ACCA · Question 31 · Preparation of Single Entity Financial Statements

Section C - Constructed Response 1

Titanium Heavy Industries (THI) is preparing its financial statements for the year ended 31 December 20X6. The trial balance shows a draft profit before tax of $12,500,000. However, the following issues have not yet been accounted for:

1. Revenue Contract:
On 1 July 20X6, THI entered into a contract to build a specialized heavy crane for a customer for $8,000,000. The contract meets the criteria to recognize revenue over time. By 31 December 20X6, THI had incurred costs of $3,000,000. The total estimated costs to complete the contract are $6,000,000. THI measures progress based on costs incurred relative to total expected costs. No entries have been made for this contract.

2. Convertible Loan Note:
On 1 January 20X6, THI issued $5,000,000 of 4% convertible loan notes at par. Interest is payable annually in arrears. The notes are convertible in 3 years. The market interest rate for similar debt without a conversion option is 8%. The present value of $1 at 8% is: Yr 1: 0.926, Yr 2: 0.857, Yr 3: 0.794. The draft profit includes a deduction of $200,000 for the interest paid, but no other adjustments have been made.

3. Property Revaluation:
THI owns a factory that had a carrying amount of $10,000,000 on 1 January 20X6. On 31 December 20X6, an independent valuer assessed the fair value of the factory at $14,000,000. The factory has a remaining useful life of 20 years from 1 January 20X6. THI's policy is to revalue its properties and make an annual transfer between the revaluation surplus and retained earnings. Depreciation for the year has already been correctly charged based on the $10,000,000 carrying amount, but the revaluation has not been recorded.

4. Taxation:
The estimated current tax bill for the year is $2,200,000. Furthermore, the revaluation of the factory creates a taxable temporary difference. The corporate tax rate is 25%.

Required:
(a) Calculate the revised Profit Before Tax for the year ended 31 December 20X6. Show all workings for the Revenue and Convertible Loan Note adjustments. (10 marks)
(b) Calculate the Income Tax Expense for the year and the Revaluation Surplus (net of tax) to be recognized in Other Comprehensive Income. (5 marks)
(c) Explain the impact of the Convertible Loan Note adjustment on THI's Gearing ratio (Debt / Equity) compared to if it had been treated entirely as debt. (5 marks)