Expert Answer :2 QUESTION 1 95 marks You are the audit senior in

Solved by verified expert :2QUESTION 1 95 marksYou are the audit senior in charge of the group audit of Ezweni Ltd, a holding company listed onthe JSE Ltd. Your audit firm is responsible for the audit of all of the companies in the group andyou are currently completing the audit for the year ended 28 February 2006. The group usesInternational Financial Reporting Standards (IFRS) in the preparation of their annual financialstatements.The group carries on trade in the clothing industry and consists of the following individualcompanies that all play a role in the production chain of the group:• The holding company – Ezweni Ltd• Four subsidiarieso Retail Ltd, a retail company;o Manufacture Ltd, a manufacturing company;o Property Ltd, a property investment company; ando Foreign Ltd, clothing manufacturer and distributor in the United States of America.The following information was extracted from the audited financial packs received from theauditors of the individual companies in the group for the year ended 28 February 2006:EzweniLtdR’000RetailLtdR’000ManufactureLtdR’000PropertyLtdR’000ForeignLtdUS $’000Profit after taxation 35 500 65 800 55 300 15 700 6 900Dividends paid:28 February 2006 (25 000) (20 000) (40 000)(2 000) (500)Retained earnings:1 March 200585 600240 300310 90045 60012 800Additional information on the companies in the groupEzweni LtdThe income received by Ezweni Ltd consists mainly of income from lease agreements anddividends received from subsidiaries. Ezweni Ltd has also incurred operating expenses whichhave been deducted correctly in order to calculate the profit after taxation. Ezweni Ltd hasissued share capital of 2 million equity shares (with a par value of R1 per share) that were allissued at R2 above par value. No shares were issued during the year ended 28 February 2006.On 1 March 2005 the remuneration committee of the board of Ezweni Ltd decided to rewardeight of its directors, as part of a performance management scheme to link the directors’interests with the interest of the shareholders. The details of the scheme are as follows:• Participants may elect, at grant date, to receive 10 000 share options or 10 000 shareappreciation rights. On the grant date five directors chose share options while threechose share appreciation rights.3• The share options give the directors the right to obtain shares in Ezweni Ltd. The directorsmust remain in the employ of the group for three years, and the options will only vest if theshare price is R95 or higher on 29 February 2008.• The share appreciation rights entitle the directors to receive, in cash, the increase in theshare price over R58 at 29 February 2008. The directors must remain in the employ of thegroup for three years, and the rights will only vest if the share price is R95 or higher on29 February 2008.• On 1 March 2005 the Ezweni Ltd share price was R60. The options have a strike price ofR58. On that date an independent valuer determined that the fair value of the options wasR20 each. The valuer used the binomial option pricing model, which takes into accountmarket conditions.• By 28 February 2006 the Ezweni Ltd share price had fallen to R50 and the fair value ofthe option, determined using the binomial option pricing model, was R10. The directorsare of the opinion that the company’s share price will not reach R95 at 29 February 2008.• On 1 February 2006 one of Ezweni Ltd’s directors resigned. That director had previouslychosen to receive share options. No further directors were expected to leave the companyup to 29 February 2008.Retail LtdRetail Ltd is a retailer that sells clothing through its own retail outlets. Retail Ltd acquires itsinventory from Manufacture Ltd (see information below). Ezweni Ltd acquired its 80%investment in Retail Ltd at the incorporation of the company on 1 March 2002 for R5,2 millionwhen the equity of Retail Ltd consisted of the following:R’000Share capital (R1 par value shares)Share premium1 0005 250Because of its strategic importance to the group, Ezweni Ltd was willing to pay a premium forthe interest in Retail Ltd.Manufacture LtdManufacture Ltd is a manufacturing company which is responsible for the manufacture of all ofthe finished goods sold by Retail Ltd. Ezweni Ltd acquired all the share capital of ManufactureLtd on 1 July 2001 for R120 million when the equity of Manufacture Ltd consisted of thefollowing:R’000Share capital (R1 par value shares)Retained earnings100125 900The assets and liabilities were all considered to be fairly valued in the accounting records ofManufacture Ltd at the date of acquisition by Ezweni Ltd.4Manufacture Ltd was unable to obtain the required financing to purchase non-specialisedmanufacturing machinery from a financial institution. Ezweni Ltd therefore decided to purchasethe machinery and lease it to Manufacture Ltd. Ezweni Ltd acquired the manufacturingmachinery on 1 March 2003 at a cost of R15 million (excluding VAT). On the same date itentered into a lease agreement with Manufacture Ltd in terms of which Ezweni Ltd leased thenon-specialised manufacturing machinery to Manufacture Ltd. Ezweni Ltd qualifies for a capitalallowance of 20% per annum on cost price in respect of the manufacturing machinery forincome tax purposes.The lease agreement between the two companies contains no special arrangements and allterms are considered to be market-related. The lease agreement between the two partiescontains amongst others the following conditions:Commencement of the lease termCash cost price (fair value) of the machinery(including VAT at 14%) on which lease is basedEconomic life of the manufacturing machineryLease termRate implicit in the leaseIncremental borrowing rateUnguaranteed residual value (including VAT at 14%)Instalments1 March 2003R22,8 million10 years6 years10%11%R2 millionPayable monthly in arrearsIt has been clearly stipulated in the lease agreement that Manufacture Ltd will not at any stageduring or after the lease term obtain ownership of the manufacturing machinery. The groupexpects the useful life of the production machinery to be the same as its economic life. Themachine is used for a qualifying purpose in terms of the Value-Added Tax Act and bothManufacture Ltd and Ezweni Ltd are registered VAT vendors.Manufacture Ltd sells all of its manufactured inventories to Retail Ltd at a gross profit margin of20% calculated on manufactured cost price. The inventory account in the general ledger ofRetail Ltd reflected the following closing inventories on hand (at cost to Retail Ltd):R’00028 February 200528 February 200630 00042 000Property LtdProperty Ltd is a property investment company which invests in land and buildings and holdsthese investments primarily for capital gain. Ezweni Ltd acquired a 60% interest in Property Ltdon 1 September 2002 for R30 million when the equity of Property Ltd consisted of the following:R’000Share capital (R2 par value shares)Share premiumRetained earnings1 00020 00024 0005At the date of acquisition by Ezweni Ltd the assets and liabilities were all considered to be fairlyvalued in the accounting records of Property Ltd, except for land which was undervalued byR5 million. Land has never been impaired in the accounting records of Property Ltd.On 1 March 2005, Property Ltd decided to buy back some of its own share capital from theshareholders. The existing shareholders agreed that 200 000 shares would be bought backfrom Ezweni Ltd and none from the other shareholders. Ezweni Ltd received R100 per sharefrom Property Ltd for the buyback.Property Ltd sought to minimise any additional secondary tax on companies (STC) that might bepayable as a result of the share buyback. No profit or loss arising from the share buyback ineither the separate or consolidated financial statements of the Ezweni Ltd group of companieshad any tax implications.The abridged balance sheet of Property Ltd as at 1 March 2005 was as follows:PROPERTY LTDABRIDGED BALANCE SHEET AS AT 1 MARCH 2005R’000AssetsProperty, plant and equipmentReceivablesBank and cash balances127 8005 1002 100135 000Equity and liabilitiesShare capitalShare premiumRetained earningsLong-term liabilities1 00020 00045 60068 400135 000Foreign LtdForeign Ltd is a clothing manufacturer and distributor situated in the United States of America.Ezweni Ltd acquired 75% of the share capital of this company on 1 March 2004 for R35 millionto expand into the global clothing industry. Foreign Ltd’s functional currency is the US dollar ($).At the date of acquisition the equity of Foreign Ltd consisted of the following:$’000Share capital ($1 par value shares)Retained earnings5003 500At the date of acquisition by Ezweni Ltd the assets and liabilities were all considered to be fairlystated in the accounting records of Foreign Ltd, except for factory buildings which wereundervalued by $200 000. At that date the factory buildings had a remaining useful life of tenyears. Foreign Ltd qualifies for the relevant capital allowances on the factory building.6The relevant foreign exchange rates were as follows at the specified dates:1 March 200428 February 2005Average for 2005 financial year28 February 2006Average for 2006 financial year$1 = R10,00$1 = R8,50$1 = R9,50$1 = R6,80$1 = R8,00Notes on accounting policies• The Ezweni Ltd group accounts for all investments over which significant influence isexercised according to the equity method.• The Ezweni Ltd group accounts for all items of property, plant and equipment accordingto the cost model in terms of IAS 16, Property, plant and equipment (AC 123). No itemsof property, plant and equipment have been revalued in the separate annual financialstatements of any group companies.• Where applicable, assume a local company tax rate of 29% and a foreign company taxrate of 40% in all your calculations. Ignore capital gains tax in respect of foreign assetsand liabilities.REQUIRED Marks(a)Prepare the journal entries relating to the share-based payment transaction(including the tax effects) in the separate accounting records of Ezweni Ltd forthe year ended 28 February 2006.12(b)Prepare a reconciliation of the goodwill balance as it should appear in the notesto the annual consolidated financial statements of Ezweni Ltd for the year ended28 February 2006. No comparative figures are required.16(c)Calculate the consolidated profit or loss on the share buyback of Property Ltd asit would appear in the annual consolidated financial statements of Ezweni Ltd forthe year ended 28 February 2006.8(d)Describe the procedures you should have performed to audit the share buybackin the annual financial statements of Property Ltd for the year ended 28February 2006.12(e)Calculate the consolidated net profit or loss before minority interests of theEzweni Ltd group for the year ended 28 February 2006.22(f)Show the following items as they would be disclosed in the consolidatedstatement of changes in equity for the Ezweni Ltd group for the year ended28 February 2006:• Foreign currency translation reserve; and• Minority interest.25TOTAL MARKS 95