equity accounting text chap 20 equity accounting text chap 20

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EQUITY ACCOUNTING TEXT CHAP 20

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Page 1: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

EQUITY ACCOUNTINGTEXT CHAP 20

EQUITY ACCOUNTINGTEXT CHAP 20

Page 2: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Accounting for Investments

Cost method

used in the purchasing company’s books Equity method - AASB 1016

applied when a significant interest exists

often described as one-line consolidation

Consolidation - control– applied when control exists

Page 3: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Application of Equity Accounting

Purpose of the standard is to prescribe the circumstances in which investors must apply the equity method to account for investments in associates

Associates defined : Investment not being

– a Subsidiary

– not a partnership

– investment not acquired for resale

Page 4: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Application of Equity Accounting

Significant influence

– equity accounting is to be applied when a entity has significant influence over an associate company

Defined as :– the capacity of an entity to affect substantially (but not control)

financial & operation of another entity

20% test

– where a company holds 20% or more (without control) then a presumption that significant influence exist

Page 5: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

General description The investor will bring to account, in each

period, its share of the profits or losses of the other company - other than income already received by way of dividends.

AASB 1016

If the investor prepares consolidation then adjust in accounts

or

if not a holding company then adjust in the books of the investor

Page 6: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

example

Investee Ltd- Profit & Loss (25%) Operating Profit 100 000

Dividend Paid 20 000

$80 000

Share of profit 25% $100 000= $25 000already recorded Dividend Paid

25% of $20 000 = $5 000

still to be recorded = $20 000

Page 7: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

example

Investee Ltd- Profit & Loss (25%) Operating Profit 100 000

Dividend Paid 20 000

$80 000

Share of profit 25% $100 000= $25 000already recorded Dividend Paid

25% of $20 000 = $5 000

still to be recorded = $20 000

DR Investment in Associate 20 000 CR Share of Profits in Associate 20 000

DR Investment in Associate 20 000 CR Share of Profits in Associate 20 000

Page 8: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Example- Goodwill

At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $49 375. At this date the shareholders equity section of Bear Ltd consisted of:-

Share Capital 100 000

Reserves 50 000

Retained Profits 20 000

All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost.

Tax Rate 30% -Plant 5 year life- Inventory sold 2001

Any goodwill over 10 years

Page 9: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Example- Goodwill

At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $49 375. At this date the shareholders equity section of Bear Ltd consisted of:-

Share Capital 100 000

Reserves 50 000

Retained Profits 20 000

All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost.

Tax Rate 30% -Plant 5 year life- Inventory sold 2001

Any goodwill over 10 years

Fair Value of Assets acquired

–Capital 100 000

–Reserves 50 000

–Retained Profits 20 000

–Plant .7*10 000 7 000

–Inventory .7*5000 3 500

180 500

25% 45 125

–Cost 49375

–Goodwill $4 250

Fair Value of Assets acquired

–Capital 100 000

–Reserves 50 000

–Retained Profits 20 000

–Plant .7*10 000 7 000

–Inventory .7*5000 3 500

180 500

25% 45 125

–Cost 49375

–Goodwill $4 250

Page 10: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Example- Goodwill

At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $49 375. At this date the shareholders equity section of Bear Ltd consisted of:-

Share Capital 100 000

Reserves 50 000

Retained Profits 20 000

All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost.

Tax Rate 30% -Plant 5 year life- Inventory sold 2001

Any goodwill over 10 years

Amortisation of Goodwill 10% 4 250 = 425Depreciation 20% (25% * 7 000) = 350Inventory 25% 3 500 875

Amortisation of Goodwill 10% 4 250 = 425Depreciation 20% (25% * 7 000) = 350Inventory 25% 3 500 875

Fair Value of Assets acquired

–Capital 100 000

–Reserves 50 000

–Retained Profits 20 000

–Plant .7*10 000 7 000

–Inventory .7*5000 3 500

180 500

25% 45 125

–Cost 49375

–Goodwill $4 250

Fair Value of Assets acquired

–Capital 100 000

–Reserves 50 000

–Retained Profits 20 000

–Plant .7*10 000 7 000

–Inventory .7*5000 3 500

180 500

25% 45 125

–Cost 49375

–Goodwill $4 250

Page 11: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Calculation of Profit

Assume Bear Ltd’s profit after tax $15 000

– Recorded profit

25% of 15 000 3 750

– Pre-acquisition Adjustments Goodwill 425 Depreciation 350 Inventory 875

1 650

Net Adjustment $2 100

Amortisation of Goodwill 10% 4 250 = 425Depreciation 20% (25% * 7 000) = 350Inventory 25% 3 500 875

Amortisation of Goodwill 10% 4 250 = 425Depreciation 20% (25% * 7 000) = 350Inventory 25% 3 500 875

Page 12: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Entry in Books orConsolidation Adjustment

Assume Bear Ltd’s profit after tax $15 000

– Recorded profit

25% of 15 000 3 750

– Pre-acquisition Adjustments Goodwill 425 Depreciation 350 Inventory 875

1 650

Net Adjustment $2 100

EntryDr Investment in Bear Ltd 2 100 Cr Revenue from Associate 2 100

EntryDr Investment in Bear Ltd 2 100 Cr Revenue from Associate 2 100

Page 13: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Consolidation Adjustment- following year

Assume Bear Ltd’s profit after tax $15 000

– Recorded profit

25% of 15 000 3 750

– Pre-acquisition Adjustments Goodwill 425 Depreciation 350 Inventory 875

1 650

Net Adjustment $2 100

EntryDr Investment in Bear Ltd 2 100 Cr Retained profits 2 100(No entry if adjusted in BOOKS!!)

EntryDr Investment in Bear Ltd 2 100 Cr Retained profits 2 100(No entry if adjusted in BOOKS!!)

Page 14: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Example- Discount

At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $44 125. At this date the shareholders equity section of Bear Ltd consisted of:-

Share Capital 100 000

Reserves 50 000

Retained Profits 20 000

All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost.

Tax Rate 30% -Plant 5 year life- Inventory sold 2001

Any goodwill over 10 years

Page 15: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Example- Discount

At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $44 125. At this date the shareholders equity section of Bear Ltd consisted of:-

Share Capital 100 000

Reserves 50 000

Retained Profits 20 000

All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost.

Tax Rate 30% -Plant 5 year life- Inventory sold 2001

Any goodwill over 10 years

Carrying Fair Amount ValuePlant 86 000 96 000Inventory 21 000 26 000

Carrying Fair Amount ValuePlant 86 000 96 000Inventory 21 000 26 000

Page 16: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Example- Discount

At 1 July 2000 Teddy Ltd acquired 25% of Bear Ltd’s share capital for $44 125. At this date the shareholders equity section of Bear Ltd consisted of:-

Share Capital 100 000

Reserves 50 000

Retained Profits 20 000

All assets @ Fair Values except Plant has a fair value of $10 000 greater than carrying amount & Inventory $5 000 greater than cost.

Tax Rate 30% -Plant 5 year life- Inventory sold 2001

Any goodwill over 10 years

Fair Value of Assets acquired

–Capital 100 000

–Reserves 50 000

–Retained Profits 20 000

–Plant .7*10 000 7 000

–Inventory .7*5000 3 500

180 500

25% 45 125

–Cost 44 125

–Discount $1 000

Fair Value of Assets acquired

–Capital 100 000

–Reserves 50 000

–Retained Profits 20 000

–Plant .7*10 000 7 000

–Inventory .7*5000 3 500

180 500

25% 45 125

–Cost 44 125

–Discount $1 000

Page 17: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Allocation of Discount

Fair Value 25% Discount Cost BV(25%) Adj

Plant 96 000 24 000 797 23203

Inventory

24 500* 6 125 203 5922 5250 672

120 500 30 125 3 000

*21 000+.7*5000

Page 18: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Allocation of Discount

Fair Value 25% Discount Cost BV(25%) Adj

Plant 96 000 24 000 797 23203

Inventory

24 500* 6 125 203 5922 5250 672

120 500 30 125 3 000

*21 000+.7*5000

Depreciation of Plant 20% of 797= 159Inventory adjustment = 672

Depreciation of Plant 20% of 797= 159Inventory adjustment = 672

Page 19: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Calculation of Profit

Assume Profit - $15 000

(after tax)

Share of Recorded Profit

25% 15 000 3 750

Pre-acquisition Adjustment

Depreciation 191 *

Cost of Sales 672

$2 887

* 20% of 25% (.7* 10 000)-159

Depreciation of Plant 20% of 797= 159Inventory adjustment = 672

Depreciation of Plant 20% of 797= 159Inventory adjustment = 672

Page 20: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Calculation of Profit

Assume Profit - $15 000

(after tax)

Share of Recorded Profit

25% 15 000 3 750

Pre-acquisition Adjustment

Depreciation 191 *

Cost of Sales 672

$2 887

* 20% of 25% (.7* 10 000)-159

entryInvestment in Bear Ltd 2 887 Revenue from Associate 2 887

entryInvestment in Bear Ltd 2 887 Revenue from Associate 2 887

Page 21: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Additional Adjustments Interim Dividends Paid

The carrying amount has to be reduced for any dividend adjustments- otherwise the profit would be double counted

ie Company has recorded as Dividend Income & Equity accounting has recorded total profit

Dividends Provided

– accounted for as for interim dividend as assumed that investor records as dividend receivable ie taken up as income

Preference Dividend

If regarded as equity then this must be deducted fron the profit to arrive at the profit available to ordinary shareholders

Page 22: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

example Investee Ltd- Profit & Loss (25%)

Year 1 Year 2

Operating Profit 100 000 200 000

Dividend Provided 20 000 -

$80 000 200 000

Share of profit 25% $300 000= $75 000 Recorded as follows:-

– Year 1 Equity 25%(100 000-20 000) 20 000

– plus in books as Dividend Receivable 5 000

– Year 2 Equity 25%(200 000) 50 000

– $75 000

Page 23: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Example- dividend paid or provided

Recorded Profit 100 000

Less- Adjustments

Dividends Paid or Provided 20 000

Total $ 80 000

Share of Profit 25% $ 20 000

Page 24: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Example- dividend paid or provided

Recorded Profit 100 000

Less- Adjustments

Dividends Paid or Provided 20 000

Total $ 80 000

Share of Profit 25% $ 20 000

entryInvestment in Bear Ltd 20 000 Revenue from Associate 20 000

entryInvestment in Bear Ltd 20 000 Revenue from Associate 20 000

Page 25: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Increase/Decrease in Reserves

Asset Revaluation ReserveCarrying amount must be increased/ decreased

for adjustments to reserves

eg Company has revalued its assets by $100 000

Dr Investment in Associate 25 000

CR Asset Revaluation Reserve 25 000

Page 26: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Inter-entity transactions

Like consolidations we have to remove the unrealised profits between the investor & the investee

sale of inventory

sale of depreciable asset

Page 27: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Sale of Inventory

Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period

Tax 30% Recorded profit 30 000

Adjustment

Inventory in Closing stock -1 400 #

$ 28 600

# Unrealised Profit .7*2 000

Page 28: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Sale of Inventory

Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period

Tax 30% Recorded profit 30 000

Adjustment

Inventory in Closing stock -1 400 #

$ 28 600

# Unrealised Profit .7*2 000

entryInvestment in Bear Ltd 7 150 Revenue from Associate 7 15025% 28600

entryInvestment in Bear Ltd 7 150 Revenue from Associate 7 15025% 28600

Page 29: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Sale of Inventory- opening inventory

Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period

Tax 30% Recorded profit 30 000

Adjustment

Inventory in Closing stock -1 400

$ 28 600 Following period

Recorded Profit 40 000

Adj- Opening Inventory +1 400

$41 400

Page 30: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Sale of Inventory- opening inventory

Investee Ltd sells goods to Investor Ltd $5 000. Cost Investee $3 000. Unsold at end of period

Tax 30% Recorded profit 30 000

Adjustment

Inventory in Closing stock -1 400

$ 28 600 Following period

Recorded Profit 40 000

Adj- Opening Inventory +1 400

$41 400

entryInvestment in Bear Ltd 10 350 Revenue from Associate 10 35025% $41 400

entryInvestment in Bear Ltd 10 350 Revenue from Associate 10 35025% $41 400

Page 31: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Sale of Depreciable Asset Investee Ltd sells an item of Plant to Investor for $8 000. Book value $3

000. Further 5 years life. (tax 30%) Recorded Profit 40 000

– Adjustments

Unrealised profit -3 500 (Gain .7 *$ 5 000)

Realised Profit

(3500/5) +700 (Depreciation)

$37 200 Following Year

Recorded Profit 40 000

Realised Profit +700

$40 700

Page 32: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Losses

Losses

Losses should also be adjusted BUT once asset reduced to Zero suspend AASB 1016.

Page 33: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Investee Ltd- Profit & Loss (25%) Operating Loss 400 000

Share of Loss 25% $400 000= $100 000

Assume paid $50 000– General ledger:

Shares in Investee Ltd

dr cr Balance

1/1/xx Cash 50 000 50 000

30/6/99 Equity -loss 100 000 (50 000) ???

Page 34: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Investee Ltd- Profit & Loss (25%) Operating Loss 400 000

Share of Loss 25% $400 000= $100 000

Assume paid $50 000– General ledger:

Shares in Investee Ltd

dr cr Balance

1/1/xx Cash 50 000 50 000

30/6/99 Equity -loss 50 000 Nil

ie SUSPEND using equity accounting

Page 35: EQUITY ACCOUNTING TEXT CHAP 20 EQUITY ACCOUNTING TEXT CHAP 20

Tutorial Questions

Exercise 20.1 Exercise 20.3 Exercise 20.4 Problem 20.1 Problem 20.3