SECTION A – CASE QUESTIONS (Total: 50 marks)

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

You are the accounting manager of Forever Young Limited (“FYL”), a listed company in Hong
Kong which is principally engaged in the manufacture of beauty products in Hong Kong. In
order to penetrate the Australian market, FYL acquired 20 per cent of the issued share
capital of Beautiful Lady Limited (“BLL”), a company incorporated in Australia, on 1 April
2004. This 20 per cent shareholding enables FYL to exercise significant influence on BLL.
The cost of investment was five million Australian Dollars (AUD5,000,000). The difference
between the cost of investment and FYL’s share of the book values of BLL’s net identifiable
assets attributes to the fair value of the plant and equipment at the acquisition date.

On the same date, i.e. 1 April 2004, FYL acquired 100 per cent of the issued share capital of
Smart Gentleman Limited (“SGL”), also a company incorporated in Australia. The cost of
investment was five million Australian Dollars (AUD5,000,000), which is approximately the
same as the book value as well as the fair value of SGL’s net assets.

The functional currency and presentation currency for FYL is the Hong Kong Dollar (HKD),
while the functional currency for both BLL and SGL is the Australian Dollar (AUD). The
relevant trial balances of the three companies on 31 March 2005 are as follows:

FYL BLL SGL

Debit/(Credit) Debit/(Credit) Debit/(Credit)
HKD'000 AUD'000 AUD'000
Plant and equipment 150,000 24,000 5,000
Accumulated depreciation (37,500) (6,000) (750)
Investment in BLL 29,000 - -
Investment in SGL 29,000 - -
Inventory 100,000 8,600 500
Accounts payable (50,000) (5,380) (300)
Cash and receivables 75,000 11,610 2,425
Long term loans (100,000) (11,950) (1,250)
Share capital (129,000) (9,000) (4,000)
Retained profits – at 1 April 2004 (50,000) (4,000) (1,000)
Sales (400,000) (57,900) (5,000)
Cost of goods sold 250,000 33,000 2,250
Depreciation expense 15,000 2,400 300
Operating expense 113,500 13,150 1,150
Interest expense 6,008 570 675
Dividend income (1,008) - -
Dividend paid - 900 -
- - -

FYL adopted a group accounting policy to depreciate and amortise plant and equipment
using the straight-line method over a 10-year life with no residual value.

Module A (May 2005 Session) 1

Dividends were declared and paid by BLL on 1 May 2004.

Relevant exchange rates were as follows:

1 April 2004 AUD 1 = HKD 5.80

1 May 2004 AUD 1 = HKD 5.60
31 March 2005 AUD 1 = HKD 6.00
Average for the year ended 31 March 2005 AUD 1 = HKD 5.70

After you have sent a summary of the financial results of the FYL Group to FYL’s directors
for review, one of the directors, who is not a certified public accountant, sends you an e-mail
as follows:

To: Accounting Manager, FYL

From: Peter LIN (Director)
c.c.: L.P. LEE, Ricky YUEN, S.Y. LEUNG (Directors)
Date: 18 June 2005

Financial summary of FYL for the year ended 31 March 2005

Could you please clarify the following points relating to FYL’s draft financial summary which I
have just reviewed.

1) We have paid the same amount to acquire shares of BLL and SGL. I noticed that
SGL’s financial results, such as sales and cost of goods sold, have been included in
the consolidated amounts in the financial summary of FYL for the year ended
31 March 2005. However, the corresponding financial results of BLL have not been
included in the financial summary. Moreover, the investment in BLL (now you call it
investment in associate) remains in the consolidated balance sheet that you have
prepared, but the amount is not the investment cost of HKD29 million. What has
caused these differences?

2) I am puzzled about the reduction of the financial results of the three separate
companies, that are in different currencies, into a single set of financial statements in
HKD. In particular, why is the item “translation reserve” not found in the trial
balances of any one of our companies? How has the reserve been calculated?

I would appreciate clarification in time for the upcoming board meeting.

Best regards,

Peter

Module A (May 2005 Session) 2

Required:

Question 1 (50 marks – approximately 90 minutes)

(a) Prepare a memorandum in response to the issues raised by Mr. Peter LIN.

(21 marks)

(b) Prepare an annex to your memorandum translating the trial balances of both
BLL and SGL as at 31 March 2005 from AUD to HKD.
(8 marks)

(c) Prepare an annex to your memorandum showing the calculation of the carrying
amount of investment in BLL included in FYL’s consolidated balance sheet as
at 31 March 2005. You should show clearly all the movements in the carrying
amount during the year.
(13 marks)

(d) Prepare an annex to your memorandum showing the worksheet (alternatively,

you may show the consolidation journals only) for the preparation of the
consolidated balance sheet of FYL as at 31 March 2005. Also explain any
mistakes you have made in FYL’s trial balances.

(8 marks)

* * * END OF SECTION A * * *
(QUESTIONS)

Module A (May 2005 Session) 3

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 2 (10 marks – approximately 18 minutes)

“It is simply not appropriate for an accountant employed in a business entity, whose
duties are mainly in financial reporting, to call himself a certified public accountant.
He owes duties to his employer only. He does not have any duty to the public or
person other than his employer.”

Discuss this statement.

(10 marks)

Question 3 (13 marks – approximately 23 minutes)

Bloom Company Limited (“BCL”) is engaged in the business of property development and
holding. During the year ending 31 December 2005, the company has completed the
following transactions:

(a) Lease of five floors of an investment property for five years from 1 July 2005 at a
monthly rental of HK$1.8 million. A six-month rent-free period was given to the
lessee for the period 1 July to 31 December 2005.

(b) Sale of a house with a consideration of HK$12 million. 10% of the consideration
was paid at the agreement date, and the remaining 90% of the consideration was
settled with nine semi-annual instalment payments of HK$1.2 million each.

(c) Pre-sale of 50 units out of the 180 units of a self-developed residential property which
was still under construction (75% completion). Total consideration for the 50 units is
HK$322 million and BCL had received HK$38.5 million as down payments.

Required:

Determine and explain how BCL should recognise and measure these transactions in
the financial statements for the year ending 31 December 2005 in accordance with
relevant Hong Kong Financial Reporting Standards.

(13 marks)

Module A (May 2005 Session) 4

Question 4 (12 marks – approximately 22 minutes)

On 1 April 2004, Best Compensation Company Limited, a listed company, adopted a share
option plan that granted options to each of the four regional managers, Messrs. A, B, C and
D, for the purchase of 100,000 shares of the company’s ordinary shares of HK$1 par at an
exercise price of HK$20 per share. The options granted on 1 April 2004 are exercisable
within a two-year period beginning one year after the date of grant, provided that the
manager is still an employee of the company when he exercises the options. On the date
of grant, Best Compensation Company Limited’s share was trading at HK$18 per share, and
the fair value of the share option for purchase of one share was determined to be HK$5.
The company expects that all outstanding share options will vest.

On 1 November 2004, one regional manager, Mr. C, resigned from the company and his
option shares were cancelled. The market price of the company’s share was HK$21 per
share on that day.

The market price of the company’s share was HK$23 per share as at 31 December 2004.

On 1 June 2005, 30,000, 40,000 and 50,000 option shares were exercised by each of the
remaining three regional managers, Messrs. A, B and D, respectively, when the market price
of the company’s share was HK$28 per share.

On 1 August 2005, Mr. A resigned from the company and his unexercised option shares
were cancelled. The market price of the company’s share was HK$26 per share on that
day.

Required:

(a) Calculate the amount of compensation expense in relation to the share options
granted by Best Compensation Company Limited for the year ended
31 December 2004 and the year ending 31 December 2005 respectively.

(8 marks)

(b) Explain the principal differences in accounting treatment if share appreciation

rights instead of a share option had been granted to the managers.
(4 marks)

For the purpose of this question, assume Best Compensation Company Limited
applies HKFRS 2 in its financial statements for the year ended 31 December 2004 and
the year ending 31 December 2005.

Module A (May 2005 Session) 5

Question 5 (15 marks – approximately 27 minutes)

Benson Holdings Limited (“BHL”) established a wholly-owned subsidiary, Ape Processing

Limited (“APL”), in Chongqing, Mainland China, in 2003. On 1 October 2003, APL
purchased production equipment with a cost of HK$20,000,000. For the purpose of BHL to
prepare consolidated financial statements, APL prepared a set of financial statements in
accordance with Hong Kong Financial Reporting Standards (“HKFRS”). For HKFRS
reporting purposes, the useful life of APL’s equipment is eight years from the date of
purchase and depreciation is recognised monthly on a straight-line basis with nil residual
value. For tax computation under the tax laws of Mainland China, depreciation is calculated
monthly on a straight-line basis over ten years with a residual value of 10% based on the
cost recorded in the books of APL.

As APL is located in a special economic zone at Chongqing, it is exempted from income tax
for the first three years after establishment and subject to a reduced income tax rate of 15%
thereafter.

During the year ended 31 December 2004, BHL purchased products from APL for a total
amount of HK$40 million. As at 31 December 2004, HK$9 million of these goods was
unsold to outside customers. APL had recognised a profit of HK$5,600,000 for these
intragroup transactions in 2004. No such intragroup purchase was made in 2003.

BHL is subject to Hong Kong Profits Tax at the rate of 17.5% for the year of assessment
2004/2005.

There are no other temporary differences for both BHL and APL as at 31 December 2003
and 2004.

Required:

(a) Calculate the temporary differences as at 31 December 2004 in respect of the

equipment in the financial statements of APL prepared in accordance with
HKFRS.
(4 marks)

(b) Determine and explain the amount of deferred tax assets/liabilities to be

recognised in the consolidated balance sheet of BHL as at 31 December 2004.

(11 marks)

* * * END OF EXAMINATION PAPER * * *

(QUESTIONS)

Module A (May 2005 Session) 6