equity accounting text chap 20 equity accounting text chap 20
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EQUITY ACCOUNTINGTEXT CHAP 20
EQUITY ACCOUNTINGTEXT 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
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
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
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
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
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
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
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
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
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
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
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!!)
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
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
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
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
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
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
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
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
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
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
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
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
Inter-entity transactions
Like consolidations we have to remove the unrealised profits between the investor & the investee
sale of inventory
sale of depreciable asset
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
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
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
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
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
Losses
Losses
Losses should also be adjusted BUT once asset reduced to Zero suspend AASB 1016.
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) ???
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
Tutorial Questions
Exercise 20.1 Exercise 20.3 Exercise 20.4 Problem 20.1 Problem 20.3