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Crosswire debrief (December 2009) | ACCA Qualification | Students | ACCA http://www.accaglobal.

com/students/acca/paperf7/resources/3356413

CROSSWIRE DEBRIEF (DECEMBER 2009)

by Bobbie Retallack
06 Sep 2010

This article is designed to show you how to tackle a performance appraisal question using Crosswire from the December 2009 exam.

Access a copy of this question

Performance appraisal overview


In the Paper F7 exam there will always be a performance appraisal question at Question 3. The tasks that you generally might be asked to undertake
here are, preparing a statement of cash flow or calculate accounting ratios (or both) and appraising the company using the calculations prepared in
the early part of the question and the financial statements themselves.

Question 3, therefore, examines candidates' ability to understand the information contained within the financial statements rather than simply
preparing them.

Question technique
Because there are several tasks that may be required of you in the exam, question practice and becoming familiar with the question style is of
upmost importance.

If you are asked to prepare a statement of cash flow there are often easy marks that can be obtained. For example, within the further information to
the question there may be information given to you by the examiner that can be taken directly to the statement of cash flow such as, dividends paid,
depreciation and profit or loss on disposal. It is important that you recognise this information and take it to the relevant heading in the statement of
cash flow.

When including balances in your statement of cash flow you must ensure that the movement reflects the relevant cash inflow or outflow. An incorrect
position could cost you marks in the exam. It is advised that you ask yourself logically what has happened. If you have calculated a payment to
purchase new non-current assets for example, then this has to be a cash outflow in the answer and must be reflected as such.

If asked to calculate ratios, make sure you always state the formula that you are following and show your working for the ratio, as often your
calculation/formula may be right but you may have made a mistake in your final answer. If you show all of your working, your marker will be able to
give you the relevant marks accordingly, but when your working is not present and you have an incorrect answer, the ratio will simply be marked as
being incorrect.

In the exam you may be asked to comment on your statement of cash flow or ratios in line with the question requirement. Please make sure that you

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Crosswire debrief (December 2009) | ACCA Qualification | Students | ACCA http://www.accaglobal.com/students/acca/paperf7/resources/3356413

understand the requirement and answer the question actually being asked, rather than simply the question you wish had been asked.

Also, consider your presentation. Markers often complain of candidates' answers that are almost illegible in some instances. This situation can arise
due to the time pressure in the exam, it is far better to take your time and make fewer, quality comments, rather than many comments that cannot be
read or are not worth a full mark.

Crosswire debrief
The question from the December 2009 exam required candidates to prepare a movement in the carrying value of non-current assets, the amounts
that would appear under the headings Cash Flow from Investing Activities and Cash Flow from Financing Activities in the statement of cash flows,
the calculation of return on capital employed (ROCE) and interpretation of ROCE.

Candidates at this sitting found the question unusual as the requirement wasn't a straightforward 'prepare a statement of cash flow or ratios and
comment on them'. However, all of Part (a) really was just a requirement to prepare the last two headings in the statement of cash flow.

Part (a)(i) debrief


The requirement for this part of the question is to:

Prepare a statement of the movements in the carrying amount of Crosswire's non-current assets for the year ended 30 September 2009.

Part (a)(i) of the question is worth nine marks in total, which means you should be planning to spend approximately 16 minutes to answer the
requirement.
This part of the question appeared to cause a lot of confusion to some candidates in the exam, but when the requirement is actually analysed, the
task is simply to reflect any movement in non-current assets from the beginning of the year to those present at the end of the year. This should not
have been a difficult task, and for those candidates that understood the requirements, high marks were awarded.

All of the information required to complete Part (a)(i) is contained within notes (i) and (ii) of the further information. Note (i) gives details regarding
movements in property, plant and equipment and note (ii) gives detail regarding movements in development costs.

To begin this answer, it is useful to set up two headings - one for property, plant and equipment and one for development costs that include the
opening carrying values from September 2008 as your starting point. It is these values that need to be adjusted to determine the closing balance on
the non-current assets.

Below, are extracts from the further information at note (i) and an explanation of the impact this will have on the movement in property, plant and
equipment:

On 1 October 2008 Crosswire acquired a platinum mine at a cost of $5m. A condition of mining the platinum is a requirement to
landscape the mining site at the end of its estimated life of 10 years. The present value of this cost at the date of the purchase was
calculated at $3m (in addition to the purchase price of the mine of $5m).

When the mine was purchased for $5m Crosswire would have accounted for this using the following entry:

Dr Non-current assets

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Cr Bank

Therefore, the $5m represents an increase to property, plant and equipment during the year and should be represented as such.

There is also the requirement to landscape the mine in 10-years' time at a present value of $3m. A provision for the future cost of $3m (at present
value) would have been recorded in the financial statements as the recognition criteria per IAS 37, Provisions, Contingent Assets and Liabilities
have been met (ie present obligation, probable will be paid and a reliable estimate at present value has been made). The provision would have
been accounted for as:

Dr Non-current assets
Cr Provisions

Again therefore, the $3m would have represented an increase in property, plant and equipment during the year.
Also on 1 October 2008 Crosswire revalued its freehold land for the first time. The credit in the revaluation reserve is the net amount
of the revaluation after a transfer to deferred tax on the gain. The tax rate applicable to Crosswire for deferred tax is 20% per annum.

When looking at the equity section of the financial statements, it can be seen that there has been an increase on the revaluation reserve during the
year. The balance on this reserve at the year end is $2m but this represents the net amount after a transfer has been made to deferred tax.

The original gain on the revaluation must therefore have been $2.5m ($2m/80 x 100). The initial revaluation gain of $2.5 million would have been
accounted for during the year as:

Dr Non-current assets
Cr Revaluation reserve

This gain on valuation would have represented an increase in property, plant and equipment during the year.
On 1 April 2009 Crosswire took out a finance lease for some new plant. The fair value of the plant was $10m.

When an asset is acquired under a finance lease, per IAS 17 Leases, the initial accounting is to:

Dr Non-current assets
Cr Finance lease obligations

Therefore this would have represented an increase in non-current assets during the year.
Plant disposed of during the year had a carrying amount of $500,000 and was sold for $1.2m. The remaining movement on the
property, plant and equipment, after charging depreciation of $3m, was the cost of replacing plant.

The carrying amount of $500,000 disposed of would simply reduce the carrying value of property plant and equipment as would the depreciation
of $3m.

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When you have dealt with all of the information at note (i), you will realise that the solution is not yet complete - now include the carrying value of the
property, plant and equipment at the year end and the balancing figure will be the cash spent to acquire new property, plant and equipment during the
year (ie non-current asset additions).

Your movement on property, plant and equipment should now represent:

$000
B/fwd carrying value (per question) 13,100
Mine:
- Cost (cash) *5,000
- Provision at present value 3,000
Gross revaluation 2,500
Finance leased asset $10,000
Disposal (500)
Depreciation ($3,000)
Cash paid to purchase property, plant and equipment *2,400
C/fwd carrying value (per question) 32,500

*The cash balances to purchase property, plant and equipment will be required for Part (a)(ii) in investing activities.

Below, is the extract from the further information at note (ii) and an explanation of the impact that this will have on the movement in development
costs:

From 1 October 2008 to 31 March 2009 a further $500,000 was spent completing the development project at which date marketing and
production started. The sales of the new product proved disappointing and on 30 September 2009 the development costs were written
down to $1m via an impairment charge.

The cash spent on development costs of $500,000 would have been capitalised in accordance with IAS 38 Intangible Assets. Crosswire would
have accounted for this using the following entry:

Dr Development costs
Cr Bank
With regards to the impairment, you must be very careful and read the wording of the information correctly! Development costs were written down to
$1m (not by $1m) and, therefore, the impairment should have been the balancing amount.

Your movement on development costs should now represent:

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$000
B/fwd carrying value (per question) 2,500
Capitalised development (cash) *500
Impairment (2,000)
C/fwd carrying value (per question) 1,000

*The cash spent on development cost will be required for Part (a) (ii) in investing activities.

Part (a)(ii) debrief


The requirement for this part of the question is to:

Calculate the amounts that would appear under the headings of 'cash flows from investing activities' and 'cash flows from financing
activities' in the statement of cash flows for Crosswire for the year ended 30 September 2009.

Part (a)(ii) is for 8 marks and therefore you should be planning to spend approximately 14 minutes on this section.

This part of the question requires you to prepare the last two headings of the statement of cash flow which many candidates find the more difficult
aspect of the cash flow. You should already have some entries to include in here though from part (a) (i).

Investing activities
At Part (a) (i) the cash spent on new property, plant and equipment additions were calculated and at note (i) you were told about the cash spent to
acquire the mine. At note (ii) you were told about the cash spent on further development costs. These balances are cash outflows that can be
included directly into the investing activities section. In addition to this information at note (i), (last paragraph) you are told of the disposal proceeds
of $1.m. This is the cash received upon disposal and therefore represents a cash inflow.

Your investing activities section should, therefore, be very straightforward and completed as follows:

$000
Purchase of property, plant and equipment (Part (a) (i)):
- Mine (5,000)
- Other property, plant and equipment (2,400)
Payment for capitalised development costs (Part (a) (i)) (500)
Proceeds on disposal of plant 1,200
Net cash outflow (6,700)

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Financing activities
This section is slightly more complex than the investing activities section, mainly due to note (iii) and the convertible loan information. However,
there is also a finance lease and interest paid which are standard Paper F7 cash flow adjustments. It is advised that you deal with the finance lease
and interest paid first:

Finance lease

Amount repaid:

$000
Bal b/fwd Nil
Additions 10,000
Bal c/fwd (NCL) (5,040)
Bal c/fwd (CL) (1,760)
Cash repayment - balancing figure 3,200

Interest paid

Information regarding finance costs given at note (iv) is required to find the interest paid. Included in this information is the unwinding of the
environmental provision. This is NOT a cash flow. When a long-term provision has been made, each year the discount is unwound via the following
journal:

Dr Finance costs
Cr Provisions

Therefore, only the finance lease interest and the loan note interest should be taken into account. On the basis that the statement of financial
position does not contain any interest accruals, the interest paid must be:

$000
Finance lease charges 400
Loan note interest 350
Cash outflow 750

Convertible loan

Below is an extract from note (iii)

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During the year ended 30 September 2009, $4m of the 10% convertible loan notes matured. The loan note holders had the option of
redemption at par in cash or to exchange them for equity shares on the basis of 20 new shares for each $100 of loan notes. 75% of the
loan-note holders chose the equity option. Ignore any effect of this on the other equity reserve.

Here we can see that $4m of the loan notes have matured during the year, some were repaid in cash (25%) and some were converted into equity
shares (75%). The cash element is straightforward 25% of the $4m borrowed was repaid, ie $1m, which is therefore a cash outflow.

The number of shares issued upon maturity of the loan note also need to be calculated to determine whether or not any shares were issued during
the year for cash. The shares issued upon maturity of the loan note were:

($4m x 75%) X 20 = 600,000 shares issued upon conversion


$100

These shares would have been accounted for on issue by the following journal:

$000
Dr Loan note 3,000
Cr Share capital (600,000 shares x $1 (nominal value)) 600
Cr Share premium (balancing amount) 2,400

So it can be seen that this share issue does not in any way have a cash impact - you can now use these shares to do a further working to determine
if any shares were issued for cash during the year:

Share issue:

$000
B/fwd share capital 4,000
B/fwd share premium 2,000
Convertible shares issued:
- Capital 600
- Premium 2,400
C/fwd share capital (5,000)
C/fwd share premium (6,000)
Cash received on share issues (balancing amount) (cash inflow) 2,000

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Now that you have considered the information your financing activities section should be completed as follows:

$000
Finance lease repayments (3,200)
Interest paid (750)
Convertible loan note repayment (1,000)
Share issue 2,000
Net cash outflow (2,950)

Part (b) debrief


The requirement for this part of the question is to:

Calculate Crosswire's ROCE for the two years ended 30 September 2008 and 2009 and comment on the apparent cause of its
deterioration.

Note: ROCE should be taken as profit before interest on long-term borrowings and tax as a percentage of equity plus loan notes and
finance lease obligations (at the year end).

Part (b) is for 8 marks and therefore you should be planning to spend approximately 14 minutes on this section.

ROCE should therefore be calculated as:

2009 = 4,000 + 1,000 + 400 + 350 X 100 = 21.3%


1,000 + 5,040 + 1,760 + 19,200

2008 = 3,000 + 800 + 500 X 100 = 29.3%


5,000 + 9,700

Once ROCE has been calculated you can begin to investigate the reasons behind the deterioration. To do this it is advised that you calculate Asset
Turnover and Net Profit Margin. These ratios have a direct link to ROCE and can aid your interpretation of the deterioration.

For Crosswire, once the above has been calculated it can be seen that the main reason for the deterioration of ROCE is a result of the decline in
asset turnover rather than profit margin. This is a direct result of asset turnover declining due to the revaluation of land and acquisition of assets all
of which increase the capital base therefore reducing asset turnover.

There are many comments that you can make when it comes to interpreting the performance of a company. Please ensure that you stick to the point
in the question being asked and try to avoid making sweeping comments, such as, ROCE deteriorated because profit might have fallen or capital
employed may have increased. These comments will score you relatively few, if any marks.

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So in summary, in this style of question, it is very important that you attempt to answer all parts of the question. To allow yourself the chance of
doing this, you need to ensure that you stick to the time allocated to each part of the question. It has already been mentioned, but practice of past
questions is vital to ensure a well-rounded knowledge of these topic areas.

As with any exam question, there may be information that you are unsure of. Such information should not prevent you from answering the majority of
the question. Ensure that you do the things that you can do and if there are areas of confusion, ignore them and move onto the next point.

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