1,060)

Inventory write-down (W4) (2,620)

Profit for the year 2,909

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Statement of financial position for Mervin Co at 31 December 20X8 $000

Assets

Non-current assets:

Property, plant and equipment-carrying amount (36,000+ (W1) 5,000+ 2,000+ 43,989
1,260-(W2) 271)

Current assets:

Inventory (8,620 – (W4)2,620) 6,000

Trade receivables 11,020

Cash 33,030

Total assets 94,039

Equity & liabilities

Equity

Share capital 10,000

Retained earnings (55,740 + (a) 2,909 – (Div) 7,240) 51,409

Revaluation reserve (1,600 – 1,600) -

Total equity 61,409

Non-current liabilities

Loan 19,890

Current liabilities

Provision for warranties (5,000 + (W3)1,060) 6,060

Current tax payable 2,800

Trade payables 3,880

12,740

Total equity and liabilities 94,039

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Workings:
(W1) Factory – initial cost

$000

Capitalised cost 20X7 (Given) 8,000

Materials, labour and sub-contractors 5,000

Other directly attributable overhead costs 2,000

Administrative overhead costs –Indirect costs not included -

Borrowing cost (8 months) ((18,000x 10.5%x 8/12m) 1,260

Carrying amount 31 August 20X8 16,260

(W2) Factory – depreciation

$000

Carrying amount (W1) 16,260

Less: Depreciation ((16,260/20) x 4/12m) (271)

Carrying amount 31 December 20X8 15,989

(W3) Provision for warranties

$000

Opening balance 5,000

Expense in profit or loss 1,060

Closing balance (25,000 x 15% x $32) + (1,100 x 30% x $18) 6,060

(W4) Inventory write-down

$000

Carrying amount 8,620

Less: NRV 6,000

Write-down 2,620

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Question 32: This scenario relates to three requirements.
Bite Co, a prominent food manufacturing company specialising in prepacked meals, purchased an
80% shareholding in Munch Co on 1 January 20X8. Munch Co, its sole subsidiary, focuses exclusively
on organic prepacked meals. This acquisition was strategic, reflecting the growing consumer
demand for food from organic sources.
Extracts from the Bite group’s consolidated financial statements for the year ended 31 December
20X8 and Bite Co’s individual financial statements for the year ended 31 December 20X7 are
provided below.
20X8 20X7
Statements of profit & loss
(Bite Co consolidated) (Bite Co single entity)
(extract)
$000 $000
Revenue 220,000 160,000

Cost of sales (160,000) (108,009)

Gross profit 60,000 51,991

Operating expenses (35,000) (20,245)

Operating profit 25,000 31,746

20X8 20X7
Statements of financial
(Bite Co consolidated) (Bite Co single entity)
position (extract)
$000 $000

Equity and liabilities

Equity

Share capital 60,000 60,000

Revaluation reserve 5,000

Retained earnings 52,929 35,679

Total equity 117,929 95,679

Non-current liabilities

Borrowings 8,000 3,000

The following information is relevant:

1. On 1 January 20X8 the carrying amounts of all of Munch Co’s assets and liabilities were equal to
their fair values. The company had disclosed a contingent liability related to ongoing litigation
concerning a food poisoning case in its financial statements for the year ended 31 December 20X7.
This had an estimated fair value of $250,000 at 1 January 20X8.On 1 October 20X8, the case was
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settled at an amount of $310,000.
2. Munch Co’s individual financial statements for the year ended 31 December 20X8 reflected
revenue of $ 50 million.
3. Munch Co currently focuses exclusively on manufacturing prepared meals, but it plans to expand
its product range in the future to include cold-pressed juices, food supplements, baby purees, and
vegan meals. This decision comes as the organic food industry has become highly competitive, and
the new products are expected to generate higher profit margins to support Munch Co. In the 20X8
financial year, Munch Co incurred substantial research costs related to its strategy for expanding its
product line and invested significantly in marketing its existing offerings. To finance these expenses
and future costs associated with the expansion, the company has secured a loan.
4. On 1 January, 20X8, Munch Co revalued its sole factory. All other categories of property, plant, and
equipment at Bite Co are measured using the cost model. Munch Co follows the same accounting
policies as Bite Co for property, plant, and equipment. Throughout the 20X8 financial year, Munch
Co's properties accurately reflected their fair values and thus did not necessitate a revaluation.
5. For a number of years Bite Co has consistently achieved a 10% annual growth in revenue.
Requirements:
(a) Explain how the contingent liability of Munch Co should be accounted for by the Bite Group on
1 January 20X8.
(3 marks)
(b) Calculate the following ratios for the years ended 31 December 20X8 and 31 December 20X7
for the Bite Group and Bite Co respectively:
Gross profit margin;
Operating profit margin and
Return on capital employed (ROCE)
(3 marks)
(c) Comment on the performance for the Bite Group for the year ended 31 December 20X8
compared to the performance of Bite Co for the year ended 31 December 20X7.
(14 marks)
(20 marks)

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Answer – Suggested Solution
(a) According to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, a contingent liability
cannot be recognised in an individual entity’s statement of financial position.
However, if a subsidiary has a contingent liability at the acquisition date and this relates to a present
obligation that has not been recognised because an outflow of economic benefits is not probable,
IFRS 3 requires a provision is recognised on acquisition.
Since the fair value of the Munch Co’s contingent liability was established at $250000 at the
acquisition date, this amount should be recognised as a liability of the subsidiary when calculating
goodwill at acquisition. As a result, the initial measurement of goodwill increases.

(b)
20X8 Bite
Working Working 20X7 Bite Co
Group

Gross profit
(60,000/220,000) 27% (51,991/160,000) 32%
margin

Operating
profit (25,000/220,000) 11% (31,746/160,000) 20%
percentage

Return on
capital (25,000/117,929+8,000) 20% (31,746/95,679+3,000) 32%
employed

(c)
Revenue
Revenue has increased in 20X8 by 38%. The increase is attributed to the revenue from Munch Co and
growing revenue of Bite Co. If revenue from Munch Co is stripped out, it shows Bite Co’s revenue has
increased by $10m (220m-50m-160m). This is approximately a 6% increase from the 20X7 financial
year. However, this is 4% below the historic trend. A possible reason for this is the shift in consumer
preference for food from organicsources, which Bite Co does not sell. The Bite Group however
anticipates future revenues to increase, as Munch Co expands its product lines, which is the reason
for its acquisition.
Gross profit margin
The gross profit margin has declined slightly from 32% to 27%. A possible reason for this is the
change in productmix from 20X7 to 20X8. Munch Co is likely to yield a lower gross profit margin
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since organic food options are more costly to manufacture. Although they also have higher selling
prices than non-organic options, the organic food market has become highly competitive, which
creates downward pressure on selling prices, meaning that the gross profit margin is also squeezed
from above. If Munch Co does have a lower gross profit margin, this will drag down the Bite Group’s
profit margin. However, the introduction of Munch Co’s new product lines is expected to improve the
profit margin in future. It is unclear whether this improvement will be compared to the current year
or compared to Bite Co’s individual margin. Another reason for the declining gross profit margin is
likely to be the adoption of the revaluation model by Bite for its factory. This will result in an increase
in depreciation, reflected in the cost of sales.
Operating profit percentage
The operating profit margin has declined from 20% to 11%. This decline is due to a decrease in gross
profit margin as discussed above, and an increase in operating costs. A contributing factor to the
increased operating costs is that Munch Co has undertaken significant research costs to expand its
product lines. However, these are likely to be non-recurring costs and once the new product lines are
launched, the operating profit margin percentage will improve. Equally, the new products developed
as a result will contribute to higher margins in the future. A further factor that may contribute to the
fall in operating profit margin is the marketing spend incurred by Munch Co to address the issue of
increasing competition in its existing products. The settlement of the litigation at $60,000 more than
expected also creates an extra cost which will reduce the margin. This is, however, a once-off cost,
presuming that there is no further litigation, and will not affect future margins.
ROCE
ROCE has declined significantly. This is due to a decline in operating profit and an increase in capital
employed.
The increase in capital employed is due to Bite Co (and so the group) adopting the revaluation model
for properties, and the loan which Munch Co obtained for the product expansion. It should be noted
that the revaluation does not affect the operating capacity of Munch Co but contributes to a decline
in the ratio as it both increases the capital employed and reduces the operating profit due to
increased depreciation.
Overall, whilst the ROCE has declined after the acquisition of Munch Co, it is expected to increase in
future years when Munch Co’s new products have been launched and when the Bite Group benefits
from improved margins from Munch Co’s new products.
Conclusion:
The acquisition of Munch Co seems to have adversely affected the profitability of the Bite Group for
the current period. Nevertheless, this acquisition was undertaken with long-term strategic goals in
mind, and the benefits are expected to materialise once Munch Co introduces its new product lines.
Without the acquisition, Bite Co’s revenue may have fallen in the future because it does not sell

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organic meals which consumers increasingly demand. Additionally, Bite Co should remain vigilant
regarding potential future litigation claims against Munch Co, as these could pose a reputational risk
to the group.

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