preparing financial statements

Ntchisi Ltd manufactures and sells metal products. Sadya, the New Finance Director, who is a Chartered accountant, has drafted the financial statements for the year ended 31 December, 2012. The Managing Director has some concerns about these financial statements, as he suspects that Sadya’s treatment of certain matters has been influenced by the fact that Sadya is entitled to a bonus based on Ntchisi’s Ltd profit for the year.
The Managing Director has asked Lunda, an independent chartered accountant, to redraft these financial statements and to produce one of the notes for the published financial statements.

Lunda has a meeting with Sadya, who has hinted that if Lunda makes as few adjustments to the draft financial statements as possible, he will see that Lunda is offered a permanent position at Ntchisi Ltd.

The matters which may be of concern are set out below, together with the draft financial statements as prepared by Lunda:

Draft Statement of financial position as at 31 December, 2012

K K
Assets
Non-Current Assets
Property, plant and equipment (1)

Current assets
Inventories (2)
Trade and other receivables
Cash and cash equivalents

125,200
71,900
11,500

600,800

208,600
TOTAL ASSETS 809,400

EQUITY AND LIABILITIES
Equity
K1 Ordinary share capital
Share premium
Retained earnings

Current liabilities
Trade and other payables
Provisions (3)

200,000
150,000
368,700

83,700
7,000

718,700

90,700
TOTAL EQUITY AND LIABILITIES 809,400

Draft Statement of profit or loss for the year ended 31 December, 2012

K
Revenue 2,786,000
Cost of Sales (1,870,900)
Gross Profit 915,100
Administrative expenses (408,200)
Other operating costs (105,300)
Operating profit 401,600
Income tax (5) 30,000
Profit for the year 431,600

The following matters have been identified by the managing Director for Lunda’s consideration;
(1) Property, plant and equipment has always been measured using the cost model until the Directors decided at the board meeting late in 2011 that Ntchisi Ltd would adopt the revaluation model for land and buildings with effect from 1 January 2012. On the basis of this decision, an independent surveyor valued Ntchisi Ltd’s land at K75, 000 at K145, 000 on 1January, 2012 and estimated that the remaining useful life at that date was 25years.
Lunda has omitted to adjust for this valuation and has included land and buildings at its original cost on 1 January 2000 (land K50, 000, buildings K114, 000) less accumulated depreciation at 31 December 2012 using the original useful life of 40years.
The Directors do not wish to make annual transfers between the revaluation surplus and retained earnings. Depreciation on buildings has been presented in administrative expenses.

(2) Sadya has included inventories in the financial statements at cost. However, minutes from a recent board meeting show that the amount includes two product lines, Product A and Product B, which were discontinued on 1 December 2012. The following information relates to these products at 31 December, 2012:

Units Cost per Unit K
Product A 1,000 8.50
Product B 7,000 14.00

Product A can be sold as it is and has a net realisable value of K10 per unit. Product B needs an additional process that costs K4 per unit and can then be sold for K16 per unit.
(3) The provision shown in the statement of financial position above relates to a legal claim made by a customer against Ntchisi Ltd in 2011. The claim is still outstanding at 31 December 2012 and is expected to be settled within the next few months. Ntchisi Ltd’s lawyers believe that the customer has a strong case and following the latest discussions with all parties, the probabilities of given levels of damages payable are estimated as follows:

Damages payable Probability
None 15%
K10, 000 45%
K20, 000 20%
K50, 000 20%
The Managing Director passed the above information to Sadya as He was preparing the draft financial statements, but Sadya has not changed the provision for the legal claim from its brought forward amount.

(4) From 1 January, 2012, Ntchisi Ltd offered one year warranties on all its products sold from that date. If minor repairs were to be required for all goods sold in the year, total cost would be K20, 000. However, if major repairs were to be needed the total cost would be K30, 000. Ntchisi Ltd estimates that 85% of goods will have no defects, 10% will have minor defects and 5% will have major defects. Sadya has made no adjustment in the draft financial statements to allow for this new policy.

(5) Sadya has estimated that an income tax refund of K30, 000 will be due for the current year and has included this in trade and other receivables. However, the Managing director believes that a liability of K80, 000 will be payable and you concur with his calculations. There was an under provision of income tax last year with the final amount paid being K5, 000 higher than the amount provided for in the financial statements for the year ended 31 December, 2011. Sadya posted the additional tax paid in respect of the year ended 31 December 2011 to administrative expenses.

(6) During the year it was discovered that inventory on 31 December 2011 had been understated by K13, 000 due to an error in summarizing the count sheets. Sadya has not adjusted for this error.

(7) Ntchisi Ltd rents its remaining properties under operating leases. On 31 December 2012 Ntchisi Ltd moved out of one of its properties and the building currently remains empty. The lease expires on 31 December 2015 and the annual rent is K15, 000, payable in advance on 1 January each year. The lease conditions do not allow Ntchisi Ltd to sublet the building. Sadya has not made any entries in respect of these future lease commitments.
Ntchisi Ltd uses a discount rate of 7% pa where necessary to reflect the time value in the preparation of its financial statements.

Requirements:
a) Prepare the following for Ntchisi Ltd, in a form suitable for publication, for inclusion in the financial statements for the year ended 31 December 2012:
i. A revised statement of financial position.
ii. A revised statement of profit or loss
iii. The provisions note showing the numerical movements table only. No other notes to the financial statements are required.
b) Identify and explain any ethical issues arising for Sadya and Lunda and any action that Lunda should take.
c) Identify the elements of the financial statements which are relevant to the statement of financial position and explain how these are used in IAS 37 Provisions, Contingent Liabilities and Contingent assets using examples from Ntchisi Ltd where appropriate.
30 Marks