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Preparation of Single Entity Financial StatementsSingle EntityFinancial StatementsRatio AnalysisSection C

ACCA · Question 32 · Preparation of Single Entity Financial Statements

Section C

GreenGrid operates renewable energy infrastructure. You are preparing the financial statements for the year ended 31 December 20X5.

Draft Trial Balance Extracts at 31 December 20X5:
Revenue: $45,000,000 (Credit)
Cost of Sales: $22,000,000 (Debit)
Operating Expenses: $8,000,000 (Debit)
Solar Farms (Carrying amount 1 Jan 20X5): $60,000,000 (Debit)
Convertible Loan Note (Issued 1 Jan 20X5): $10,000,000 (Credit)
Interest paid on Loan Note: $400,000 (Debit)
Tax paid during year: $200,000 (Debit)
Deferred Tax Liability (1 Jan 20X5): $1,500,000 (Credit)

Additional Information:

  1. Solar Farms: GreenGrid uses the revaluation model. On 31 December 20X5, an independent valuer assessed the solar farms at $65,000,000. The farms have a remaining useful life of 20 years from 1 Jan 20X5. Depreciation for the year has not yet been charged to Cost of Sales.
  2. Convertible Loan Note: Issued on 1 Jan 20X5 at par ($10m). It pays a coupon of 4% annually. The market rate for a similar bond without conversion rights is 8%. The equity component of $1,030,000 has already been correctly recorded in equity, and the liability component was initially recorded at $8,970,000. The $400,000 interest paid has been deducted from the liability balance in the trial balance.
  3. Taxation: The current tax estimate for the year is $1,200,000. The deferred tax liability at 31 December 20X5 is calculated to be $1,800,000. The tax paid in the trial balance relates to an under-provision from the previous year.

Required:
(a) Prepare the Statement of Profit or Loss and Other Comprehensive Income for GreenGrid for the year ended 31 December 20X5. (12 marks)
(b) Calculate the following ratios for 20X5 and provide a brief commentary (max 3 sentences) on GreenGrid's profitability:
i. Operating Profit Margin
ii. Return on Capital Employed (Assume total Capital Employed is $75,000,000 for this calculation).
(8 marks)

How to approach this question

Part A: 1. Calculate depreciation ($60m / 20 years) and add to Cost of Sales. 2. Calculate revaluation gain (Valuation - Carrying amount after depreciation) and put in OCI. 3. Calculate effective interest on the loan note (8% of initial liability $8.97m) and put in Finance Costs. 4. Calculate tax expense (Current estimate + Under-provision + Increase in Deferred Tax). Part B: Use Operating Profit (PBIT) for both ratios. Margin = PBIT / Revenue. ROCE = PBIT / Capital Employed.

Full Answer

**Part (a) Workings:** 1. **Depreciation & Revaluation:** - Depreciation = $60,000,000 / 20 years = $3,000,000. Add to Cost of Sales. - Carrying amount at 31 Dec before revaluation = $60m - $3m = $57,000,000. - Revaluation amount = $65,000,000. - Revaluation gain (OCI) = $65m - $57m = $8,000,000. 2. **Finance Costs (IFRS 9):** - Initial liability = $8,970,000. - Effective interest = $8,970,000 x 8% = $717,600. (This goes to P&L). 3. **Taxation:** - Current tax estimate = $1,200,000. - Under-provision from prior year = $200,000. - Increase in DTL = $1,800,000 - $1,500,000 = $300,000. - Total tax expense = $1,200k + $200k + $300k = $1,700,000. **Statement of Profit or Loss and OCI:** Revenue: $45,000,000 Cost of Sales ($22m + $3m depn): ($25,000,000) **Gross Profit: $20,000,000** Operating Expenses: ($8,000,000) **Operating Profit (PBIT): $12,000,000** Finance Costs: ($717,600) **Profit Before Tax: $11,282,400** Income Tax Expense: ($1,700,000) **Profit for the Year: $9,582,400** **Other Comprehensive Income:** Gain on revaluation of property: $8,000,000 **Total Comprehensive Income: $17,582,400** **Part (b) Ratios:** i. **Operating Profit Margin:** (Operating Profit / Revenue) x 100 = ($12,000,000 / $45,000,000) x 100 = **26.67%** ii. **ROCE:** (Operating Profit / Capital Employed) x 100 = ($12,000,000 / $75,000,000) x 100 = **16.00%** **Commentary:** GreenGrid demonstrates strong profitability with an operating margin of nearly 27%, indicating good control over its operating costs and cost of sales relative to its revenue. The ROCE of 16% shows a healthy return on the capital invested in the business, which is particularly impressive given the capital-intensive nature of renewable energy infrastructure. The revaluation of the solar farms will increase capital employed next year, which may put downward pressure on future ROCE unless profits grow proportionally.

Common mistakes

1. Using the coupon rate (4%) for finance costs instead of the effective rate (8%). 2. Forgetting to deduct depreciation before calculating the revaluation gain. 3. Deducting the tax paid from the current estimate instead of adding it as an under-provision.
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