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Section B – TWO questions ONLY to be attempted

(a) Cate is an entity in the software industry. Cate had incurred substantial losses in the fi nancial years 31 May 2004 to 31 May 2009. In the fi nancial year to 31 May 2010 Cate made a small profi t before tax. This included signifi cant non-operating gains. In 2009, Cate recognised a material deferred tax asset in respect of carried forward losses, which will expire during 2012. Cate again recognised the deferred tax asset in 2010 on the basis of anticipated performance in the years from 2010 to 2012, based on budgets prepared in 2010. The budgets included high growth rates in profi tability. Cate argued that the budgets were realistic as there were positive indications from customers about future orders. Cate also had plans to expand sales to new markets and to sell new products whose development would be completed soon. Cate was taking measures to increase sales, implementing new programs to improve both productivity and profi tability. Deferred tax assets less deferred tax liabilities represent 25% of shareholders’ equity at 31 May 2010. There are no tax planning opportunities available to Cate that would create taxable profi t in the near future. (5 marks)

(b) At 31 May 2010 Cate held an investment in and had a signifi cant infl uence over Bates, a public limited company. Cate had carried out an impairment test in respect of its investment in accordance with the procedures prescribed in IAS 36, Impairment of assets. Cate argued that fair value was the only measure applicable in this case as value-in-use was not determinable as cash fl ow estimates had not been produced. Cate stated that there were no plans to dispose of the shareholding and hence there was no binding sale agreement. Cate also stated that the quoted share price was not an appropriate measure when considering the fair value of Cate’s signifi cant infl uence on Bates. Therefore, Cate estimated the fair value of its interest in Bates through application of two measurement techniques; one based on earnings multiples and the other based on an option–pricing model. Neither of these methods supported the existence of an impairment loss as of 31 May 2010. (5 marks)

(c) At 1 April 2009 Cate had a direct holding of shares giving 70% of the voting rights in Date. In May 2010, Date issued new shares, which were wholly subscribed for by a new investor. After the increase in capital, Cate retained an interest of 35% of the voting rights in its former subsidiary Date. At the same time, the shareholders of Date signed an agreement providing new governance rules for Date. Based on this new agreement, Cate was no longer to be represented on Date’s board or participate in its management. As a consequence Cate considered that its decision not to subscribe to the issue of new shares was equivalent to a decision to disinvest in Date. Cate argued that the decision not to invest clearly showed its new intention not to recover the investment in Date principally through continuing use of the asset and was considering selling the investment. Due to the fact that Date is a separate line of business (with separate cash fl ows, management and customers), Cate considered that the results of Date for the period to 31 May 2010 should be presented based on principles provided by IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. (8 marks)

(d) In its 2010 fi nancial statements, Cate disclosed the existence of a voluntary fund established in order to provide a post-retirement benefi t plan (Plan) to employees. Cate considers its contributions to the Plan to be voluntary, and has not recorded any related liability in its consolidated fi nancial statements. Cate has a history of paying benefi ts to its former employees, even increasing them to keep pace with infl ation since the commencement of the Plan. The main characteristics of the Plan are as follows:

(i) the Plan is totally funded by Cate;

(ii) the contributions for the Plan are made periodically;

(iii) the post retirement benefi t is calculated based on a percentage of the fi nal salaries of Plan participants dependent on the years of service;

(iv) the annual contributions to the Plan are determined as a function of the fair value of the assets less the liability arising from past services.

Cate argues that it should not have to recognise the Plan because, according to the underlying contract, it can terminate its contributions to the Plan, if and when it wishes. The termination clauses of the contract establish that Cate must immediately purchase lifetime annuities from an insurance company for all the retired employees who are already receiving benefi t when the termination of the contribution is communicated. (5 marks)

Required:

Discuss whether the accounting treatments proposed by the company are acceptable under International Financial Reporting Standards.

Professional marks will be awarded in this question for clarity and quality of discussion. (2 marks)

The mark allocation is shown against each of the four parts above.

(b) Explain how the non-payment of contributions and the change in the pension benefits should be treated in

the financial statements of Savage for the year ended 31 October 2005. (4 marks)

2 Helen Bradshaw, a recent graduate with a degree in catering management, has spotted a market opportunity during

her first job with a large supermarket chain. She knows there is a growing market for distinctive, quality cakes in the

bakery sections of the supermarket chains, as well as in supplying independent individual premium cake shops, and

also for catering wholesalers supplying restaurants and hotels.

Helen is very determined to set up her own business under the brand name of ‘Helen’s cakes’, and has bought some

equipment – industrial food mixers, ovens, cake moulds – and also rented a small industrial unit to make the cakes.

Helen has created three sets of recipes – one for the premium cake shop market, one for the supermarkets and one

for the catering wholesalers but is uncertain which market to enter first. Each channel of distribution offers a different

set of challenges. The premium cake shop market consists of a large number of independent cake shops spread

through the region, each looking for daily deliveries, a wide product range and low volumes. The supermarkets are

demanding good quality, competitive prices and early development of a product range under their own brand name.

The catering wholesalers require large volumes, medium quality and low prices.

Helen has learnt that you are a consultant specialising in start-up enterprises and is looking to you for advice.

Required:

(a) Acting as a consultant, prepare a short report for Helen advising her on the advantages and disadvantages

each channel offers and the implications for a successful start-up. (12 marks)

1 Rowlands & Medeleev (R&M), a major listed European civil engineering company, was successful in its bid to become

principal (lead) contractor to build the Giant Dam Project in an East Asian country. The board of R&M prided itself in

observing the highest standards of corporate governance. R&M’s client, the government of the East Asian country, had

taken into account several factors in appointing the principal contractor including each bidder’s track record in large

civil engineering projects, the value of the bid and a statement, required from each bidder, on how it would deal with

the ‘sensitive issues’ and publicity that might arise as a result of the project.

The Giant Dam Project was seen as vital to the East Asian country’s economic development as it would provide a

large amount of hydroelectric power. This was seen as a ‘clean energy’ driver of future economic growth. The

government was keen to point out that because hydroelectric power did not involve the burning of fossil fuels, the

power would be environmentally clean and would contribute to the East Asian country’s ability to meet its

internationally agreed carbon emission targets. This, in turn, would contribute to the reduction of greenhouse gases

in the environment. Critics, such as the environmental pressure group ‘Stop-the-dam’, however, argued that the

project was far too large and the cost to the local environment would be unacceptable. Stop-the-dam was highly

organised and, according to press reports in Europe, was capable of disrupting progress on the dam by measures such

as creating ‘human barriers’ to the site and hiding people in tunnels who would have to be physically removed before

proceeding. A spokesman for Stop-the-dam said it would definitely be attempting to resist the Giant Dam Project when

construction started.

The project was intended to dam one of the region’s largest rivers, thus creating a massive lake behind it. The lake

would, the critics claimed, not only displace an estimated 100,000 people from their homes, but would also flood

productive farmland and destroy several rare plant and animal habitats. A number of important archaeological sites

would also be lost. The largest community to be relocated was the indigenous First Nation people who had lived on

and farmed the land for an estimated thousand years. A spokesman for the First Nation community said that the ‘true

price’ of hydroelectric power was ‘misery and cruelty’. A press report said that whilst the First Nation would be unlikely

to disrupt the building of the dam, it was highly likely that they would protest and also attempt to mobilise opinion in

other parts of the world against the Giant Dam Project.

The board of R&M was fully aware of the controversy when it submitted its tender to build the dam. The finance

director, Sally Grignard, had insisted on putting an amount into the tender for the management of ‘local risks’. Sally

was also responsible for the financing of the project for R&M. Although the client was expected to release money in

several ‘interim payments’ as the various parts of the project were completed to strict time deadlines, she anticipated

a number of working capital challenges for R&M, especially near the beginning where a number of early stage costs

would need to be incurred. There would, she explained, also be financing issues in managing the cash flows to R&M’s

many subcontractors. Although the major banks financed the client through a lending syndicate, R&M’s usual bank

said it was wary of lending directly to R&M for the Giant Dam Project because of the potential negative publicity that

might result. Another bank said it would provide R&M with its early stage working capital needs on the understanding

that its involvement in financing R&M to undertake the Giant Dam Project was not disclosed. A press statement from

Stop-the-dam said that it would do all it could to discover R&M’s financial lenders and publicly expose them. Sally

told the R&M board that some debt financing would be essential until the first interim payments from the client

became available.

When it was announced that R&M had won the contract to build the Giant Dam Project, some of its institutional

shareholders contacted Richard Markovnikoff, the chairman. They wanted reassurance that the company had fully

taken the environmental issues and other risks into account. One fund manager asked if Mr Markovnikoff could

explain the sustainability implications of the project to assess whether R&M shares were still suitable for his

environmentally sensitive clients. Mr Markovnikoff said, through the company’s investor relations department, that he

intended to give a statement at the next annual general meeting (AGM) that he hoped would address these

environmental concerns. He would also, he said, make a statement on the importance of confidentiality in the

financing of the early stage working capital needs.

(a) Any large project such as the Giant Dam Project has a number of stakeholders.

Required:

(i) Define the terms ‘stakeholder’ and ‘stakeholder claim’, and identify from the case FOUR of R&M’s

external stakeholders as it carries out the Giant Dam Project; (6 marks)