Reading the question

Quiz A
Carefully read requirement (a) and then the scenario, twice. Then, without further reference to the question, answer the following - and no cheating, or the aim of this exercise will be completely lost.

Q1 What does Cerise manufacture?

Q2 Which financial statements are you auditing (what is the balance sheet date)?

Q3 What has been sold/purchased?

Q4 Is Cerise the seller or the buyer?

Q5 Was the sale/purchase transaction before or after the balance sheet date?

Q6 What significant event(s) took place on 31 October?

Q7 Were premises put on the market before or after the balance sheet date?

Quiz A answers
A1 Computer-controlled equipment for production-line industries. It does not manufacture cars, washing machines, cookers etc.

A2 Year ending 31 December 2004 - in other words, a year yet to finish rather than a year already ended. If you didn't realise that the example was set in real time then refer to the minutes of the Teachers' Conference (www.accaglobal.com/colleges) and feedback of past exams to understand the importance of the timeframe within which questions are set.

A3 Cerise's patented technology and manufacturing equipment - not the equity share capital of Cerise/the company in its entirety that would result in the acquiring entity (unnamed) assuming Cerise's liabilities. It is important that this is understood at the outset.

A4 The seller (see answer 3). If you got this wrong (for example, you thought that Cerise was buying the patented technology and manufacturing equipment from another entity) then this misunderstanding would result in your answer being incorrect or irrelevant.

A5 Before. The year end is 31 December 2004. 'The sale was duly completed' 31 October 2004. Even if the question had not spelt this out, note that the offer was accepted on the 1 September and communicated to those affected on the 10 September. Also, assets not part of the agreement were put on the market on 1 November 2004. (To assume that the sale was post year-end would be bizarre, given the management's consequential actions.)

A6

1. Cerise ceased all manufacturing activities on 31 October 2004.
2. The 200-strong factory workforce and the majority of the accounts department and support staff were made redundant.
3. The sale was duly completed.

A7 Nine premises (excluding head office and four offices on leases that cannot be sub-let) were put on the market on 1 November (two months before the balance sheet date).

Quiz B
Having established from Quiz A that Cerise is not a going concern at 31 December 2004, answer the following questions. Research your responses as necessary by re-reading the scenario.

Q1 Which of the following should you expect to be carried in Cerise's balance sheet? Where relevant, clearly indicate if they are an asset or liability:

1. patented technology
2. manufacturing equipment
3. premises held on non-cancellable leases
4. inventory
5. trade receivables
6. trade payables.

Q2 From the scenario, identify any further assets or liabilities that you should expect to see carried in the balance sheet of Cerise at 31 December 2004.

Q4 Should Cerise provide for or only disclose (as contingent) the liabilities arising from product warranties? (You must justify your answer.)

Q5 Which of the following statements are true in the context of Cerise?

1. Non-current assets under the cost model are likely to be impaired because they have not been revalued.
2. A lease that expires in five years (say) and cannot be sold or sub-let could be a finance lease.
3. There is a great risk of overstatement of assets or understatement of liabilities because the shareholder-managers will want to present Cerise in a good light.
4. Inventory is at risk of overstatement as the nature of the goods (cars, washing machines, cookers, etc) means they are at risk of theft.

Quiz B answers
A1 Asset or liability on the balance sheet?

1. Patented technology - No (sold)
2. Manufacturing equipment - No (sold)
3. Premises held on non-cancellable leases - Liability (onerous contracts)
4. Inventory - Asset
5. Trade receivables - Asset (amount due from distributors)
6. Trade payables - Liability (amounts due to suppliers)

A2 Further assets and liabilities:

1. Any of the nine premises put on the market on 1 November 2004 that have not been sold at 31 December.
2. Head office premises (if held on a finance lease).
3. Provisions for redundant workforce (if not yet paid).
4. Provisions for severance packages of managers ceasing employment on 31 December 2004.

A3 Inventory that may be carried at 31 December 2004: Finished goods (of computer-controlled equipment) and raw materials (bought-in components). No work-in-progress is expected (as the cessation of manufacturing two months before the year end was planned for). Reasons why the carrying amount of inventory might be overstated in the balance sheet:

1. Slow-moving finished goods (unsold for at least two months if they are still held at the balance sheet date).
2. Finished goods are no longer offered with extended product warranties.
3. Purchased components cannot be used, as manufacturing has ceased.

A5 True or false?

1. False. Carrying amount under the cost model will most likely be less (significantly) than under a revaluation model. Therefore less likely to be impaired.
2. False (in any context, not just Cerise). On the risks and rewards criteria alone this should be considered an operating lease.
3. False. The shareholder-managers are not selling the entity for a price that will be in any way dependent on the financial statements. Assets have already been sold (months before the preparation of the financial statements).
4. False. Cerise does not manufacture these items (See Quiz A).

Conclusion
How did you do? Be honest! Really reading the question - and that means the requirements and the scenario - is essential to passing this examination. I did not 'dream up' the statements in Question 5 of Quiz B - they were all false assertions made by candidates who did not take sufficient time and care to understand the scenario presented to them. Be warned, if you want to succeed at this examination, no amount of preparation will help if you do not read the question (RTQ).

Kim Smith is examiner for Paper 3.1