Workshop_Tutorial 7 EPS&CI_QUESTIONS_2_2012

ACCT 7102 Workshop Tutorial 7 Semester 2 / 12Earnings per Share and Comprehensive IncomeHPH 14th EDITION: CHAPTER 18Q18.20 Briefly outline the requirements of AASB 133 for calculation of earnings per share.Q18.21 Distinguish between basic and diluted earnings per share. Additional Question 1 (Source: Deegan 2008 Q27.2)How would you determine whether potential ordinary shares are dilutive?Additional Question 2 (source: Deegan 2008 Q27.4)When should both basic and diluted EPS be disclosed?P18.4On 30 June 2010, XYZ Company Ltd had the following equity:Ordinary shares (issued at $2 each) $20 000 000 Preference shares (issued at $1 each) 1 000 000 Retained earnings 1 584 764 Reserves 4 689 657Total equity $27 238 421On 1 October 2008, the company had issued $500 000 of 10% convertible notes. Each $100 note was convertible into 60 ordinary shares at the holder’s option. No conversions had occurred by 30 June 2010. On 31 December 2009, the company had issued 10000 options to purchase ordinary shares. Each option entitled its holder to purchase ten ordinary shares at $2 each. No options had been exercised by 30 June 2010. During the year ended 30 June 2010, XYZ Company Ltd made a profit of $4 million and paid a dividend to preference shareholders of $80 000.Assume that the company pays income tax at a rate of 30 cents in the dollar and that the company’s ordinary shares were trading at $2.50 on 30 June 2010. Required:Following the requirements of AASB 133:a.Calculate basic earnings per share;b.Calculate diluted earnings per share, if required by AASB 133.On 30 June 2010, Repulse Company had the following equity:Ordinary shares (issued at $2 each) $50 000 000 Preference shares (issued at $1 each) 1 000 000 Retained earnings 12 430 000 Reserves 4 570 000Total equity $68 000 000During the year ended 30 June 2010, the company had the following results: Profit from ordinary activities after related income tax expenses $6 250 000The following additional information is available:a.On 28February 2010, the company made a rights issue of 10 millionordinary shares that did not have a bonus element;b.On 31 December 2009, the company made a one-for-three bonus issue ofordinary shares;c.The 1 million preference shares were convertible to 1 million ordinaryshares at the discretion of shareholders. No conversions had occurredduring the year to 30 June 2010;d.There were 100 000 $100 8% convertible notes outstanding. Each notewas convertible at the owner’s option into 50 ordinary shares. Noconversions had occurred during the year to 30 June 2010;e.There were options to purchase 150 000 ordinary shares at $4.00. Nooptions had been exercised by 30 June 2010;f.During the year ended 30 June 2010, the company paid preferencedividends of $60 000; andg.On 30 June 2010, the ordinary shares were trading at $5.00 and theincome tax rate was 30%.Required:Following the requirements of AASB 133:a.Calculate basic earnings per share;b.Calculate diluted earnings per share, if required by AASB 133.The statement of comprehensive income for Montlake Ltd for the year ended 30 June 2010 is as follows:Revenue from ordinary activities 10 300 000 Expenses from ordinary activities excluding borrowing costs expenses 7 400 000 Finance costs 200 000 Profit from ordinary activities before related income tax expense 2 700 000 Income tax expense relating to ordinary activities 300 000 Profit 2 400 000 On 30 June 2010, the company had the following equity:Ordinary shares (issued at $2 each) $8 000 000 Preference shares (issued at $1 each) 1 000 000 Retained earnings 1 600 000 Reserves 2 000 000Total equity $12 600 000Other information:a.On 30 September 2009, the company made a rights issue of 1 millionshares;b.On 31 December 2008, the company issued 500 000 options to purchase 2ordinary shares at $2.00 each. No options had been exercised by 30 June2010;c.During the year, the company paid preference dividends of $100 000;d.On 30 June 2010, the shares were trading at $2.50 and the income tax ratewas 30%.Required:Following the requirements of AASB 133:a.Calculate basic earnings per share;b.Calculate diluted earnings per share, if required by AASB 133.27.13 C Ltd is an Australian listed company (source: Deegan)Results for the year are as follows:6 months Ended 31/12/1112 months Ended 30/6/12Profit $7 035 800 $17 500 000 Income tax expenses $1 756 000 $5 500 000 Year-end price of the shares is $2.40.SharesNumber of fully paid ordinary sharesAt 1/7/11 5 000 000At 30/6/12 5 000 000Ten million options were issued by the company on 15 September 2011. These are exercisable by the holder at $2.50 per option on or before 22 November 2017.One million options were also issued by the company on 15 March 2012. These are exercisable by the holder at $2 per option on or before 11 May 2019.Other informationAverage share price for the year $2.20Company tax rate 33 percentREQUIREDCalculate the basic earnings per share and diluted earnings per share for C Ltd for the year ending 30 June 2012.Additional Question 1 (Source: A. Hodgson)XYZ LtdStatement of Comprehensive IncomeFor year ended 30 June 2010Revenues $16 000 000Impairment of inventory (500 333)General Expenses (14 272 667)*OPERATING PROFIT 1 227 000 Gain on land sale 1 200 000Revaluation gain (NCA) 120 000Foreign exchange gain 55 000OTHER BUSINESS INCOME 1 375 000 Increase value of shares held 700 000Dividends received 100 000INVESTMENT INCOME 800 000BUSINESS PROFIT 3 402 000Fair value change in debt held 75 000Change in pension liability (20 000)Interest on lease (480 000)FINANCING INCOME (425 000)2 977 000TAX (902 000)2 075 000Loss on destruction of plant (320 000)DISCOUNTINUED ACTIVITIES (320 000) TOTAL COMPREHENSIVE INCOME $1 755 000*Expenses, classified by natureCost of sales 5 000 000Wages & salaries costs 5 492 000Selling expenses 2 500 000Electricity/water costs 480 000Administrative costs 100 000B ad debts expense 200 000Other expenses 440 667FX translation loss 60 00014272 667Required: Assume the weighted average number of ordinary shares is 1 million over the year ended 30 June 2010. How would you report the EPS for XYZ Ltd?THE FOLLOWING HAVE SOLUTIONS ATTACHEDCASE STUDY 1No income gained from revaluationsby Robert HarleyOn February 27 2006, Westfield Group declared an annual profit of $5.58 billion. It was a great headline number, up more than 30 per cent on last year, but Frank Lowy's investors did not see a cent of additional payout.Why? Because the result included $5.1 billion worth of asset revaluations which, under AIFRS - the Australian equivalent of International financial Reporting Standards - were reported as profit, even though they add nothing to income. Westfield is not alone. The latest property results reinforce the problems the sector is having, and will continue to have, with statutory accounting, which insists that cash and non-cash items (such as revaluations) be combined as profit. "The market is still coming to grips with the appropriate way of disclosing the underlying performance of property companies and listed property trusts," says joint chief executive of Mirvac Funds Management, Adrian Harrington."It is not going to be until property revaluations head down that people will truly understand the impact of putting revaluations through the P&L [profit and loss statement] and the confusion that will create [for] investors,” he says.GPT Group chief financial officer Kieran Pryke holds a similar view: “The financial statements are no longer useful. We had a reported profit of $1.3 billion, but the actual money was $560 million."AIFRS has made the production of financial statements a compliance exercise; the market does not use the financial statements to assess financial performance but is relying upon supplementary information that is not subject to any proscribed process or a director's sign-off," says Pryke."I am not sure these conditions are conducive to an orderly market."For the International Accounting Standards Board in London, the logic seems simple. Property investors gain their return through both cash income and capital gain. Both should be included in profit. However, many of Pryke's investors regard real estate as a cash flow business."Profit should refer to how much money I have made, not necessarily how much value I have," he says.In its Real Estate Investment Trust reporting wrap, Goldman Sachs JBWere notes that a few REITS, notably Westfield, Tishman Speyer Office Fund, Multiplex Group and Bunnings Warehouse Property Trust, did not present a distribution-reconciliation statement on the basis of the accounting system before AIFRS."We believe investors should insist on these statements so exact composition of distributions can be compared on a like for like basis, GSJBW notes. Property Council of Australia chief executive Peter Verwer says AIFRS had aimed to give global investors comparable numbers wherever they were investing. "It hasn't worked because the framers of the standards did not understand property markets," he says.He notes, however, that in recent weeks, "the Australian Accounting Standards Board has shown more willingness to revisit key issues".Source: The Australian Financial Review, 14 March 2007.Questions1.Explain why Westfield's result for 2006 was 30 per cent better than theprevious year. How do reporting requirements of AIFRS differ to Australian Generally Accepted Accounting Principles, (AGAAP) for companies in the property sector?2.Why does the IASB consider that revaluation gains are part of income?(Refer to material in the chapter.)3.What is meant by the statement 'IFRS has made the production of financialstatement a compliance exercise; the market does not use the financial statements to assess financial performance' ?1. Explain why Westfield’s result for 2006 was 30% better than the previousyear. How do reporting requirements of AIFRS differ to AGAAP for companies in the property sector?The increase in operating profit reflects the adoption of IFRS. Westfield has elected under AASB 140 Investment Property to include increases in value of property in the income statement when they occur, irrespective of whether the gains are realised or not. Under IFRS the company included $5.1 billion of asset revaluations in income. Previous AGAAP did not include a specific investment property standard. It allowed, but did not require, companies to revalue property under the general rules for measurement of property, plant and equipment. Companies recording asset revaluations under AGAAP showed an increase in assets but the increase was not taken to the income statement, but rather directly to equity.DR Property (Asset, balance sheet)CR Asset revaluation reserve (Reserve, equity)Thus the change under AIFRS is that AASB 141 allows companies to choose a policy of including increases/decreases in value of investment property to form part of property trusts’ income.DR Property (Asset, balance sheet)CR Gain on remeasurement of asset (Gain, income statement)2. Why does the IASB consider that revaluation gains are part of income? The IASB Framework states that ‘income is recognised in the income statement when an increase in future economic benefits related to an increase in assets or decrease in liability has arisen an d can be measured reliably’ (paragraph 92). This approach to income measurement has been called the asset/liability approach and means that ‘recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities’ (paragraph 92). Gains and losses are recognised in the period they occur, and form part of income of the period, irrespective of realisation. The IASB approach is based on Hicks’ (1934) concept of income: that changes in net assets (excluding transactions with owners) represent an increase/decrease in net income. It is argued by members of the IASB (e.g. Mary Barth) that there is indeed no other way to measure income than based on the changes in net assets.3. What is meant by the statement that “IFRS has made the production of financial statement a compliance exercise; the market does not use the financial statements to assess financial performance.”The IFRS approach is that the return for investors in property trusts reflects both cash income and capital gain. Therefore both should be included in profit. However, in the view of the CFO quoted in the article (Kieran Pryke), investors regard property trusts as a cash flow business and are therefore interested in the cash flow generated by the business, not the value of the assets.Property investment companies have responded by providing a distribution reconciliation statement which shows the source of income (both cash income and remeasurement gains) so that investors can distinguish between distributable income and gains relating to revaluation.It seems unrealistic to suggest that investors are not interested in the increase in property values, as in the long term these are increases in wealth for the owners of the trust. In the short term, the reconciliation statement should mitigate any confusion among investors as to the nature of the gains, i.e. realised cash flows or unrealised remeasurement gains.Another point of interest is that companies have a choice under AASB 140; to use the cost or revaluation model for investment property. The article implies trusts must use the revaluation model, but they choose to use it, implying some benefits from the revaluation model. Students could explore the incentives for companies/trusts to use the revaluation model and the costs and benefits of their choice.CASE STUDY 2The following article describes several revenue recognition violations identified by the US securities market regulator, the SEC.Improper revenue recognitionby H. Lynn Stallworth and Dean DigregorioUS Securities and Exchange Commission (SEC) enforcement activity aimed at curbing earnings management and fraudulent financial reporting has increased markedly in recent years. In 2003, the SEC filed a record number of accounting and auditing enforcement actions against both companies and individuals. The individuals charged included senior managers and lower-level staff, accountants and sales managers, external auditors, and even customers. Most of these enforcement actions focused on earnings management, with violations of Generally Accepted Accounting Principles (GAAP) for revenue recognition constituting the most common offense. The SEC has also frequently cited violations of its Staff Accounting Bulletin (SAB) No. 101 revenue recognition guidelines...In recent years, revenue recognition has become increasingly complex due to factors such as international competition and rapidly evolving business models. Constant process and technology innovation also create challenges, as both Internet-based and traditional brick-and-mortar businesses continue to develop innovative distribution channels and sales agreements that complicate revenue recognition. For example, Web-based companies must determine how revenue should be recognized for online sales, licensing, subscription, service, and maintenance agreements. Unless effective controls are in place, the real-time nature of online transactions can easily lead to accounting violations such as recording revenues before goods are actually shipped or services are provided. Progressive fulfillment practices such as outsourcing and drop-shipping can also cause revenue-recognition problems due to delays in recording liabilities and related expenses...Revenue-recognition violationsCompanies manage earnings for a variety of reasons, but the pressure to achieve targeted earnings is usually the primary motivation. To boost revenues, companies might recognize sales prematurely, or during a period prior to the one dictated by GAAP. Methods include using improper sales cut-offs for legitimate transactions, treating consignment sales as if they are final, and entering into parking, bill-and-hold, or channel-stuffing agreements. More flagrant violations include recording fabricated transactions, or fictitious sales. The SEC has taken action against companies for each of these types of violations. Impropersales cut-off. To ensure consistency with GAAP requirements, companies must record sales during the period in which goods are shipped or services are performed. Although the complexity of some business models may make this determination difficult, the accounting literature clearly indicates that intentionally holding the books open past the end of a period - until the company reaches a pre-determined revenue target - represents a violation of GAAP. According to SEC investigations, Minuteman International Inc., a manufacturer of commercial floor care products, engaged in improper sales cut-offs as aroutine practice between 1989 and 2001. During the first three quarters of each year, the company left its sales register open past quarter-end, until its target revenue - as determined by the company's chief executive officer - had been reached. Sales invoices were backdated to the last day of the quarter, even though shipping transactions were actually processed after the quarter had ended. This activity resulted in the overstatement of quarterly revenues, as well as incentive bonuses for the company's sales staff. The SEC settled charges with Minuteman in May 2003.Consignment sales recorded as revenue. Consignment sales typically are characterized by a mutual agreement in which the buyer, or consignee, has an unconditional right to return purchased merchandise to the seller, or consignor. Usually, title does not formally pass to the consignee, nor is the consignee required to pay the seller, until the goods are sold to a third party. As discussed in SAS No. 101, the risks of ownership have not passed to the buyer before this stage of the transaction, nor is the collectability of the receivable ensured. Consequently, revenues from the delivery of goods on consignment should not be recognized until the goods are sold by the consignee.Consignment sales serve a legitimate business purpose. They allow sellers to gain access to distribution channels that might otherwise not be available. However, abuses arise when the shipment of consigned goods is booked as a revenue transaction or when the true arrangement is disguised or hidden. For example, firms may have a valid sales agreement in place, then negotiate the consignment feature as a side agreement and backdate it to precede the original sales agreement.In April 2003, the SEC settled charges with electrical component manufacturer Thomas & Betts Corp., which was accused of committing consignment sales violations between 1998 and 2000. The company created a new type of sales arrangement known as a 'power buy'. The terms of individual agreements varied, though generally they included unusually large sales volumes and price discounts, extended payment terms, shipment to third-party warehouses where goods were stored and insured at the seller's expense, unqualified rights to return products, and assistance from the seller in procuring an end user for the products. In some cases, these conditions were negotiated in side agreements.Thomas & Betts booked revenues from the power buys when goods were shipped. In substance, however, the power-buy arrangements constituted consignment sales and should not have been reported as revenues by the seller until the goods were subsequently sold by the buyers. GAAP requires the buyer to make payment, or to be obligated to make payment without the contingency of product resale, before revenue can be recorded.The SEC's complaint against the firm alleged that three of the firm's executives approved or were aware of many of the side agreements. All three executives consented to the entry of final judgments against them and were eventually required to pay disgorgement, prejudgment interest, and other penalties. Parking, bill and hold, and channel stuffing. Parking, bill-and-hold, and channel stuffing sales arrangements each essentially represent the same type of premature revenue recognition scheme. As the end of an accounting period approaches, the firm negotiates sales with customers who either may not need the offered goods or may not have the ability to take delivery of the goods within that period. The goods may be temporarily held by an intermediary (parking), left in the seller's inventory (bill and hold), or shipped to the buyer (channel stuffing). Typically, deferred payment terms are included within the agreements.In April 2003, the SEC settled charges of premature revenue recognition through improper bill-and-hold sales with Candle's Inc., a designer and distributor of women's footwear, apparel, and fashion products. Although the company's stated practice was to recognize revenue when products are shipped, Candle's recorded purchase orders received for future shoe deliveries as revenue in the current period, even though shoes had not yet been shipped. SAB No. 101 includes specific criteria that preclude this type of transaction from being recognized as current period revenue. According to the bulletin, transactions must be initiated at the request of the customer, the customer must have a legitimate business reason for requesting delayed delivery, and goods must be segregated from the seller's stock and may not be available to fill other orders. Candle's failed to meet these criteria, eventually prompting the SEC to issue a cease-and-desist order.Back-to-back swaps. Even less defensible than the revenue manipulation methods discussed thus far are the fabrication of transactions through back-to-back swaps, also referred to as round-trips. This earnings-management technique requires the cooperation of a customer, related affiliate, or other organization. One firm 'sells' an asset at a gain to another organization and agrees, in turn, to purchase assets from the 'buyer' during either the current accounting period or a subsequent period. Both firms inflate earnings by recording gains on the assets transferred to the other party.Enron engaged in this type of transaction, with the cooperation of Merrill Lynch, by trading Nigerian barges. Homestore,com Inc., an Internet provider of residential real estate listings and related services now known as Homestore, also used this technique. In 2001, Homestore participated in a fourparty round-trip transaction designed to allow the company to recognize its own cash payments as advertising revenue. Homestore purchased unneeded products and services at inflated prices from two vendors. The vendors then used the cash to purchase online advertising from the fourth firm, a media buyer, which in turn purchased online advertising from Homestore, thus returning the cash as advertising revenue. Although Homestore argued that the transactions were merely barter, the complaint filed by the SEC in September 2003 charged that the purpose of the transactions was to artificially and fraudulently inflate Homestore's advertising revenues to exceed analysts' expectations.Fictitious sales. Perhaps the most egregious form of revenue manipulation is the creation of fictitious sales. Under this type of scheme, company goods may be ordered but never shipped, shipped but not ordered, or never ordered or shipped. Furthermore, the company may fabricate purchase orders and shipping records, or even neglect to produce such documents altogether.Anicom Inc., a now-bankrupt, distributor of wire and cable products, reported revenues from sales to fictitious customers - and engaged in other fraudulent practices - to boost revenues. Most of Anicom's sales consisted of drop shipments, or shipments in which the company arranged for a vendor or manufacturer to ship the product directly to the customer. According to the company’s stated policies, Anicom recognized revenue and the associated cost of sales when products were shipped to the customer. At the end of financial quarters between 1998 and 2000, however, Anicom manipulated revenue by recording sales for orders that customers had not yet placed, creating charges that sometimes exceeded the customer's existing credit line. Because customers had not actuallyplaced these orders, Anicom did not order products from vendors or manufacturers for shipment. Customer credits were entered into Anicom's billing system during subsequent quarters to eliminate the receivables previously generated by improper sales. In 1999, the company also recorded sales to an entirely fictitious company that was created solely for the purpose of obscuring uncollectible accounts receivable write-offs on Anicom's books. In March 2003, the SEC indicted six former Anicom executives and employees for 30 counts of fraud-related violations.Source: Internal Auditor, vol. 61, no. 3. June 2004, p. 53.QuestionThe violations outlined involve techniques to boost revenue, including ∙improper sales cut-off∙consignment sales recorded as revenue∙parking, bill and hold and channel stuffing∙back-to-back. swaps∙fictitious sales.Describe each of these techniques and explain whether they would be in breach of Australian accounting standards. In your answer, refer to the recognition criteria of IAS 18 /AASB 118 Revenue presented in figure 9.3. .Case Study 2SolutionsThe violations outlined involve techniques to boost revenue, including:∙improper sales cut-off∙consignment sales recorded as revenue∙parking, bill and hold and channel stuffing∙back-to-back swaps∙fictitious sales.Describe each of these techniques and explain whether they would be in breach of Australian accounting standards. In your answer, refer to the recognition criteria of IAS 18/AASB 118 Revenue presented in figure 9.3.Improper sales cut-offUS GAAP requires a firm to record sales in the period the goods are shipped or services performed. Intentionally holding open the books of account beyond the end of the period is a violation of GAAP. Although sale or delivery is an accepted point for revenue recognition, this has not occurred at the period end date.AASB 118 para 14 (a) requires risks and rewards of ownership to be transferred to the buyer. Tranfer of title for sale of goods did not occur within the period, so a sale should not be recorded. Although sale or delivery is an accepted point for revenue recognition, this has not occurred at the period end date.For a service transaction, the transaction was not complete at the reporting date (AASB 118 para 20). The transaction should not be included in revenue. Consignment sales recorded as revenueConsignment sales usually feature an agreement whereby the buyer (consignee) has the unconditional right to return the merchandise to the seller (consignor). Title does not pass.AASB 118 para 14 (a) requires risks and rewards of ownership to be transferred to the buyer. Tranfer of title for consigned goods did not pass, so the transaction should not be recorded as a sale. Appendix para 2(c) states that a sale should be recognised by the seller (consignor) in a consignment sale when the consignee sells the goods to a third party.Parking, bill and hold and channel stuffingPremature revenue recognition by negotiating sales with customers who do not need, or cannot take delivery, of goods in the period. The goods are held with an intermediary (par king), left in seller’s inventory (bill and hold), or shipped to the buyer (channel stuffing). Deferred payment terms are included in the agreement.The guidance of AASB 118 para 14 (a) requires that risks and rewards of ownership to be transferred to the buyer. In the cases descibed above, ownership of the goods remains with the seller. The risks and rewards of ownership have not passed, irrespective of the location of the goods. Therefore a sale should not be recorded. Appendix to AASB 118 provides further guidance in relation to the above situations. For example, bill and hold sales can be recognised when the buyer takes title and accepts billing, subject to additional conditions (delivery is probable; item is ready for delivery; buyer acknowledges deferred delivery instructions and usual payment terms apply). Under these conditions, sales such as those in item 3 would not be recorded as revenue.Back-to-back swapsFirm A sells assets to Firm B at a gain, and in turn agrees to buy assets from Firm B in the same or subsequent period, also at a gain.These transactions may appear to be within the revenue recognition guidelines of AASB 118 para 14. However, Appendix to AASB 118 provides further guidance. Para 5 states that sales and repurchase agreements need to be analysed to determine whether there is an in substance transfer of the risks and rewards of ownership. If not, despite the fact of legal transfer of title, a sale should not be recorded.Fictitious salesCompany goods may be ordered, but not shipped; shipped but not ordered; or never ordered or shipped. The company may fabricate purchase orders or shipping records (fictitious customers), or not produce any records.These transactions cannot be recorded as revenue because it is not probable that economic benefits associated with the transaction will flow to the entity (AASB 118, para 14c)。