THE OPEN UNIVERSITY OF HONG KONG

Higher Level Course SPECIMEN Examination August 2002 Company Accounting

SPECIMEN EXAMINATION PAPER (B301 October 2001 presentation)

Section A -- Both questions are compulsory in this section

Question 1 (20 marks)

“A financial concept of capital is adopted by most enterprises in preparing their financial statements”(paragraph 100, Statement 2.01, The Framework in the Preparation and Presentation of Financial Statements). The Framework further states that there are two concepts of capital maintenance, namely, financial capital maintenance concept and physical capital maintenance concept.

Required:

(a) Explain “financial concept of capital” and “physical concept of capital”. Discuss briefly the “financial capital maintenance concept” and “physical capital maintenance concept”. (8 marks)

“The selection of the measurement bases and concept of capital maintenance will determine the accounting model used in the preparation of the financial statements.” (paragraph 108, Statement 2.01)

Required:

(b) State the main components in an accounting model and the accounting model currently being adopted by most enterprises in the preparation of financial statements. Why does such accounting model prevail over others? (7 marks)

(c) Discuss the drawbacks of the accounting model stated in (b). (5 marks)

Question 2 (30 marks)

Maria Chan is one of your classmates and she has recently been employed as accountant in a trading company. She is preparing the financial statements for the company for the year ended 31 December 2001. The company’s draft income statement, before any of the adjustments, is as follows:

$000

Turnover 21,000

Cost of sales 9,050

Finance costs 180

Distribution costs 2,600

Administrative expenses 3,800

Taxation 860

Profit after tax 4,510

Dividends:

Interim paid 200

Final proposed 400

Retained profit for the year 3,910

Retained profit from previous years 3,356

Retained profit carried down 7,266

Maria is unsure about the accounting treatment of some accounting items that have not been adjusted by preceding accountant. She provides you with the following information and seeks your advice on them.

i. A debtor of $888,000 declared bankruptcy as a result of a fire happened suddenly on 12 January 2002 and half of the debt would be written off,

ii. A research expenditure of $800,000 incurred in 2000 was mistakenly debited to investment account.

iii. On 31 December 2001, the company revalued its land and buildings to $20 million. The book value of the land and buildings was $25 million and the accumulated depreciation of the assets before revaluation was $1O million.

iv. The directors recommended a final dividend of $400,000 on 20 January 2002 for the approval at the annual general meeting. It was subsequently approved in the annual general meeting.

v. On 15 December 2001, the Board of Directors decided to reorganize some of the departments and the decision was announced to staff in the affected departments at the end of December 2001. Some of the staff in these departments would be laid off and the estimated redundancy payment would be amounted to $560,000. It was further estimated that an additional amount of $240,000 would be used to train up existing staff for new skills to cope with new assigned work in those restructured departments. The Board of Directors was considering whether the redundancy payment and training costs should be recognized as a provision or not.

vi. On 28 February 2002, the board of directors reviewed the financial statements and authorized them for issue.

Required:

(a) Describe the methods of presenting the above income statement in accordance with the HKSSAP 1 (note. the preparation of income statement is not required). (4 marks)

(b) Advise Maria Chan, with supporting reasons, on the appropriate accounting treatment and the related disclosure of the above items (i) to (v). Show your calculations and prepare the related journal entries (ignore the tax involved in the above adjustments and state any assumptions that you feel necessary). (16 marks)

(c) Redraft the income statement, after all the adjustments of items in (b), for the year ended 31 December 2001. (6 marks)

(d) Explain briefly the needs of the notes to financial statements. (4 marks)

Section B -- Answer TWO questions in this section.

Question 3 (25 marks)

Peter Pang has some spare money and wants to invest in listed securities. He has obtained some financial information of Sunshine Manufacturing Company Ltd., a listed company in Hong Kong, from his securities broker and the summarized financial information of the company is shown below.

Income statement for the year ended 31 December 2001

$000

Turnover 280,000

Cost of sales 12,000

Gross profit 160,000

Distribution costs 46,000

Administrative expenses 28,000

86,000

Interest expenses 2,000

Profit before tax 84,000

Tax 12,250

Profit after tax 71,750

Extraordinary losses (net of tax) 750

Net profit 71,000

Dividends:

Preference 1,000

Ordinary 3,000

Retained profit for the year 67,000

Earnings per share X

Diluted earnings per share X

Other financial information is also available:

Share capital

Sunshine Manufacturing Company Ltd. had an issued share capital at 1 January 2001 as follows:

$20,000,000 ordinary shares of $0.5 each

$10,000,000 10% preference shares of $1 each

On 1 July 2001, the company issued bonus shares at 1 for every 10 shares held at 1 January 2001.

Share options

The company has issued 2,000,000 share options to senior management as part of its incentive scheme. The share option holders entitle to subscribe 2,000,000 ordinary shares at a price of $5 per share. The average fair value of one ordinary share is $8 in the year 2001.

Loans

The following loan was outstanding throughout the year 2001:

$10,000,000 10% convertible debentures

The terms of conversion of the 10% convertible debentures to ordinary shares are as follows:

Conversion date Conversion terms

31 Dec. 2003 20 ordinary share per $1,000 10% convertible debentures

31 Dec. 2004 190 ordinary share per $1,000 10% convertible debentures

31 Dec. 2005 80 ordinary share per $1,000 10% convertible debentures

Earnings per share in 2000

The basic earnings per share was $1.5 in Year 2000.

Tax rate

The profit tax rate is 16%.

Required:

(a) Comment briefly on the usefulness of the earnings per share (EPS) to Peter as a small investor. (5 marks)

(b) HKSSAP 5 prescribes the requirement to present the basic and diluted earnings per share on the face of the income statement. Discuss why “diluted earnings per share” should also be disclosed. (4 marks)

(c) Compute the basic earnings per share for the year 2001 and restate the earnings per share for 2000 as comparative EPS. (5 marks)

(d) Determine the diluted earnings per share for the year 2001. (8 marks)

(e) Assuming that the company would distribute 10% of its earnings as dividends, advise Peter whether he should invest in Sunshine’s shares or not. (3 marks)

Question 4 (25 marks)

Skyscraper Trading Company Ltd. has an issued share capital of $4,000,000 divided into $3,000,000 ordinary shares of $1 each and $1,000,000 preference shares of $1 each. The extract of shareholders’ funds in the balance sheet as at 1 January 2001 is as follows:

Share capital and reserves

3,000,000 Ordinary shares of$1 each 3,000,000

1,000,000 Preference shares of $1 each 1,000,000

Share premium 300,000

Profit and loss account 1,200,000

On 1 January 2001, the directors decided to redeem all preference shares and finance it by issuing $400,000 ordinary shares at a price of $2 per share, payable as follows:

On application $0.2 per share

On allotment (including share premium) $1.3 per share

First and final call $0.5 per share

Applications had been received for 600,000 shares. Applications for 100,000 shares were rejected and money returned to applicants. The company decided to allot the shares to the remaining applicants on the basis of 4 for every 5 shares applied. The excess balance of application money was to be applied to the amount due on allotment. The balance of allotment money was received in due course. The amount of the first and final call, except for 10,000 shares, was duly received. The shares defaulted were forfeited and reissued at $0.5 per share.

On 1 March 2001, immediately after the issue of ordinary shares was completed, $1,000,000 preference shares were redeemed at a price of $l.5 per share. These preference shares were originally issued at $l.3 per share.

Required:

(a) Distinguish the nature of share premium and profit and loss account. (4 marks)

(b) Prepare the journal entries for:

i) issue of ordinary shares (12 marks)

(note: application account and allotment account are two separate accounts)

ii) redemption of preference shares (6 marks)

(c) Prepare an extract of shareholders’ funds in the balance sheet immediately after the issue of ordinary shares and redemption of preference shares. (3 marks)

Question 5 (25 marks)

Wing Shun Manufacturing Company Ltd. has fixed assets with net book value of $22,000,000 and tax written down value of $19,500,000 at 31 December 2001. The provision for deferred tax liabilities shown in the balance sheet as at 31 December 2000 was $220,000. The estimated accounting depreciation and tax depreciation allowance for the next few years based on the capital expenditure budget are shown below:

Year ending 31 Dec. Accounting Depreciation Tax Depreciation Allowances

$000 $000

2002 1,250 1,500

2003 1,500 1,000

2004 2,400 3,000

2005 2,800 1,200

From 2006 onwards, the company expects that timing differences would not be reversed as a result of increasing capital expenditures in future.

The tax rate is fluctuating from year to year as follows:

Year Tax rate

2001 20%

2002 20%

2003 30%

2004 35%

2005 20%

It is assumed that all the estimated depreciation and depreciation allowances are turned out to be the actual figures.

Required:

(a) Discuss why the provision for deferred tax is important for financial reporting. (5 marks)

(b) Calculate the deferred tax to be charged or credited to profit and loss account for the years from 2001 to 2004. (12 marks)

(c) Show the deferred tax balance to be shown in balance sheets and related notes as at 31

December 2001 to 2004 (answers can be presented in columnar form) (8 marks)

[END OF SPECIMEN EXAMINATION PAPER]