SECTION A – CASE QUESTIONS (Total: 50 marks)
Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.
CASE
Precious Biotech Limited (“PBL”) is a company listed on the Stock Exchange of Hong Kong.
Special Medicine Limited
On 1 April 2013, PBL acquired a 90% interest in Special Medical Limited (“SML”) for
HK$260,000,000, and thus obtained control of SML. On the date of acquisition, the equity of
SML was:
HK$’000
Share capital 220,000
Retained earnings 16,000
Revaluation reserves 10,000
246,000
The carrying amounts of assets and liabilities of SML were the same as their fair values,
except for property, plant and equipment for which the fair value was HK$2,000,000 greater
than the carrying amount. The property, plant and equipment had a remaining economic life
(same as useful life) of eight years on 1 April 2013.
Accentual Verse Limited
On 1 April 2015, PBL acquired a 50% interest in Accentual Verse Limited (“AVL”) for
HK$66,000,000, and thus obtained significant influence over AVL. Investment in AVL
is recorded at cost in PBL’s separate financial statements. PBL’s share of fair value and
carrying amount of identifiable net assets of AVL were HK$60,500,000 and HK$55,000,000,
respectively. Excess of fair value of identifiable net assets relates to an intangible asset,
with a remaining economic life (same as useful life) of five years on 1 April 2015.
On 31 March 2019, PBL disposed of a 10% interest in AVL at HK$70,000,000.
No accounting entries have been made in PBL’s draft financial statements for this disposal.
PBL has assessed that it continues to maintain significant influence over AVL subsequent to
the disposal of the 10% interest. The finance director mentioned in a directors’ meeting that:
“HKFRS 10 requires a partial disposal of a subsidiary in which the parent does not lose
control to be accounted for as an equity transaction; this principle should apply here and
thus this partial disposal of AVL should be accounted for as an equity transaction in the
consolidated financial statements of PBL”.
Module A (December 2019 Session) Page 1 of 9
The equity of AVL is as follows:
31 March 2019 1 April 2015
HK$’000 HK$’000
Share capital 10,000 Share capital 10,000
Retained earnings Retained earnings
at 1 April 2018 410,000 at 1 April 2015 80,000
Profit for the year ended
31 March 2019 30,000
Revaluation reserves at Revaluation reserves
31 March 2019 * 100,000 at 1 April 2015 20,000
550,000 110,000
* There is no change of revaluation reserves of AVL during the year ended 31 March 2019.
The revaluation reserves of AVL as at 1 April 2015 solely consists of gain on property revaluations,
while the revaluation reserves of AVL as at 31 March 2019 consists of gain on property revaluations
amounting to HK$70,000,000 and changes in the fair value of debt instruments at fair value through
other comprehensive income amounting to HK$30,000,000.
The following is the financial information in relation to PBL and SML as at
31 March 2018 and 31 March 2019 before accounting for the partial disposal of AVL:
Statements of financial position as at 31 March 2018 and 31 March 2019
PBL PBL SML SML
figures in credit are shown in ( ) 2018 2019 2018 2019
HK$’000 HK$’000 HK$’000 HK$’000
Property, plant and equipment 679,000 849,100 280,000 300,000
Intangible assets 280,000 274,000 140,000 140,000
Investment in SML 260,000 260,000 - -
Investment in AVL 66,000 66,000 - -
4.5% debenture loan (125,000) (125,000) - -
Bank loan at 5% per annum - (120,000) - -
Other net assets 50,000 50,000 30,000 40,000
Total net assets 1,210,000 1,254,100 450,000 480,000
Share capital (930,000) (930,000) (220,000) (220,000)
Retained earnings (180,000) (220,000) (160,000) (200,000)
Profit for the year (40,000) (44,100) (40,000) (30,000)
Revaluation reserves (60,000) (60,000) (30,000) (30,000)
Total equity (1,210,000) (1,254,100) (450,000) (480,000)
Module A (December 2019 Session) Page 2 of 9
Additional information
(a) PBL, SML and AVL have a financial year end date at 31 March.
(b) Tax impact is ignored.
(c) During the year ended 31 March 2019, SML sold goods to PBL for HK$37,000,000.
The inventory of PBL, as at 31 March 2019, included goods acquired from SML on which
SML recognised a profit of HK$1,200,000.
(d) It is the Group’s policy to measure the non-controlling interests as a proportionate share
of the fair value of the identifiable net assets at the date of acquisition.
Disposal of PBL’s existing headquarter building
On 1 March 2019, PBL is committed to a plan to sell its headquarter building and has initiated
actions to locate a buyer. PBL will continue to use the building until the construction of
PBL’s new headquarter building at Zhejiang is completed. The new headquarter building is
expected to be completed by 31 May 2020.
The finance director expects to classify the existing headquarter building as
non-current asset held for sales as at 31 March 2019.
New manufacturing facility
On 1 July 2018, PBL engages to construct a new manufacturing facility located in Zhejiang,
which is expected to take three years to complete, at a cost of HK$600,000,000. To finance
the construction of the new manufacturing facility, a bank loan of HK$120,000,000 with
an effective interest rate at 5% per annum was taken out and fully drawn on 1 July 2018.
Investment income was earned at 2% on the unapplied funds. Expenditure on the
construction of the new manufacturing facility was paid from the proceed of the bank loan
as follows:
HK$’000
1 July 2018 60,000
1 October 2018 40,000
1 January 2019 20,000
120,000
Module A (December 2019 Session) Page 3 of 9
Research and development
The total research and development expenditure of PBL for the year ended 31 March 2019
is substantially higher than that in previous years. The finance director has asked for advice
on whether it is acceptable to carry forward some of the expenditure to a future accounting
period. The following items are included in the research and development expenditure for
the year:
(a) Laboratory costs of HK$3,000,000 to convert one type of traditional chemotherapy into
oral form, i.e. as a pill that patient can take at home that causes less disruption to
the patient’s life and no physical discomfort when the patient take it. If the conversion
into oral form prove successful, PBL expects to promote the oral chemotherapy rather
than the traditional chemotherapy to all hospitals and clinics;
(b) Costs to test a new targeted therapy medication that works by inhibiting molecular
targets in the cancer cell that contribute to the growth, spread and progression of cancer.
The new medication are to be introduced into the market in 2020 if the government
approval can be obtained by that time.
Module A (December 2019 Session) Page 4 of 9
Question 1 (12 marks – approximately 22 minutes)
Assume that you are Miranda Chan, the accounting manager of Precious Biotech Limited
(“PBL”).
Required:
Prepare a memorandum to the directors in response to the finance director’s comment
in the directors’ meeting to:
(a) advise the appropriate accounting treatment for the partial disposal of AVL in the
consolidated financial statements of PBL for the year ended 31 March 2019; and
(b) calculate the gain or loss on the partial disposal of the investment in AVL, if any,
to be presented in the separate and consolidated financial statements of PBL
for the year ended 31 March 2019.
Note: Mark(s) will be awarded for proper memorandum format with logical presentation.
(12 marks)
Question 2 (5 marks – approximately 9 minutes)
Advise the appropriate accounting classification for PBL’s existing headquarter
building as at 31 March 2019.
(5 marks)
Question 3 (9 marks – approximately 16 minutes)
Advise, with calculations, the appropriate accounting treatment for the interest charge
in relation to the construction of the new manufacturing facility as at 31 March 2019.
(9 marks)
Question 4 (4 marks – approximately 7 minutes)
Advise the appropriate accounting treatment of the research and development
expenditure as at 31 March 2019.
(4 marks)
Module A (December 2019 Session) Page 5 of 9
Question 5 (20 marks – approximately 36 minutes)
Consider that the appropriate accounting entries for the transactions and other
information as set out in Question 1 above are not yet recorded in the separate
financial statements; incorporate the appropriate accounting entries and prepare
the worksheets for the consolidated statement of financial position of PBL
(showing separately the retained earnings as at 31 March 2018 and current year profit
for 2019) as at 31 March 2019.
Note: Assume that the appropriate accounting entries for the transactions and other
information as set out in Questions 2 and 3 above have been correctly recorded in
the separate financial statements. Consolidation adjustments are to be shown in the form of
a worksheet. For this question, you may wish to use the templates printed on the green
paper provided to prepare your answers or continue your answer in the script booklet for
Case Questions. You have to show the supporting calculation for each figure in the
worksheet, but journal entries are not required.
(20 marks)
* * * * * * * *
Module A (December 2019 Session) Page 6 of 9
End of Section A
SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks)
Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.
Question 6 (10 marks – approximately 18 minutes)
Eureka Limited (“EL”) acquired the following investments during the financial year ended
31 March 2019:
(i) 10% ordinary shares in Ai Limited (“AL”)
AL is a private company operating in mainland China. It is a start-up in the business
of research and development of robotic limbs. After EL acquiring its shares in
April 2018, AL reached a breakthrough in product development earlier than initially
expected.
As a result, EL’s management revised their expectations on AL’s upcoming technical
product milestones.
EL’s investments represents 10% of the issued share capital of AL and such holding
does not give EL the control / joint control or significant influence over AL.
(ii) Convertible bonds issued by in Cyborg World Limited (“CWL”)
CWL is a listed company on the Main Board of Hong Kong Stock Exchange Limited
(“HKEx”). EL holds convertible bond issued by CWL which is also quoted on the HKEx.
Under the terms of the convertible bond, EL has the option to convert its holding into
a fixed number of equity shares of CWL. The investment does not give EL control /
joint control or significant influence over CWL.
The Directors of EL believe that the investment in AL should be stated at cost because
it is a strategic long term investment. They consider that cost should be an appropriate
approximation of fair value as it was the amount EL paid to acquire the investment.
In addition, the Directors of CWL believe that they should be using amortised cost to measure
the convertible bond in CWL, as they do not intend to exercise the conversion option.
Ms Priscilla Chan, the Finance Manager of EL, is being tasked to assess the possible
categories under which the investments can be classified and she is trying to understand
the various criteria that need to be fulfilled under each category.
Required:
(a) From the perspective of EL, explain the possible classification(s) each of
the above investments could fall under for the purposes of measurement.
(7 marks)
(b) Explain whether you agree with the justification of the Directors of EL that
they could use “cost” as the measurement basis for the investment in AL.
(3 marks)
Module A (December 2019 Session) Page 8 of 12
Question 7 (21 marks – approximately 38 minutes)
Clean & Pure Limited (“CPL”) is a company in the business of selling wellbeing and hygiene
products. It has a financial year end of 31 December.
Logistics Services Contract signed in January 2019
In January 2019, CPL entered into a 5-year non-cancellable logistics services contract with
Awesome Logistics Limited (“ALL”), commencing on 1 April 2019.
Under the terms of the contract:
- A monthly fee of HK$420,000 is payable on the first of each month.
The fee includes warehouse management services to be provided by ALL. Apart from
packing / unpacking and transportation of the goods in and out of the warehouse,
such services also include the use of ALL’s inventory tracking system so that the system
can automatically place orders with CPL’s suppliers when the inventory level goes below
a certain level.
- A variable fee is charged based on revenue
When orders are placed by CPL’s customers through ALL’s ordering system,
ALL will deliver the goods and issue the related invoices on behalf of CPL to the ultimate
customers. CPL is required to share 5% of the invoiced amount receivable from its
customers as handling fees to ALL whenever goods are being delivered out of the
warehouse. ALL is also using the system to serve its many other customers.
- A designated room of 7,000 sq. ft. in ALL’s warehouse in Tsing Yi is allocated to store
CPL’s inventories.
ALL is not allowed to use the space for other customers even if there is excess capacity,
and there is no substitution rights within the contract. However, CPL is not allowed to
store dangerous goods on the premise as further defined in the Appendix to that contract.
Logistics Services Contract signed in May 2019
In May 2019, in view of the expansion of the eco-friendly detergents and cleaning products
market, CPL signed another 3-year contract with ALL. This new contract states that CPL can
further occupy up to 2,000 sq. ft. anywhere in ALL’s warehouse at a charge of HK$5 per sq.
ft. per day. The total floor area of the warehouse is 14,000 sq. ft. This contract is negotiated
independently from the one signed in January 2019.
Module A (December 2019 Session) Page 9 of 12
Required:
(a) Evaluate whether each of the two logistics services contracts that CPL signed with
ALL in January and May 2019 contain a lease under HKFRS 16 Leases.
(14 marks)
(b) For the contract signed in January 2019, advise the accounting treatments of the
monthly fee and variable fee to be made by CPL. Journal entries are not required.
(7 marks)
Module A (December 2019 Session) Page 10 of 12
Question 8 (19 marks – approximately 34 minutes)
Flying Eagle Limited (“FEL”) is a logistics company listed on the Hong Kong Stock Exchange
Limited. On 27 July 2018, one of its delivery trucks crashed into the foot of a bridge creating
severe damage. The truck needs to be scraped due to the collision.
In November 2018, FEL was named as a defendant in a writ as a result of the damage to
the bridge. While the statement of claim was asking for HK$14 million in damages,
FEL intended to settle out of court and counter-offered HK$8 million. FEL’s lawyers believed
that there was 90% chance that FEL needed to pay approximately HK$12 million.
Proposed accounting treatment
In its draft financial statements for the year ended 31 March 2019, FEL establishes a provision
based on the estimated financial effect of the lawsuit, detailed breakdown as follow:
HK$
Estimated damages 14,000,000
Incremental legal costs for the lawsuit 1,000,000
Loss of future profits due to truck being taken out of operations 3,000,000
Reimbursement from insurance cover (500,000)
Total 17,500,000
The net liability of HK$17.5 million was included in “Other payables”. The reimbursement of
insurance cover is virtually certain. FEL has no other provisions.
Proposed disclosures
Apart from a table showing the movements in the amount of provision during the year,
no further disclosures were provided in the draft financial statements.
Purchase of new truck
On 31 December 2018, FEL accepted delivery of a new truck from mainland China at a cost
of RMB1 million. FEL applies cost model in accounting for its property, plant and equipment.
FEL’s functional currency is HKD. The exchange rates of RMB against HKD was as follow:
Date Exchange rate
31 December 2018 1:0.88
31 March 2019 1:0.85
Average exchange rate of RMB against the HKD during the year ended 31 March 2019
was 1:0.86.
Module A (December 2019 Session) Page 11 of 12
Mr Hayden Young is the Finance Manager of FEL. He is instructed by Mr Hugo Yang,
the CFO of FEL, to increase the level of provision solely based on the numbers Hugo told him.
Hayden later overheard a call between Hugo and his girlfriend about the company’s
unannounced profits and that Hugo has done everything to make sure the price of the
company would be advantageous to her father, who is going to acquire FEL’s businesses.
Both Hugo and Hayden are members of the Hong Kong Institute of Certified Public
Accountants.
Required:
(a) Explain and advise the appropriateness of (i) the amount of the provisions
recognised and (ii) the draft disclosures proposed by FEL in relation to the legal
case. You are NOT required to draft the disclosures.
(10 marks)
(b) Explain which exchange rate(s) should be applied upon initial recognition and
subsequent measurement of the new truck in FEL’s financial statements as of
and for the year ended 31 March 2019. No calculations or journal entries are
required.
(4 marks)
(c) Advise the appropriateness of Hugo’s behaviours in the context of the Code of
Ethics for Professional Accountants.
(5 marks)
* * * END OF EXAMINATION PAPER * * *
Module A (December 2019 Session) Page 12 of 12