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ACCA P2 - Corporate Reporting
Workbook - Questions & Solutions
P2 Corporate Reporting www.mapitaccountancy.com
Group Accounts
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 1
Almeria Murcia
Non Current Assets
Tangible 100 100
Investment in Murcia 300
Current Assets
Inventory 40 200
Receivables 60 100
Cash 200 200
700 600
Ordinary Shares 160 100
Accumulated Profits 240 200
Equity 400 300
Non Current Liabilities 100 200
Current Liabilities 200 100
700 600
Additional Information
Almeria today acquired all the shares in Murcia for $300m
Required
Prepare the consolidated statement of financial position for the Almeria group
P2 Corporate Reporting www.mapitaccountancy.com
Pro-Forma
Working 1 - Group Structure
Almeria
Murcia
Date Acquired
Parent Share
NCI
Working 2 - Equity Table At Acquisition At Year End
Share Capital
Accumulated Profits
! ! ! !
Working 3 - Goodwill
Cost of Parent Investment
Less Parent % of the net assets at acquisition (W2)
Goodwill
P2 Corporate Reporting www.mapitaccountancy.com
Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2)
Working 5 - Accumulated Profits
$
Parentʼs Accumulated Profits
Add: Parent % of the subsidiaryʼs post acquisition profits
P2 Corporate Reporting www.mapitaccountancy.com
SFP for Almeria Group
Almeria Murcia Group
Non Current Assets
Goodwill
Tangible 100 100
Investment in Murcia 300
Current Assets
Inventory 40 200
Receivables 60 100
Cash 200 200
700 600
Ordinary Shares 160 100
Accumulated Profits 240 200
Non Controlling Interest
Equity 400 300
Non Current Liabilities 100 200
Current Liabilities 200 100
700 600
P2 Corporate Reporting www.mapitaccountancy.com
Solution
Working 1 - Group Structure
Almeria
↓100%
Murcia
Date Acquired TODAY
Parent Share 100%
NCI 0%
Working 2 - Equity Table At Acquisition At Year End
Share Capital 100 100
Accumulated Profits 200 200
300 300
! ! ! !
Working 3 - Goodwill
Cost of Parent Investment 300
Less Parent % of the net assets at acquisition (W2)
(300 x 100%) -300
Goodwill 0
P2 Corporate Reporting www.mapitaccountancy.com
Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2) (300 x 0%) 0
! ! !Working 5 - Accumulated Profits
$
Parentʼs Accumulated Profits 240
Add: Parent % of the subsidiaryʼs post acquisition profits Nil
240
P2 Corporate Reporting www.mapitaccountancy.com
SFP for Almeria Group
Almeria Murcia Group
Non Current Assets
Goodwill None (W3) Nil
Tangible 100 100 100 + 100 200
Investment in Murcia 300 Cancel out Nil
Current Assets
Inventory 40 200 40 + 200 240
Receivables 60 100 60 +100 160
Cash 200 200 200 + 200 400
700 600 1000
Ordinary Shares 160 100 Parent 160
Accumulated Profits 240 200 W5 240
Non Controlling Interest W4 Nil
Equity 400 300 400
Non Current Liabilities 100 200 100 + 200 300
Current Liabilities 200 100 200 + 100 300
700 600 1000
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 2
Ant Dec
Assets 500 500
Investment in Dec 350
850 500
Ordinary Shares 100 200
Accumulated Profits 250 100
Equity 350 300
Liabilities 500 200
850 500
Additional Information
Ant today acquired 160m of the 200m shares in Dec.
Required
Prepare the consolidated statement of financial position for the Ant group
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 2 Pro-Forma
Working 1- Group Structure
↓
Date Acquired
Parent Share
NCI
Working 2- Equity Table At Acquisition At Year End
Share Capital
Accumulated Profits
Working 3 - Goodwill
Cost of Parent Investment
Less Parent % of the net assets at acquisition (W2)
Goodwill
P2 Corporate Reporting www.mapitaccountancy.com
Working 4 NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2)
! ! ! ! !Working 5 - Accumulated Profits
$
Parentʼs Accumulated Profits
Add: Parent % of the subsidiaryʼs post acquisition profits
P2 Corporate Reporting www.mapitaccountancy.com
Statement of Financial Position for Ant Group
Ant Dec Group
Goodwill
Assets 500 500
Investment in Dec
350
850 500
Ordinary Shares
100 200
Accumulated Profits
250 100
NCI
Equity 350 300
Liabilities 500 200
850 500
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 2 Solution
Working 1- Group Structure
Ant
↓80%
Dec
Date Acquired TODAY
Parent Share 80%
NCI 20%
100%
Working 2- Equity Table At Acquisition At Year End
Share Capital 200 200
Accumulated Profits 100 100
300 300
Working 3 - Goodwill
Cost of Parent Investment 350
Less Parent % of the net assets at acquisition (W2)
(300 x 80%) -240
Goodwill 110
P2 Corporate Reporting www.mapitaccountancy.com
Working 4 NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2) (300 x 20%)
60
! ! ! ! !Working 5 - Accumulated Profits
$
Parentʼs Accumulated Profits 250
Add: Parent % of the subsidiaryʼs post acquisition profits Nil
250
P2 Corporate Reporting www.mapitaccountancy.com
Statement of Financial Position for Ant Group
Ant Dec Group
Goodwill W3 110
Assets 500 500 500 + 500 1000
Investment in Dec
350 Cancelled in Goodwill W3
Nil
850 500 1110
Ordinary Shares
100 200 Parent Only 100
Accumulated Profits
250 100 W5 250
NCI W4 60
Equity 350 300 410
Liabilities 500 200 500 +200 700
850 500 1110
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 4
Evan Dando
Assets 200 350
Investment in Dando 500
Current Assets 200 300
900 650
Ordinary Shares ($1) 200 200
Accumulated Profits 250 100
Equity 450 300
Non Current Liabilities 280 200
Liabilities 170 150
900 650
Additional Information
Evan acquired 150m shares in Dando one year ago when the reserves of Dando were $40m.
Required
Prepare the consolidated statement of financial position for the Evan group and show the journal entries for accumulated profits.
P2 Corporate Reporting www.mapitaccountancy.com
Solution
Working 1- Group Structure
↓
Date Acquired
Parent Share
NCI
Working 2 - Equity Table
At Acquisition At Year End
Share Capital
Accumulated Profits
! ! ! !
Working 3 - Goodwill
Cost of Parent Investment
Less Parent % of the net assets at acquisition (W2)
Goodwill
P2 Corporate Reporting www.mapitaccountancy.com
Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2)
! ! ! ! !
Working 5 - Accumulated Profits
$
Parentʼs Accumulated Profits
Add: Parent % of the subsidiaryʼs post acquisition profits
P2 Corporate Reporting www.mapitaccountancy.com
Statement of Financial Position for Evan Group
Evan Dando Group
Goodwill
Assets 200 350
Investment in Dando
500
Current Assets 200 300
900 650
Ordinary Shares ($1)
200 200
Accumulated Profits
250 100
NCI
Equity 450 300
Non Current Liabilities
280 200
Liabilities 170 150
900 650
Accumulated Profits Double Entry
DR CR
P2 Corporate Reporting www.mapitaccountancy.com
Solution
Working 1- Group Structure
Evan
↓75%
Dando
Date Acquired 1 Year Ago
Parent Share 75%
NCI 25%
100%
Working 2 - Equity Table
At Acquisition At Year End
Share Capital 200 200
Accumulated Profits 40 100
240 300
! ! ! !
Working 3 - Goodwill
Cost of Parent Investment 500
Less Parent % of the net assets at acquisition (W2)
(240 x 75%) -180
Goodwill 320
P2 Corporate Reporting www.mapitaccountancy.com
Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2) (300 x 25%)
75
! ! ! ! !
Working 5 - Accumulated Profits
$
Parentʼs Accumulated Profits 250
Add: Parent % of the subsidiaryʼs post acquisition profits (75% x 60m) 45
295
P2 Corporate Reporting www.mapitaccountancy.com
Statement of Financial Position for Evan Group
Evan Dando Group
Goodwill W3 320
Assets 200 350 200 + 350 550
Investment in Dando
500 Cancelled out in W3.
Nil
Current Assets 200 300 200 + 300 500
900 650 1370
Ordinary Shares ($1)
200 200 Parent Only 200
Accumulated Profits
250 100 W5 295
NCI W4 75
Equity 450 300 570
Non Current Liabilities
280 200 280 + 200 480
Liabilities 170 150 170 + 150 320
900 650 1370
Accumulated Profits Double Entry
DR CR
DR Subsidiary Accumulated Profits at year end 100
CR NCI 100 x 25% 25
CR Parent share of pre acquisition profits (W3) 40 x 75% 30
CR Parent share Post acquisition Profits 60 x 75% 45
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 5
Virtual Insanity
Assets 1000 800
Investment in Insanity 600
Current Assets 400 200
2000 1000
Ordinary Shares ($1) 800 100
Accumulated Profits 750 400
Equity 1550 500
Non Current Liabilities 250 300
Liabilities 200 200
2000 1000
Additional Information
Virtual acquired 60m shares in Insanity one year ago when the reserves of Insanity were $60m.
Required
Prepare the consolidated statement of financial position for the Virtual group
P2 Corporate Reporting www.mapitaccountancy.com
SolutionWorking 1- Group Structure
Virtual
↓60%
Insanity
Date Acquired 1 Year Ago
Parent Share 60%
NCI 40%
100%
! !
Working 2 - Equity Table
At Acquisition At Year End
Share Capital 100 100
Accumulated Profits 60 400
160 500
! ! ! ! ! ! ! !
Working 3 - Goodwill
Cost of Parent Investment 600
Less Parent % of the net assets at acquisition (W2)
160 x 60% -96
Goodwill 504
! ! ! !
P2 Corporate Reporting www.mapitaccountancy.com
Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2) (500 x 40%)
200
! ! ! ! !
Working 5 - Accumulated Profits
$
Parentʼs Accumulated Profits 750
Add: Parent % of the subsidiaryʼs post acquisition profits (60% x (500 - 160)
204
954
P2 Corporate Reporting www.mapitaccountancy.com
Statement of Financial Position for Virtual Group
Virtual Insanity Group
Goodwill W3 504
Assets 1000 800 1000 + 800 1800
Investment in Insanity
600 Cancelled in W3
Nil
Current Assets 400 200 400 + 200 600
2000 1000 2904
Ordinary Shares ($1)
800 100 Parent Only 800
Accumulated Profits
750 400 W5 954
NCI W4 200
Equity 1550 500 1954
Non Current Liabilities
250 300 250 + 300 550
Liabilities 200 200 200 + 200 400
2000 1000 2904
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 6
Jabba has acquired 100% of the shares in Hutt.
The consideration was as follows:
1. Cash of $36,000.2. 2000 Shares in Jabba (the share price is currently $3).3. $30,000 to be paid three years after the date of acquisition. The relevant
discount rate is 10%4. If the group meets certain targets there will be a further payment with fair
value of $60,000 at a later date.
Required:
Calculate the fair value of the consideration which Jabba has given in purchasing the investment in Hutt.
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 6 Solution
$
Cash Amount 36,000
Shares Market Value (2000 x 3) 6,000
Deferred Consideration 30,000 x 0.751 22,530
Contingent Consideration Fair Value 60,000
Total 124,530
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 7
Brad acquires 80% of Angelinaʼs share capital in a share for share exchange. Brad gives Angelina 2 shares for every one in Angelina. Angelina has 100 shares in issue with a nominal value of $1. Bradʼs share price is $5. At the date of acquisition the net assets of Angelina are $600.
Calculate the goodwill arising using the proportionate method and the NCI.
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 7 Solution
Consideration
Brad is purchasing 80% of 100 shares = 80 shares
He is issuing 2 shares for each of the 80 he is purchasing (80 x 2) = 160
Each of the 160 shares is worth $5 so consideration is (160 x 5) = $800
Goodwill
Cost of Parent Investment 800
Less Parent % of the net assets at acquisition (W2)
600 x 80% -480
Goodwill 320
NCI
NCI % of the subsidiaryʼs net assets 600 x 20% 120
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 8
Brad acquires 80% of Angelinaʼs share capital in a share for share exchange. Brad gives Angelina 2 shares for every one in Angelina. Angelina has 100 shares in issue with a nominal value of $1 and a current share price of $8. Bradʼs share price is $5. At the date of acquisition the net assets of Angelina are $600.
Calculate the gross goodwill and the NCI.
P2 Corporate Reporting www.mapitaccountancy.com
Solution
Consideration
Brad is purchasing 80% of 100 shares = 80 shares
He is issuing 2 shares for each of the 80 he is purchasing (80 x 2) = 160
Each of the 160 shares is worth $5 so consideration is (160 x 5) = $800
Goodwill
$
Cost of Parent Investment 800
Less Parent % of the net assets at acquisition (W2)
600 x 80% -480
Goodwill attributable to Parent 320
$
Fair Value of NCI at acquisition (100 x 20%) x $8 160
Less NCI% of the net assets at acquisition (W2)
(20% x 600) -120
Goodwill attributable to NCI 40
$
Goodwill Attributable to Parent 320
Goodwill Attributable to Subsidiary 40
Gross Goodwill 360
P2 Corporate Reporting www.mapitaccountancy.com
Alternative working
Cost of Parentʼs investment 800
Fair value of NCI at acquisition (Market Value) 160
960
Less 100% net assets at acquisition in W2 -600
Gross Goodwill 360
NCI
NCI % of the subsidiaryʼs net assets 600 x 20% 120
Add goodwill attributable to NCI 40
160
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 9 - Do this yourself!
Archie acquires 60% of Mitchellʼs share capital with consideration of $900. Mitchell has 200 shares in issue with a share price is $5. At the date of acquisition the net assets of Mitchell were $800 and are $950 at the year end.
Calculate the gross goodwill and the NCI.
P2 Corporate Reporting www.mapitaccountancy.com
Solution
Goodwill
$
Cost of Parent Investment 900
Less Parent % of the net assets at acquisition (W2)
800 x 60% -480
Goodwill attributable to Parent 420
$
Fair Value of NCI at acquisition (200 x 40%) x $5 400
Less NCI% of the net assets at acquisition (W2)
(40% x 800) -320
Goodwill attributable to NCI 80
$
Goodwill Attributable to Parent 420
Goodwill Attributable to Subsidiary 80
Gross Goodwill at acquisition 500
P2 Corporate Reporting www.mapitaccountancy.com
Alternative working
Cost of Parentʼs investment 900
Fair value of NCI at acquisition (Market Value) 400
1300
Less 100% net assets at acquisition in W2 -800
Gross Goodwill 500
NCI
NCI % of the subsidiaryʼs YEAR END net assets 950 x 40% 380
Add goodwill attributable to NCI 80
460
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 9a - And another one to try!
French acquired 75% of Shambles several years ago.
Cost of Investment Fair Value of NCI at acquisition
Net assets at acquisition
Net assets at year end
$ $ $ $
1,000 300 800 3,000
Calculate the gross goodwill and the NCI.
P2 Corporate Reporting www.mapitaccountancy.com
Solution
Goodwill
$
Cost of Parent Investment 1,000
Less Parent % of the net assets at acquisition (W2)
800 x 75% 600
Goodwill attributable to Parent 400
$
Fair Value of NCI at acquisition 300
Less NCI% of the net assets at acquisition (W2)
(25% x 800) -200
Goodwill attributable to NCI 100
$
Goodwill Attributable to Parent 400
Goodwill Attributable to Subsidiary 100
Gross Goodwill at acquisition 500
P2 Corporate Reporting www.mapitaccountancy.com
Alternative working
Cost of Parentʼs investment 1,000
Fair value of NCI at acquisition (Market Value) 300
1300
Less 100% net assets at acquisition in W2 -800
Gross Goodwill 500
NCI
NCI % of the subsidiaryʼs YEAR END net assets 3000 x 25% 750
Add goodwill attributable to NCI 100
850
or
Fair Value of NCI at acquisition 300
Plus NCI share of post acquisition profits 2200 x 25% 550
850
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 10
Jimmy acquired 80% of Gent 1 year ago. The following information relates to Gent at the date of acquisition.
Accumulated profits at
acquisition
Fair Value adjustment of
plant at acquisition
Cost of investment Fair Value of NCI at acquisition
$ $ $ $
150 100 800 160
The plant subject to the fair value adjustment had a remaining life of 5 yrs at the date of acquisition. Goodwill is to be calculated gross.
Jimmy Gent
Investment in Gent 800
Assets 700 700
1500 700
Ordinary Shares ($1) 700 250
Accumulated Profits 500 350
Equity 1200 600
Liabilities 300 100
1500 700
P2 Corporate Reporting www.mapitaccountancy.com
SolutionWorking 1- Group Structure
Jimmy
↓80%
Gent
Date Acquired 1 Year Ago
Parent Share 80%
NCI 20%
100%
Working 2 - Equity Table
At Acquisition At Year End
Share Capital 250 250
Accumulated Profits 150 350
Fair Value Adjustment 100 100
Additional Depreciation -20
500 680
P2 Corporate Reporting www.mapitaccountancy.com
Working 3 - Goodwill
$
Cost of Parent Investment 800
Less Parent % of the net assets at acquisition (W2)
500 x 80% -400
Goodwill attributable to Parent 400
Fair Value of NCI at acquisition 160
Less NCI% of the net assets at acquisition (W2)
500 x 20% -100
Goodwill attributable to NCI 60
Gross Goodwill on Acquisition 460
Alternative working
Cost of Parentʼs investment 800
Fair value of NCI at acquisition (Market Value) 160
960
Less 100% net assets at acquisition in W2 -500
Gross Goodwill 460
! ! !
P2 Corporate Reporting www.mapitaccountancy.com
Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2) 680 x 20%
136
Add Goodwill attributable to NCI (W3) 60
196
or
Fair Value of NCI at acquisition 300
Plus NCI share of post acquisition profits 2200 x 25% 550
850
! ! !
Working 5 - Group Accumulated Profit
$
Parentʼs Accumulated Profits 500
Add: Parent % of the subsidiaryʼs post acquisition profits 80% x (680 - 500) (W2)
144
644
P2 Corporate Reporting www.mapitaccountancy.com
Statement of Financial Position for Jimmy Group
Jimmy Gent Group
Goodwill W3 460
Investment in Gent
800 Cancelled Nil
Assets 700 700 700 + 700 + 100 - 20
1480
1500 700 1940
Ordinary Shares ($1)
700 250 Parent only 700
Accumulated Profits
500 350 W5 644
NCI W4 196
Equity 1200 600 1540
Liabilities 300 100 300 + 100 400
1500 700 1940
Double EntryItem DR CR
DR Plant 100
CR Pre Acquisition Reserves 100
This increases the value of the asset by the fair value adjustment and also increases reservesThis increases the value of the asset by the fair value adjustment and also increases reservesThis increases the value of the asset by the fair value adjustment and also increases reservesThis increases the value of the asset by the fair value adjustment and also increases reserves
Item DR CR
DR Post Acquisition Reserves 20
CR Plant 20
This entry adjusts post acquisition reserves for additional depʼn and decreases the value of plantThis entry adjusts post acquisition reserves for additional depʼn and decreases the value of plantThis entry adjusts post acquisition reserves for additional depʼn and decreases the value of plantThis entry adjusts post acquisition reserves for additional depʼn and decreases the value of plant
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 11
Devil acquired 90% of Detail 2 years ago. The following information relates to Gent at the date of acquisition.
Accumulated profits at acquisition
Fair Value adjustment of plant at acquisition
Cost of investment
$ $ $
250 100 1000
The plant subject to the fair value adjustment had a remaining life of 4 yrs at the date of acquisition. Goodwill is to be calculated using the proportionate method.
Devil Detail
Investment in Detail 1000
Assets 600 800
1600 800
Ordinary Shares ($1) 650 100
Accumulated Profits 250 500
Equity 900 600
Liabilities 700 200
1500 700
P2 Corporate Reporting www.mapitaccountancy.com
SolutionWorking 1- Group Structure
Devil
↓90%
Detail
Date Acquired 2 Years Ago
Parent Share 90%
NCI 10%
100%
Working 2 - Net Assets Subsidiary
At Acquisition At Year End
Share Capital 100 100
Accumulated Profits 250 500
Fair Value Adjustment 100 100
Additional Depreciation (2yrs) -50
450 650
P2 Corporate Reporting www.mapitaccountancy.com
Working 3 - Goodwill
$
Cost of Parent Investment 1000
Less Parent % of the net assets at acquisition (W2) 450 x 90% -405
Goodwill 595
! ! !
Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2) 650 x 10% 65
! ! Working 5 - Group Accumulated Profit
$
Parentʼs Accumulated Profits 250
Add: Parent % of the subsidiaryʼs post acquisition profits 90% x (650 - 450) (W2)
180
430
P2 Corporate Reporting www.mapitaccountancy.com
Statement of Financial Position for Devil Group
Devil Detail
Goodwill 1000 W3 595
Assets 600 800 600 + 800 + 100 - 50
14502045
1600 800 2070
Ordinary Shares ($1)
650 100 Parent 650
Accumulated Profits
250 500 W5 430
NCI W4 65
Equity 900 600 1145
Liabilities 700 200 700 + 200 900
1500 700 2045
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 12
Pinky acquired 80% of Brain 4 years ago. The following information is relevant:
Net Assets at year end
Net Assets at acquisition
Cost of investment
Fair Value of NCI at
acquisition
Recoverable amount at year end
$ $ $ $ $
150 100 175 25 230
Goodwill is calculated gross and is subject to an annual impairment review.
Pinky Brain
Investment in Pinky 175
Assets 100 100
Inventory 140 200
Receivables 160 100
Bank 125 200
700 600
Ordinary Shares ($1) 160 50
Accumulated Profits 240 100
Equity 400 150
Non current liabilities 100 250
Liabilities 300 100
700 600
P2 Corporate Reporting www.mapitaccountancy.com
Solution
Working 1- Group Structure
Pinky
↓80%
Brain
Date Acquired 4 Years Ago
Parent Share 80%
NCI 20%
100%
Working 2 - Net Assets Subsidiary
At Acquisition At Year End
Share Capital 50 50
Accumulated Profits 50 100
100 150
! ! ! !
P2 Corporate Reporting www.mapitaccountancy.com
Working 3 - Goodwill
$
Cost of Parent Investment 175
Less Parent % of the net assets at acquisition (W2)
100 x 80% -80
Goodwill attributable to Parent 95
Fair Value of NCI at acquisition 25
Less NCI% of the net assets at acquisition (W2)
100 x 20% -20
Goodwill attributable to NCI 5
Gross Goodwill on Acquisition 100
Alternative working
Cost of Parentʼs investment 175
Fair value of NCI at acquisition (Market Value) 25
200
Less 100% net assets at acquisition in W2 -100
Gross Goodwill 100
P2 Corporate Reporting www.mapitaccountancy.com
Impairment
Impairment ReviewImpairment ReviewImpairment Review
Carrying Value of asset Net Assets + Goodwill (150 + 100) 250
Less Recoverable amount -230
Impairment Loss 20
! ! !Goodwill after impairmentGoodwill after impairment
Gross Goodwill 100
Impairment Loss -20
Goodwill after impairment 80
! ! ! ! !
Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2) 150 x 20% 30
Add Goodwill attributable to NCI (W3) 5
Less Impairment of goodwill 20 x 20% -4
31
or
Fair Value of NCI at acquisition 25
Plus NCI share of post acquisition profits 50 x 20% 10
Less Goodwill Impairment 20 x 20% -4
31
! ! !
P2 Corporate Reporting www.mapitaccountancy.com
Working 5 - Group Accumulated Profit
$
Parentʼs Accumulated Profits 240
Less Goodwill Impairment 20 x 80% -16
Add: Parent % of the subsidiaryʼs post acquisition profits 80% x (100 - 150) (W2)
40
264
Statement of Financial Position for Pinky Group
Pinky Brain Group
Goodwill W3 80
Assets 100 100 100 + 100 200
Inventory 140 200 140 + 200 340
Receivables 160 100 160 + 100 260
Bank 125 200 125 + 200 325
700 600 1205
Ordinary Shares ($1)
160 50 Parent Only 160
Accumulated Profits
240 100 W5 264
NCI W4 31
Equity 400 150 455
Non current liabilities
100 250 100 + 250 350
Liabilities 300 100 300 + 100 400
700 600 1205
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 13
George owns 80% of the subsidiary Bungle. During the impairment review it was found that the carrying value of Bungleʼs net assets were $250 and the goodwill $300. The recoverable amount of the subsidiary is $500 and goodwill is calculated on a proportionate basis.
What amount of goodwill will appear on the group SFP?
P2 Corporate Reporting www.mapitaccountancy.com
Solution
Gross up proportionate goodwillGross up proportionate goodwill
Proportionate Goodwill 300
Gross this up (300 x 100/80) 375
We will use this grossed up value for goodwill in the impairment review.We will use this grossed up value for goodwill in the impairment review.
Impairment ReviewImpairment Review
Carrying Value of asset 250
Grossed up Goodwill 375
Less Recoverable amount -500
Impairment Loss 125
Goodwill on Balance SheetGoodwill on Balance Sheet
Proportionate goodwill 300
Share of Impairment (125 x 80%) -100
Goodwill after impairment 200
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 14A Parent company has recorded an asset of $300 goods receivable with a subsidiary.
The subsidiary had recorded this as an initial liability payable of $300 but has just recorded and sent a cheque payment to the parent of $50 leaving the payable balance of $250.
How should this be adjusted for on consolidation?
P2 Corporate Reporting www.mapitaccountancy.com
SolutionWhen cross casting assets & liabilities:
Less Payables $250 (DR)
Plus Cash at bank $50 (DR)
Less Receivables $300 (CR)
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 15Parent has been selling goods to subsidiary. The parent has recorded an asset of $500 receivable from the subsidiary.
The $500 includes goods worth $100 sent prior to the year end to the subsidiary who has not received them. As a result the subsidiary has a balance of $400 recorded as a liability in payables.
How should this be treated on consolidation?
P2 Corporate Reporting www.mapitaccountancy.com
SolutionWhen cross casting assets & liabilities:
Less Payables $400 (DR)
Plus Inventory $100 (DR)
Less Receivables $500 (CR)
P2 Corporate Reporting www.mapitaccountancy.com
Illustration 16Arctic is the parent of a subsidiary Monkeys. Extracts of their SFPs are below
Arctic Monkeys
Current Assets
Inventory 300 100
Receivables 200 250
Bank 100 50
600 400
Current Liabilities 420 220
The trade payables of Monkeys includes $35m due to Arctic. This was after the deduction of $10m in respect of cash sent by Monkeys but not yet received by Arctic.
The receivables of Arctic at the year end include $70m due from Monkeys. $25m of these goods had been dispatched by Arctic, but were not yet received by Monkeys.
Show the treatment on consolidation.
P2 Corporate Reporting www.mapitaccountancy.com
SolutionRemember!
Add the goods/cash in transit
Subtract the inter company current accounts
+/- Item Where? $m
+ Cash in transit Cash at Bank 10
+ Goods in transit Inventory 25
- Inter Company Current Account Payables 35
- inter Company Current Account Receivables 70
Arctic Monkeys Group
Current Assets
Inventory 300 100 300 + 100 + Goods in transit of 25
425
Receivables 200 250 200 + 250 - 70 inter company current account
380
Bank 100 50 100 + 50 + cash in transit 10
160
600 400 965
Current Liabilities 420 220 420 + 220 - inter company current account 35
605
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Illustration 17Sea is the parent of a subsidiary Lion. Extracts of their SFPs are below
Sea Lion
Current Assets
Inventory 400 250
Receivables 100 100
Bank 150 100
650 450
Current Liabilities 90 140
The trade payables of Lion includes $20m due to Arctic. This was after the deduction of $15m in respect of cash sent by Lion but not yet received by Sea.
The receivables of Sea at the year end include $50m due from Lion. $15m of these goods had been dispatched by Sea, but were not yet received by Lion.
Show the treatment on consolidation.
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SolutionRemember!
Add the goods/cash in transit
Subtract the inter company current accounts
+/- Item Where? $m
+ Cash in transit Cash at Bank 15
+ Goods in transit Inventory 15
- Inter Company Current Account Payables 20
- inter Company Current Account Receivables 50
Sea Lion Group
Current Assets
Inventory 400 250 400 + 250 + Goods in transit of 15
665
Receivables 100 100 100 + 100 - 50 inter company current account
150
Bank 150 100 150 + 100 + cash in transit 15
265
650 450 965
Current Liabilities 90 140 90 + 140 - inter company current account 20
210
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Illustration 18Inter company sales of $400 have occurred in Attila group at a mark up on cost of 25%. At the year end 1/4 of these goods had been sold on. Attila has an 80% interest in Hun.
I. Calculate the PURP.
II. Show the accounting treatment if the parent company is the seller.
III. Show the accounting treatment if the subsidiary company is the seller.
IV. Do parts I - III if the goods had been sold at a margin of 30%.
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Solution (Mark-up)
Unsold Inventory Mark-up PURP
(400 x 3/4) = 300 25/125 60
Parent is seller
DR/CR Account $ $
DR Accumulated Profits (W5) to decrease 60
CR Inventory to decrease 60
Subsidiary is seller
DR/CR Account $ $
DR Accumulated Profits (W5) with parent share to decrease (60 x 80%)
48
DR NCI (W4) with subsidiary share to decrease 12
CR Inventory to decrease 60
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Solution (Margin)
Unsold Inventory Margin PURP
(400 x 3/4) = 300 30% 90
Parent is seller
DR/CR Account $ $
DR Accumulated Profits (W5) to decrease 90
CR Inventory to decrease 90
Subsidiary is seller
DR/CR Account $ $
DR Accumulated Profits (W5) with parent share to decrease (90 x 80%)
72
DR NCI (W4) with subsidiary share to decrease 18
CR Inventory to decrease 90
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Illustration 19Argentina owns an 80% share of Messi which it purchased one year ago.
The information below relates to Messi at the date of acquisition.
Ordinary Share Capital
Reserves Fair Value of the net assets
Fair value of the NCI
Cost of the investment
$m $m $m $m $m
200 400 800 200 1900
The income statements for both are:
Argentina Messi
Revenue 8000 3000
Cost of Sales -4000 -1000
Gross Profit 4000 2000
Operating Costs -1500 -1500
Finance Costs -1000 -200
Profit Before Tax 1500 300
Tax -700 -100
Profit for the year 800 200
Other information
I. Argentina sold goods to Messi during the year at a margin of 40% and worth $100m. Half of these goods have been sold on by Messi by the year end.
II. The fair value of Messiʼs net assets were equal to their book value at the date of acquisition, with the exception of some machinery which had a useful life of 5 years.
III. Calculate goodwill using the fair value of the NCI at the date of acquisition. At the year end an impairment review has found that the goodwill has been impaired by 10%.
Produce a consolidated Income Statement for the Argentina group.
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Illustration 19 SolutionWorking 1- Group Structure
Argentina
↓80%
Messi
Date Acquired 1 Year Ago (No time apportionment)
Parent Share 80%
NCI 20%
100%
Working 2 - Inter Company
PURP
Unsold Inventory Margin PURP
(100 x 1/2) = 50 40% 20
As the Parent is seller
DR/CR Account $ $
DR Cost of sales to increase 20
CR Inventory to decrease 20
Remember to remove the total amount of the sales also from sales and cost of sales
DR/CR Account $ $
DR Revenue to decrease 100
CR Cost of sales to decrease 100
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Working 3 - Goodwill
We donʼt need the net assets at the year end, but we do need them at acquisition to calculate goodwill. Be careful - we are given the total and told that the difference is machinery - this will lead to an additional depreciation expense.
At Acquisition At Year End
Share Capital 200 N/A
Accumulated Profits 400 N/A
Fair Value Adjustment (Balancing figure)
200 N/A
800 N/A
The $200m asset has a useful life of 5 years so the extra depreciation will be $200m x 1/5 = $40m. The treatment for this is:
DR/CR Account $ $
DR Cost of sales to increase 40
CR Non current assets to decrease 40
We can then use this to calculate the goodwill on acquisition
$
Cost of Parent Investment 1900
Less Parent % of the net assets at acquisition
800 x 80% 640
Goodwill attributable to Parent 1260
Fair Value of NCI at acquisition 200
Less NCI% of the net assets at acquisition
800 x 20% 160
Goodwill attributable to NCI 40
Gross Goodwill on Acquisition 1300
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Alternative working
Cost of Parentʼs investment 1900
Fair value of NCI at acquisition (Market Value) 200
2100
Less 100% net assets at acquisition in W2 -800
Gross Goodwill 1300
Goodwill impairmentGoodwill impairment
Gross Goodwill 1300
Impairment Loss (1300 x 10%) 130
! ! ! ! !The treatment for this is:
DR/CR Account $ $
DR Cost of sales to increase 130
CR Goodwill Intangible Asset to decrease 130
Working 4 - Cost of Sales
$m
Parent 4000
Subsidiary 1000
Less Inter Company Sales -100
Plus the PURP 20
Plus additional depreciation 40
Plus impairment loss 130
5090
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Working 5 - NCI
$
NCI % of the subsidiaryʼs profits in question 200 x 20% 40
Less NCI share of additional depreciation 40 x 20% -8
Less NCI share of Impairment of goodwill 130 x 20% -26
6
Income statement for Argentina Group
Argentina Messi Group
Revenue 8000 3000 8000 + 3000 - 100 inter company sales
10900
Cost of Sales -4000 -1000 W4 -5090
Gross Profit 4000 2000 5810
Operating Costs -1500 -1500 1500 + 1500 -3000
Finance Costs -1000 -200 1000 + 200 -1200
Profit Before Tax 1500 300 1610
Tax -700 -100 700 + 100 -800
Profit for the year 800 200 810
Attributable to Parent (Balancing Figure)Attributable to Parent (Balancing Figure)Attributable to Parent (Balancing Figure)Attributable to Parent (Balancing Figure) 804
Attributable to NCI (W5)Attributable to NCI (W5)Attributable to NCI (W5)Attributable to NCI (W5) 6
810
! ! !
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Statement of Changes in Equity Pro-forma
Share Capital
Share Premium
Revaluation Reserve
Accumulated Profits
NCI Total
OʼBalance X X X X X X
Share Issues X X X
Revaluation Gains
X X X
Profit for period
X X X
Less Dividends
(X) (X) (X)
ClʼBalance X X X X X X
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Illustration 20Nadal is a 90% subsidiary of Federer. It was acquired one year ago for $4000m. At that time the accumulated profits were $800m.
Income StatementsFederer Nadal
Revenue 20000 4000
Cost of Sales -12000 -2000
Gross Profit 8000 2000
Distribution Costs -2100 -300
Admin Expenses -1400 -500
Operating Profit 1500 1200
Exceptional Gain Nil 580
Investment Income 90 Nil
Finance Costs -600 -150
Profit Before Tax 3990 1630
Tax -700 -130
Profit for the year 3290 1500
Statements of Financial PositionFederer Nadal
Investment in Nadal 4000
Assets 20000 5000
24000 5000
Share Capital 5000 1000
Accumulated Profits 15690 2200
Equity 20690 3200
Liabilities 3310 1800
24000 5000
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Federer Statement of changes in EquityShare Capital Accumulated
ProfitsTotal Equity
Opening Balance 5000 12600 17600
Profits for the year 3290 3290
Less Dividends -200 -200
Closing Balance 5000 15690 20690
Nadal Statement of changes in EquityShare Capital Accumulated
ProfitsTotal Equity
Opening Balance 1000 800 1800
Profits for the year 1500 1500
Less Dividends -100 -100
Closing Balance 1000 2200 3200
Other Information:
In the year Federer sold goods to Nadal at a margin of 20%. The total amount sold was $100m, of which a quarter remain in inventory at the year end.
Also during the year Nadal sold $180m of goods to Federer. These goods were sold at a mark up of 50%. Half of the goods remain in inventory at the year end.
At the date of acquisition the fair values of Nadalʼs net assets were equal to their book value with the exception of an item of plant that had a fair value of $200m in excess of its carrying value and a remaining useful life of 4 years. Goodwill is to be calculated on a proportionate basis.
Federer paid a dividend during the year of $200m while Nadal paid a dividend of $100m. Federer has recognised the dividend received from Nadal as investment income.
Required
Prepare the consolidated Income Statement, consolidated Statement of Changes in Equity and the consolidated Statement of Financial Position for the Federer group.
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SolutionWorking 1- Group Structure & PURP
Federer
↓90%
Nadal
Date Acquired 1 Year Ago
Parent Share 90%
NCI 10%
100%
! ! ! ! ! ! ! ! ! !PURP
Unsold Inventory Margin PURP
(100 x 1/4) = 25 20% 5
Parent is seller
DR/CR Account $ $
DR Accumulated Profits (W5) to decrease 5
CR Inventory to decrease 5
Unsold Inventory Margin PURP
(180 x 1/2) = 90 50/150 30
Subsidiary is seller
DR/CR Account $ $
DR Accumulated Profits (W5) with parent share to decrease (30 x 90%)
27
DR NCI (W4) with subsidiary share to decrease 3
CR Inventory to decrease 30
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Working 2 - Equity TableAt Acquisition At Year End
Share Capital 1000 1000
Accumulated Profits 800 2200
Fair Value Adjustment 200 200
Additional Depʼn (200 x 1/4) -50
2000 3350
Remember to take the $50m extra depʼn to the income statement! ! ! ! !
Working 3 - Goodwill$
Cost of Parent Investment 4000
Less Parent % of the net assets at acquisition (W2)
2000 x 90% -1800
Goodwill 2200
! ! ! ! !Working 4 - NCI
SFP$
NCI % of the subsidiaryʼs net assets at the year end (W2) 3350 x 10% 335
PURP W1 -3
332
Income Statement$
NCI Percentage of profit from question 1500 x 10% 150
Additional Depreciation 50 x 10% -5
PURP W1 -3
142
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! ! !
Working 5 - Group Accumulated Profit$
Parentʼs Accumulated Profits 15690
PURP 5 + 27 -32
Add: Parent % of the subsidiaryʼs post acquisition profits 90% x (2000 - 3350) (W2)
1215
16873
Income Statement
Federer Nadal Group
Revenue 20000 4000 20000 + 4000 - 100 - 180
23720
Cost of Sales -12000 -2000 12000 + 2000 - 100 - 180 - 35 - 50
-13805
Gross Profit 8000 2000 9915
Distribution Costs -2100 -300 2100 + 300 -2400
Admin Expenses -1400 -500 1400 + 500 -1900
Operating Profit 1500 1200 5615
Exceptional Gain Nil 580 580
Investment Income 90 Nil Nil
Finance Costs -600 -150 600 + 150 -750
Profit Before Tax 3990 1630 5445
Tax -700 -130 700 + 130 -830
Profit for the year 3290 1500 4615
Attributable to Parent (Balancing Figure) 4473
Attributable to NCI W4 142
4615
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Statement of Financial Position
Federer Nadal Group
Goodwill W3 2200
Investment in Nadal 4000 Cancelled Nil
Assets 20000 5000 20000 + 5000 + 200 - 50 -35
25115
24000 5000 27315
Share Capital 5000 1000 Parent Only 5000
Accumulated Profits 15690 2200 W5 16873
NCI W4 332
Equity 20690 3200 22205
Liabilities 3310 1800 3310 + 1800 5110
24000 5000 27315
Statement of changes in Equity
Share Capital Accumulated Profits
NCI Total Equity
Opening Balance
5000 12600 200 17800
Profits for the year
4473 142 4615
Less Dividends -200 -10 210
Closing Balance
5000 16873 332 22205
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Illustration 21 (December 2010 Q3 (b))
Greenie was one of three shareholders in a regional airport Manair. As at 30 November 2010, the majority shareholder held 60·1% of voting shares, the second shareholder held 20% of voting shares and Greenie held 19·9% of the voting shares. The board of directors consisted of ten members. The majority shareholder was represented by six of the board members, while Greenie and the other shareholder were represented by two members each. A shareholders’ agreement stated that certain board and shareholder resolutions required either unanimous or majority decision. There is no indication that the majority shareholder and the other shareholders act together in a common way. During the financial year, Greenie had provided Manair with maintenance and technical services and had sold the entity a software licence for $5 million. Additionally, Greenie had sent a team of management experts to give business advice to the board of Manair. Greenie did not account for its investment in Manair as an associate, because of a lack of significant influence over the entity. Greenie felt that the majority owner of Manair used its influence as the parent to control and govern its subsidiary. (10 marks)
Discuss how the above be accounted for in the financial statements of Greenie.
In order for Greenie to treat Manair as an Associate it will have to have ‘significant influence’ over them, otherwise they will treat Manair as a simple investment.
IAS 28 states that significant influence is the power to participate in the financial and operating decisions of the investee but is not control or joint control over the policies. This will be demonstrated by holding 20% of the voting rights. If they don’t hold 20% as in this case then it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated.
This can be demonstrated by:
(i) representation on the board of directors or equivalent governing body of the investee;(ii) participation in the policy-making process; (iii) material transactions between the investor and the investee;(iv) interchange of managerial personnel; or(v) provision of essential technical information.
In this case it appears likely that the shareholders agreement enables Greenie to participate in policy decisions.
There is also management representation by Greenie on the board of directors which will enable Greenie to influence decisions.
In addition there is evidence of material transactions between the investor and the investee and technical and maintenance services provided by Greenie.
All the evidence suggests that Greenie has significant influence and should be treated as an Associate. The transactions between the two companies are therefore related party transactions and should be disclosed under IAS 24.
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Illustration 21 (December 2010 Q3 (b))
Greenie was one of three shareholders in a regional airport Manair. As at 30 November 2010, the majority shareholder held 60·1% of voting shares, the second shareholder held 20% of voting shares and Greenie held 19·9% of the voting shares. The board of directors consisted of ten members. The majority shareholder was represented by six of the board members, while Greenie and the other shareholder were represented by two members each. A shareholders’ agreement stated that certain board and shareholder resolutions required either unanimous or majority decision. There is no indication that the majority shareholder and the other shareholders act together in a common way. During the financial year, Greenie had provided Manair with maintenance and technical services and had sold the entity a software licence for $5 million. Additionally, Greenie had sent a team of management experts to give business advice to the board of Manair. Greenie did not account for its investment in Manair as an associate, because of a lack of significant influence over the entity. Greenie felt that the majority owner of Manair used its influence as the parent to control and govern its subsidiary. (10 marks)
Discuss how the above be accounted for in the financial statements of Greenie.
In order for Greenie to treat Manair as an Associate it will have to have ‘significant influence’ over them, otherwise they will treat Manair as a simple investment.
IAS 28 states that significant influence is the power to participate in the financial and operating decisions of the investee but is not control or joint control over the policies. This will be demonstrated by holding 20% of the voting rights. If they don’t hold 20% as in this case then it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated.
This can be demonstrated by:
(i) representation on the board of directors or equivalent governing body of the investee;(ii) participation in the policy-making process; (iii) material transactions between the investor and the investee;(iv) interchange of managerial personnel; or(v) provision of essential technical information.
In this case it appears likely that the shareholders agreement enables Greenie to participate in policy decisions.
There is also management representation by Greenie on the board of directors which will enable Greenie to influence decisions.
In addition there is evidence of material transactions between the investor and the investee and technical and maintenance services provided by Greenie.
All the evidence suggests that Greenie has significant influence and should be treated as an Associate. The transactions between the two companies are therefore related party transactions and should be disclosed under IAS 24.
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Illustration 22
On 1 April 2009 Picant acquired 75% of Sander’s equity shares in a share exchange of three shares in Picant for every two shares in Sander. The market prices of Picant’s and Sander’s shares at the date of acquisition were $3·20 and $4·50 respectively.
In addition to this Picant agreed to pay a further amount on 1 April 2010 that was contingent upon the post-acquisition performance of Sander. At the date of acquisition Picant assessed the fair value of this contingent consideration at $4·2 million, but by 31 March 2010 it was clear that the actual amount to be paid would be only $2·7 million (ignore discounting). Picant has recorded the share exchange and provided for the initial estimate of $4·2 million for the contingent consideration.
On 1 October 2009 Picant also acquired 40% of the equity shares of Adler paying $4 in cash per acquired share and issuing at par one $100 7% loan note for every 50 shares acquired in Adler. This consideration has also been recorded by Picant.
Picant has no other investments. The summarised statements of financial position of the three companies at 31 March 2010 are:
Picant Sander Alder
Property, plant & equipment 37,500 24,500 21,000
Investments 45,000
82,500 24,500 21,000
Inventory 10,000 9,000 5,000
Receivables 6,500 1,500 3,000
Total Assets 99,000 35,000 29,000
Ordinary Shares 25,000 8,000 5,000
Share Premium 19,800 0 0
Ret. Earnings B/F 16,200 16,500 15,000
For year to 31/3/10 11,000 1,000 6,000
72,000 25,500 26,000
7% Loan Notes 14,500 2,000 0
Contingent Consideration 4,200 0 0
Current Liabilities 8,300 7,500 3,000
Total Equity & Liabilities 99,000 35,000 29,000
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(i) At the date of acquisition the fair values of Sander’s property, plant and equipment was equal to its carrying amount with the exception of Sander’s factory which had a fair value of $2 million above its carrying amount. Sander has not adjusted the carrying amount of the factory as a result of the fair value exercise. This requires additional annual depreciation of $100,000 in the consolidated financial statements in the post-acquisition period.
(ii)Also at the date of acquisition, Sander had an intangible asset of $500,000 for software in its statement of financial position. Picant’s directors believed the software to have no recoverable value at the date of acquisition and Sander wrote it off shortly after its acquisition.
(iii)At 31 March 2010 Picant’s current account with Sander was $3·4 million (debit). This did not agree with the equivalent balance in Sander’s books due to some goods-in-transit invoiced at $1·8 million that were sent by Picant on 28 March 2010, but had not been received by Sander until after the year end. Picant sold all these goods at cost plus 50%.
(iv)Picant’s policy is to value the non-controlling interest at fair value at the date of acquisition. For this purpose Sander’s share price at that date can be deemed to be representative of the fair value of the shares held by the non-controlling interest.
(v)Impairment tests were carried out on 31 March 2010 which concluded that the value of the investment in Adler was not impaired but, due to poor trading performance, consolidated goodwill was impaired by $3·8 million.
(vi)Assume all profits accrue evenly through the year.
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Working 1- Group Structure
Picant
↓75% ↓40%
Sander Alder
Sander
Date Acquired 1 April 2009 (1 Yr ago)
Parent Share 75
NCI 25
100
Consideration for Sander
Item $ʻ000
Share Exchange No. Shares Purchased (8000 x 75%) = 6000
Picant Shares Issued ((6000 / 2) x 3) = 9000
Total Value (9000 x 3.20) = $28,800 28,800
Contingent Consideration Fair Value 4,200
Total ConsiderationTotal Consideration 33,000
Consideration for Alder
Item $ʻ000
Cash Fair Value (4 x (5000 x 40%)) 8,000
Loan Notes (5000 x 40%) / 50 x 100 4,000
Total ConsiderationTotal Consideration 12,000
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Working 2 - Net Assets Subsidiary
At Acquisition At Year End
Share Capital 8,000 8,000
Accumulated Profits 16,500 17,500
Fair Value of Factory 2,000 2,000
Additional Depʼn -100
Software -500
26,000 27,400
Working 3 - Goodwill in Sander
$ʻ000 $ʻ000
Cost of Parent Investment 33,000
Less Parent % of the net assets at acquisition (W2)
26,000 x 75% 19,500
Goodwill attributable to Parent 13,500
Fair Value of NCI at acquisition (8,000 x 25%) x $4.5
9,000
Less NCI% of the net assets at acquisition (W2)
26,000 x 25% 6,500
Goodwill attributable to NCI 2,500
Gross Goodwill on Acquisition 16,000
Impairment -3,800
Goodwill at year endGoodwill at year endGoodwill at year end 12,200
Impairment to Parent in W5 (3,800 x 75%) Impairment to Parent in W5 (3,800 x 75%) Impairment to Parent in W5 (3,800 x 75%) 2,850
Impairment to NCI in W4 (3,800 x 25%) Impairment to NCI in W4 (3,800 x 25%) Impairment to NCI in W4 (3,800 x 25%) 950
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Working 4 - NCI
$
NCI % of net assets at the year end (W2) 27,400 x 25% 6,850
Goodwill Attributable to NCI (W3) 2,500
Goodwill Impairment to NCI (W3) -950
8,400
Working 5 - PURP & Group Accumulated Profit
PURP
Total Unsold Goods Profit on Goods PURP
1,800 1,800 /150 x 50 600
DR Retained Earnings (W5)DR Retained Earnings (W5) 600
CR Inventory (SFP)CR Inventory (SFP) 600
Group Accumulated Profit
$
Parentʼs Accumulated Profits 27,200
Add: Parent % of Subʼs post acquisition profits (W2) (27,400 - 26,000) x 75%
1050
Add: Parent % of Associate post acquisition profits (6,000 x 6/12) x 40% 1,200
PURP -600
Parent Share of goodwill impairment W3 -2850
Gain on contingent consideration 4,200 - 2,700 1,500
27,500
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Working 6 - Associate
$ʻ000
Cost of Parentʼs Investment (W1) 12,000
Post Acquisition Profits ((6000 x 6/12) x 40%) 1,200
13,200
SFPPicant Sander Group
Goodwill W3 12,200
Property, plant & equipment
37,500 24,500 37,500 + 24,500 + 2,000 - 100
63,900
Associate Investment W6 13,200
Investments 45,000 0
82,500 24,500 89,300
Inventory 10,000 9,000 10,000 + 9,000 - 600 +1,800
20,200
Receivables 6,500 1,500 6,500 + 1,500 - 3,400 4,600
Total Assets 99,000 35,000 114,100
Ordinary Shares 25,000 8,000 Parent Only 25,000
Share Premium 19,800 0 19,800
Ret. Earnings B/F 16,200 16,500
For year to 31/3/10 11,000 1,000 W5 27,500
NCI W4 8,400
72,000 25,500 80,700
7% Loan Notes 14,500 2,000 14,500 + 2,000 16,500
Contingent Consideration
4,200 0 4,200 - 1,500 2,700
Current Liabilities 8,300 7,500 8,300 + 7,500 - 1,600 14,200
Total Equity & Liabilities 99,000 35,000 114,100
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Illustration 23Vic purchased 10% of the shares in Bob several years ago. The investment cost $17,000 and Vic currently carries the investment at cost in the accounts. Vic has subsequently purchased 45% of the shares in Bob for $120,000. The net assets of Bob have a fair value of $60,000 and the fair value of the original investment is $45,000. The fair value of the NCI is $90,000.
Calculate the gross goodwill arising on the acquisition of Bob.
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Solution 23
Working 1- Group Structure
Vic
↓10% ↓45%
Bob
Date 20% Acquired 2 Years Ago
Date 45% Acquired Now
Parent Share 55%
NCI 45%
100%
Working 2 - Revaluation
Fair value of original investment 45,000
Less the cost of the original investment -17,000
Gain taken to income statement 28,000
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Working 3 - Goodwill$
Fair Value of original investment 45,000
Fair value consideration for second investment
120,000
165,000
Less Parent % of the net assets at acquisition
60000 x 55%
-33,000
Goodwill attributable to Parent 132,000
Fair Value of NCI at acquisition 90,000
Less NCI% of the net assets at acquisition 60000 x 45%
-27,000
Goodwill attributable to NCI 63,000
Gross Goodwill on Acquisition 195,000
Alternative working
Fair value of original investment 45,000
Fair value of consideration for second investment 120,000
165,000
Fair value of NCI at acquisition 90,000
Less 100% net assets at acquisition -60,000
Gross Goodwill 195,000
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Illustration 24A parent has owned 90% of a subsidiary for a long period of time. The NCI in the subsidiary is currently measured at $300,000.
I. The parent acquires all of the remaining shares for consideration of $250,000.
II. The parent acquires 3% of the shares for $200,000 reducing the NCI to 7%.
What is the difference taken to equity in both situations?
Solution
I.
$
Amount of cash paid for subsequent investment 250,000
Decrease in the NCI 300,000
Difference to an equity reserve 50,000
II.
$
Amount of cash paid for subsequent investment 200,000
Decrease in the NCI 300,000 x 3/10 90,000
Difference to an equity reserve -110,000
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Illustration 25Inter purchased 70% of the shares in Milan several years ago. At that time goodwill of $80,000 arose. The net assets of Milan are currently $100,000 and the NCI is $18,000.
I. Calculate the gain arising on disposal if Inter sells itʼs entire holding for $350,000.
II. Calculate the gain arising on disposal if Inter sells 30% for $250,000 and the fair value of the residual value is $30,000
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Solution 25I.
$
Sale Proceeds 350,000
Less net assets of sub at date of disposal -100,000
Less all goodwill remaining at disposal -80,000
Plus all NCI at date of disposal 18,000
Plus fair value of any residual holding Nil
Gain to group 188,000
II.
$
Sale Proceeds 250,000
Less net assets of sub at date of disposal -100,000
Less all goodwill remaining at disposal -80,000
Plus all NCI at date of disposal 18,000
Plus fair value of any residual holding 30,000
Gain to group 118,000
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Illustration 26For several years Jeremy has owned 70% of Richard. The net assets of Richard at this time are $250,000. The NCI is $68,000 and the gross goodwill is $200,000.
Jeremy has just sold 15% to take the holding to 55% for consideration of $150,000. Calculate the difference arising that will be taken to equity.
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Solution 26
$
Amount of cash received for sale of subsequent investment 150,000
Increase in the NCI (% of net assets & goodwill) 15% x (250,000 + 200,000)
67,500
Difference to an equity reserve 82,500
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Illustration 27a
P
↓80% - 1 Year Ago
S
↓60% - 1 Year Ago
S1
Cost of Investment
Net Assets 1 Year Ago
FV NCI
S 250 200 60
S1 220 150 100
Calculate the Goodwill & the NCI at the acquisition date.
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Working 1 - Effective Interest
Working Total
Pʼs Direct Interest in S 80%
Non Controlling Interest in S 20%
100%
Pʼs direct interest in S1 0%
Pʼs indirect interest in S1 (80% x 60%) 48%
Pʼs effective interest in S1 48%
Non Controlling Interest in S1 (Balancing figure) 52%
100%
Working 2 - Goodwill in S
$
Cost of Parent Investment 250
Less Parent % of the net assets at acquisition
200 x 80% -160
Goodwill attributable to Parent 90
Fair Value of NCI at acquisition 60
Less NCI% of the net assets at acquisition 200 x 20% -40
Goodwill attributable to NCI 20
Gross Goodwill on Acquisition 110
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Working 3 - Goodwill in S1
$
Cost of Investment 220
Less indirect holding adjustment 220 x 20% -44
Less Parent % of the net assets at acquisition 150 x 48% -72
Goodwill attributable to Parent 104
Fair Value of NCI at acquisition 100
Less NCI% of the net assets at acquisition 150 x 52% -78
Goodwill attributable to NCI 22
Gross Goodwill on Acquisition 126
Working 4 - NCI
$
NCI % of Sʼs net assets 200 x 20% 40
NCI % of S1ʼs net assets 150 x 52% 78
Less indirect holding adjustment -44
Add Sʼs goodwill attributable to NCI 20
Add S1ʼs goodwill attributable to NCI 22
116
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Illustration 28Ozzy acquired a 70% holding in Sharon 2 years ago. Sharon purchased a 60% shareholding in Jack one year ago. The following financial statements relate to the Ozzy group.
Statements of Financial Position Ozzy Sharon Jack
$ $ $
Investment in Sharon 50
Investment in Jack 17
Other assets 25 18 20
75 35 20
Ordinary Shares 50 20 8
Accumulated profits 20 12 8
Equity 70 32 16
Liabilities 5 3 4
75 35 20
Income Statements Ozzy Sharon Jack
$ $ $
Revenue 400 60 85
Operating Costs -395 55 -83
Operating Profit 5 5 2
Tax -3 -2 -1
Profit for Year 2 3 1
Accumulated Profits Sharon Jack
One year ago 3 4
Two years ago 2 3
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Fair Value of NCI based on effective shareholdings Sharon Jack
One year ago 8 10
Two years ago 7 6
Goods worth $8m were sold in the year by Jack to Sharon and by the year end all of these had been sold to a third party.
An impairment review at the year end found the goodwill of Sharon to be impaired by $3m, goodwill is to be calculated gross.
Prepare the consolidated statement of financial position and consolidated income statement for the Ozzy group.
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SolutionWorking 1- Group Structure
Ozzy
↓70% - 2 Years Ago
Sharon
↓60% - 1 Year Ago
Jack
Ozzyʼs effective Interest in JackWorking Total
Ozzyʼs direct interest in Jack 0%
Ozzyʼs indirect interest (via Sharon) (70% x 60%) 42%
Ozzyʼs effective interest in Jack 42%
Non Controlling Interest in Jack (Balancing figure) 58%
100%
Ozzyʼs Direct Interest in Sharon 70%
Non Controlling Interest in Sharon 30%
100%
!
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Working 2 - Equity Table
At Acquisition At Year
EndAt Acquisition At Year
End
SharonSharon JackJack
Share Capital 20 20 8 8
Accumulated Profits 2 12 4 8
22 32 12 16
Working 3 - Goodwill in Sharon
$
Cost of Parent Investment 50
Less Parent % of the net assets at acquisition (W2)
22 x 70% -15.4
Goodwill attributable to Parent 34.6
Fair Value of NCI at acquisition 7
Less NCI% of the net assets at acquisition (W2)
22 x 30% -6.6
Goodwill attributable to NCI 0.4
Gross Goodwill on Acquisition 35
Impairment -3
Goodwill after Impairment 32
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Alternative working
Cost of Parentʼs investment 50
Fair value of NCI at acquisition (Market Value) 7
57
Less 100% net assets at acquisition in W2 -22
Gross Goodwill 35
Impairment -3
Goodwill after Impairment 32
!
Working 3 - Goodwill in Jack
$
Cost of Parent Investment 17
Less indirect holding adjustment 17 x 30% -5.1
Less Parent % of the net assets at acquisition (W2)
12 x 42% -5.04
Goodwill attributable to Parent 6.86
Fair Value of NCI at acquisition 10
Less NCI% of the net assets at acquisition (W2)
12 x 58% -6.96
Goodwill attributable to NCI 3.04
Gross Goodwill on Acquisition 9.9
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Alternative working
Cost of Parentʼs investment 17
Less indirect holding adjustment -5.1
Fair value of NCI at acquisition (Market Value) 10
21.9
Less 100% net assets at acquisition in W2 -12
Gross Goodwill 9.9
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Working 4 - NCI
$
NCI % of Sharonʼs net assets at the year end (W2) 32 x 30% 9.6
NCI % of Jackʼs net assets at the year end (W2) 16 x 58% 9.28
Less indirect holding adjustment -5.1
Add Sharonʼs goodwill attributable to NCI 0.4
Add Jackʼs goodwill attributable to NCI 3.04
Less NCI share of Sharonʼs Impairment of goodwill 3 x 30% -0.9
16.32
or
Fair Value of Sharonʼs NCI at acquisition 7
Fair Value of Jackʼs NCI at acquisition 10
Less indirect holding adjustment -5.1
Plus Sharon NCI share of post acquisition profits (32-22) x 30% 3
Plus Jack NCI share of post acquisition profits (16-12) x 58% 2.32
Less NCI share of Sharon Goodwill Impairment 3 x 30% -0.9
16.32
! ! !
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Working 5 - Group Accumulated Profit
$
Parentʼs Accumulated Profits 20
Less Goodwill Impairment 3 x 70% -2.1
Add: Parent % of Sharonʼs post acquisition profits 10 x 70% 7
Add: Parent % of the Jackʼs post acquisition profits 4 x 42% 1.68
26.58
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Financial Statements for Ozzy Group
Statement of Financial Position
Ozzy Sharon Jack Group
$ $ $
Goodwill W3 41.9
Other assets 25 18 20 25 + 18 +20 63
104.9
Ordinary Shares 50 20 8 50
Accumulated profits 20 12 8 W5 26.58
NCI W4 16.32
Equity 70 32 16 92.9
Liabilities 5 3 4 5 + 3 + 4 12
104.9
Income Statement Ozzy Sharon Jack
$ $ $
Revenue 400 60 85 400 + 60 + 85 - 8 (inter company)
537
Operating Costs -395 -55 -83 395 +55 + 83 - 8 -525
Operating Profit 5 5 2 12
Tax -3 -2 -1 3 + 2 + 1 -6
Profit for Year 2 3 1 6
Attributable to parent (Balancing figure)Attributable to parent (Balancing figure)Attributable to parent (Balancing figure)Attributable to parent (Balancing figure)Attributable to parent (Balancing figure) 4.52
Attributable to NCI (3 x 30%) + (1 x 58%)Attributable to NCI (3 x 30%) + (1 x 58%)Attributable to NCI (3 x 30%) + (1 x 58%)Attributable to NCI (3 x 30%) + (1 x 58%)Attributable to NCI (3 x 30%) + (1 x 58%) 1.48
6
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Illustration 29
The parent has an 60% holding in the subsidiary. The subsidiary has an associate in which it holds 40%. The following information is relevant.
Subsidiaryʼs cost of investment in associate 200
Fair value of net assets in associate at acquisition 120
Fair value of net assets in associate at year end 300
Show the treatment for the associate in the group financial statements.
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Solution 29
Effective interest & NCIEffective interest & NCIEffective interest & NCI
Parentʼsʼs indirect interest (via Sub) (60% x 40%) 24%
NCI (Balancing figure) 16%
Parentʼs effective interest 40%
Post Acquisition ProfitsPost Acquisition Profits
Fair value of net assets in associate at year end 300
Fair value of net assets in associate at acquisition -120
Post acquisition profits 180
Carrying Value of Associate $
Cost of Investment 200
Subsidiary share of post acquisition profits (40% x 180) 72
Carrying Value of Associate 272
TreatmentTreatmentTreatmentTreatmentTreatment
DR Investment in Associate 40% x 180 72
CR Equity W5 (Parent share of post acquisition profits)
24% x 72 43.2
CR NCI W4 (NCI share of post acquisition profits) 16% x 72 28.8
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Illustration 30The statements of financial position for 3 companies are as follows:
John Paul Ringo
Investments 675 200
Assets 900 700 400
1575 900 400
Share Capital 300 200 100
Accumulated Profits 700 400 100
Equity 1000 600 200
Liabilities 575 300 200
1575 900 400
Other information:
I. John acquired a 60% holding in Paul for $600
II. Paul acquired a 60% holding in Ringo for $200
III. John acquired a 30% holding in Ringo for $75
IV. All of the investments were made on the same date
V. Goodwill is to be calculated gross and no impairment has been recorded
VI. The carrying value of assets & liabilities were the same as the fair values on the date of acquisition
VII. On the date of acquisition the following information was correct:
Paul Ringo
Accumulated Profits 250 60
Fair value of the effective NCI 100 60
Prepare the consolidated statement of financial position for John Group.
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Solution 30
Working 1- Group Structure
John
↓ ↓60%
30% ↓ Paul
↓ ↓60%
Ringo
Control
John Controls Paul.
Paul controls Ringo and in addition John controls another 30% of Ringo.
Ringo is therefore a subsidiary of John group.
Effective interest & NCI
Johnʼs direct interest in Ringo 30%
Johnʼs indirect interest in Ringo (60% x 60%) 36%
Johnʼs effective interest in Ringo 66%
Effective NCI in Ringo 100% - 66% 34%
Indirect Holding Adjustment
NCI in Paul Paulʼs investment in Ringo
40% X 200 = 80
Use this to reduce the cost of investment in W3 and the NCI in W4.
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Working 2 - Net Assets Subsidiary
At Acquisition At Year End
At Acquisition At Year End
PaulPaul RingoRingo
Share Capital 200 200 100 100
Accumulated Profits 250 400 60 100
450 600 160 200
Working 3 - Goodwill in Paul
$
Cost of Parent Investment 600
Less Parent % of the net assets at acquisition (W2)
450 x 60% -270
Goodwill attributable to Parent 330
Fair Value of NCI at acquisition 100
Less NCI% of the net assets at acquisition (W2)
450 x 40% -180
Goodwill attributable to NCI -80
Gross Goodwill on Acquisition 250
Alternative working
Cost of Parentʼs investment 600
Fair value of NCI at acquisition (Market Value) 100
700
Less 100% net assets at acquisition in W2 -450
Gross Goodwill 250
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Working 3 - Goodwill in Ringo
$
Cost of Paul Investment 200
Cost of John Investment 75
Less indirect holding adjustment W1 -80
Less Parent % of the net assets at acquisition (W2)
160 x 66% -105.6
Goodwill attributable to Parent 89.4
Fair Value of NCI at acquisition 60
Less NCI% of the net assets at acquisition (W2)
160 x 34% -54.4
Goodwill attributable to NCI 5.6
Gross Goodwill on Acquisition 95
Alternative working
Cost of Paulʼs investment 200
Cost of Johnʼs investment 75
Less indirect holding adjustment -80
Fair value of NCI at acquisition (Market Value) 60
255
Less 100% net assets at acquisition in W2 -160
Gross Goodwill 95
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Working 4 - NCI
$
NCI % of Paulʼs net assets at the year end (W2) 600 x 40% 240
NCI % of Ringoʼs net assets at the year end (W2) 200 x 34% 68
Less indirect holding adjustment -80
Add Paulʼs goodwill attributable to NCI -80
Add Ringoʼs goodwill attributable to NCI 5.6
153.6
or
Fair Value of Sharonʼs NCI at acquisition 100
Fair Value of Jackʼs NCI at acquisition 60
Less indirect holding adjustment -80
Plus Paul NCI share of post acquisition profits (600-450) x 40% 60
Plus Ringo NCI share of post acquisition profits (100 - 60) x 34% 13.6
153.6
Working 5 - Group Accumulated Profit$
Parentʼs Accumulated Profits 700
Add: Parent % of Paulʼs post acquisition profits 150 x 60% 90
Add: Parent % of Ringoʼs post acquisition profits 40 x 66% 26.4
816.4
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Statement of financial position for John Group
John Paul Ringo Group
Goodwill W3 (95 + 250)
345
Assets 900 700 400 900 + 700 + 400
2000
2345
Share Capital 300 200 100 Parent 300
Accumulated Profits
700 400 100 W5 816.4
NCI W4 153.6
Equity 1270
Liabilities 575 300 200 500 + 300 +200
1075
2345
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Changes in Mixed Groups
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Solutions to Lecture Illustrations
Working Total
Aʼs direct interest in C 25%
Aʼs indirect interest (via B) (90% x 70%) 63%
Aʼs effective interest in C 88%
Non Controlling Interest in C (Balancing figure) 12%
100%
Working Total
Dʼs direct interest in F 30%
Dʼs indirect interest (via E) (70% x 40%) 28%
Dʼs effective interest in F 58%
Non Controlling Interest in F (Balancing figure) 42%
100%
Action Result
D invests in E in 2008 D owns 70% of E making it a subsidiary
D invests in F in 2009 D owns 30% of F making it an associate
E invests in F in the current year This makes Dʼs effective interest in F 58% as per our working.
F has gone from an associate to a subsidiary.This is a step-acquisition so we need to revalue the current investment in F and take the gain or loss to the income statement.
F has gone from an associate to a subsidiary.This is a step-acquisition so we need to revalue the current investment in F and take the gain or loss to the income statement.
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Action Result
D invests in E in 2008 D owns 70% of E making it a subsidiary
E invests in F in 2009 E owns 40% of F making it an associate as E has significant influence and D controls that influence.
D invests in F in the current year This makes Dʼs effective interest in F 58% as per our working.
F has gone from an associate to a subsidiary.This is a step-acquisition so we need to revalue the current investment in F and take the gain or loss to the income statement.
F has gone from an associate to a subsidiary.This is a step-acquisition so we need to revalue the current investment in F and take the gain or loss to the income statement.
Working Total
Gʼs direct interest in I 80%
Gʼs indirect interest (via H) (90% x 10%) 9%
Gʼs effective interest in I 89%
Non Controlling Interest in I (Balancing figure) 11%
100%
Action Result
G invests in H in 2008 G owns 90% of H making it a subsidiary
G invests in I in 2009 G owns 80% of I making it a subsidiary
H invests in I in the current year This makes Gʼs effective interest in I 89% as per our working.
I was a subsidiary before with an 80% holding.It is now still a subsidiary with an 89% holding.This is a decrease in the NCI of 9% and will be a transaction within equity.
I was a subsidiary before with an 80% holding.It is now still a subsidiary with an 89% holding.This is a decrease in the NCI of 9% and will be a transaction within equity.
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Action Result
G invests in H in 2008 G owns 90% of H making it a subsidiary
H invests in I in 2009 I is a simple investment of 10%
G invests in I in the current year This makes Gʼs effective interest in I 89% as per our working.
I was an investment before.It is now a subsidiary with an 89% holding.This is a step acquisition.
I was an investment before.It is now a subsidiary with an 89% holding.This is a step acquisition.
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IAS 21 Foreign Currency
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Illustration 1June 2008 Q1 (Small section)
Zian is located in a foreign country and imports its raw materials at a price which is normally denominated in dollars. The product is sold locally at selling prices denominated in dinars, and determined by local competition. All selling and operating expenses are incurred locally and paid in dinars. Distribution of profits is determined by the parent company, Ribby. Zian has financed part of its operations through a $4 million loan from Hall which was raised on 1 June 2007. This is included in the financial assets of Hall and the non-current liabilities of Zian. Zianʼs management have a considerable degree of authority and autonomy in carrying out the operations of Zian and other than the loan from Hall, are not dependent upon group companies for finance.
Required
Discuss and apply the principles set out in IAS 21 ʻThe effects of changes in foreign exchange ratesʼ in order to determine the functional currency of Zian.
# # # # # # # # # # # # # (8 marks)
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Solution to Illustration 1The functional currency is the currency of the primary economic environment in which the entity operates (IAS21). The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash.
An entityʼs management considers the following factors in determining its functional currency (IAS21):(i)the currency that dominates the determination of the sales prices; and (ii) the currency that most influences operating costs
The currency that dominates the determination of sales prices will normally be the currency in which the sales prices for goods and services are denominated and settled. It will also normally be the currency of the country whose competitive forces and regulations have the greatest impact on sales prices. In this case it would appear that currency is the dinar as Zian sells its products locally and the prices are determined by local competition. However, the currency that most influences operating costs is in fact the dollar, as Zian imports goods which are paid for in dollars although all selling and operating expenses are paid in dinars. The emphasis is, however, on the currency of the economy that determines the pricing of transactions, as opposed to the currency in which transactions are denominated.
Factors other than the dominant currency for sales prices and operating costs are also considered when identifying the functional currency. The currency in which an entityʼs finances are denominated is also considered. Zian has partly financed its operations by raising a $4 million loan from Hall but it is not dependent upon group companies for finance. The focus is on the currency in which funds from financing activities are generated and the currency in which receipts from operating activities are retained.
Additional factors include consideration of the autonomy of a foreign operation from the reporting entity and the level of transactions between the two. Zian operates with a considerable degree of autonomy both financially and in terms of its management. Consideration is given to whether the foreign operation generates sufficient functional cash flows to meet its cash needs which in this case Zian does as it does not depend on the group for finance.
It would be said that the above indicators give a mixed view but the functional currency that most faithfully represents the economic effects of the underlying transactions, events, and conditions is the dinar, as it most affects sales prices and is most relevant to the financing of an entity. The degree of autonomy and independence provides additional supporting evidence in determining the entityʼs functional currency.
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Illustration 2Bulldog Ltd has a year end of 31 January.
On 13th October Bulldog Ltd buys goods from Eagle Inc. a US supplier for $250,000.
On 24th November Bulldog settles the transaction in full.
Exchange rates
13th October £1 : $1.45
24th November £1 : $1.55
Show the accounting entries for these transactions.
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Illustration 2 Solution
Agreeing Transaction Working £
On date of agreeing the transaction use the spot rate to record it
250,000 / 1.45 172,414
DR Purchases 172,414
CR Payables 172,414
On Settlement Working £
On date of agreeing the transaction use the spot rate to record it
250,000 / 1.55 161,290
DR Payables 172,414
CR Cash with amount actually paid 161,414
CR FX Gain with the difference 11,000
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Illustration 3Jeff Ltd. purchases an item of plant from a foreign supplier for cash of €100,000. Jeff is a US company and the exchange rate at the time was $ = €1.50.
What value in $ will the asset be recorded at?
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Solution to Illustration 3
Working $
The rate at the time of purchase is $ : €1.50 €100,000 / 1.50 66,666
DR Asset 66,666
CR Cash 66,666
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Illustration 4Jeff Ltd. purchases an item of plant on 1st June from a foreign supplier on one monthʼs credit for €100,000. Jeff is a US company.
Exchange rates
1st June# # $ = €1.50
21st June## $ = €1.40
How will this transaction be dealt with in the accounts for the year to 21st June?
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Solution to Illustration 4
At Purchase Date Working $
The rate at the time of purchase is $ : €1.50 €100,000 / 1.50 66,666
DR Asset 66,666
CR Payables 66,666
At 21st June Working $
The rate at this time is $ : €1.40 €100,000 / 1.40 71,429
The payable must be retranslated at the year end as it is a monetary balance. So........The payable must be retranslated at the year end as it is a monetary balance. So........The payable must be retranslated at the year end as it is a monetary balance. So........
DR FX Loss (71,429 - 66,666) 4,763
CR Payables (71,429 - 66,666) 4,763
The $4,763 is unrealised so is included in Other Comprehensive Income.The $4,763 is unrealised so is included in Other Comprehensive Income.The $4,763 is unrealised so is included in Other Comprehensive Income.
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Pro-Forma for FX Differences on SCI
Exchange Difference $ $ Group % NCI%
Opening Net assets at acquisition rate X
Opening Net assets at closing rate (X)
X X X
Profit for the year (W2) at average rate X
Profit for the year (W2) at closing rate (X)
X X X
Goodwill at acquisition rate X
Goodwill at closing rate (X)
X X X
Total FX exchange gains & lossesTotal FX exchange gains & losses X X X
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Illustration 5
Big Ltd. acquired 80% of Cahoona Inc. on 1st July 2001.
Cahoona Inc are based in Burgerland where the functional currency is Francs (Fr).
The financial statements for the year to 30 June 2002 are below.
SFP Big$
CahoonaFr
Investment in Cahoonas 5000
Non Current Assets 10,000 3,000
Current Assets 5,000 2,000
20,000 5,000
Share Capital 6,000 1,500
Retained Earnings 4,000 2,500
Liabilities 10,000 1,000
20,000 5,000
Income Statement Big$
CahoonaFr
Revenue 25,000 35,000
Operating Costs -15,000 -26,250
Profit Before Tax 10,000 8,750
Tax -5,000 -7,450
Profit for the Year 5,000 1,300
There was no other comprehensive income for either entity in the period.
Other information:
I. The fair value of the net assets of Cahoona was Fr6,000 on the date of acquisition with any increase being attributable to land held at historic cost.
II. Big sold goods to Cahoona during the year for $1,000 cash.
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III.Big made a short term loan to Cahoona on 1 June 2002. The loan was for $400 and is recorded as a liability by Cahoona at the historic rate.
IV. The NCI is valued using the proportionate method.
Exchange rates to $1:
# # # # Fr1 July 2001# # 1.5Average rate# # 1.751 June# # # 1.930 June# # # 2
Prepare the group statement of financial position, income statement, and statement of other comprehensive income.
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Illustration 5 Solution
Working 1- Group Structure
Big
↓80%
Cahoona
Date Acquired 1 Year Ago
Parent Share 80%
NCI 20%
100%
Removal of Loan
Working Fr
Loan Received 1 June by Cahoona $400 / 1.9 760
Retranslate at closing rate on 30 June $400 / 2 800
Difference (760 - 800) -40
This is an FX loss which reduces the net assets of Cahoona at the year end.This is an FX loss which reduces the net assets of Cahoona at the year end.This is an FX loss which reduces the net assets of Cahoona at the year end.
We need to take this to our W2.We need to take this to our W2.We need to take this to our W2.
! ! !
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Working 2 - Equity Table in Functional Currency
At AcquisitionFr
At Year EndFr
Share Capital 1,500 1,500
Accumulated Profits 1,200 2,500
Fair Value Adjustment on land (Balancing figure) 3,300 3,300
FX Loss on Loan (W1) -40
6,000 7,260
Post acquisition profit (7,260 - 6,000) 1,2601,260
Working 3 - Goodwill in Functional Currency
Fr Fr
Cost of Parent Investment (5,000 @ 1.5) 7,500
Less Parent % of the net assets at acquisition (W2)
6,000 x 80% -4,800
Goodwill 2,700
Translated at closing rate (2,700 / 2) = $1,350 to SFP.Translated at closing rate (2,700 / 2) = $1,350 to SFP.Translated at closing rate (2,700 / 2) = $1,350 to SFP.Translated at closing rate (2,700 / 2) = $1,350 to SFP.
FX Loss on Investment by the parent in $FX Loss on Investment by the parent in $FX Loss on Investment by the parent in $FX Loss on Investment by the parent in $
$ $
Cost of Investment at acquisition rate Fr7,500 @ 1.5 5,000
Cost of Investment at closing rate Fr7,500 @ 2 3,750
FX Loss on retranslation of investment by the parentFX Loss on retranslation of investment by the parentFX Loss on retranslation of investment by the parent 1,250
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Working 4 - NCI
$
NCI % of the subsidiaryʼs net assets at the year end (W2) translated at the closing rate (Fr7,260 x 20%) / 2 726
726
Working 5 - Group Accumulated Profit
$
Parentʼs Accumulated Profits 4,000
Share of Sub at closing rate 80% x (1,260 / 2) 504
Less FX loss on cost of investment (W3) -1,250
3,254
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Working 8 - FX Differences for SCI
Exchange Difference Working $ $ Group %
NCI%
Opening Net assets (W2) at closing rate
(6,000 / 2) 3,000
Opening Net assets (W2) at acquisition rate
(6,000 / 1.5) -4,000
-1,000 -800 -200
Profit for the year (W2) at closing rate
(1,260 / 2) 630
Profit for the year (W2) at average rate
(1,260 / 1.75 -720
-90 -72 -18
Goodwill at closing rate (2,700 / 2) 1,350
Goodwill at acquisition rate (2,700 / 1.5) -1,800
-450 -450
Total FX exchange gains & lossesTotal FX exchange gains & losses -1,540 -1,322 -218
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Statement of Financial Position
SFP Big Cahoona $
Non Current Assets 10,000 ((3,000 + 3,300) / 2) = 3,150 13,150
Goodwill (W3) 1,350
Current Assets 5,000 (2000 / 2) - 400 Inter Co(W1) 5,600
20,100
Share Capital 6,000 Parent 6,000
Retained Earnings 4,000 W5 3,254
NCI W4 726
Liabilities 10,000 ((1,000 + 40(W1)) / 2) - 400 Inter Co(W1)
10,120
20,000 0 20,100
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Statement of Comprehensive Income
Income Statement Big Cahoonas Adjustment $
Revenue 25,000 (35,000 / 1.75) Inter Co-1,000
44,000
Operating Costs -15,000 (26,250 + 40(W1)) / 1.75 Inter Co-1,000
-29,023
Profit Before Tax 14,977
Tax -5000 (7,450 / 1.75) -9257
Profit for the Year 5,720
Profit Attributable to:Profit Attributable to:Profit Attributable to:Profit Attributable to:Profit Attributable to:
ParentParentParent (Balance) 5,576
Non Controlling InterestNon Controlling InterestNon Controlling Interest (20% x (1,260 / 1.75)
144
5,720
Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income
Profit for the YearProfit for the YearProfit for the YearProfit for the Year 5,720
FX differences on translation of foreign operations (W6)FX differences on translation of foreign operations (W6)FX differences on translation of foreign operations (W6)FX differences on translation of foreign operations (W6) -1,540
4,180
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Ethics
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Illustration 1December 2010 Q1 (Small section)
Jocatt operates in the energy industry and undertakes complex natural gas trading arrangements, which involve exchanges in resources with other companies in the industry. Jocatt is entering into a long-term contract for the supply of gas and is raising a loan on the strength of this contract. The proceeds of the loan are to be received over the year to 30 November 2011 and are to be repaid over four years to 30 November 2015. Jocatt wishes to report the proceeds as operating cash flow because it is related to a long-term purchase contract. The directors of Jocatt receive extra income if the operating cash flow exceeds a predetermined target for the year and feel that the indirect method is more useful and informative to users of financial statements than the direct method.
(i) Comment on the directorsʼ view that the indirect method of preparing statements of cash flow is more useful and informative to users than the direct method. (7 marks)
(ii) Discuss the reasons why the directors may wish to report the loan proceeds as an operating cash flow rather than a financing cash flow and whether there are any ethical implications of adopting this treatment.# (6 marks)
Professional marks will be awarded in part (b) for the clarity and quality of discussion. # # # # # # # # # # # # # # (2 marks)
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Solution to Illustration 1i.
Many companies use the indirect method for preparing the statement of cash flow on the grounds of cost.
The indirect method is essentially a reconciliation of the net income reported in the statement of financial position with the cash flow from operations whereas the direct method shows the inflows and outflows of cash under different categories.
The method of reconciliation in the indirect method is confusing to users and not easy to match to the rest of the financial statements with the only real information being the difference between net profit before tax and cash from operations.
The direct method allows for reporting operating cash flows by understandable categories as they can see the amount of cash collected from customers, cash paid to suppliers, cash paid to employees and cash paid for other operating expenses. Users can gain a better understanding of the major trends in cash flows and can compare these cash flows with those of the entityʼs competitors.
An issue in the use of the indirect method for users is the abuse of the classifications of specific cash flows such as cash outflows which should have been reported in the operating section being classified as investing cash outflows with the result that companies enhance operating cash flows.
A problem for users is the fact that entities can choose the method used and there is not enough guidance on the classification of cash flows in the operating, investing and financing sections of the indirect method used in IAS 7.
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ii.
The directors main reason for wishing to do this is to manipulate the income of the firm.
The complex nature of the indirect method as discussed previously means that the directors are attempting to confuse users who do not have a detailed understanding of cash flow accounting.
The information provided by directors should be a faithful representation which is unbiased so that information disclosed is truthful and neutral. They have a responsibility to perform in an ethical manner.
The reliance of users on the information provided for investment decisions means that the directors must put aside their own self interest to provide information that is true and fair.
They may be tempted to manipulate the income of the firm for several reasons:
i. To gain performance related bonuses.ii.To protect the share price of the firm.iii.To ensure that their jobs are safe and reputations enhanced.
Regardless of the personal impact on the directors they must act independently and objectively in the application of the accounting standards reporting the loan as cash flows from financing activities.
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IFRS 8 & IAS 33Operating Segments & EPS
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Illustration 1 (June 2008 Q2 (a))Norman, a public limited company, has three business segments which are currently reported in its financial statements. Norman is an international hotel group which reports to management on the basis of region. It does not currently report segmental information under IFRS8 ʻOperating Segmentsʼ. The results of the regional segments for the year ended 31 May 2008 are as follows:
RegionRevenueRevenue Segmental
Profit/LossSegmental
AssetsSegmentalLiabilitiesRegion
External InternalSegmentalProfit/Loss
SegmentalAssets
SegmentalLiabilities
$m $m $m $m $m
European 200 3 -10 300 200
South East Asia 300 2 60 800 300
Other 500 5 105 2,000 1,400
There were no significant inter company balances in the segment assets and liabilities. The hotels are located in capital cities in the various regions, and the company sets individual performance indicators for each hotel based on its city location.
Required:
Discuss the principles in IFRS8 ʻOperating Segmentsʼ for the determination of a companyʼs reportable operating segments and how these principles would be applied for Norman plc using the information given above.
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Solution
Requirements of IFRS 8
IFRS 8 requires operating segments to be identified based on the management structure and reporting system in the entity. The components that are reviewed regularly by the CEO in order to allocate resources and assess performance will form the segments.
The standard seeks to enable users to view information on the business operations which fully discloses the financial effects of the different areas and types of operations undertaken.
Under the standard an operating segment is defined as a component:
I. That engages in business activities from which it may earn revenues and incur expenses (even if the revenues & expenses are with other components in the entity).
II. Whose operating results are reviewed regularly by the entityʼs chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance; and for which discrete financial information is available
An operating segment will be a reportable segment if it meets the following criteria:
I. Revenues (internal & external) are more than 10% of combined revenue.
II. Profit or loss is more than 10% of combined total.
III. Assets are more than 10% of combined total.
75% or more of the entities external revenue must be reported by operating segments. If not then, other segments must be identified even if they do not meet the criteria for reportable segments until 75% is reported.
Application to Norman
The KPIs used by the management of Norman are based on city so it may well be that the operating segments of Norman could be split further on a city basis.
Norman should investigate their reporting structure to evaluate whether decisions about allocation and performance are made within the entity on a city basis and consider splitting the segments further.
Regarding the current segments, only the South East Asia segment passes all 3 tests for a reportable segment. The European segment meets only the criteria for 10% + of reported revenue and fails on the others.
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The current reported segments report only 50% of the entityʼs total external revenue so they will have to identify further operating segments regardless of whether they meet the criteria until the reach 75%.
By examining the internal reports of Norman the entity can determine whether the operating segments should be further split based on the information used by management.
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Illustration 2An entity issued 300,000 shares at full market price on 1st July 2009. The year end of the entity is 31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st December 2009 was $1,000,000.
Calculate the EPS at 31st December 2009.
Solution
Date Shares Months Fraction Ave
1/01/09 900,000 6/12 - 450,000
1/07/09 1,200,000 6/12 - 600,000
1,050,000
EPS = 1,000,000 / 1,050,000 = 95.24cEPS = 1,000,000 / 1,050,000 = 95.24cEPS = 1,000,000 / 1,050,000 = 95.24cEPS = 1,000,000 / 1,050,000 = 95.24cEPS = 1,000,000 / 1,050,000 = 95.24c
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Illustration 3ABC Ltd. makes a bonus issue of 1 for 6 on 1st July 2009. The year end of the entity is 31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st December 2009 was $1,000,000.
Calculate the EPS at 31st December 2009.
Solution
Date Shares Months Fraction Ave
1/01/09 900,000 6/12 7/6 525,000
1/07/09 1,050,000 6/12 525,000
1,050,000
EPS = 1,000,000 / 1,050,000 = 95.24cEPS = 1,000,000 / 1,050,000 = 95.24cEPS = 1,000,000 / 1,050,000 = 95.24cEPS = 1,000,000 / 1,050,000 = 95.24cEPS = 1,000,000 / 1,050,000 = 95.24c
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Illustration 4ABC Ltd. makes a rights issue of 1 for 3 on 1st July 2009. The current share price is $4 and the rights issue is at a price of $3 The year end of the entity is 31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st December 2009 was $1,000,000.
Last yearʼs earnings were $900,000
Calculate the EPS at 31st December 2009 and the new EPS for 2008.
Solution
No. Shares Price Total
3 4 12
1 3 3
4 15
THERP = (15 / 4) = $3.75 so rights fraction is: 4/3.75THERP = (15 / 4) = $3.75 so rights fraction is: 4/3.75THERP = (15 / 4) = $3.75 so rights fraction is: 4/3.75
Date Shares Months Fraction Ave
1/01/09 900,000 6/12 4/3.75 480,000
1/07/09 1,200,000 6/12 600,000
1,080,000
December 2009 EPS = 1,000,000 / 1,080,000 = 92.59cDecember 2009 EPS = 1,000,000 / 1,080,000 = 92.59cDecember 2009 EPS = 1,000,000 / 1,080,000 = 92.59cDecember 2009 EPS = 1,000,000 / 1,080,000 = 92.59cDecember 2009 EPS = 1,000,000 / 1,080,000 = 92.59c
c
December 2008 EPS (900,000 / 900,000) 100
Inverted Bonus Fraction 3.75/4
Comparable EPS 93.75
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IFRS 5 & IAS 18AHFS & Revenue
Recognition
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Illustration 1 (June 2004 (Adapted))Rockby, a public limited company, has committed itself before its year-end of 31 March 2004 to a plan of action to sell a subsidiary, Bye. The sale is expected to be completed on 1 July 2004 and the financial statements of the group were signed on 15 May 2004. The subsidiary, Bye, a public limited company, had net assets at the year end of $5 million and the book value of related goodwill is $1 million. Bye has made a loss of $500,000 from 1 April 2004 to 15 May 2004 and is expected to make a further loss up to the date of sale of $600,000. Rockby was at 15 May 2004 negotiating the consideration for the sale of Bye but no contract has been signed or public announcement made as of that date.
Rockby expected to receive $4·5 million for the company after selling costs. The value-in-use of Bye at 15 May 2004 was estimated at $3·9 million.
Further the non-current assets of Rockby include the following items of plant and head office land and buildings:
I. Tangible non-current assets held for use in operating leases: at 31 March 2004 the company has at carrying value $10 million of plant which has recently been leased out on operating leases. These leases have now expired. The company is undecided as to whether to sell the plant or lease it to customers under finance leases. The fair value less selling costs of the plant is $9 million and the value-in-use is estimated at $12 million.Plant with a carrying value of $5 million at 31 March 2004 has ceased to be used because of a downturn in the economy. The company had decided at 31 March 2004 to maintain the plant in workable condition in case of a change in economic conditions. Rockby subsequently sold the plant by auction on 14 May 2004 for $3 million net of costs.
II. The Board of Rockby approved the relocation of the head office site on 1 March 2003. The head office land and buildings were renovated and upgraded in the year to 31 March 2003 with a view to selling the site. During the improvements, subsidence was found in the foundations of the main building. The work to correct the subsidence and the renovations were completed on 1 June 2003. As at 31 March 2003 the renovations had cost $2·3 million and the cost of correcting the subsidence was $1 million. The carrying value of the head office land and buildings was $5 million at 31 March 2003 before accounting for the renovation. Rockby moved its head office to the new site in June 2003 and at the same time, the old head office property was offered for sale at a price of $10 million. However, the market for commercial property had deteriorated significantly and as at 31 March 2004, a buyer for the property had not been found. At that time the company did not wish to reduce the price and hoped that market conditions would improve. On 20 April 2004, a bid of $8·3 million was received for the property and eventually it was sold (net of costs) for $7·5 million on 1 June 2004. The carrying value of the head office land and buildings was $7 million at 31 March 2004.
Non-current assets are shown in the financial statements at historical cost.
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Required:
(a) Discuss the way in which the sale of the subsidiary, Bye, would be dealt with in the group financial statements of Rockby at 31 March 2004 under IFRS 5 Non-current assets held for sale and discontinued operations. # (8 marks)
(b) Discuss whether the following non-current assets would be classed as ʻheld for saleʼ if IFRS 5 had been applied to:
(i) the items of plant in the group financial statements at 31 March 2004; (7 marks)
(ii)the head office land and buildings in the group financial statements at 31 March 2003 and 31 March 2004.# (5 marks)
# # # # # # # # # # # (20 marks)
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Solution
(a) Under IFRS5, a non-current asset or disposal group (in this case Bye – as it is a cash generating unit) should be classified as ʻheld for saleʼ if its carrying amounts will be recovered principally through a sale transaction rather than through continuing use. The criteria which have to be met are:
(i) a commitment to a plan (ii) the asset is available for immediate sale(iii) actively trying to find a buyer (iv) sale is highly probable (v) asset is being actively marketed (vi) unlikely to be significant changes to the plan
These criteria seem to have been met in this case. Before classification of the item as ʻheld for saleʼ an impairment review will need to be undertaken irrespective of any indication or otherwise of impairment. Any loss will be charged to the income statements.
IFRS5 requires items ʻheld for saleʼ to be reported at the lower of carrying value and ʻfair value less costs to sellʼ. IFRS 5 requires extensive disclosure on the face of the income statements and in the notes regarding the subsidiary. In the balance sheet, it should be presented separately from other assets and liabilities. The assets and liabilities should not be offset. There are additional disclosures to be made concerning the facts and circumstances leading to the disposal and the segment in which the subsidiary is presented under IFRS 8 ʻOperating Segmentsʼ.
The figure of $4·5 million will be used as ʻfair value less costs to sellʼ. The net assets and goodwill will be written down to $4·5 million with the write off going against non-current assets in the first instance.
(b)
(i) To qualify as a ʻheld for saleʼ asset, the sale must be ʻhighly probableʼ and generally must be completed within one year.
In the case of the operating lease assets, they will not qualify as ʻheld for saleʼ assets at 31 March 2004 as the company has not made a decision as to whether they should be sold or leased. They should, therefore, be shown as non-current assets and depreciated. ʻHeld for saleʼ assets are not depreciated. The carrying value of the assets will be $10 million. ʻHeld for saleʼ assets are valued at the lower of carrying value and fair value less selling costs under IFRS 5. The assets are not impaired because the value-in-use is above the carrying value.
The plant would not be classed as a ʻheld for saleʼ asset at 31 March 2004 even though the plant was sold at auction prior to the date that the financial statements were signed. The ʻheld for saleʼ criteria were not met at the Statement of Financial Position date and IFRS prohibits the classification of non-current assets as ʻheld for saleʼ if the criteria are
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met after that date and before the financial statements are signed. The company should disclose relevant information in the financial statements for the year ended 31 March 2004.
(ii)Under IFRS 5, a non-current asset qualifies as ʻheld for saleʼ if it is available for immediate sale in its present condition subject to the usual selling terms. The company should have the intent and the ability to sell the asset in its present condition.
At 31 March 2003, although the company ultimately wishes to sell the property, it would be unlikely to achieve this until the subsidence was dealt with. Additionally the companyʼs view was that the property should be sold when the renovations were completed which would have been at 1 June 2003. Also as at 31 March 2003, the company had not attempted to find a buyer for the property. Hence the property could not be classed as ʻheld for saleʼ at that date.
As at 31 March 2004, the property had not been sold although it had been on the market for over nine months. The market conditions had deteriorated significantly and yet the company did not wish to reduce the price.
It seems as though the price asked for the property is in excess of its fair value especially as a bid of $8·3 million was received shortly after the year end (20 April 2004).
The property has been vacated and, therefore, is available for sale but the price does not seem reasonable in relation to its current fair value ($10 million price as opposed to $8·3 million bid and ultimate sale of $7·5 million). Therefore, it would appear that at 31 March 2004, the intent to sell the asset might be questionable.
The property fails the test set out in IFRS 5 as regards the reasonableness of price and, therefore, should not be classed as ʻheld for saleʼ.
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Illustration 2 (December ʼ08 Q3)Johan purchases telephone handsets from a manufacturer for $200 each, and sells the handsets direct to customers for $150 if they purchase call credit (call card) in advance on what is called a prepaid phone. The costs of selling the handset are estimated at $1 per set. The customers using a prepaid phone pay $21 for each call card at the purchase date. Call cards expire six months from the date of first sale. There is an average unused call credit of $3 per card after six months and the card is activated when sold.
Johan also sells handsets to dealers for $150 and invoices the dealers for those handsets. The dealer can return the handset up to a service contract being signed by a customer. When the customer signs a service contract, the customer receives the handset free of charge. Johan allows the dealer a commission of $280 on the connection of a customer and the transaction with the dealer is settled net by a payment of $130 by Johan to the dealer being the cost of the handset to the dealer ($150) deducted from the commission ($280). The handset cannot be sold separately by the dealer and the service contract lasts for a 12 month period. Dealers do not sell prepaid phones, and Johan receives monthly revenue from the service contract.
The chief operating officer, a non-accountant, has asked for an explanation of the accounting principles and practices which should be used to account for the above events.
Required:
Discuss the principles and practices which should be used in the financial year to 30 November 2008 to account for the purchase of handsets and the recognition of revenue from customers and dealers.# # # # # # # # # # (8 marks)
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Solution 2
The inventory of handsets should be measured at the lower of cost and net realisable value (IAS2, ʻInventoriesʼ, para 9). Johan should recognise a provision at the point of purchase for the handsets to be sold at a loss.
The inventory should be written down to its net realisable value (NRV) of $149 per handset as they are sold both to prepaid customers and dealers. The NRV is $51 less than cost. Net realisable value is the estimated selling price in the normal course of business less the estimated selling costs.
IAS18, ʻRevenueʼ, requires the recognition of revenue by reference to the stage of completion of the transaction at the reporting date. Revenue associated with the provision of services should be recognised as service as rendered. Johan should record the receipt of $21 per call card as deferred revenue at the point of sale.
Revenue of $18 should be recognised over the six month period from the date of sale. The unused call credit of $3 would be recognised when the card expires as that is the point at which the obligation of Johan ceases.
Revenue is earned from the provision of services and not from the physical sale of the card.
IAS18 does not deal in detail with agency arrangements but says the gross inflows of economic benefits include amounts collected on behalf of the principal and which do not result in increases in equity for the entity.
The amounts collected on behalf of the principal are not revenue. Revenue is the amount of the ʻcommissionʼ. Additionally where there are two or more transactions, they should be taken together if the commercial effect cannot be understood without reference to the series of transactions as a whole.
As a result of the above, Johan should not recognise revenue when the handset is sold to the dealer, as the dealer is acting as an agent for the sale of the handset and the service contract. Johan has retained the risk of the loss in value of the handset as they can be returned by the dealer and the price set for the handset is under the control of Johan.
Note that no money changes hands at this point as the cost of the handset is netted off the commission.
The handset sale and the provision of the service would have to be assessed as to their separability. However, the handset cannot be sold separately and is commercially linked to the provision of the service.
Johan would, therefore, recognise the net payment of $130 as a customer acquisition cost which may qualify as an intangible asset under IAS38, and the revenue from the service contract will be recognised as the service is rendered.
The intangible asset would be amortised over the 12 month contract. The cost of the handset from the manufacturer will be charged as cost of goods sold ($200).
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so...
Valuation of Inventory (Handsets)
Inventory should be valued at the lower of cost and net realisable value (IAS 2)
Cost of the handsets is $200.
Net realisable value is (150 -1) $149.
Inventory should be written down to $149 per handset allow for the sale at a lower than cost price.
Revenue Recognition
1. On the call cards,
This is revenue from a service provision and therefore should be recognised over the length of time of the contract under IAS 18.
The $21 received in advance should be deferred and recognised as the service is rendered.
If there is any unused call credit at the end of the six months this should be recognised at the end of the 6 months when the obligation of Johan ceases.
2. Agency Agreement
The risk & reward of ownership of the handset transfers to the dealer only when they sell a contract on to a customer.
No revenue should therefore be recognised by Johan when the handset is ʻsoldʼ to the dealer as they have the right to return it to Johan.
The service contract and the handset sale cannot be separated as they cannot be sold in isolation.
Payment by Johan
The payment by Johan of $130 (net) to the dealer can be treated as a customer acquisition cost.
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IAS 19Pensions
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Illustration 1A company maintains a defined benefit pension scheme for itʼs employees. The following information is relevant:
The pension assets brought forward in 20X0 $1,000 with a closing balance of $2,000.
The expected return on these assets is 11%.
Calculate the expected return on Pension Assets.
Solution
Pension Assets Brought Forward 1,000
Expected Return % 11%
Expected Return on Plan Assets 110
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Illustration 2
A company maintains a defined benefit pension scheme for itʼs employees. The following information is relevant:
The liabilities of the scheme were $1,400 at the start of the period and $2,600 at the end.
The discount rate for liabilities is 12%.
Calculate the Interest Cost for the period.
Solution
Pension Liabilities Brought Forward 1,400
Discount Rate 12%
Interest Cost 168
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Illustration 3The following details refer to Company Aʼs pension scheme.
B/F C/F
Pension Assets 1,000 2,000
Pension Liabilities 1,400 2,600
Unrecognised Gains 350 700
The average working lives of the employees is 20 years.The average working lives of the employees is 20 years.The average working lives of the employees is 20 years.
Calculate the amount of any actuarial gains or losses recognised in the Income Statement if the company wishes to use the 10% corridor method to recognise those gains & losses.
Solution
Working $
10% Opening Assets (1,000 x 10%) 100
10% Opening Liabilities (1,400 x 10%) 140
Liabilities are higher so use themLiabilities are higher so use themLiabilities are higher so use them
10% Opening Liabilities 140
Opening Unrecognised Gains 350
Difference 210
Working Lives of Employees 20
Amount to Recognise (210 / 20) 10.5
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Illustration 4A company maintains a defined benefit pension scheme for itʼs employees. The following information is relevant:
The pension assets brought forward in 20X0 $1,800 with a closing balance of $2,700.
The expected return on these assets is 14%.
The company contributes $90 per year into the scheme.
Benefits paid out in the period were $100.
The liabilities of the scheme were $1,600 at the start of the period and $2,100 at the end.
The discount rate for liabilities is 12%.
The terms of the scheme have changed meaning that past service costs have arisen of $35 and the current service costs for the period are $70.
The company has unrecognised gains brought forward of $347 and wishes to use the 10% corridor method to recognise gains & losses. The expected average working life remaining of employees is 10 years.
Required:
Show the treatment for the pension scheme in the financial statements of the company.
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IFRS 2Share Based Payments
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Illustration 1
An entity grants 1 share option to each of its 100 employees on 1 January Year 1. Each grant is conditional upon the employee working for the entity over the next three years.
The fair value of each share option as at 1 January Year 1 is $8
At the end of each year the number of employees expected to take up the options are:
Year 1:# 95Year 2:# 97
When the rights are taken up in year 3, 98 employees actually receive the options.
Show the treatment for the employee benefits over the three years.
Solution
Year Total Employees expected to
qualify
Value of option
Proportion of vesting
period
Total cumulative
charge
Cost for each periodDr WagesCr equity
1 95 8 1/3 253 253
2 97 8 2/3 517 517 - 253 = 264
3 98 8 3/3 784 784 - 253 - 264 = 267
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Illustration 2An entity grants 1 share option to each of its 500 employees on 1 January Year 1. Each grant is conditional upon the employee working for the entity over the next three years.
The fair value of each share option as at 1 January Year 1 is $10
On the basis of a weighted average probability, the entity estimates on 1 January that 100 employees will leave during the three-year period and therefore forfeit their rights to share options.
The following actually occurs:
– 20 employees leave during Year 1 and the estimate of total employee departures over the three-year period is revised to 70 employees
– 25 employees leave during Year 2 and the estimate of total employee departures over the three-year period is revised to 60 employees
– 10 employees leave during Year 3
Solution
Year Employee Departures
Total EXPECTED to leave
TOTAL EXPECTED TO VEST AT YEAR
END
1 20 70 430
2 25 60 440
3 10 20 + 25 + 10 (Actual) 445
Year Total Employees expected to
qualify
Value of option
Proportion of vesting
period
Total cumulative
cost
Cost for each periodDr Expense
Cr equity
1 430 10 1/3 1433 1433
2 440 10 2/3 2933 2,933 - 1,433 = 1,500
3 445 10 3/3 4450 4,450 - 2933 = 1,517
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Illustration 3
Same question with additional information of share option price at the end of each year:
Year 1## 10 Year 2## 12 Year 3## 14
Solution
Year Total Employees expected to
qualify
Share Option Price
Proportion of vesting
period
Total cumulative
cost
Cost for each periodDr ExpenseCr Liability
1 430 10 1/3 1433 1433
2 440 12 2/3 3520 3,520 - 1,433 = 2,087
3 445 14 3/3 6230 6,230 - 3,520 = 2,710
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Illustration 4At the beginning of year 1, an entity grants 1 share options to each of its 500 employees over a vesting period of 3 years at a fair value of $15
Year 140 leave, further 70 expected to leave;
Share options now repriced (as market value of shares has fallen) as the Fair Value of the options had fallen to $5. After the repricing they are now worth $8. The modification has therefore increased the Fair Value from $5 to $8.
Year 235 leave, further 30 expected to leave
Year 328 leave
Hint!
The repricing has increased the Fair Value of the Option by $3.
This amount is recognised over the remaining two years of the vesting period, along with remuneration expense based on the original option value of $15
Solution
Year Total Employees expected to
qualify
Option Value
Proportion of vesting
period
Total cumulative
cost
Cost for each periodDr ExpenseCr Equity
1 390 15 1/3 1950 1950
2 395 15 2/3 3950 3,950 - 1,950 = 2,000
3 397 15 3/3 5955 5,955 - 3,950 = 2,005
Year Total Employees expected to
qualify
Option Value
Proportion of vesting
period
Total cumulative
cost
Cost for each periodDr ExpenseCr Equity
2 395 3 1/2 593 593
3 397 3 2/2 1191 1191 - 593 = 598
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Year Original Charge Additional Charge Total Charge in Year
1 1950 1950
2 2000 593 2593
3 2005 598 2603
Total 5955 1191 7146
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IAS 16 & 36Non Current Assets and
Impairment
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Illustration 1A company purchases a crane with a useful economic life of 15 years for $200m with an obligation to decommission at a cost of $50m. The applicable discount rate is 8%.
Show the recognition of the asset in the financial statements and the treatment over the first accounting period.
Solution
Initial Recognition DR CR
Asset (200 + (50 x 1/1.0815) 215.75
Cash 200
Liability 15.75
Year 1 Treatment DR CR
Depreciation Charge (215.75 / 15) 14.38
Accumulated Depreciation 14.38
Finance Cost to I/S (15.75 x 8%) 1.26
Dismantling Liability 1.26
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Illustration 2
IAS 16 (June 2010 Q1)Ashanti owned a piece of property, plant and equipment (PPE) which cost $12 million and was purchased on 1 May 2008. It is being depreciated over 10 years on the straight-line basis with zero residual value. On 30 April 2009, it was revalued to $13 million and on 30 April 2010, the PPE was revalued to $8 million. The whole of the revaluation loss had been posted to the statement of comprehensive income and depreciation has been charged for the year. It is Ashantiʼs company policy to make all necessary transfers for excess depreciation following revaluation.
Solution
Balance
B/F 0.00
Initial Revaluation 2.20
Transfer to Equity -0.24
C/F 1.96
Historic Cost Revalued Amʼt Revaluation Reserve
BF 12 12 0.0
Depʼn (12/10) -1.2 -1.2 0.0
Revaluation 2.2 2.2
CF 10.8 13 2.2
Depʼn -1.2 -1.44 -0.24
NBV 9.6 11.56 1.96
New ValuationNew Valuation 8
Total ImpairmentTotal Impairment 3.56
Remove revaluation less depʼnRemove revaluation less depʼn 1.96
Income StatementIncome Statement 1.6
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Illustration 3
Property, plant & equipment with a total cost of $1m has components of a structure valued at $700,000 with a useful economic life of 20 years and plant worth $300,000 with a useful economic life of 10 years.
Show the depreciation charges in the financial statements in year 1.
Solution
Structure Plant Total
Cost 700,000 300,000 1,000,000
Depreciation (700,000 / 20) = 35,000 (300,000 /10) = 30,000 65,000
NBV 665,000 270,000 935,000
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Illustration 4
The carrying value of an item of plant in the financial statements is $400,000. By operating the plant the business expects to earn discounted cash-flows of $350,000 over the rest of itʼs useful life. The could sell the plant now for $300,000 with costs to sell of $25,000.
What is the recoverable amount?
Solution
$m
Value in Use 350,000
Fair Value less cost to sell (300,000 - 25,000) 275,000
Recoverable amount is the higher of these two which is the Value in Use of $350,000.Recoverable amount is the higher of these two which is the Value in Use of $350,000.
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Illustration 5
A company has an asset for which the following information is relevant:
$ʻ000
Carrying amount 400
Fair Value 350
Cost to sell 25
Cash flows expected in each of the next 5 years 90
Discount rate 10%
Annuity rate for 10% over 5 years 3.791
Carry out the impairment review for the asset.
Solution
$ʻ000
Value in Use (90 x 3.791) 341.19
Fair Value less cost to sell (350,000 - 25,000) 325
Recoverable amount is the higher of these two which is the Value in Use of $341,190.Recoverable amount is the higher of these two which is the Value in Use of $341,190.
Carrying Value 400
Recoverable Amount 341.19
Impairment 58.81
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Illustration 6
A cash generating unit has the assets outlined below. Itʼs recoverable amount has been assessed as $1,000. Show the treatment for any impairment.
Assets Carrying Value
Goodwill 100
PPE 800
Intangible 400
1300
Solution
Impairment TestImpairment Test
Carrying Value of Assets 1,300
Recoverable Amount 1,000
Impairment 300
Assets Carrying Value Impairment Post Impairment
Goodwill 100 -100 Nil
PPE 800 (200 x 800/1,200) = -133 667
Intangible 400 (200 x 400/1,200) = -67 333
1300 1,000
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IAS 40, 38, 20, 23Investment Property
Intangible AssetsGovernment Grants
Borrowing Costs
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Illustration 1Which of the following are Investment Property?
• Building once used and now held for resale.• Land purchased as an investment. No planning consent yet.• New office building purchased for capital appreciation.
Solution
Building once used and now held for resale. HFS (IFRS 5)
Land purchased as an investment. No planning consent yet. IAS 40
New office building purchased for capital appreciation. IAS 40
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Illustration 2Lockfine has internally developed intangible assets comprising the capitalised expenses of the acquisition and production of electronic map data which indicates the main fishing grounds in the world. The intangible assets generate revenue for the company in their use by the fishing fleet and are a material asset in the statement of financial position. Lockfine had constructed a database of the electronic maps. The costs incurred in bringing the information about a certain region of the world to a higher standard of performance are capitalised. The costs related to maintaining the information about a certain region at that same standard of performance are expensed. Lockfineʼs accounting policy states that intangible assets are valued at historical cost. The company considers the database to have an indefinite useful life which is reconsidered annually when it is tested for impairment. The reasons supporting the assessment of an indefinite useful life were not disclosed in the financial statements and neither did the company disclose how it satisfied the criteria for recognising an intangible asset arising from development.#
# # # # # # # # # # # (6 marks)SolutionAn intangible asset is an identifiable non-monetary asset without physical substance. Thus, the three critical attributes of an intangible asset are:(a) identifiability (b) control (power to obtain benefits from the asset) (c) future economic benefits (such as revenues or reduced future costs)
The electronic maps meet the above three criteria for recognition as an intangible asset as they are identifiable, Lockfine has control over them and future revenue will flow from the maps. The maps will be recognised because there are future economic benefits attributable to the maps and the cost can be measured reliably. After initial recognition the benchmark treatment is that intangible assets should be carried at cost less any amortisation and impairment losses and thus Lockfineʼs accounting policy is in compliance with IAS 38.
An intangible asset has an indefinite useful life when there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. The term indefinite does not mean infinite. An important underlying assumption in assessing the useful life of an intangible asset is that it reflects only the level of future maintenance expenditure required to maintain the asset ʻat its standard of performance assessed at the time of estimating the assetʼs useful lifeʼ. The indefinite useful life should not depend on planned future expenditure in excess of that required to maintain the asset. The companyʼs accounting practice in this regard seems to be in compliance with IAS 38. IAS 38 identifies certain factors that may affect the useful life and it is important that Lockfine complies with IAS 38 in this regard. For example, technical, technological or commercial obsolescence and expected actions by competitors. IAS 38 specifies the criteria that an entity must be able to satisfy in order to recognise an intangible asset arising from development. There is no specific requirement that this be disclosed. However, IAS 1 Presentation of Financial Statements requires that an entity discloses accounting policies relevant to an understanding of its financial statements. Given that the internally generated intangible assets are a material amount of total assets, this information should also have been disclosed.
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Illustration 3A company purchases an item of plant on which it receives a government grant of 30% of the purchase price. The plant cost $2m and has no residual value.
The plant is to be depreciated on a straight line basis over itʼs 10 year life.
Show the accounting treatment for the government grant in the first year if they decide to use the deferred income method.
Solution
DR CR
Cash ($2m x 30%) 600,000
Deferred Income 600,000
Deferred Income (600,000 / 10) 60,000
Income Statement 60,000
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Illustration 4
Borrow £1m at 7.5% to construct a building. As all was not needed at once, the unused cash was reinvested and interest received was £35,000.
What borrowing costs should be capitalised?
Solution
Borrowing Cost ($1m x 7.5%) 75,000
Interest Received -35,000
Capitalise 40,000
Illustration 5A company has a £1m 6% loan and a £2m 8% loan. It builds a building costing £600,000 and it takes 8 months.
What borrowing costs should be capitalised?
Solution
Total Borrowing Cost Total Cost
$1m 6% 6
$2m 8% 16
$3m At total cost 22
Average Rate therefore is (22/3) = 7.33%Average Rate therefore is (22/3) = 7.33%Average Rate therefore is (22/3) = 7.33%
We can capitalise 600,000 x 7.33% x 8/12 = $29,320We can capitalise 600,000 x 7.33% x 8/12 = $29,320We can capitalise 600,000 x 7.33% x 8/12 = $29,320
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Illustration 6Company buys land on 1/12, a planning application is prepared during December and January. Permission is obtained at the end of January. Payment for the land is made on 1/2. On this date a loan is taken out to pay for the land and building constructionAdverse weather conditions meant a delay in the commencement of work until 15/3.When should interest be capitalised from?
Solution
Expenses start being incurred 1 December
Borrowing costs incurred 1 February
Activities started 15 March
Start Capitalising on 15 MarchStart Capitalising on 15 March
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IAS 17Leases
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Illustration 1An asset is leased by a company on the 01/01/X0 over a 3 year period. They pay 3 annual payments of $2,500, the first of which is payable on 31/12/X0.
The actuarial interest rate is 12% (annuity rate for 3 years 2.402) and the fair value of the asset was $6,500.
Show the treatment in the lessees financial statements over the life of the asset.
Solution
Recognition of the AssetRecognition of the AssetRecognition of the Asset
Fair Value 6,500
PV minimum lease payments 2,500 x 2.402 6,005
Recognise at lower of the two so..... 6,005
DR Asset 6,0056,005
CR Lease Liability 6,0056,005
Lease Liability on SFPLease Liability on SFPLease Liability on SFPLease Liability on SFPLease Liability on SFP
Period Opening Bal
Interest Charge(12%)DR Income Statement
CR Lease Liability
Lease PaymentDR Lease Liability
CR Cash
Closing Bal
1 6,005 721 -2,500 4,226
2 4,226 507 -2,500 2,233
3 2,233 268 -2,500 0
The asset will be depreciated over the 3 year period at (6,005 x 1/3) = 2,002The asset will be depreciated over the 3 year period at (6,005 x 1/3) = 2,002The asset will be depreciated over the 3 year period at (6,005 x 1/3) = 2,002The asset will be depreciated over the 3 year period at (6,005 x 1/3) = 2,002The asset will be depreciated over the 3 year period at (6,005 x 1/3) = 2,002
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Illustration 2A company takes out a 20 year lease on 01/01/X0 the useful life of the building is 20 years. $60,000 is to be paid in advance each year.
The interest rate is 6% and the fair value of the land is $70,000 of the $700,000 total value in the land & buildings.
The present value of the lease payments to be made is $700,000.
Show the treatment in the income statement and the statement of financial position for the year ended 31/12/X0.
Solution
Land is always an operating lease 70,000
Buildings will be a finance lease 700,000 - 70,000 630,000
Therefore 10% of the lease payments will be for land and the rest for buildingsTherefore 10% of the lease payments will be for land and the rest for buildingsTherefore 10% of the lease payments will be for land and the rest for buildings
DR CR
Buildings 630,000
Finance Lease Liability 630,000
Depreciation (630,000 / 20) 31,500
Accumulated Depreciation 31,500
Buildings LeaseBuildings LeaseBuildings Lease
Finance Lease Liability (60,000 x 90%) 54,000
Cash 54,000
Interest Charge (630,000 - 54,000) x 6%) 34,560
Finance Lease Liability 34,560
Operating Lease on LandOperating Lease on LandOperating Lease on Land
Income Statement (60,000 x 10%) 6,000
Cash 6,000
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Illustration 3A Lease term 4 years from 1/1/2010. Annual installments are payable in advance of $10,000.
The expected residual value at end of lease is $6,000 . Fair value of the asset $39,366 Interest rate implicit in the lease 10%.
Show the treatment for the lease in the financial statements of the lessor.
Solution
Present Value of minimum lease paymentsPresent Value of minimum lease paymentsPresent Value of minimum lease paymentsPresent Value of minimum lease paymentsPresent Value of minimum lease payments
$ Discount Rate
1 Payment 10,000 1 10,000
2 Payment 10,000 0.909 9,090
3 Payment 10,000 0.826 8,260
4 Payment 10,000 0.751 7,510
Lessees LiabilityLessees LiabilityLessees LiabilityLessees Liability 34,860
Un-guaranteed Residual ValueUn-guaranteed Residual ValueUn-guaranteed Residual ValueUn-guaranteed Residual Value
$ Discount Rate
Residual Value 6,000 0.751 4,506
Net Investment in LeaseNet Investment in Lease
Present value of minimum lease payments 34,860
Un-guaranteed Residual Value 4,506
Lessors Net Investment in Lease 39,366
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Net Investment over term of the leaseNet Investment over term of the leaseNet Investment over term of the leaseNet Investment over term of the leaseNet Investment over term of the lease
OʼBal Receipt Balance Interest Income (10%)
ClʼBal
39,366 10,000 29,366 2,937 32,303
32,303 10,000 22,303 2,230 24,533
24,533 10,000 14,533 1,453 15,986
15,986 10,000 5,986
The 5,986 is the 6,000 un-guaranteed residual value with slight rounding difference.The 5,986 is the 6,000 un-guaranteed residual value with slight rounding difference.The 5,986 is the 6,000 un-guaranteed residual value with slight rounding difference.The 5,986 is the 6,000 un-guaranteed residual value with slight rounding difference.The 5,986 is the 6,000 un-guaranteed residual value with slight rounding difference.
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Illustration 4A company hires out plant to other businesses on long term operating leases.
On 01/04/X0 it hires out an item of plant on a 6 year lease with an amount payable on that date of $200,000 followed by 5 payments of $100,000 on 01/04/X1 - 01/04/X5.
The plant will be returned to the company on 31/03/X6.
The cost of the plant to the company was $1,100,000 and it has a 30 year useful economic life with no residual value.
i. What is the annual rental income recognised by the company?
ii.Show the treatment in the income statement and the statement of financial position for the years 20X0 and 20X1.
Solutioni.
Total Rental Income over the lease 200,000 + (100,000 x 5) 700,000
Recognise on Straight Line Basis 700,000 / 6 116,667
Rental Income to be recognised in Income Statement each periodRental Income to be recognised in Income Statement each period 116,667
ii.
Period Rental Received Rental Recognised
Difference to Deferred Income
Total Deferred Income
20X0 200,000 116,667 83,333 83,333
20X1 100,000 116,667 -16,667 66,666
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Income Statement 20X0 20X1
Rental Income Receivable 116,667 116,667
Depreciation ($1.1m / 30 yrs.) -36,667 -36,667
20X0 20X1
Plant at Cost 1,100,000 1,100,000
Depreciation -36,667 -73,334
Carrying Value 1,063,333 1,026,666
Non Current Liabilities Deferred Income 66,666 49,999
Current Liabilities Deferred Income 16,667 16,667
83,333 66,666
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Illustration 5Company A acquires a new tractor to rent out over 2 years. The tractor cost $30,000 on 01/01/X0 with a residual value of $9,000 in 2 years
It immediately rented the tractor out to Company B on a 2 year lease for $1,000 per month payable in advance. $600 negotiation costs were incurred by Company A and an incentive of $300 cash-back given to Company B to encourage them to take up the lease.
Show the treatment in the accounts of each Company for the year ended 31/12/X0.
Solution
Company ACompany A $
Capitalise Cost 30,000
Depreciation (30,000 - 9,000) / 2) 10,500
Capitalise Negotiation Cost 600
Capitalise Incentive Cost 300
Rental Income 12,000
Release Negotiation Costs (600 / 2) -300
Incentive (300 / 2) -150
Net Rental Income 11550
Company BCompany B $
Capitalise Incentive 300
Rental Payments 12,000
Release Incentive (300/2) -150
Rental Payments 11,850
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Illustration 6
How would the following be treated in the financial statements for the next year?
Company A has sold 6 assets with the intention of leasing them back on 5 year operating leases.
Item Carrying Value Proceeds Fair Value Annual Lease Payments
1 360 300 400 50
2 400 300 360 50
3 300 360 400 66
4 300 400 360 70
5 360 400 300 70
6 400 360 300 66
Solution
Item Carrying Value
Proceeds Fair Value Above/Below Fair
Value?
Gain/Loss
1 360 300 400 Below -60
2 400 300 360 Below -100
3 300 360 400 Below 60
4 300 400 360 Above 100
5 360 400 300 Above 40
6 400 360 300 Above -40
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Year 1 TreatmentYear 1 TreatmentYear 1 TreatmentYear 1 Treatment
Item Gain/Loss Recognised Lease Payments
1 60 loss on sale (unless lower future rentals) -60 50
2 100 loss on sale (unless 60 is for lower future rentals) -100 50
3 60 gain on sale 60 66
4 60 gain on sale; 40 to deferred income 60 + (40 /5) =68 70
5 60 impairment to income statement; 100 to deferred income
60 Impairment20 Deferred Income 70
6 100 impairment to income statement; 60 to deferred income
100 Impairment12 Deferred Income 66
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Illustration 7A company enters into a sale and finance leaseback agreement on 1/1/X1 when the Carrying Value of the asset was $70,000. The sale proceeds were $120,000, which was the fair value of the asset, with the remaining useful economic life of the asset being 5 years.
The lease was for 5 annual rentals of $30,000 in arrears. Implicit interest rate of 8% (5 year annuity 3.99).
What are the journal entries at the date of disposal and show the lease effects in the income statement and SFP for the first year.
Solution
Removal of Asset DR CR
Cash 120,000
Asset 70,000
Deferred Income 50,000
Finance Lease DR CR
Asset (30,000 x 3.99 (8% 5 yrs.) 119,700
Finance Lease 119,700
Interest (119,700 x 8%) 9,576
Finance Lease 9,576
Finance Lease (Cash Paid) 30,000
Cash 30,000
Deferred Income Amortisation DR CR
Deferred Income (50,000 / 5) 10,000
Income Statement 10,000
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Illustration 8Sale and leaseback of football stadium (excluding the land element)
The football stadium is currently accounted for using the cost model in IAS16, ʻProperty, Plant, and Equipmentʼ. The carrying value of the stadium will be $12 million at 31 December 2006. The stadium will have a remaining life of 20 years at 31 December 2006, and the club uses straight line depreciation. It is proposed to sell the stadium to a third party institution on 1 January 2007 and lease it back under a 20 year finance lease. The sale price and fair value are $15 million which is the present value of the minimum lease payments. The agreement transfers the title of the stadium back to the football club at the end of the lease at nil cost. The rental is $1·2 million per annum in advance commencing on 1 January 2007. The directors do not wish to treat this transaction as the raising of a secured loan. The implicit interest rate on the finance in the lease is 5·6%.
# # # # # # # # # # # (9 Marks)
SolutionA sale and leaseback agreement releases capital for expansion, repayment of outstanding debt or repurchase of share capital. The transaction releases capital tied up in non liquid assets. There are important considerations. The price received for the asset and the related interest rate/rental charge should be at market rates. The interest rate will normally be dependent upon the financial strength of the ʻtenantʼ and the risk/reward ratio which the lessor is prepared to accept. There are two types of sale and leaseback agreements. One utilising a finance lease and another an operating lease.
The accounting treatment is determined by IAS17, ʻLeasesʼ. The substance of the transaction is essentially one of financing as the title to the stadium is transferred back to the club. Thus a sale is not recognised. The excess of the sale proceeds over the carrying value of the assets is deferred and amortised to profit or loss over the lease term. The leaseback of the stadium is for the remainder of its economic and useful life, and therefore under IAS17, the lease should be treated as a finance lease. The stadium will remain as a non-current asset and will be depreciated. The finance lease loan will be accounted for under IAS39 ʻFinancial Instruments: Recognition and Measurementʼ in terms of the derecognition rules in the standard.
The transaction will be recognised by the club as follows in the year to 31 December 2007:
Removal of Asset DR CR
Cash 15
Asset 12
Deferred Income 3
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Finance Lease DR CR
Asset 15,000,000
Finance Lease 15,000,000
Interest (15 - 1.2 x 5.6%) 773,000
Finance Lease 773,000
Finance Lease (Cash Paid) 1,200,000
Cash 1,200,000
Deferred Income Amortisation DR CR
Deferred Income (3,000,000 / 20) 150,000
Income Statement 150,000
Depreciation DR CR
Income Statement (15m / 20yrs) 750,000
Accumulated Depʼn 750,000
Summary
Income Statement
Deferred Income 150,000
Depreciation -750,000
Finance Charge -773,000
Statement of Financial Position
Stadium (15m - 750,000) 14,250,000
Deferred Income (3m - 150,000) 2,850,000
LT Liability (15m - (1.2m x 2) + 773,000 13,373,000
Current Lease Liability 1,200,000
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IAS 37Provisions
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Illustration 1Greenie, a public limited company, builds, develops and operates airports. During the financial year to 30 November 2010, a section of an airport collapsed and as a result several people were hurt. The accident resulted in the closure of the terminal and legal action against Greenie. When the financial statements for the year ended 30 November 2010 were being prepared, the investigation into the accident and the reconstruction of the section of the airport damaged were still in progress and no legal action had yet been brought in connection with the accident. The expert report that was to be presented to the civil courts in order to determine the cause of the accident and to assess the respective responsibilities of the various parties involved, was expected in 2011.
Financial damages arising related to the additional costs and operating losses relating to the unavailability of the building. The nature and extent of the damages, and the details of any compensation payments had yet to be established. The directors of Greenie felt that at present, there was no requirement to record the impact of the accident in the financial statements.
Compensation agreements had been arranged with the victims, and these claims were all covered by Greenieʼs insurance policy. In each case, compensation paid by the insurance company was subject to a waiver of any judicial proceedings against Greenie and its insurers. If any compensation is eventually payable to third parties, this is expected to be covered by the insurance policies.
The directors of Greenie felt that the conditions for recognising a provision or disclosing a contingent liability had not been met. Therefore, Greenie did not recognise a provision in respect of the accident nor did it disclose any related contingent liability or a note setting out the nature of the accident and potential claims in its financial statements for the year ended 30 November 2010.## # # # # # # # # # # # (6 marks)
SolutionIAS 37 paragraph 14, states that an entity must recognise a provision if, and only if:(i) a present obligation (legal or constructive) has arisen as a result of a past event (the
obligating event), (ii)payment to settle the obligation is probable (ʻmore likely than notʼ), (iii)and the amount can be estimated reliably.
An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an enterprise having no realistic alternative but to settle the obligation [IAS 37.10].
At the date of the financial statements, there was no current obligation for Greenie. In particular, no action had been brought in connection with the accident. It was not yet probable that an outflow of resources would be required to settle the obligation. Thus no provision is required.
Greenie may need to disclose a contingent liability. IAS 37 defines a contingent liability as:
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(a) a possible obligation that has arisen from past events and whose existence will be confirmed by the occurrence or not of uncertain future events; or
(b) a present obligation that has arisen from past events but is not recognised because: (i) it is not probable that an outflow of resources will occur to settle the obligation; or (ii)the amount of the obligation cannot be measured with sufficient reliability.
IAS 37 requires that entities should not recognise contingent liabilities but should disclose them, unless the possibility of an outflow of economic resources is remote. It appears that Greenie should disclose a contingent liability. The fact that the real nature and extent of the damages, including whether they qualify for compensation and details of any compensation payments remained to be established all indicated the level of uncertainty attaching to the case. The degree of uncertainty is not such that the possibility of an outflow of resource could be considered remote. Had this been the case, no disclosure under IAS 37 would have been required.
Thus the conditions for establishing a liability are not fulfilled. However, a contingent liability should be disclosed as required by IAS 37.
The possible recovery of these costs from the insurer give rise to consideration of whether a contingent asset should be disclosed. Given the status of the expert report, any information as to whether judicial involvement is likely will not be available until 2011. Thus this contingent asset is more possible than probable. As such no disclosure of the contingent asset should be included.
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Illustration 2Grange has prepared a plan for reorganising the parent companyʼs own operations. The board of directors has discussed the plan but further work has to be carried out before they can approve it. However, Grange has made a public announcement as regards the reorganisation and wishes to make a reorganisation provision at 30 November 2009 of $30 million. The plan will generate cost savings. The directors have calculated the value in use of the net assets (total equity) of the parent company as being $870 million if the reorganisation takes place and $830 million if the reorganisation does not take place. Grange is concerned that the parent companyʼs property, plant and equipment have lost value during the period because of a decline in property prices in the region and feel that any impairment charge would relate to these assets. There is no reserve within other equity relating to prior revaluation of these non-current assets.
SolutionA provision for restructuring should not be recognised, as a constructive obligation does not exist. A constructive obligation arises when an entity both has a detailed formal plan and makes an announcement of the plan to those affected. The events to date do not provide sufficient detail that would permit recognition of a constructive obligation. Therefore no provision for reorganisation should be made and the costs and benefits of the plan should not be taken into account when determining the impairment loss. Any impairment loss can be allocated to non-current assets, as this is the area in which the directors feel that loss has occurred.
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Interim Reporting (IAS 34) & First Time Adoption (IFRS 1)
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Illustration 1In the IFRS opening statement of financial position at 1 May 2009, Lockfine elected to measure its fishing fleet at fair value and use that fair value as deemed cost in accordance with IFRS 1 First Time Adoption of International Financial Reporting Standards. The fair value was an estimate based on valuations provided by two independent selling agents, both of whom provided a range of values within which the valuation might be considered acceptable. Lockfine calculated fair value at the average of the highest amounts in the two ranges provided. One of the agentsʼ valuations was not supported by any description of the method adopted or the assumptions underlying the calculation. Valuations were principally based on discussions with various potential buyers. Lockfine wished to know the principles behind the use of deemed cost and whether agentsʼ estimates were a reliable form of evidence on which to base the fair value calculation of tangible assets to be then adopted as deemed cost.#
Lockfine was unsure as to whether it could elect to apply IFRS 3 Business Combinations retrospectively to past business combinations on a selective basis, because there was no purchase price allocation available for certain business combinations in its opening IFRS statement of financial position.
SolutionThe question arises as to whether the selling agentsʼ estimates can be used to calculate fair value in accordance with IFRS 1 First Time Adoption of International Financial Reporting Standards. Assets carried at cost (e.g. property, plant and equipment) may be measured at their fair value at the date of the opening IFRS statement of financial position. Fair value becomes the ʻdeemed costʼ going forward under the IFRS cost model.
Deemed cost is an amount used as a surrogate for cost or depreciated cost at a given date. If, before the date of its first IFRS statement of financial position, the entity had revalued any of these assets under its previous GAAP either to fair value or to a price-index-adjusted cost, that previous GAAP revalued amount at the date of the revaluation can become the deemed cost of the asset under IFRS 1. It is generally advantageous to use independent estimates when determining fair value, but Lockfine should ensure that the valuation is prepared in accordance with the requirements of the relevant IFRS standard.
An independent valuation should generally, as a minimum, include enough information for Lockfine to assess whether or not this is the case. The selling agentsʼ estimates provided very little information about the valuation methods and underlying assumptions that they could not, in themselves, be relied upon for determining fair value in accordance with IAS 16 Property, Plant and Equipment. Furthermore it would not be prudent to value the boats at the average of the higher end of the range of values.
IFRS 1, however, does not set out detailed requirements under which fair value should be determined. Issuers who adopt fair value as deemed cost have only to provide the limited disclosures, and methods and assumptions for determining the fair value do not have to be disclosed. The revaluation has to be broadly comparable to fair value. The use of fair value as deemed cost is a cost effective alternative approach for entities which do not
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perform a full retrospective application of the requirements to IAS 16. Thus Lockfine was not in breach of IFRS 1 and can determine fair value on the basis of selling agent estimates.
In accordance with IFRS 1, an entity which, during the transition process to IFRS, decides to retrospectively apply IFRS 3 to a certain business combination must apply that decision consistently to all business combinations occurring between the date on which it decides to adopt IFRS 3 and the date of transition. The decision to apply IFRS 3 cannot be made selectively. The entity must consider all similar transactions carried out in that period; and when allocating values to the various assets (including intangibles) and liabilities of the entity acquired in a business combination to which IFRS 3 is applied, an entity must necessarily have documentation to support its purchase price allocation, extended or applied to other similar situations.
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Financial Instruments I
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Illustration 1Aron held 3% holding of the shares in Smart, a public limited company. The investment was classified as available-for-sale and at 31 May 2009 was fair valued at $5 million. The cumulative gain recognised in equity relating to the available-for-sale investment was $400,000.
On the same day, the whole of the share capital of Smart was acquired by Given, a public limited company, and as a result, Aron received shares in Given with a fair value of $5·5 million in exchange for its holding in Smart.
Show the treatment for the transaction in the accounts to the 31 May 2009:
i) Under IAS 39ii)If the asset was classified as FVOCI under IFRS 9
Solution
i)IAS 39 $m
Proceeds of Share exchange 5.5
Carrying amount of Shares 5
Gain on de-recognition 0.5
Recycle gain previously recognised in Equity 0.4
Gain to Income Statement 0.9
IFRS 9 $m
Proceeds of Share exchange 5.5
Carrying amount of Shares 5
Gain on de-recognition 0.5
Gain to Income Statement 0.5
Previous gain transferred from other reserves to retained earnings 0.4
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Illustration 2The publication of IFRS 9, Financial Instruments, represents the completion of the first stage of a three-part project to replace IAS 39 Financial Instruments: Recognition and Measurement with a new standard. The new standard purports to enhance the ability of investors and other users of financial information to understand the accounting of financial assets and reduces complexity.
Required:
Discuss the approach taken by IFRS 9 in measuring and classifying financial assets and the main effect that IFRS 9 will have on accounting for financial assets.# (11 marks)
SolutionIFRS 9 Financial instruments retains a mixed measurement model with some assets measured at amortised cost and others at fair value. The distinction between the two models is based on the business model of each entity and a requirement to assess whether the cash flows of the instrument are only principal and interest. The business model approach is fundamental to the standard and is an attempt to align the accounting with the way in which management uses its assets in its business whilst also looking at the characteristics of the business. A debt instrument generally must be measured at amortised cost if both the ʻbusiness model testʼ and the ʻcontractual cash flow characteristics testʼ are satisfied. The business model test is whether the objective of the entityʼs business model is to hold the financial asset to collect the contractual cash flows rather than have the objective to sell the instrument prior to its contractual maturity to realise its fair value changes.
The contractual cash flow characteristics test is whether the contractual terms of the financial asset give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal amount outstanding.All recognised financial assets that are currently in the scope of IAS 39 will be measured at either amortised cost or fair value. The standard contains only the two primary measurement categories for financial assets unlike IAS 39 where there were multiple measurement categories. Thus the existing IAS 39 categories of held to maturity, loans and receivables and available-for-sale are eliminated along with the tainting provisions of the standard.
A debt instrument (e.g. loan receivable) that is held within a business model whose objective is to collect the contractual cash flows and has contractual cash flows that are solely payments of principal and interest generally must be measured at amortised cost. All other debt instruments must be measured at fair value through profit or loss (FVTPL). An investment in a convertible loan note would not qualify for measurement at amortised cost because of the inclusion of the conversion option, which is not deemed to represent payments of principal and interest. This criterion will permit amortised cost measurement when the cash flows on a loan are entirely fixed such as a fixed interest rate loan or where interest is floating or a combination of fixed and floating interest rates.
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IFRS 9 contains an option to classify financial assets that meet the amortised cost criteria as at FVTPL if doing so eliminates or reduces an accounting mismatch. An example of this may be where an entity holds a fixed rate loan receivable that it hedges with an interest rate swap that swaps the fixed rates for floating rates. Measuring the loan asset at amortised cost would create a measurement mismatch, as the interest rate swap would be held at FVTPL. In this case the loan receivable could be designated at FVTPL under the fair value option to reduce the accounting mismatch that arises from measuring the loan at amortised cost.
All equity investments within the scope of IFRS 9 are to be measured in the statement of financial position at fair value with the default recognition of gains and losses in profit or loss. Only if the equity investment is not held for trading can an irrevocable election be made at initial recognition to measure it at fair value through other comprehensive income (FVTOCI) with only dividend income recognised in profit or loss. The amounts recognised in OCI are not recycled to profit or loss on disposal of the investment although they may be reclassified in equity.
The standard eliminates the exemption allowing some unquoted equity instruments and related derivative assets to be measured at cost. However, it includes guidance on the rare circumstances where the cost of such an instrument may be appropriate estimate of fair value.
The classification of an instrument is determined on initial recognition and reclassifications are only permitted on the change of an entityʼs business model and are expected to occur only infrequently. An example of where reclassification from amortised cost to fair value might be required would be when an entity decides to close its mortgage business, no longer accepting new business, and is actively marketing its mortgage portfolio for sale. When a reclassification is required it is applied from the first day of the first reporting period following the change in business model.
All derivatives within the scope of IFRS 9 are required to be measured at fair value. IFRS 9 does not retain IAS 39ʼs approach to accounting for embedded derivatives. Consequently, embedded derivatives that would have been separately accounted for at FVTPL under IAS 39 because they were not closely related to the financial asset host will no longer be separated. Instead, the contractual cash flows of the financial asset are assessed as a whole and are measured at FVTPL if any of its cash flows do not represent payments of principal and interest.
One of the most significant changes will be the ability to measure some debt instruments, for example investments in government and corporate bonds at amortised cost. Many available-for-sale debt instruments currently measured at fair value will qualify for amortised cost accounting.
Many loans and receivables and held-to-maturity investments will continue to be measured at amortised cost but some will have to be measured instead at FVTPL. For example some instruments, such as cash-collateralised debt obligations, that may under IAS 39 have been measured entirely at amortised cost or as available-for-sale will more likely be measured at FVTPL. Some financial assets that are currently disaggregated into host financial assets that are not at FVTPL will instead by measured at FVTPL in their entirety.
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IFRS 9 may result in more financial assets being measured at fair value. It will depend on the circumstances of each entity in terms of the way it manages the instruments it holds, the nature of those instruments and the classification elections it makes.Assets that are currently classified as held-to-maturity are likely to continue to be measured at amortised cost as they are held to collect the contractual cash flows and often give rise to only payments of principal and interest.
IFRS 9 does not directly address impairment. However, as IFRS 9 eliminates the available-for-sale (AFS) category, it also eliminates the AFS impairment rules. Under IAS 39 measuring impairment losses on debt securities in illiquid markets based on fair value often led to reporting an impairment loss that exceeded the credit loss that management expected. Additionally, impairment losses on AFS equity investments cannot be reversed within the income statement section of the statement of comprehensive income under IAS 39 if the fair value of the investment increases. Under IFRS 9, debt securities that qualify for the amortised cost model are measured under that model and declines in equity investments measured at FVTPL are recognised in profit or loss and reversed through profit or loss if the fair value increases.
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Financial Instruments II
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Illustration 1A company invests $10,000 in a 3 year redeemable 10% bond which is redeemable at a premium.
The bond consists of interest payments and principle only and the company intends to hold it until it is redeemed.
The effective interest rate on the bond is 12%.
Show the treatment for the bond over the 3 year period.
OʼBal Interest (12%)DR Financial Asset
CR Income Statement
Cash Recʼd (10% x 10,000)
DR CashCR Financial Asset
Clʼbal
10,000 1,200 -1,000 10,200
10,200 1,224 -1,000 10,424
10,424 1,251 -1,000 10,675
The Premium payable at the end of the term therefore is $675.The Premium payable at the end of the term therefore is $675.The Premium payable at the end of the term therefore is $675.The Premium payable at the end of the term therefore is $675.
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Illustration 2A company issues a $30,000 3 year 7% redeemable bond at a discount of 10% with issue costs of $1,000.
The bond is redeemable at a premium of $1,297.
The effective interest rate is 14%.
Show the treatment for the bond over the 3 year period.
$
Issue Proceeds 30,000
Discount -3,000
Issue Costs -1,000
Net Proceeds 26,000
OʼBal Interest (14%)DR Income StatementCR Financial Liability
Cash Paid (7% x 30,000)DR Financial Liability
CR Cash
Clʼbal
26,000 3,640 -2,100 27,540
27,540 3,856 -2,100 29,296
29,296 4,101 -2,100 31,297
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Illustration 3Ambush loaned $200,000 to Bromwich on 1 December 2003. The effective and stated interest rate for this loan was 8 per cent. Interest is payable by Bromwich at the end of each year and the loan is repayable on 30 November 2007. At 30 November 2005, the directors of Ambush have heard that Bromwich is in financial difficulties and is undergoing a financial reorganisation. The directors feel that it is likely that they will only receive $100,000 on 30 November 2007 and no future interest payment. Interest for the year ended 30 November 2005 had been received. The financial year end of Ambush is 30 November 2005.
Required: (i)# Outline the requirements of IAS 39 as regards the impairment of financial # assets.# # # # # # # # # # (6 marks)
(ii)# Explain the accounting treatment under IAS39 of the loan to Bromwich in the # financial statements of Ambush for the year ended 30 November 2005.# (4 marks)
SolutionIAS 39 requires an entity to assess at each balance sheet date whether there is any objective evidence that financial assets are impaired and whether the impairment impacts on future cash flows. Objective evidence that financial assets are impaired includes the significant financial difficulty of the issuer or obligor and whether it becomes probable that the borrower will enter bankruptcy or other financial reorganisation.
For investments in equity instruments that are classified as available for sale, a significant and prolonged decline in the fair value below its cost is also objective evidence of impairment.
If any objective evidence of impairment exists, the entity recognises any associated impairment loss in profit or loss. Only losses that have been incurred from past events can be reported as impairment losses. Therefore, losses expected from future events, no matter how likely, are not recognised. A loss is incurred only if both of the following two conditions are met:
(i) there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a ʻloss eventʼ), and
(ii) the loss event has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated
The impairment requirements apply to all types of financial assets. The only category of financial asset that is not subject to testing for impairment is a financial asset held at fair value through profit or loss, since any decline in value for such assets are recognised immediately in profit or loss.
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For assets at amortised cost, impaired assets are measured at the present value of the estimated future cash flows discounted using the original effective interest rate of the financial assets. Any difference between the carrying amount and the new value of the impaired asset is an impairment loss.
There is objective evidence of impairment because of the financial difficulties and reorganisation of Bromwich. The impairment loss on the loan will be calculated by discounting the estimated future cash flows. The future cash flows will be $100,000 on 30 November 2007. This will be discounted at an effective interest rate of 8% to give a present value of $85,733. The loan will, therefore, be impaired by ($200,000 – $85,733) i.e. $114,267.
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Illustration 4A company purchases a $2 million bond that has a fixed interest rate of 6% per year . The instrument is classed as a FVPL financial asset. The fair value is $2 million.
The company enters into an interest rate swap (fair value zero) to offset the risk of a decline in fair value. If the derivative hedging instrument is effective, any decline in the fair value of the bond should be offset by opposite increases in the fair value of the derivative instrument. The swap is expected to be 100% effective.
The company designates and documents the swap as a hedging instrument.
Market interest rates increase to 7% and the fair value of the bond decreases to $1,920,000.
The instrument is a hedged item in a fair value hedge, this change in fair value of the instrument is recognised in profit or loss, as follows:
Dr Income statement 80,000
Cr Bond 80,000
The fair value of the swap has increased by $80,000. Since the swap is a derivative, it is measured at fair value with changes in fair value recognised in profit or loss.
Dr Swap 80,000
Cr Income statement 80,000
The changes in fair value of the hedged item and the hedging instrument exactly offset, the hedge is 100% effective and, the net effect on profit or loss is zero.
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Financial Instruments II
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Illustration 1Aron issued one million convertible bonds on 1 June 2006. The bonds had a term of three years and were issued with a total fair value of $100 million which is also the par value. Interest is paid annually in arrears at a rate of 6% per annum and bonds, without the conversion option, attracted an interest rate of 9% per annum on 1 June 2006. The company incurred issue costs of $1 million. If the investor did not convert to shares they would have been redeemed at par. At maturity all of the bonds were converted into 25 million ordinary shares of $1 of Aron. No bonds could be converted before that date. The directors are uncertain how the bonds should have been accounted for up to the date of the conversion on 31 May 2009 and have been told that the impact of the issue costs is to increase the effective interest rate to 9·38%.
Solution
Debt & Equity SplitDebt & Equity SplitDebt & Equity SplitDebt & Equity Split
Year Cash Flows DR 9% PV
1 6 0.917 5.50
2 6 0.841 5.05
3 6 0.772 4.63
3 100 0.772 77.20
Debt Total 92.38
Total Value 100.00
Equity Total (Bal) 7.62
Issue CostsIssue Costs $
Debt ($1m x 92.38/100) 923,800
Equity ($1m x 7.62/100) 76,200
Debt Equity Total
Pre- Issue Costs 92.38 7.62 100
Issue Costs 0.92 0.08 1
Net Value 91.46 7.54 99
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Year Oʼbal Interest (9.38%)
Cash Paid Clʼbal
1 91.46 8.58 6.00 94.04
2 94.04 8.82 6.00 96.86
3 96.86 9.09 6.00 99.95
This is the $100m conversion value of the bond with slight rounding differenceThis is the $100m conversion value of the bond with slight rounding differenceThis is the $100m conversion value of the bond with slight rounding differenceThis is the $100m conversion value of the bond with slight rounding differenceThis is the $100m conversion value of the bond with slight rounding difference
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IAS 12Deferred Tax
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Illustration 1An entity has the following assets & liabilities recorded in itʼs balance sheet at 31 December 2008:
Carrying Value$m
Tax Base$m
Property 20 14
Plant & Equipment 10 8
Inventory 8 12
Trade Receivables 6 8
Trade Payables 12 12
Cash 4 4
The entity had made a provision for inventory obsolescence of $4m that is not allowable for tax purposes until the inventory is sold and an impairment charge against trade receivables of $2m that will not be allowed in the current year for tax purposes but will be in the future. Income tax paid is at 30%.
Required:
Calculate the deferred tax provision at 31 December 20X8.
SolutionCarrying Value
$mTax Base
$mTemporary Difference
Asset/Liability?
Property 20 14 6 Liability
Plant & Equipment 10 8 2 Liability
Inventory 8 12 -4 Asset
Trade Receivables 6 8 -2 Asset
Trade Payables 12 12 0 -
Cash 4 4 0 -
Total 2 Liability
The deferred tax liability will be $2,000,000 x 30% = $600,000The deferred tax liability will be $2,000,000 x 30% = $600,000The deferred tax liability will be $2,000,000 x 30% = $600,000The deferred tax liability will be $2,000,000 x 30% = $600,000The deferred tax liability will be $2,000,000 x 30% = $600,000
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Illustration 2Show the accounting treatment in the following situations:
(i) A company treats royalties as income when receivable in accordance with IFRS. The tax regime taxes royalties when they are received. The Income Statement of the company shows $1m of royalties in the period of which $500,000 have been received.
(ii)In accordance with IFRS a company has deferred $2m of income on a long term contract. The tax rules state that the income should be recognised immediately.
(iii)Depreciation on Plant & Equipment in the period under IFRS is $4m where the tax allowable depreciation is $2m.
(iv)Depreciation on Buildings in the period under IFRS is $3m where the tax allowable depreciation is $4m.
The tax rate is 30%
Solution
Situation Financial Statements Tax Effect Deferred Tax
Royalties More Income More Tax Liability
Deferred Income Less Income Less Tax Asset
Plant & Equipment More Expense Less Tax Asset
Buildings Less Expense More Tax Liability
Situation Working TaxTax Deferred TaxDeferred Tax
DR CR DR CR
Royalties (1m - 500k) x 30% 150 150
Deferred Income (2m x 30%) 600 600
Plant & Equipment (4m - 2m) x 30% 600 600
Buildings (4m - 3m) x 30% 300 300
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Illustration 3An entity granted 1,000 share options to an employee vesting 3 years later. The fair value of at the grant date was $3
Tax law allows a tax deduction of the intrinsic value at the end of the vesting period.
The intrinsic value is $1.20 at the end of year 1 and $3.40 at the end of year 2
Assume a tax rate of 30%.
Solution
Step 1 - Calculate the Options Expense.
Year No. Options
Value of option
Proportion Dr ExpenseCr equity
Period Expense
1 1000 3 1/3 1000 1000
2 1000 3 2/3 2000 1000
Step 2 - Calculate the Tax Allowable Deduction
Year No. Options
Intrinsic Value of option
Proportion Total Tax Allowable
Period Expense
1 1000 1.20 1/3 400 400
2 1000 3.40 2/3 2267 1867
Step 3 - Treatment
Share Expense
Tax Allowable(At Exercise Date)
SFPAsset
I/SCR
SCICR
Year 1 1,000 400 (400 x 30%)=120
120 Nil
Year 2 1000 1,867 (1,867) x 30%= 560
480 80
Total 2,000 2,267 680 600 80
The share expense of 2,000 is less than the 2,267 tax allowable so the extra (267 x 30% = 80) goes to equity rather than the income statement.The share expense of 2,000 is less than the 2,267 tax allowable so the extra (267 x 30% = 80) goes to equity rather than the income statement.The share expense of 2,000 is less than the 2,267 tax allowable so the extra (267 x 30% = 80) goes to equity rather than the income statement.The share expense of 2,000 is less than the 2,267 tax allowable so the extra (267 x 30% = 80) goes to equity rather than the income statement.The share expense of 2,000 is less than the 2,267 tax allowable so the extra (267 x 30% = 80) goes to equity rather than the income statement.The share expense of 2,000 is less than the 2,267 tax allowable so the extra (267 x 30% = 80) goes to equity rather than the income statement.
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Entity Reconstructions
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Illustration 1
$ʻ000
Assets 500
500
Equity & Liabilities
Issued Equity Shares @ $1 each 600
Share Premium 100
Retained Earnings -300
Liabilities 100
500
Dividends cannot be paid while accumulated losses exist.
Equity of $600,000 is only backed by assets of $500,000.
Loan finance cannot be raised due to the current financial position.
Required
Apply a capital reduction and restate the statement of financial position.
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Solution
DR CR
Share Premium 100
Equity Share Capital 200
Retained Earnings 300
$ʻ000
Assets 500
500
Equity & Liabilities
Issued Equity Shares 400
Share Premium 0
Retained Earnings 0
Liabilities 100
500
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Illustration 2
$ʻ000
Intangible Asset (Brand) 50,000
Non Current Assets 220,000
270,000
Inventory 20,000
Receivables 30,000
320,000
Equity & Liabilities
Issued Equity Shares @ $1 each 100,000
Share Premium 75,000
Retained Earnings -100,000
75,000
Debenture Loan 125,000
Overdraft 20,000
Payables 100,000
320,000
A reconstruction scheme is to take place under the following conditions:
(i) The equity shares of $1 nominal currently in issue will be written off and will be replaced on a one-for-one basis by new equity shares with nominal value of $0.25.
(ii)The debenture loan will be replaced by the issue of new equity shares - four new shares with nominal value of $0.25 each for every $1 debenture loan converted.
(iii)New shares with a nominal value of $0.25 will be offered to the existing equity holders in the ratio of three new shares for every one currently held. All current equity holders are expected to take this up.
(iv)Share premium account to be eliminated.(v)Brand to be written off as it is impaired.(vi)Deficit on the retained earnings to be eliminated.
Prepare the revised SFP and show any workings undertaken to achieve this.
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SolutionReconstruction AccountReconstruction AccountReconstruction AccountReconstruction Account
DRDR CRCR
New Equity Shares(100,000 x 0.25) Note (i)
25,000 Remove Equity SharesNote (i)
100,000
Conversion of Debenture (125,000 x 4 x 0.25) Note (ii)
125,000 Remove Debenture LoanNote (ii)
125,000
Brand Impairment Note (v)
50,000 Share Premium RemovedNote (iv)
75,000
Retained EarningsNote (vi)
100,000
300,000 300,000
$ʻ000
Intangible Asset (Brand) 0
Non Current Assets 220,000
220,000
Bank (-20,000 + 75,000) Note (iii) 55,000
Inventory 20,000
Receivables 30,000
325,000
Equity & Liabilities
Issued Equity Shares (125,000 + 25,000 + 75,000) 225,000
Share Premium 0
Retained Earnings 0
225,000
Debenture Loan 0
Overdraft 0
Payables 100,000
325,000
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IAS 7Cash Flow Statements
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Illustration 1The group financial statements for Nasser Ltd. show the following information:
X1 X0
NCI on Statement of Financial Position 820 700
NCI share of Profit after Tax 220 130
What was the dividend paid to the NCI in the year X1?
Solution 1
NCINCINCINCI
DRDR CRCR
Balance Brought Forward 700
Share of Profit in X1 220
Dividend Paid to NCI 100
Balance Carried Down 820
920 920
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NCI $
Balance Brought Forward 700
Share of Profit in X1 220
Dividend Paid to NCI (BALANCING FIGURE) -100
Balance Carried Down 820
Illustration 2Indigo Ltd, took up a 40% holding in Violet Ltg. for consideration of $120 in 20X1. Tthe group financial statements for Indigo Ltd. show the following information:
X1 X0
Post tax Income from Associate (Income Statement) 50 0
Investment in Associate (SFP) 150 0
Loan to Associate 20 0
What amounts will be included in the group cash flow statement in the year X1?
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Solution 2
AssociateAssociateAssociateAssociate
DRDR CRCR
Balance Brought Forward 0
Consideration Paid 120
Profit in period 50 Dividend Received 20
Balance Carried Down 150
170 170
Associate $
Balance Brought Forward 0
Consideration 120
Income From Associate 50
Dividend received from Associate (BALANCING FIGURE) -20
Balance Carried Down 150
Amounts for cash flow statementAmounts for cash flow statement $
Income from Associate (Remove from profit before tax) -50
Consideration Paid (Cash paid out) -120
Dividend Received from associate 20
Loan to Associate 0 - 20 -20
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Illustration 3Extracts from the group SFP of Express Ltd are outlined below:
X1 X0
Property Plant & Equipment 50,600 44,050
Inventory 33,500 28,700
Receivables 27,130 26,300
Trade Payables 33,340 32,810
During the period Express Ltd purchased 75% of Delivery Ltd. At the date of acquisition the fair value of the following assets and liabilities were determined:
Property Plant & Equipment 4,200
Inventory 1,650
Receivables 1,300
Payables 1,950
Show the movements in cash for the 4 items outlined above.
Solution 3
X1 X0 Delivery Working Cash
Property Plant & Equipment
50,600 44,050 4,200 (44,050 + 4,200 - 50,600) -2,350
Inventory 33,500 28,700 1,650 (28,700 + 1,650 - 33,500) -3,150
Receivables 27,130 26,300 1,300 (26,300 + 1,300 - 27130) 470
Trade Payables 33,340 32,810 1,950 (32,810 + 1,950 - 33,340) -1,420
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Illustration 4Using the information in illustration 3 show the movements in cash if Express Ltd. Had already owned the subsidiary and sold it during the period.
Solution 4
X1 X0 Delivery Working Cash
Property Plant & Equipment
50,600 44,050 4,200 (44,050 - 4,200 - 50,600) -10,750
Inventory 33,500 28,700 1,650 (28,700 - 1,650 - 33,500) -6,450
Receivables 27,130 26,300 1,300 (26,300 - 1,300 - 27,130) -2,130
Trade Payables 33,340 32,810 1,950 (32,810 - 1,950 - 33,340) 2,480
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Illustration 5
Consolidated Financial Statements for Group.
Group Income Statement $m
Revenue 4,000
COS -2,200
Gross Profit 1,800
Other Expenses -789
Profit from operations 1,011
Gain on sale of sub (Note i) 50
Finance cost (Note ii) -200
PBT 861
Tax -180
Profit after tax 681
Foreign Currency Translations 62
Total Comprehensive Income 743
Attributable to Parent 600
Attributable to NCI 143
Group Statement of Changes in Equity $m
Balance B/F 3,307
Profit Attributable to Parent 600
Dividends Paid -240
Issue of Shares 1000
Balance C/F 4,667
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20X2 20X1
Goodwill 52 72
Property Plant & Equipment 5,900 4,100
Inventories 950 800
Receivables 1,000 900
Cash 80 98
7,982 5,970
Share Capital 3,500 2,500
Retained Earnings 1,167 807
NCI 543 500
Non-Current Liabilities
Obligations under Finance Leases 225 140
Long term borrowings 1,554 1,200
Deferred Tax 278 218
Current Liabilities
Trade Payables 450 400
Accrued Interest 25 20
Income Tax 130 120
Obligations under Finance Leases 45 25
Overdraft 65 40
7,982 5,970
(i) On 1 April 20X2 the parent disposed of a 75% subsidiary for $250m in cash which had the following net assets at the time:# # # # # # $mProperty Plant & Equipment# # 200Inventory# # # # # 100
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Receivables# # # # # 110Cash# # # # # # 10Payables# # # # # (80)Income Tax# # # # # (25)Interest bearing borrowings# # (75)# # # # # # 240
The subsidiary had been purchased several years ago for a cash payment of $110m when itʼs net assets had been $120m.
(ii) Goodwill is measured using the proportionate method
(iii)The following currency differences occurred
Total $m
Parent Share $m
On retranslation of net assets:
Property Plant & Equipment 25 20
Inventories 20 15
Receivables 20 16
Payables -9 -6
56 45
Retranslation of Profit for period 16 12
Offset exchange losses on borrowings (see below)
-10 -10
62 47
The exchange losses on borrowings relate to foreign loans taken out to finance investments in subsidiaries. The accounts assistant has offset these against the retranslation of the net investments in the subsidiaries. The exchange gain on retranslation of the income statement (from average rate for the year to the closing rate) relates to operating profit excluding depreciation.
(iv) Depreciation for the year was $320m and the group disposed of PPE with a net book value of $190m for cash of $198m. the profit on this disposal has been credited to ʻOther operating expensesʼ.
The group entered into a significant number of new finance leases in the period of which $250m related to additions to property, plant & equipment.
Prepare the consolidated cash flow statement for the period.
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SolutionW1 - Disposal of Subsidiary
Goodwill in Disposal SubsidiaryGoodwill in Disposal Subsidiary $m
Cost of Investment 110
Net assets acquired 120 x 75% -90
Goodwill 20
Goodwill (Proof)Goodwill (Proof)Goodwill (Proof)Goodwill (Proof)
DRDR CRCR
Balance b/d 72
Disposal Goodwill 20
Balance c/d 52
72 72
W2 - Working Capital Movements
20X2 20X1 Sub Cash
Inventories 950 800 100 -250
Receivables 1,000 900 110 -210
Payables 450 400 80 130
Total MovementTotal MovementTotal MovementTotal Movement -330
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W3 - NCI
Non Controlling InterestNon Controlling InterestNon Controlling InterestNon Controlling Interest
DRDR CRCR
Balance b/d 500
Disposal of Sub(240 x 25%)
60
Cash Paid to NCI 40 Profit to NCI 143
Balance c/d 543
643 643
W4 - PPE
Property, Plant & EquipmentProperty, Plant & EquipmentProperty, Plant & EquipmentProperty, Plant & Equipment
DRDR CRCR
Balance b/d 4,100
Exchange Differences 25 Subsidiary Disposal 200
Finance Leases 250 Other Disposals 190
Cash Paid 2235 Depreciation 320
Balance c/d 5,900
6610 6610
W4 - Share Capital
20X2 20X1 Movement
3,500 2,500 1,000
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W5 - Finance Leases
Finance LeasesFinance LeasesFinance LeasesFinance Leases
DRDR CRCR
Balance b/d (140 + 25) 165
New Leases 250
Cash Repaid 145
Balance c/d (225 + 45) 270
415 415
W6 - Long Term borrowings
Long Term BorrowingsLong Term BorrowingsLong Term BorrowingsLong Term Borrowings
DRDR CRCR
Balance b/d 1,200
Disposal of Sub 75 Exchange Loss 10
New Borrowings (Cash) -419
Balance c/d (225 + 45) 1,554
1,210 1,210
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W7 - Tax
TaxTaxTaxTax
DRDR CRCR
Balance b/d Income Tax 120
Disposal of Sub 25 Balance b/d Deferred Tax 218
Income Statement 180
Tax Paid 85
Bal c/d Deferred Tax 278
Balance c/d Income Tax 130
518 518
W8 - Interest Payable
Interest PayableInterest PayableInterest PayableInterest Payable
DRDR CRCR
Balance b/d 20
Income Statement 200
Cash Paid 195
Balance c/d 25
220 220
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Cash Flow Statement$m
Profit Before Tax 861
Depreciation 320
FX Differences on Profit 16
FX Differences on Working Capital (10 + 20 -9) 31
Profit on sale of PPE (198 - 190) -8
Gain on Sale of Subsidiary 250 - ((240 x 75%)+ 20)
-50
Finance Expense 200
Working Capital Movements -330
Cash Generated from Operations 1040
Interest Paid -195
Income Taxes Paid -85
Net Cash from Operating activities 760
Cash Flow from Investing Activities
Receipts from the sale of PPE 198
Purchases of PPE (W4) -2,235
Sale of Subsidiary Less cash sold 240
-1,797
Cash Flow from Financing Activities
Issue of Shares 1,000
New Long Term Borrowings (W6) 419
Finance Leases Repaid (W5) -145
Dividends Paid -240
Dividend Paid to NCI (W3) -40
994
Net Decrease in Cash & Cash equivalents -43
Cash b/f (98 - 40) 58
Cash c/f (80 - 65) 15
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IAS 19 (Updated)Pensions
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Illustration 1A company maintains a defined benefit pension scheme for itʼs employees. The following information is relevant:
The pension assets brought forward in 20X0 $1,000 with a closing balance of $2,000.
The Discount Rate is 11%.
Calculate the expected return on Pension Assets.
Solution
Pension Assets Brought Forward 1,000
Expected Return % 11%
Expected Return on Plan Assets 110
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Illustration 2
A company maintains a defined benefit pension scheme for itʼs employees. The following information is relevant:
The liabilities of the scheme were $1,400 at the start of the period and $2,600 at the end.
The discount rate is 12%.
Calculate the Interest Cost for the period.
Solution
Pension Liabilities Brought Forward 1,400
Discount Rate 12%
Interest Cost 168
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Illustration 3 - Try this yourself!The following details refer to Company Aʼs pension scheme.
B/F C/F
Pension Assets 1,000 2,000
Pension Liabilities 1,400 2,600
The discount rate is 11%The discount rate is 11%The discount rate is 11%
Calculate the return on assets and the interest cost.
Solution
Pension Assets Brought Forward 1,000
Expected Return % 11%
Expected Return on Plan Assets 110
Pension Liabilities Brought Forward 1,400
Discount Rate 11%
Interest Cost 154
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Illustration 4A company maintains a defined benefit pension scheme for itʼs employees. The following information is relevant:
The pension assets brought forward in 20X0 $1,800 with a closing balance of $2,700.
The company contributes $90 per year into the scheme.
Benefits paid out in the period were $100.
The liabilities of the scheme were $1,600 at the start of the period and $2,100 at the end.
The discount rate is 12%.
The terms of the scheme have changed meaning that past service costs have arisen of $35 and the current service costs for the period are $70.
Required:
Show the treatment for the pension scheme in the financial statements of the company.
(See Video)
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