p2 workbook q & a pdf

ACCA P2 - Corporate Reporting

Workbook - Questions & Solutions

P2 Corporate Reporting www.mapitaccountancy.com

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Group Accounts




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




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




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




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



Non Controlling Interest

Equity 400 300



700 600




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


300 300

! ! ! !


Cost of Parent Investment 300


(300 x 100%) -300

Goodwill 0




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




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




Illustration 2

Ant Dec

Assets 500 500

Investment in Dec 350

850 500



Equity 350 300

Liabilities 500 200

850 500


Ant today acquired 160m of the 200m shares in Dec.

Required

Prepare the consolidated statement of financial position for the Ant group




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




Goodwill




Working 4 NCI

$


! ! ! ! !Working 5 - Accumulated Profits

$






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




Illustration 2 Solution


Ant

↓80%

Dec

Date Acquired TODAY

Parent Share 80%

NCI 20%

100%

Working 2- Equity Table At Acquisition At Year End



300 300




(300 x 80%) -240

Goodwill 110




Working 4 NCI

$

NCI % of the subsidiaryʼs net assets at the year end (W2) (300 x 20%)

60

! ! ! ! !Working 5 - Accumulated Profits

$


Add: Parent % of the subsidiaryʼs post acquisition profits Nil

250




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




Illustration 4

Evan Dando

Assets 200 350

Investment in Dando 500

Current Assets 200 300

900 650

Ordinary Shares ($1) 200 200


Equity 450 300


Liabilities 170 150

900 650


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.




Solution


↓

Date Acquired

Parent Share

NCI

Working 2 - Equity Table

At Acquisition At Year End

Share Capital

Accumulated Profits

! ! ! !




Goodwill




Working 4 - NCI

$


! ! ! ! !


$






Statement of Financial Position for Evan Group

Evan Dando Group

Goodwill

Assets 200 350

Investment in Dando

500


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




Solution


Evan

↓75%

Dando

Date Acquired 1 Year Ago

Parent Share 75%

NCI 25%

100%





240 300

! ! ! !




(240 x 75%) -180

Goodwill 320




Working 4 - NCI

$


75

! ! ! ! !


$


Add: Parent % of the subsidiaryʼs post acquisition profits (75% x 60m) 45

295




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



Accumulated Profits

250 100 W5 295

NCI W4 75

Equity 450 300 570


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




Illustration 5

Virtual Insanity

Assets 1000 800

Investment in Insanity 600


2000 1000



Equity 1550 500


Liabilities 200 200

2000 1000


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




SolutionWorking 1- Group Structure

Virtual

↓60%

Insanity


Parent Share 60%

NCI 40%

100%

! !





160 500

! ! ! ! ! ! ! !




160 x 60% -96

Goodwill 504

! ! ! !




Working 4 - NCI

$


200

! ! ! ! !


$


Add: Parent % of the subsidiaryʼs post acquisition profits (60% x (500 - 160)

204

954




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



Accumulated Profits

750 400 W5 954

NCI W4 200

Equity 1550 500 1954


250 300 250 + 300 550

Liabilities 200 200 200 + 200 400

2000 1000 2904




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.





$

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




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.





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



600 x 80% -480

Goodwill 320

NCI

NCI % of the subsidiaryʼs net assets 600 x 20% 120




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.




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

$



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




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




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.





Solution

Goodwill

$



800 x 60% -480


$

Fair Value of NCI at acquisition (200 x 40%) x $5 400


(40% x 800) -320


$



Gross Goodwill at acquisition 500




Alternative working



1300


Gross Goodwill 500

NCI

NCI % of the subsidiaryʼs YEAR END net assets 950 x 40% 380


460




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





Solution

Goodwill

$

Cost of Parent Investment 1,000


800 x 75% 600


$

Fair Value of NCI at acquisition 300


(25% x 800) -200


$



Gross Goodwill at acquisition 500




Alternative working

Cost of Parentʼs investment 1,000


1300


Gross Goodwill 500

NCI

NCI % of the subsidiaryʼs YEAR END net assets 3000 x 25% 750


850

or


Plus NCI share of post acquisition profits 2200 x 25% 550

850




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



Equity 1200 600

Liabilities 300 100

1500 700





Jimmy

↓80%

Gent


Parent Share 80%

NCI 20%

100%





Fair Value Adjustment 100 100

Additional Depreciation -20

500 680





$



500 x 80% -400




500 x 20% -100


Gross Goodwill on Acquisition 460

Alternative working



960


Gross Goodwill 460

! ! !




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



850

! ! !

Working 5 - Group Accumulated Profit

$


Add: Parent % of the subsidiaryʼs post acquisition profits 80% x (680 - 500) (W2)

144

644




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


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




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



Equity 900 600

Liabilities 700 200

1500 700





Devil

↓90%

Detail

Date Acquired 2 Years Ago

Parent Share 90%

NCI 10%

100%

Working 2 - Net Assets Subsidiary





Additional Depreciation (2yrs) -50

450 650





$


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

$



180

430




Statement of Financial Position for Devil Group

Devil Detail

Goodwill 1000 W3 595

Assets 600 800 600 + 800 + 100 - 50

14502045

1600 800 2070


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




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



Equity 400 150

Non current liabilities 100 250

Liabilities 300 100

700 600




Solution


Pinky

↓80%

Brain

Date Acquired 4 Years Ago

Parent Share 80%

NCI 20%

100%



Share Capital 50 50


100 150

! ! ! !





$



100 x 80% -80




100 x 20% -20



Alternative working



200


Gross Goodwill 100




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

$


Add Goodwill attributable to NCI (W3) 5

Less Impairment of goodwill 20 x 20% -4

31

or



Less Goodwill Impairment 20 x 20% -4

31

! ! !





$


Less Goodwill Impairment 20 x 80% -16


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



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




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?




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




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?




SolutionWhen cross casting assets & liabilities:

Less Payables $250 (DR)

Plus Cash at bank $50 (DR)

Less Receivables $300 (CR)




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?




SolutionWhen cross casting assets & liabilities:

Less Payables $400 (DR)

Plus Inventory $100 (DR)

Less Receivables $500 (CR)




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


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.




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




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


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.




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




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%.




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





Solution (Margin)

Unsold Inventory Margin PURP

(400 x 3/4) = 300 30% 90

Parent is seller

DR/CR Account $ $




DR/CR Account $ $


72






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.




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


(100 x 1/2) = 50 40% 20

As the Parent is seller

DR/CR Account $ $

DR Cost of sales to increase 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





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.


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 $ $


CR Non current assets to decrease 40

We can then use this to calculate the goodwill on acquisition

$


Less Parent % of the net assets at acquisition

800 x 80% 640



Less NCI% of the net assets at acquisition

800 x 20% 160






Alternative working



2100


Gross Goodwill 1300

Goodwill impairmentGoodwill impairment

Gross Goodwill 1300

Impairment Loss (1300 x 10%) 130

! ! ! ! !The treatment for this is:

DR/CR Account $ $


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




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

! ! !




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




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



Equity 20690 3200

Liabilities 3310 1800

24000 5000




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.




SolutionWorking 1- Group Structure & PURP

Federer

↓90%

Nadal


Parent Share 90%

NCI 10%

100%

! ! ! ! ! ! ! ! ! !PURP


(100 x 1/4) = 25 20% 5

Parent is seller

DR/CR Account $ $




(180 x 1/2) = 90 50/150 30


DR/CR Account $ $


27






Working 2 - Equity TableAt Acquisition At Year End




Additional Depʼn (200 x 1/4) -50

2000 3350

Remember to take the $50m extra depʼn to the income statement! ! ! ! !

Working 3 - Goodwill$



2000 x 90% -1800

Goodwill 2200

! ! ! ! !Working 4 - NCI

SFP$


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




! ! !

Working 5 - Group Accumulated Profit$


PURP 5 + 27 -32


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




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




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.




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




(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.





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






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


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


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




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




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




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.




Solution 23


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




Working 3 - Goodwill$

Fair Value of original investment 45,000

Fair value consideration for second investment

120,000

165,000


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




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




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




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




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.




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




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.




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

$



200 x 80% -160



Less NCI% of the net assets at acquisition 200 x 20% -40






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



Less NCI% of the net assets at acquisition 150 x 52% -78



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




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




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.





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%

!





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

$



22 x 70% -15.4

Goodwill attributable to Parent 34.6



22 x 30% -6.6

Goodwill attributable to NCI 0.4


Impairment -3

Goodwill after Impairment 32




Alternative working



57


Gross Goodwill 35

Impairment -3

Goodwill after Impairment 32

!

Working 3 - Goodwill in Jack

$


Less indirect holding adjustment 17 x 30% -5.1


12 x 42% -5.04




12 x 58% -6.96


Gross Goodwill on Acquisition 9.9




Alternative working


Less indirect holding adjustment -5.1


21.9


Gross Goodwill 9.9




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


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


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

! ! !





$


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




Financial Statements for Ozzy Group


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




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.




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 $


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




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


Fair value of the effective NCI 100 60

Prepare the consolidated statement of financial position for John Group.




Solution 30


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.







PaulPaul RingoRingo

Share Capital 200 200 100 100

Accumulated Profits 250 400 60 100

450 600 160 200

Working 3 - Goodwill in Paul

$



450 x 60% -270




450 x 40% -180

Goodwill attributable to NCI -80


Alternative working



700


Gross Goodwill 250




Working 3 - Goodwill in Ringo

$

Cost of Paul Investment 200

Cost of John Investment 75

Less indirect holding adjustment W1 -80


160 x 66% -105.6




160 x 34% -54.4



Alternative working

Cost of Paulʼs investment 200

Cost of Johnʼs investment 75



255


Gross Goodwill 95




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


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


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$


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




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




Changes in Mixed Groups




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.





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.



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.




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.




IAS 21 Foreign Currency




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)




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.




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.





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




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?




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




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?




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.




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




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


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.




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.






Big

↓80%

Cahoona


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.

! ! !




Working 2 - Equity Table in Functional Currency

At AcquisitionFr

At Year EndFr


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


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




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


$

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




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





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




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




Ethics




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)




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.




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.




IFRS 8 & IAS 33Operating Segments & EPS




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.




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.




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.




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




Illustration 3ABC Ltd. makes a bonus issue of 1 for 6 on 1st July 2009. The year end of the entity is 31st December.


Calculate the EPS at 31st December 2009.

Solution


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




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.


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


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




IFRS 5 & IAS 18AHFS & Revenue

Recognition




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.




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)




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




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.




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)




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).




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.




IAS 19Pensions




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




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




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






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 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.




IFRS 2Share Based Payments




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




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


qualify

Value of option


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




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


qualify

Share Option Price


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




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


qualify

Option Value


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


qualify

Option Value


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




Year Original Charge Additional Charge Total Charge in Year

1 1950 1950

2 2000 593 2593

3 2005 598 2603

Total 5955 1191 7146




IAS 16 & 36Non Current Assets and

Impairment




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




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




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




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.




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




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




IAS 40, 38, 20, 23Investment Property

Intangible AssetsGovernment Grants

Borrowing Costs




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




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.




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




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




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




IAS 17Leases




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




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




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




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.




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




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




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




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




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




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


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





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




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


Depreciation DR CR

Income Statement (15m / 20yrs) 750,000

Accumulated Depʼn 750,000

Summary

Income Statement


Depreciation -750,000

Finance Charge -773,000


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




IAS 37Provisions




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:




(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.




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.




Interim Reporting (IAS 34) & First Time Adoption (IFRS 1)




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




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.




Financial Instruments I




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




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.




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.




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.




Financial Instruments II




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.




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




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.




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.




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.




Financial Instruments II




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




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




IAS 12Deferred Tax




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




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




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.




Entity Reconstructions




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.




Solution

DR CR

Share Premium 100

Equity Share Capital 200

Retained Earnings 300

$ʻ000

Assets 500

500


Issued Equity Shares 400

Share Premium 0

Retained Earnings 0

Liabilities 100

500




Illustration 2

$ʻ000

Intangible Asset (Brand) 50,000

Non Current Assets 220,000

270,000

Inventory 20,000

Receivables 30,000

320,000


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.




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


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




IAS 7Cash Flow Statements




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




NCI $


Share of Profit in X1 220

Dividend Paid to NCI (BALANCING FIGURE) -100


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?




Solution 2

AssociateAssociateAssociateAssociate

DRDR CRCR


Consideration Paid 120

Profit in period 50 Dividend Received 20


170 170

Associate $


Consideration 120

Income From Associate 50

Dividend received from Associate (BALANCING FIGURE) -20


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




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




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




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




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


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




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.




SolutionW1 - Disposal of Subsidiary

Goodwill in Disposal SubsidiaryGoodwill in Disposal Subsidiary $m


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




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




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




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




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




IAS 19 (Updated)Pensions






The Discount Rate is 11%.

Calculate the expected return on Pension Assets.

Solution







Illustration 2

A company maintains a defined benefit pension scheme for itʼs employees. The following information is relevant:


The discount rate is 12%.

Calculate the Interest Cost for the period.

Solution


Discount Rate 12%

Interest Cost 168




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





Discount Rate 11%

Interest Cost 154






The company contributes $90 per year into the scheme.

Benefits paid out in the period were $100.


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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