ACCA P2 - Corporate Reporting - Mapit Accountancy
Transcript of ACCA P2 - Corporate Reporting - Mapit Accountancy
P2 Corporate Reporting www.mapitaccountancy.com
ACCA P2 - Corporate Reporting
Workbook - Questions & Solutions
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Group Accounts
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Illustration 1
Additional Information
Almeria today acquired all the shares in Murcia for $300m.
The Fair Value of the NCI at acquisition was 0.
Required
Prepare the consolidated statement of financial position for the Almeria group
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
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Pro-Forma
Working 1 - Group Structure
Working 2 - Equity Table
Working 3 - Goodwill
Almeria
Murcia
Date Acquired
Parent Share
NCI
At Acquisition At Year End
Share Capital
Accumulated Profits
Cost of Parent Investment
Fair Value of NCI at acquisition
Less net assets at acquisition (W2)
Goodwill
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Working 4 - NCI
Working 5 - Accumulated Profits
$
Fair Value of NCI at acquisition
NCI% of Sub Post-Acq Profits
Value of NCI at Year End
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
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SFP for Almeria Group
Almeria Murcia Group
Non Current Assets
Goodwill
Tangible 100 100
Investment in Murcia 300
Current Assets
Inventory 40 200
Receivables 60 100
Cash 200 200
700 600
Ordinary Shares 160 100
Accumulated Profits 240 200
Non Controlling Interest
Equity 400 300
Non Current Liabilities 100 200
Current Liabilities 200 100
700 600
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Solution
Working 1 - Group Structure
Working 2 - Equity Table
Working 3 - Goodwill
Almeria
↓100%
Murcia
Date Acquired TODAY
Parent Share 100%
NCI 0%
At Acquisition At Year End
Share Capital 100 100
Accumulated Profits 200 200
300 300
Cost of Parent Investment 300
Fair Value of NCI 0
Less net assets at acquisition (W2) -300
Goodwill 0
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Working 4 - NCI
Working 5 - Accumulated Profits
$
Fair Value of NCI at acquisition 0
NCI% of Sub Post-Acq Profits 0
Value of NCI at Year End 0
$
Parent’s Accumulated Profits 240
Add: Parent % of the subsidiary’s post acquisition profits Nil
240
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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
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Illustration 2
Additional Information
Ant today acquired 160m of the 200m shares in Dec.
The Fair Value of the NCI was 50.
Required
Prepare the consolidated statement of financial position for the Ant group
Ant Dec
Assets 500 500
Investment in Dec 350
850 500
Ordinary Shares 100 200
Accumulated Profits 250 100
Equity 350 300
Liabilities 500 200
850 500
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Illustration 2 Pro-Forma
Working 1- Group Structure
Working 2- Equity Table
Working 3 - Goodwill
↓
Date Acquired
Parent Share
NCI
At Acquisition At Year End
Share Capital
Accumulated Profits
Cost of Parent Investment
Fair Value of NCI at acquisition
Less net assets at acquisition (W2)
Goodwill
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Working 4 - NCI
Working 5 - Accumulated Profits
$
Fair Value of NCI at acquisition
NCI% of Sub Post-Acq Profits
Value of NCI at Year End
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
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Statement of Financial Position for Ant Group
Illustration 2 Solution
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
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Working 1- Group Structure
Working 2- Equity Table
Working 3 - Goodwill
Working 4 - NCI
Ant
↓80%
Dec
Date Acquired TODAY
Parent Share 80%
NCI 20%
100%
At Acquisition At Year End
Share Capital 200 200
Accumulated Profits 100 100
300 300
Cost of Parent Investment 350
Fair Value of NCI at acquisition 50
Less net assets at acquisition (W2) -300
Goodwill 100
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Working 5 - Accumulated Profits
Statement of Financial Position for Ant Group
$
Fair Value of NCI at acquisition 50
NCI% of Sub Post-Acq Profits 0
Value of NCI at Year End 50
$
Parent’s Accumulated Profits 250
Add: Parent % of the subsidiary’s post acquisition profits Nil
250
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Illustration 3
Ant Dec Group
Goodwill W3 100
Assets 500 500 500 + 500 1000
Investment in Dec
350 Cancelled in Goodwill W3
Nil
850 500 1100
Ordinary Shares
100 200 Parent Only 100
Accumulated Profits
250 100 W5 250
NCI W4 50
Liabilities 500 200 500 +200 700
850 500 1100
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Additional Information
Evan acquired 150m shares in Dando one year ago when the reserves of Dando were $40m. The Fair Value of the NCI on the date of acquisition was $100m.
Required
Prepare the consolidated statement of financial position for the Evan group.
Solution
Evan Dando
Assets 200 350
Investment in Dando 500
Current Assets 200 300
900 650
Ordinary Shares ($1) 200 200
Accumulated Profits 250 100
Equity 450 300
Non Current Liabilities 280 200
Liabilities 170 150
900 650
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Working 1- Group Structure
Working 2 - Equity Table
Working 3 - Goodwill
↓
Date Acquired
Parent Share
NCI
At Acquisition At Year End
Share Capital
Accumulated Profits
Cost of Parent Investment
Fair Value of NCI at acquisition
Less net assets at acquisition (W2)
Goodwill
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Working 4 - NCI
Working 5 - Accumulated Profits
Statement of Financial Position for Evan Group
$
Fair Value of NCI at acquisition
NCI% of Sub Post-Acq Profits
Value of NCI at Year End
$
Parent’s Accumulated Profits
Add: Parent % of the subsidiary’s post acquisition profits
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Solution
Evan Dando Group
Goodwill
Assets 200 350
Investment in Dando
500
Current Assets 200 300
900 650
Ordinary Shares ($1)
200 200
Accumulated Profits
250 100
NCI
Equity 450 300
Non Current Liabilities
280 200
Liabilities 170 150
900 650
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Working 1- Group Structure
Working 2 - Equity Table
Working 3 - Goodwill
Working 4 - NCI
Evan
↓75%
Dando
Date Acquired 1 Year Ago
Parent Share 75%
NCI 25%
100%
At Acquisition At Year End
Share Capital 200 200
Accumulated Profits 40 100
240 300
Cost of Parent Investment 500
Fair Value of NCI at acquisition 100
Less net assets at acquisition (W2) -240
Goodwill 360
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Working 5 - Accumulated Profits
Statement of Financial Position for Evan Group
$
Fair Value of NCI at acquisition 100
NCI% of Sub Post-Acq Profits (25% x 60m) 15
Value of NCI at Year End 115
$
Parent’s Accumulated Profits 250
Add: Parent % of the subsidiary’s post acquisition profits (75% x 60m) 45
295
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Illustration 4
Evan Dando Group
Goodwill W3 360
Assets 200 350 200 + 350 550
Investment in Dando
500 Cancelled out in W3.
Nil
Current Assets 200 300 200 + 300 500
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Ordinary Shares ($1)
Parent Only 200
Accumulated Profits
W5 295
NCI W4 115
570
Non Current Liabilities
280 200 280 + 200 480
Liabilities 170 150 170 + 150 320
1410
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Additional Information
Virtual acquired 60m shares in Insanity one year ago when the reserves of Insanity were $60m. The Fair Value of the NCI at that date was $120m.
Required
Prepare the consolidated statement of financial position for the Virtual group
SolutionWorking 1- Group Structure
Virtual Insanity
Assets 1000 800
Investment in Insanity 600
Current Assets 400 200
2000 1000
Ordinary Shares ($1) 800 100
Accumulated Profits 750 400
Equity 1550 500
Non Current Liabilities 250 300
Liabilities 200 200
2000 1000
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Working 2 - Equity Table
Working 3 - Goodwill
Working 4 - NCI
Virtual
↓60%
Insanity
Date Acquired 1 Year Ago
Parent Share 60%
NCI 40%
100%
At Acquisition At Year End
Share Capital 100 100
Accumulated Profits 60 400
160 500
Cost of Parent Investment 600
Fair Value of NCI at acquisition 120
Less net assets at acquisition (W2) -160
Goodwill 560
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Working 5 - Accumulated Profits
Statement of Financial Position for Virtual Group
$
Fair Value of NCI at acquisition 120
NCI% of Sub Post-Acq Profits (40% x (500 - 160))
136
Value of NCI at Year End 256
$
Parent’s Accumulated Profits 750
Add: Parent % of the subsidiary’s post acquisition profits (60% x (500 - 160)
204
954
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Illustration 5
Virtual Insanity Group
Goodwill W3 560
Assets 1000 800 1000 + 800 1800
Investment in Insanity
600 Cancelled in W3
Nil
Current Assets 400 200 400 + 200 600
2000 1000 2960
Ordinary Shares ($1)
800 100 Parent Only 800
Accumulated Profits
750 400 W5 954
NCI W4 256
Equity 1550 500 1954
Non Current Liabilities
250 300 250 + 300 550
Liabilities 200 200 200 + 200 400
2000 1000 2960
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Jabba acquired 100% of the shares in Hutt two years ago.
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 four years after the date of acquisition. The relevant
discount rate is 12%4. If the group meets certain targets there will be a further payment with fair
value of $60,000 at a later date.
Required:
(i) Calculate the fair value of the consideration which Jabba has given in purchasing the investment in Hutt.
(ii)Show the value of the liability in the Statement of Financial Position for the deferred consideration at the end of the current year.
(iii)What is the charge to the Statement of Profit or Loss in the current period related to the deferred consideration?
Illustration 5 Solution
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Illustration 6
On 1 October 2012, Paradigm acquired 75% of Strata’s 20,000 equity shares by means of a share exchange of two new shares in Paradigm for every five acquired shares in Strata. In addition, Paradigm issued to the shareholders of Strata a $100 10% loan note for every 1,000 shares it acquired in Strata. The share price of Paradigm on the date of acquisition was $2.
Calculate the consideration paid for Strata.
Solution
Share exchange ((20,000 x 75%) x 2/5 x $2) $12,00010% loan notes (15,000 x 100/1,000) $1,500
Illustration 7
$
Cash Amount 36,000
Shares Market Value (2000 x 3) 6,000
Deferred Consideration 30,000 x (1 / (1.124) 19080
Contingent Consideration Fair Value 60,000
Total 121080
Year O’Bal Unwind (12%) C’Bal
1 19,080 2,290 21,370
2 21,370 2,564 23,934
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Jimmy acquired 80% of Gent 1 year ago. The following information relates to Gent at the date of acquisition.
An item of plant was valued at $200 in the Gent’s Financial Statements but had a Fair Value of $300, the plant had a remaining life of 5 yrs at the date of acquisition. Goodwill is to be calculated gross.
Solution
Accumulated profits at
acquisition
Cost of investment Fair Value of NCI at acquisition
$ $ $
150 800 160
Jimmy Gent
Investment in Gent 800
Assets 700 700
1500 700
Ordinary Shares ($1) 700 250
Accumulated Profits 500 350
Equity 1200 600
Liabilities 300 100
1500 700
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Working 1- Group Structure
Working 2 - Equity Table
Working 3 - Goodwill
Jimmy
↓80%
Gent
Date Acquired 1 Year Ago
Parent Share 80%
NCI 20%
100%
At Acquisition At Year End
Share Capital 250 250
Accumulated Profits 150 350
Fair Value Adjustment 100 100
Additional Depreciation -20
500 680
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Alternative working
Working 4 - NCI
Cost of Parent’s investment 800
Fair value of NCI at acquisition (Market Value) 160
960
Less 100% net assets at acquisition in W2 -500
Gross Goodwill 460
$
Cost of Parent Investment 800
Less Parent % of the net assets at acquisition (W2)
500 x 80% -400
Goodwill attributable to Parent 400
Fair Value of NCI at acquisition 160
Less NCI% of the net assets at acquisition (W2)
500 x 20% -100
Goodwill attributable to NCI 60
Gross Goodwill on Acquisition 460
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Working 5 - Group Accumulated Profit
Statement of Financial Position for Jimmy Group
Fair Value of NCI at acquisition 300
Plus NCI share of post acquisition profits 2200 x 25% 550
850
$
Parent’s Accumulated Profits 500
Add: Parent % of the subsidiary’s post acquisition profits 80% x (680 - 500) (W2)
144
644
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Illustration 8
Jimmy Gent Group
Goodwill W3 460
Investment in Gent
800 Cancelled Nil
Assets 700 700 700 + 700 + 100 - 20
1480
1500 700 1940
Ordinary Shares ($1)
700 250 Parent only 700
Accumulated Profits
500 350 W5 644
NCI W4 196
Equity 1200 600 1540
Liabilities 300 100 300 + 100 400
1500 700 1940
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Devil acquired 90% of Detail 2 years ago. The following information relates to Gent at the date of acquisition.
An item of plant was valued at $300 in the Gent’s Financial Statements but had a Fair Value of $200.
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 Gross.
Solution
Accumulated profits at
acquisitionCost of
investmentFair Value of NCI
at acquisition
$ $ $
250 1000 55
Devil Detail
Investment in Detail 1000
Assets 600 800
1600 800
Ordinary Shares ($1) 650 100
Accumulated Profits 250 500
Equity 900 600
Liabilities 700 200
1500 700
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Working 1- Group Structure
Working 2 - Net Assets Subsidiary
Working 3 - Goodwill
Devil
↓90%
Detail
Date Acquired 2 Years Ago
Parent Share 90%
NCI 10%
100%
At Acquisition At Year End
Share Capital 100 100
Accumulated Profits 250 500
Fair Value Adjustment -100 -100
Additional Depreciation (2yrs) 50
250 550
300
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Working 4 - NCI
Working 5 - Group Accumulated Profit
Statement of Financial Position for Devil Group
Cost of Parent’s investment 1000
Fair value of NCI at acquisition (Market Value) 55
1055
Less 100% net assets at acquisition in W2 -250
Gross Goodwill 805
Fair Value of NCI at acquisition 55
Plus NCI share of post acquisition profits 10% x 300 (W2) 30
85
$
Parent’s Accumulated Profits 250
Add: Parent % of the subsidiary’s post acquisition profits 90% x 300 (W2)
270
520
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Illustration 9
Devil Detail
Goodwill 1000 W3 805
Assets 600 800 600 + 800 - 100 + 50
1350
1600 800 2155
Ordinary Shares ($1)
650 100 Parent 650
Accumulated Profits
250 500 W5 520
NCI W4 85
Equity 900 600
Liabilities 700 200 700 + 200 900
1500 700 2155
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Evaro Co. Acquired 80% of Stando Co. one year ago and the following detail is relevant:
At the date of acquisition the following was relevant:
i) An item of plant was valued at $100m in the Gent’s Financial Statements but had a Fair Value of $50m, the plant had a remaining life of 10 yrs at the date of acquisition.
ii)Stando Co. owns an internally generated brand worth $20m on the date of acquisition that has a useful economic life of 20 years.
iii)At the date of acquisition a court case against Stando Co. is in process which has resulted in a contingent liability of $25m being disclosed in their financial statements. By the year end Stando Co. had won the court case resulting with no payment as a result.
Required
Compete the Equity Table (W2) based on the above information for Stando. Co.
Solution
At Acquisition$m
At Year End$m
Share Capital 100 100
Accumulated Profits 250 500
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Illustration 10
At Acquisition$m
At Year End$m
Share Capital 100 100
Accumulated Profits 250 500
Fair Value of Plant -50 -50
Remove Depreciation (50/10) 5
Brand 20 20
Amortization on Brand -1
Contingent Liability -25 0
295 574
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Brad acquires 80% of Angelina’s 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 Angelina’s share price is $8. Brad’s share price is $5. At the date of acquisition the net assets of Angelina are $600.
Calculate the gross goodwill and the NCI.
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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
Alternative working
Illustration 11
Cost of Parent’s investment 800
Fair value of NCI at acquisition (Market Value) 160
960
Less 100% net assets at acquisition in W2 -600
Gross Goodwill 360
$
Cost of Parent Investment 800
Less Parent % of the net assets at acquisition (W2)
600 x 80% -480
Goodwill attributable to Parent 320
Fair Value of NCI at acquisition (100 x 20%) x $8 160
Less NCI% of the net assets at acquisition (W2)
(20% x 600) -120
Goodwill attributable to NCI 40
Gross/Full Goodwill 360
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Brad acquires 80% of Angelina’s 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. Brad’s share price is $5. At the date of acquisition the net assets of Angelina are $600 and by the year end they were $800.
Calculate the goodwill arising using the proportionate method and the NCI.
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Illustration 11 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
NCI
Cost of Parent Investment 800
NCI Value at acquisition (600 x 20%) 120
Net assets at acquisition (W2) -600
Goodwill 320
NCI at acquisition 600 x 20% 120
NCI% Post Acquisition Profit (800 - 600) x 20% 40
160
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Illustration 12
(i)Archie acquires 60% of Mitchell’s 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. At the year end the retained earnings of Archie were $1,000.
An impairment review has been carried out on the goodwill at the year end which has found it to be impaired by $40.
Calculate the gross goodwill, the retained earnings and the NCI at the year end.
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Solution
Goodwill
NCI
Cost of Parent’s investment 900
Fair value of NCI at acquisition (200 x 40% x $5) 400
1300
Less 100% net assets at acquisition in W2 -800
Gross Goodwill 500
Impairment -40
Post Impairment Goodwill 460
Dr W4 16
Dr W5 24
Fair Value of NCI at Acquisition 400
NCI% Post Acquisition Profit (950 - 800) x 40% 60
NCI Share of Impairment -16
444
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Retained Earnings
Parent 1000
NCI% Post Acquisition Profit (950 - 800) x 60% 90
Parent Share of Impairment -24
1066
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Illustration 12 (ii)
French acquired 75% of Shambles several years ago.
If French has $1500 of retained earnings at the year end, calculate the gross goodwill, retained earnings for the group and the NCI at the year end.
Cost of Investment
Fair Value of NCI at
acquisition
Net assets at acquisition
Net assets at year end
Goodwill Impairment at
Y/E
$ $ $ $ $
1,000 300 800 3,000 200
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Solution
Goodwill
NCI
Cost of Parent’s investment 1,000
Fair value of NCI at acquisition (Market Value) 300
1300
Less 100% net assets at acquisition in W2 -800
Gross Goodwill 500
Impairment -200
Post Impairment Goodwill 300
DR W4 50
DR W5 150
Fair Value of NCI at acquisition 300
Plus NCI share of post acquisition profits 2200 x 25% 550
Impairment -50
800
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Retained Earnings
Parent 1500
NCI% Post Acquisition Profit 2200 x 75% 1650
Parent Share of Impairment -150
3000
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Illustration 12 (iii)
Pinky acquired 80% of Brain 4 years ago. The following information is relevant:
Goodwill is calculated gross and is subject to an annual impairment review.
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
Pinky Brain
Investment in Pinky 175
Assets 100 100
Inventory 140 200
Receivables 160 100
Bank 125 200
700 600
Ordinary Shares ($1) 160 50
Accumulated Profits 240 100
Equity 400 150
Non current liabilities 100 250
Liabilities 300 100
700 600
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Solution
Working 1- Group Structure
Working 2 - Net Assets Subsidiary
Pinky
↓80%
Brain
Date Acquired 4 Years Ago
Parent Share 80%
NCI 20%
100%
At Acquisition At Year End
Share Capital 50 50
Accumulated Profits 50 100
100 150
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Working 3 - Goodwill
Impairment
Working 4 - NCI
Cost of Parent’s investment 175
Fair value of NCI at acquisition (Market Value) 25
200
Less 100% net assets at acquisition in W2 -100
Gross Goodwill 100
Impairment Review
Carrying Value of asset Net Assets + Goodwill (150 + 100) 250
Less Recoverable amount -230
Impairment Loss 20
Goodwill after impairment
Gross Goodwill 100
Impairment Loss -20
Goodwill after impairment 80
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Working 5 - Group Accumulated Profit
Fair Value of NCI at acquisition 25
Plus NCI share of post acquisition profits 50 x 20% 10
Less Goodwill Impairment 20 x 20% -4
31
$
Parent’s Accumulated Profits 240
Less Goodwill Impairment 20 x 80% -16
Add: Parent % of the subsidiary’s post acquisition profits 80% x (100 - 150) (W2)
40
264
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Statement of Financial Position for Pinky Group
Pinky Brain Group
Goodwill W3 80
Assets 100 100 100 + 100 200
Inventory 140 200 140 + 200 340
Receivables 160 100 160 + 100 260
Bank 125 200 125 + 200 325
700 600 1205
Ordinary Shares ($1)
160 50 Parent Only 160
Accumulated Profits
240 100 W5 264
NCI W4 31
Equity 400 150 455
Non current liabilities
100 250 100 + 250 350
Liabilities 300 100 300 + 100 400
700 600 1205
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Illustration 13 (i)
George owns 80% of the subsidiary Bungle. During the impairment review it was found that the carrying value of Bungle’s 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?
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Solution
Gross 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.
Impairment Review
Carrying Value of asset 250
Grossed up Goodwill 375
Less Recoverable amount -500
Impairment Loss 125
Goodwill on Balance Sheet
Proportionate goodwill 300
Share of Impairment (125 x 80%) -100
Goodwill after impairment 200
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Illustration 13 (ii)
Event owns 90% of the subsidiary Horizon. During the impairment review it was found that the carrying value of Horizons net assets were $5,000 and the goodwill $2,337. The recoverable amount of the subsidiary is $6,000 and goodwill is calculated on a proportionate basis.
What amount of goodwill will appear on the group SFP?
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Solution
Gross up proportionate goodwill
Proportionate Goodwill 2,000
Gross this up (2,337 x 100/90) 2,597
We will use this grossed up value for goodwill in the impairment review.
Impairment Review
Net Assets of Sub 5,000
Grossed up Goodwill 2,597
Less Recoverable amount -6,000
Impairment Loss 1,597
Goodwill on SFP
Proportionate goodwill 2,000
Share of Impairment (1,597 x 90%) -1,437
Goodwill after impairment 563
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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?
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SolutionWhen cross casting assets & liabilities:
Less Payables $250 (DR)
Plus Cash at bank $50 (DR)
Less Receivables $300 (CR)
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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?
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SolutionWhen cross casting assets & liabilities:
Less Payables $400 (DR)
Plus Inventory $100 (DR)
Less Receivables $500 (CR)
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Illustration 16Arctic is the parent of a subsidiary Monkeys. Extracts of their SFPs are below
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.
Arctic Monkeys
Current Assets
Inventory 300 100
Receivables 200 250
Bank 100 50
600 400
Current Liabilities 420 220
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SolutionRemember!
Add the goods/cash in transit
Subtract the inter company current accounts
+/- Item Where? $m
+ Cash in transit Cash at Bank 10
+ Goods in transit Inventory 25
- Inter Company Current Account Payables 35
- inter Company Current Account Receivables 70
Arctic Monkeys Group
Current Assets
Inventory 300 100 300 + 100 + Goods in transit of 25
425
Receivables 200 250 200 + 250 - 70 inter company current account
380
Bank 100 50 100 + 50 + cash in transit 10
160
600 400 965
Current Liabilities 420 220 420 + 220 - inter company current account 35
605
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Illustration 17Sea is the parent of a subsidiary Lion. Extracts of their SFPs are below
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.
Sea Lion
Current Assets
Inventory 400 250
Receivables 100 100
Bank 150 100
650 450
Current Liabilities 90 140
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SolutionRemember!
Add the goods/cash in transit
Subtract the inter company current accounts
+/- Item Where? $m
+ Cash in transit Cash at Bank 15
+ Goods in transit Inventory 15
- Inter Company Current Account Payables 20
- inter Company Current Account Receivables 50
Sea Lion Group
Current Assets
Inventory 400 250 400 + 250 + Goods in transit of 15
665
Receivables 100 100 100 + 100 - 50 inter company current account
150
Bank 150 100 150 + 100 + cash in transit 15
265
650 450 965
Current Liabilities 90 140 90 + 140 - inter company current account 20
210
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Illustration 18Inter company sales of $400 have occurred in Attila group at a mark up on cost of 25%. At the year end 1/4 of these goods had been sold on. Attila has an 80% interest in Hun.
I. Calculate the PURP.
II. Show the accounting treatment if the parent company is the seller.
III. Show the accounting treatment if the subsidiary company is the seller.
IV. Do parts I - III if the goods had been sold at a margin of 30%.
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Solution (Mark-up)
Parent is seller
Subsidiary is seller
Unsold Inventory Mark-up PURP
(400 x 3/4) = 300 25/125 60
DR/CR Account $ $
DR Accumulated Profits (W5) to decrease 60
CR Inventory to decrease 60
DR/CR Account $ $
DR Accumulated Profits (W5) with parent share to decrease (60 x 80%)
48
DR NCI (W4) with subsidiary share to decrease 12
CR Inventory to decrease 60
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Solution (Margin)
Parent is seller
Subsidiary is seller
Unsold Inventory Margin PURP
(400 x 3/4) = 300 30% 90
DR/CR Account $ $
DR Accumulated Profits (W5) to decrease 90
CR Inventory to decrease 90
DR/CR Account $ $
DR Accumulated Profits (W5) with parent share to decrease (90 x 80%)
72
DR NCI (W4) with subsidiary share to decrease 18
CR Inventory to decrease 90
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Illustration 19Argentina owns an 80% share of Messi which it purchased one year ago.
The information below relates to Messi at the date of acquisition.
The income statements for both are:
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 Messi’s 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.
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
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
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Illustration 19 SolutionWorking 1- Group Structure
Working 2 - Inter Company
PURP
As the Parent is seller
Remember to remove the total amount of the sales also from sales and cost of sales
Argentina
↓80%
Messi
Date Acquired 1 Year Ago (No time apportionment)
Parent Share 80%
NCI 20%
100%
Unsold Inventory Margin PURP
(100 x 1/2) = 50 40% 20
DR/CR Account $ $
DR Cost of sales to increase 20
CR Inventory to decrease 20
DR/CR Account $ $
DR Revenue to decrease 100
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Working 3 - Goodwill
We don’t 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.
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:
We can then use this to calculate the goodwill on acquisition
CR Cost of sales to decrease 100
DR/CR Account $ $
At Acquisition At Year End
Share Capital 200 N/A
Accumulated Profits 400 N/A
Fair Value Adjustment (Balancing figure)
200 N/A
800 N/A
DR/CR Account $ $
DR Cost of sales to increase 40
CR Non current assets to decrease 40
Cost of Parent’s investment 1900
Fair value of NCI at acquisition (Market Value) 200
2100
Less 100% net assets at acquisition in W2 -800
Gross Goodwill 1300
Goodwill impairment
Gross Goodwill 1300
Impairment Loss (1300 x 10%) 130
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The treatment for this is:
Working 4 - Cost of Sales
Working 5 - NCI
DR/CR Account $ $
DR Cost of sales to increase 130
CR Goodwill Intangible Asset to decrease 130
$m
Parent 4000
Subsidiary 1000
Less Inter Company Sales -100
Plus the PURP 20
Plus additional depreciation 40
Plus impairment loss 130
5090
$
NCI % of the subsidiary’s 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
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Income statement for Argentina Group
Statement of Changes in Equity Pro-forma
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) 804
Attributable to NCI (W5) 6
810
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Share Capital
Share Premium
Revaluation Reserve
Accumulated Profits
NCI Total
O’Balance 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)
Cl’Balance X X X X X X
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Illustration 20Nadal is a 90% subsidiary of Federer. It was acquired one year ago for $4000m. At that time the accumulated profits were $800m.Income Statements
Statements of Financial Position
Federer Statement of changes in Equity
Federer 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
Federer Nadal
Investment in Nadal 4000
Assets 20000 5000
24000 5000
Share Capital 5000 1000
Accumulated Profits 15690 2200
Equity 20690 3200
Liabilities 3310 1800
24000 5000
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Nadal Statement of changes in Equity
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 Nadal’s 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.
Share Capital Accumulated Profits
Total Equity
Opening Balance 5000 12600 17600
Profits for the year 3290 3290
Less Dividends -200 -200
Closing Balance 5000 15690 20690
Share Capital Accumulated Profits
Total Equity
Opening Balance 1000 800 1800
Profits for the year 1500 1500
Less Dividends -100 -100
Closing Balance 1000 2200 3200
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SolutionWorking 1- Group Structure & PURP
PURP
Parent is seller
Subsidiary is seller
Federer
↓90%
Nadal
Date Acquired 1 Year Ago
Parent Share 90%
NCI 10%
100%
Unsold Inventory Margin PURP
(100 x 1/4) = 25 20% 5
DR/CR Account $ $
DR Accumulated Profits (W5) to decrease 5
CR Inventory to decrease 5
Unsold Inventory Margin PURP
(180 x 1/2) = 90 50/150 30
DR/CR Account $ $
DR Accumulated Profits (W5) with parent share to decrease (30 x 90%)
27
DR NCI (W4) with subsidiary share to decrease 3
CR Inventory to decrease 30
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Working 2 - Equity Table
Remember to take the $50m extra dep’n to the income statement!
Working 3 - Goodwill
Working 4 - NCISFP
Income Statement
At Acquisition At Year End
Share Capital 1000 1000
Accumulated Profits 800 2200
Fair Value Adjustment 200 200
Additional Dep’n (200 x 1/4) -50
2000 3350
$
Cost of Parent Investment 4000
Less Parent % of the net assets at acquisition (W2)
2000 x 90% -1800
Goodwill 2200
$
NCI % of the subsidiary’s net assets at the year end (W2) 3350 x 10% 335
PURP W1 -3
332
$
NCI Percentage of profit from question 1500 x 10% 150
Additional Depreciation 50 x 10% -5
PURP W1 -3
142
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Working 5 - Group Accumulated Profit
Income Statement
$
Parent’s Accumulated Profits 15690
PURP 5 + 27 -32
Add: Parent % of the subsidiary’s post acquisition profits 90% x (2000 - 3350) (W2)
1215
16873
Federer Nadal Group
Revenue 20000 4000 20000 + 4000 - 100 - 180
23720
Cost of Sales -12000 -2000 12000 + 2000 - 100 - 180 - 35 - 50
-13805
Gross Profit 8000 2000 9915
Distribution Costs -2100 -300 2100 + 300 -2400
Admin Expenses -1400 -500 1400 + 500 -1900
Operating Profit 1500 1200 5615
Exceptional Gain Nil 580 580
Investment Income 90 Nil Nil
Finance Costs -600 -150 600 + 150 -750
Profit Before Tax 3990 1630 5445
Tax -700 -130 700 + 130 -830
Profit for the year 3290 1500 4615
Attributable to Parent (Balancing Figure) 4473
Attributable to NCI W4 142
4615
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Statement of Financial Position
Statement of changes in Equity
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
Share Capital Accumulated Profits
NCI Total Equity
Opening Balance
5000 12600 200 17800
Profits for the year
4473 142 4615
Less Dividends -200 -10 210
Closing Balance
5000 16873 332 22205
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Associates(IAS 28)
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Illustration 1
3 years ago Star Ltd. bought 25% of the share capital of Wars Ltd. for consideration of $400,000. Since that time Wars Ltd.has had the following results:
Due to poor trading results and customer service issues, Star Ltd feel that in the current year the investment in Wars Ltd. has been impaired by $20,000.
Show the treatment of War Ltd. in the statement of financial position of Star Group and in the Income statement for the 3 years of the investment.
Solution
Year Profit Dividend Paid By Associate
1 $200,000 0
2 $160,000 $150,000
3 $30,000 0
Year 1 Investment In Associate (SFP)
Initial Investment 400,000
Parent Share of Post Acquisition Profit (200,000) x 25% 50,000
Investment in Associate 450,000
Year 1 Income From Associate (Income Statement)
Parent share of Current Year Income (200,000 x 25%) 50,000
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Year 2 Investment In Associate (SFP)
Initial Investment 400,000
Parent Share of Post Acquisition Profit (200,000 + 160,000) x 25% 90,000
Share of Dividend (150,000 x 25%) -37,500
Investment in Associate 452,500
Year 2 Income From Associate (Income Statement)
Parent share of Current Year Income (160,000 x 25%) 40,000
Year 3 Investment In Associate (SFP)
Initial Investment 400,000
Parent Share of Post Acquisition Profit (200,000 + 160,000 + 30,000) x 25% 97,500
Share of Dividend (150,000 x 25%) -37,500
Impairment -20,000
Investment in Associate 440,000
Year 3 Income From Associate (Income Statement)
Parent share of Current Year Income (30,000 x 25%) 7500
Impairment -20,000
Loss From Associate -12500
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Illustration 2
Inter company sales of $1,300 have occurred in Attila group at a mark up on cost of 30%. At the year end 1/2 of these goods had been sold on. Attila has an 30% 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 Associate company is the seller.
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Solution (Mark-up)
Parent is seller
Subsidiary is seller
Unsold Inventory Mark-up PURP Group %
(1300 x 1/2) = 650 30/130 150 45
DR/CR Account $ $
DR Accumulated Profits (W5) to decrease 45
CR Investment in Associate 45
DR/CR Account $ $
DR Accumulated Profits (W5) to decrease 45
CR Group Inventory 45
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Illustration 3
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 25500 26000
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 35000 29000
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(i) At the date of acquisition the fair values of Sander’s property, plant and equipment was equal to its carrying amount with the exception of Sander’s factory which had a fair value of $2 million above its carrying amount. Sander has not adjusted the carrying amount of the factory as a result of the fair value exercise. This requires additional annual depreciation of $100,000 in the consolidated financial statements in the post-acquisition period.
(ii)Also at the date of acquisition, Sander had an intangible asset of $500,000 for software in its statement of financial position. Picant’s directors believed the software to have no recoverable value at the date of acquisition and Sander wrote it off shortly after its acquisition.
(iii)At 31 March 2010 Picant’s current account with Sander was $3·4 million (debit). This did not agree with the equivalent balance in Sander’s books due to some goods-in-transit invoiced at $1·8 million that were sent by Picant on 28 March 2010, but had not been received by Sander until after the year end. Picant sold all these goods at cost plus 50%.
(iv)Picant’s policy is to value the non-controlling interest at fair value at the date of acquisition. For this purpose Sander’s share price at that date can be deemed to be representative of the fair value of the shares held by the non-controlling interest.
(v)Impairment tests were carried out on 31 March 2010 which concluded that the value of the investment in Adler was not impaired but, due to poor trading performance, consolidated goodwill was impaired by $3·8 million.
(vi)Assume all profits accrue evenly through the year.
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Working 1- Group Structure
Consideration for Sander
Consideration for Alder
Picant
↓75% ↓40%
Sander Alder
Sander
Date Acquired 1 April 2009 (1 Yr ago)
Parent Share 75
NCI 25
100
Item $‘000
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 Consideration 33,000
Item $‘000
Cash Fair Value (4 x (5000 x 40%)) 8,000
Loan Notes (5000 x 40%) / 50 x 100 4,000
Total Consideration 12,000
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Working 2 - Net Assets Subsidiary
Working 3 - Goodwill in Sander
At Acquisition At Year End
Share Capital 8,000 8,000
Accumulated Profits 16,500 17,500
Fair Value of Factory 2,000 2,000
Additional Dep’n -100
Software -500
26000 27400
$‘000 $‘000
Cost of Parent Investment 33,000
Fair Value of NCI at acquisition (8,000 x 25%) x $4.5
9,000
Less net assets at acquisition (W2) -26,000
Gross Goodwill on Acquisition 16,000
Impairment -3,800
Goodwill at year end 12,200
Impairment to Parent in W5 (3,800 x 75%) 2,850
Impairment to NCI in W4 (3,800 x 25%) 950
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Alternative Working
Working 4 - NCI
$‘000 $‘000
Cost of Parent Investment 33,000
Less Parent % of the net assets at acquisition (W2)
26,000 x 75% 19,500
Goodwill attributable to Parent 13,500
Fair Value of NCI at acquisition (8,000 x 25%) x $4.5
9,000
Less NCI% of the net assets at acquisition (W2)
26,000 x 25% 6,500
Goodwill attributable to NCI 2,500
Gross Goodwill on Acquisition 16,000
Impairment -3,800
Goodwill at year end 12,200
Impairment to Parent in W5 (3,800 x 75%) 2,850
Impairment to NCI in W4 (3,800 x 25%) 950
$
Fair Value of NCI at Acquisition 9,000
NCI Share of Post Acq. Profit (25% x 1,400) 350
Goodwill Impairment to NCI (W3) -950
8400
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Alternative Working
Working 5 - PURP & Group Accumulated Profit
PURP
Group Accumulated Profit
$
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
8400
Total Unsold Goods Profit on Goods PURP
1,800 1,800 /150 x 50 600
DR Retained Earnings (W5) 600
CR Inventory (SFP) 600
$
Parent’s Accumulated Profits 27,200
Add: Parent % of Sub’s 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
27500
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Working 6 - Associate
SFP
$‘000
Cost of Parent’s Investment (W1) 12,000
Post Acquisition Profits ((6000 x 6/12) x 40%) 1,200
13,200
Picant 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 25500 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 35000 114,100
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Increasing/Decreasing Holding
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Illustration 1Vic 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 gain or loss arising on the subsequent acquisition of shares
Solution 1
Fair value of original investment 45,000
Less the cost of the original investment -17,000
Gain taken to income statement 28,000
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Illustration 2Vic 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 2
Working 1- Group Structure
Working 2 - Revaluation
Vic
↓10% ↓45%
Bob
Date 10% Acquired Years Ago
Date 45% Acquired Now
Parent Share 55%
NCI 45%
1
Fair value of original investment 45,000
Less the cost of the original investment -17,000
Gain taken to income statement 28,000
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Working 3 - Goodwill
Fair value of original investment 45,000
Fair value of consideration for second investment 120,000
165,000
Fair value of NCI at acquisition 90,000
Less 100% net assets at acquisition -60,000
Gross Goodwill 195,000
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Illustration 3Aldo purchased 15% of the shares in Giro several years ago. The investment cost $85,000 and they currently carry it at cost in the accounts. Aldo has subsequently purchased 75% of the shares in Giro for $700,000. The net assets of Giro have a fair value of $750,000 and the fair value of the original investment is now $145,000. The fair value of the NCI on acquisition was $180,000.
Calculate the gross goodwill arising on the acquisition of Giro.
Solution 3
Working 1- Group Structure
Working 2 - Revaluation
Aldo
↓15% ↓75%
Giro
Date 15% Acquired Years Ago
Date 75% Acquired Now
Parent Share 90%
NCI 10%
1
Fair value of original investment 145,000
Less the cost of the original investment -85,000
Gain taken to income statement 60,000
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Working 3 - Goodwill
Fair value of original investment 145,000
Fair value of consideration for second investment 700,000
845,000
Fair value of NCI at acquisition 180,000
Less 100% net assets at acquisition -750,000
Gross Goodwill 275,000
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Illustration 4A parent has owned 70% of a subsidiary for a long period of time. The NCI in the subsidiary is currently measured at $500,000. If the parent buys another 10% what will the value of the NCI fall to?
Solution 4
$
Current NCI value (30% holding) 500,000
Proportion being purchased (500,000 x 10/30) 166,667
New Value of NCI (500,000 - 166,667) 333,333
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Illustration 5A 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 5
I.
II.
$
Amount of cash paid for subsequent investment 250,000
Decrease in the NCI 300,000
Difference to an equity reserve 50,000
$
Amount of cash paid for subsequent investment 200,000
Decrease in the NCI 300,000 x 3/10 90,000
Difference to an equity reserve -110,000
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Illustration 6Inter 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 it’s entire holding for $350,000.
II. Calculate the gain arising on disposal if Inter sells 30% for $250,000 and the fair value of the residual value is $30,000
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Solution 6I.
II.
$
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
$
Sale Proceeds 250,000
Less net assets of sub at date of disposal -100,000
Less all goodwill remaining at disposal -80,000
Plus all NCI at date of disposal 18,000
Plus fair value of any residual holding 30,000
Gain to group 118,000
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Illustration 7For several years Jeremy has owned 70% of Richard. The net assets of Richard at this time are $250,000. The NCI is $68,000 and the gross goodwill is $200,000.
Jeremy has just sold 15% to take the holding to 55% for consideration of $150,000. Calculate the difference arising that will be taken to equity.
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Solution 7
$
DR Amount of cash received for sale of subsequent investment 150,000
CR Increase in the NCI (% of net assets & goodwill)
15% x (250,000 + 200,000) 67,500
CR Difference to an equity reserve (Gain) 82,500
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Vertical Groups
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Illustration 1Consider a group with the following structure and detail:
Required
Calculate the Goodwill & the NCI at the acquisition date.
P
↓80% - 1 Year Ago
S
↓60% - 1 Year Ago
S1
Cost of Investment
Net Assets on Acquisition
FV NCI on Acquisition
S 250 200 60
S1 220 150 100
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Working 1 - Effective Interest in S1
Working 2 - Goodwill in S
Working 3 - Goodwill in S1
Working 4 - NCI
Working Total
P’s Direct Interest in S 80%
Non Controlling Interest in S 20%
100%
P’s indirect interest in S1 (80% x 60%) 48%
Non Controlling Interest in S1 (Balancing figure) 52%
100%
$
Cost of Parent Investment 250
Fair Value of NCI at acquisition 60
Less net assets at acquisition -200
Goodwill attributable to Parent 110
$
Cost of Investment 220
Less indirect holding adjustment 220 x 20% -44
Fair Value of NCI at acquisition 100
Less net assets at acquisition -150
Goodwill attributable to Parent 126
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$
Fair Value of NCI at Acquisition in S 60
Fair Value of NCI at Acquisition in S1 100
Less indirect holding adjustment -44
116
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Illustration 2Ozzy acquired a 70% holding in Sharon 2 years ago. Sharon purchased a 60% shareholding in Jack one year ago. The following financial statements relate to the Ozzy group.
Statements of Financial Position Ozzy Sharon Jack
$ $ $
Investment in Sharon 50
Investment in Jack 17
Other assets 25 18 20
75 35 20
Ordinary Shares 50 20 8
Accumulated profits 20 12 8
Equity 70 32 16
Liabilities 5 3 4
75 35 20
Income Statements Ozzy Sharon Jack
$ $ $
Revenue 400 60 85
Operating Costs -395 55 -83
Operating Profit 5 5 2
Tax -3 -2 -1
Profit for Year 2 3 1
Accumulated Profits Sharon Jack
One year ago 3 4
Two years ago 2 3
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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.
Fair Value of NCI based on effective shareholdings Sharon Jack
One year ago 8 10
Two years ago 7 6
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SolutionWorking 1- Group Structure
Ozzy’s effective Interest in Jack
Ozzy
↓70% - 2 Years Ago
Sharon
↓60% - 1 Year Ago
Jack
Working Total
Ozzy’s direct interest in Jack 0%
Ozzy’s indirect interest (via Sharon) (70% x 60%) 42%
Ozzy’s effective interest in Jack 0.42
Non Controlling Interest in Jack (Balancing figure) 0.58
100%
Ozzy’s Direct Interest in Sharon 70%
Non Controlling Interest in Sharon 30%
100%
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Working 2 - Equity Table
Working 3 - Goodwill in Sharon
At Acquisition At Year End
At Acquisition At Year End
Sharon Jack
Share Capital 20 20 8 8
Accumulated Profits 2 12 4 8
22 32 12 16
Cost of Parent’s investment 50
Fair value of NCI at acquisition (Market Value) 7
57
Less 100% net assets at acquisition in W2 -22
Gross Goodwill 35
Impairment -3
Goodwill after Impairment 32
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Working 3 - Goodwill in Jack
Working 4 - NCI
Working 5 - Group Accumulated Profit
Cost of Parent’s investment 17
Less indirect holding adjustment -5.1
Fair value of NCI at acquisition (Market Value) 10
21.9
Less 100% net assets at acquisition in W2 -12
Gross Goodwill 9.9
Fair Value of Sharon’s NCI at acquisition 7
Fair Value of Jack’s NCI at acquisition 10
Less indirect holding adjustment -5.1
Plus Sharon NCI share of post acquisition profits (32-22) x 30% 3
Plus Jack NCI share of post acquisition profits (16-12) x 58% 2.32
Less NCI share of Sharon Goodwill Impairment 3 x 30% -0.9
16.32
$
Parent’s Accumulated Profits 20
Less Goodwill Impairment 3 x 70% -2.1
Add: Parent % of Sharon’s post acquisition profits 10 x 70% 7
Add: Parent % of the Jack’s post acquisition profits 4 x 42% 1.68
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Working 6 - NCI (Income Statement)
Financial Statements for Ozzy Group
26.58
$
Sharon Jack
NCI % of Profit in Question (30% x 3) 0.9 (1 x 58%) 0.58
NCI Share Goodwill Impairment (30% x 3) -0.9
NCI Share Group Profit -0.00 0.58
Total 0.58
Statement of Financial Position
Ozzy Sharon Jack Group
$ $ $
Goodwill W3 41.9
Other assets 25 18 20 25 + 18 +20 63
104.9
Ordinary Shares 50 20 8 50
Accumulated profits 20 12 8 W5 26.58
NCI W4 16.32
Equity 70 32 16 92.9
Liabilities 5 3 4 5 + 3 + 4 12
104.9
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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 + 3 (G’will Imp)
528
Operating Profit 9
Tax -3 -2 -1 3 + 2 + 1 -6
Profit for Year 3
Attributable to parent (Balancing figure) 2.42
Attributable to NCI (W6) 0.58
3
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Indirect Associates
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Illustration 1
The parent has an 60% holding in the subsidiary. The subsidiary has an associate in which it holds 40%. The following information is relevant.
Show the treatment for the associate in the group financial statements.
Subsidiary’s 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
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Solution 1
Effective interest & NCI
Parent’s’s indirect interest (via Sub) (60% x 40%) 24%
NCI (Balancing figure) 16%
Parent’s effective interest 40%
Post Acquisition Profits
Fair value of net assets in associate at year end 300
Fair value of net assets in associate at acquisition -120
Post acquisition profits 180
Carrying Value of Associate $
Cost of Investment 200
Subsidiary share of post acquisition profits (40% x 180) 72
Carrying Value of Associate 272
Treatment
DR Investment in Associate 40% x 180 72
CR Equity W5 (Parent share of post acquisition profits)
24/40 x 72 43.2
CR NCI W4 (NCI share of post acquisition profits) 16/40 x 72 28.8
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Mixed Groups
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Illustration 1The statements of financial position for 3 companies are as follows:
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:
Prepare the consolidated statement of financial position for John Group.
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
Paul Ringo
Accumulated Profits 250 60
Fair value of the effective NCI 100 60
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Solution 1
Working 1- Group Structure
Effective interest & NCI
Indirect Holding Adjustment
Use this to reduce the cost of investment in W3 and the NCI in W4.
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.
John’s direct interest in Ringo 30%
John’s indirect interest in Ringo (60% x 60%) 36%
John’s effective interest in Ringo 66%
Effective NCI in Ringo 100% - 66% 34%
NCI in Paul Paul’s investment in Ringo
40% X 200 = 80
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Working 2 - Net Assets Subsidiary
Working 3 - Goodwill in Paul
Working 3 - Goodwill in Ringo
At Acquisition At Year End
At Acquisition At Year End
Paul Ringo
Share Capital 200 200 100 100
Accumulated Profits 250 400 60 100
450 600 160 200
Cost of Parent’s investment 600
Fair value of NCI at acquisition (Market Value) 100
700
Less 100% net assets at acquisition in W2 -450
Gross Goodwill 250
Cost of Paul’s investment 200
Cost of John’s investment 75
Less indirect holding adjustment -80
Fair value of NCI at acquisition (Market Value) 60
255
Less 100% net assets at acquisition in W2 -160
Gross Goodwill 95
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Working 4 - NCI
Working 5 - Group Accumulated Profit
Fair Value of Paul NCI at acquisition 100
Fair Value of Ringo NCI at acquisition 60
Less indirect holding adjustment -80
Plus Paul NCI share of post acquisition profits (600-450) x 40% 60
Plus Ringo NCI share of post acquisition profits (100 - 60) x 34% 13.6
153.6
$
Parent’s Accumulated Profits 700
Add: Parent % of Paul’s post acquisition profits 150 x 60% 90
Add: Parent % of Ringo’s post acquisition profits 40 x 66% 26.4
816.4
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Statement of financial position for John Group
John Paul Ringo Group
Goodwill W3 (95 + 250)
345
Assets 900 700 400 900 + 700 + 400
2,000
2,345
Share Capital 300 200 100 Parent 300
Accumulated Profits
700 400 100 W5 816
NCI W4 154
Equity 1,270
Liabilities 575 300 200 500 + 300 +200
1,075
2,345
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Changes in Mixed Groups
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Solutions to Lecture Illustrations
Working Total
A’s direct interest in C 25%
A’s indirect interest (via B) (90% x 70%) 63%
A’s effective interest in C 0.88
Non Controlling Interest in C (Balancing figure) 12%
100%
Working Total
D’s direct interest in F 30%
D’s indirect interest (via E) (70% x 40%) 28%
D’s effective interest in F 0.58
Non Controlling Interest in F (Balancing figure) 0.42
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 D’s 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.
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Action Result
D invests in E in 2008 D owns 70% of E making it a subsidiary
E invests in F in 2009 E owns 40% of F making it an associate as E has significant influence and D controls that influence.
D invests in F in the current year This makes D’s 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.
Working Total
G’s direct interest in I 80%
G’s indirect interest (via H) (90% x 10%) 9%
G’s effective interest in I 0.89
Non Controlling Interest in I (Balancing figure) 0.11
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 G’s 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.
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Action Result
G invests in H in 2008 G owns 90% of H making it a subsidiary
H invests in I in 2009 I is a simple investment of 10%
G invests in I in the current year This makes G’s 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.
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IAS 21 Foreign Currency I & II
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Illustration 1Which of the following statements relating to IAS 21 The effects of changes in foreign exchange rates is correct?
A. The functional currency of a foreign subsidiary is the currency that the group financial statements are presented in.
B. A foreign subsidiary must present it’s financial statements in the presentational currency of the parent.
C. Consideration will be given to the currency of the costs and sales of the entity when determining it’s functional currency.
D. The more autonomous a subsidiary, the more likely it’s functional currency is that of the parent entity.
Answer C
Illustration 2Bulldog Ltd has a year end of 31 January.
On 13th October Bulldog Ltd buys goods from Eagle Inc. a US supplier for $250,000.
On 24th November Bulldog settles the transaction in full.
Exchange rates
13th October £1 : $1.45
24th November £1 : $1.55
Show the accounting entries for these transactions.
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Illustration 2 Solution
Agreeing Transaction Working £
On date of agreeing the transaction use the spot rate to record it
250,000 / 1.45
172,414
DR Purchases 172,414
CR Payables 172,414
On Settlement Working £
On date of agreeing the transaction use the spot rate to record it
250,000 / 1.55
161,290
DR Payables 172,414
CR Cash with amount actually paid 161,414
CR FX Gain with the difference 11,000
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Illustration 3Jeff Ltd. purchases an item of plant on 1st June from a foreign supplier on one month’s credit for €100,000. Jeff is a US company.
Exchange rates
1st June $ = €1.50
21st June $ = €1.40
How will this transaction be dealt with in the accounts for the year to 21st June?
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Solution to Illustration 3
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........
DR FX Loss (71,429 - 66,666) 4,763
CR Payables (71,429 - 66,666) 4,763
The $4,763 is unrealised so is included in Other Comprehensive Income.
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Illustration 4
Big Ltd. acquired 80% of Cahoona Inc. on 1st July 20X1.Cahoona Inc are based in Burgerland where the functional currency is Francs (Fr). The financial statements for the year to 30 June 20X2 are below.
SFP Big$
CahoonaFr
Investment in Cahoona 5000
Non Current Assets 10,000 3,000
Current Assets 5,000 2,000
20000 5,000
Share Capital 6,000 1,500
Retained Earnings 4,000 2,500
Liabilities 10,000 1,000
20,000 5,000
Income Statement Big$
CahoonaFr
Revenue 25,000 35,000
Operating Costs -15,000 -26,250
Profit Before Tax 10,000 8,750
Tax -5,000 -7,450
Profit for the Year 5,000 1,300
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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.The NCI is valued using the Fair Value method at FR 2000 at acquisition.
IV. The Goodwill in Cahoona was impairment tested at the year end and was impaired by FR200. The impairment was deemed to have accrued evenly over the year so the average rate should be used to treat it.
Exchange rates to $1:
Fr1 July 2001 1.5Average rate 1.751 June 1.930 June 2
Prepare the group statement of financial position and statement of other comprehensive income.
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Illustration 4 Solution
Working 1- Group Structure
Working 2 - Equity Table in Functional Currency
Big
↓80%
Cahoona
Date Acquired 1 Year Ago
Parent Share 80%
NCI 20%
100%
At AcquisitionFr
At Year EndFr
Share Capital 1,500 1,500
Accumulated Profits 1,200 2,500
Fair Value Adjustment on land (Balancing figure)
3,300 3,300
6,000 7,300
Translate at 1.5 2
Total Net Assets in $ 4000 3650
Post acquisition Loss including FX movements -350
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Working 3 - Goodwill in Functional Currency
Working 4 - NCI
Fr Fr
Cost of Parent Investment (5,000 @ 1.5) 7,500
Fair Value NCI 2,000
Less net assets at acquisition (W2) -6,000
Goodwill 3,500
Translated at closing rate (3500 / 2) $1,750
Impairment -$114
Remaining Goodwill To SFP $1,636
Add Back Impairment (200 / 1.75) $114
Goodwill at Opening Rate (3500 / 1.5) -$2,333
FX Loss on Goodwill for Year -$583
$
Fair Value of NCI at Acquisition Rate (2000 / 1.5) 1,333
NCI% Post Acquisition Loss (W2) (20% x -350) -70
NCI % Goodwill Impairment in Year (20% x -114) -22.8
NCI% Goodwill FX Loss (20% x -583) -117
1,124
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Working 5 - Group Accumulated Profit
Statement of Financial Position
$
Parent’s Accumulated Profits 4,000
Share of Sub Post-Acq Loss (80% x -350) -280
Parent% Goodwill Impairment in Year (80% x -114) -91
Parent% Goodwill FX loss (80% x -583) -466
3,162
SFP Big Cahoona $
Non Current Assets 10,000 ((3,000 + 3,300) / 2) = 3,150
13,150
Goodwill (W3) 1636
Current Assets 5,000 (2000 / 2) 6000
20786
Share Capital 6,000 Parent 6,000
Retained Earnings 4,000 W5 3162
NCI W4 1124
Liabilities 10,000 ((1,000 / 2) 10500
20,000 0 20786
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FX Gains/Losses for year
NCI Share Profit/Loss for Period
Closing Net Assets at Cl. Rate (W2) (7300 / 2) 3650
Comprehensive Income for Year at Ave. Rate (1300 / 1.75)
-743
Opening Net Assets at Op. Rate (6000 / 1.5) -4000
FX Loss for Year on Net Assets -1,093
FX Loss for Year on Goodwill (W3) -583
Total FX Loss for the year -1,676
NCI Share Profit in Period 20% x 1300 260
NCI Share Goodwill Impairment 20% x 200 -40
Share of Profit in FR 220
Translate at Ave. Rate (220 / 1.75) 126
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Statement of Comprehensive Income
Big Cahoonas Adjustment $
Revenue 25,000 (35,000 / 1.75) Inter Co-1,000
44,000
Operating Costs -15,000 (26,250 / 1.75 Inter Co-1,000
-29,000
Profit Before Tax 15,000
Tax -5000 (7,450 / 1.75) -9,257
Profit for the Year 5,743
Profit Attributable to:
Parent (Balance) 5,617
Non Controlling Interest 126
5,743
Comprehensive Income
Profit for the Year 5,743
FX differences on translation of foreign operations (W6) -1,676
4,067
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Ethics
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Illustration 1Jocatt 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 directors’ 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 1�144
P2 Corporate Reporting www.mapitaccountancy.com
i.
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 entity’s competitors.
An issue in the use of the indirect method for users is the abuse of the classifications of specific cash flows such as cash outflows which should have been reported in the operating section being classified as investing cash outflows with the result that companies enhance operating cash flows.
A problem for users is the fact that entities can choose the method used and there is not enough guidance on the classification of cash flows in the operating, investing and financing sections of the indirect method used in IAS 7.
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ii.
The directors main reason for wishing to do this is to manipulate the income of the firm.
The complex nature of the indirect method as discussed previously means that the directors are attempting to confuse users who do not have a detailed understanding of cash flow accounting.
The information provided by directors should be a faithful representation which is unbiased so that information disclosed is truthful and neutral. They have a responsibility to perform in an ethical manner.
The reliance of users on the information provided for investment decisions means that the directors must put aside their own self interest to provide information that is true and fair.
They may be tempted to manipulate the income of the firm for several reasons:
i. To gain performance related bonuses.ii.To protect the share price of the firm.iii.To ensure that their jobs are safe and reputations enhanced.
Regardless of the personal impact on the directors they must act independently and objectively in the application of the accounting standards reporting the loan as cash flows from financing activities.
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IFRS 8 & IAS 33Operating Segments & EPS
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Illustration 1Norman, 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 ‘Operating Segments’. The results of the regional segments for the year ended 31 May 20X8 are as follows:
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 ‘Operating Segments’ for the determination of a company’s reportable operating segments and how these principles would be applied for Norman plc using the information given above.
RegionRevenue Segmental
Profit/LossSegmental
AssetsSegmentalLiabilitiesExternal Internal
$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
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Solution
Requirements of IFRS 8
IFRS 8 requires operating segments to be identified based on the management structure and reporting system in the entity. The components that are reviewed regularly by the CEO in order to allocate resources and assess performance will form the segments.
The standard seeks to enable users to view information on the business operations which fully discloses the financial effects of the different areas and types of operations undertaken.
Under the standard an operating segment is defined as a component:
I. That engages in business activities from which it may earn revenues and incur expenses (even if the revenues & expenses are with other components in the entity).
II. Whose operating results are reviewed regularly by the entity’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance; and for which discrete financial information is available
An operating segment will be a reportable segment if it meets the following criteria:
I. Revenues (internal & external) are more than 10% of combined revenue.
II. Profit or loss is more than 10% of combined total.
III. Assets are more than 10% of combined total.
75% or more of the entities external revenue must be reported by operating segments. If not then, other segments must be identified even if they do not meet the criteria for reportable segments until 75% is reported.
Application to Norman
The KPIs used by the management of Norman are based on city so it may well be that the operating segments of Norman could be split further on a city basis.
Norman should investigate their reporting structure to evaluate whether decisions about allocation and performance are made within the entity on a city basis and consider splitting the segments further.
Regarding the current segments, only the South East Asia segment passes all 3 tests for a reportable segment. The European segment meets only the criteria for 10% + of reported revenue and fails on the others.
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The current reported segments report only 50% of the entity’s total external revenue so they will have to identify further operating segments regardless of whether they meet the criteria until the reach 75%.
By examining the internal reports of Norman the entity can determine whether the operating segments should be further split based on the information used by management.
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Illustration 2An entity issued 300,000 shares at full market price on 1st July 2009. The year end of the entity is 31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st December 2009 was $1,000,000.
Calculate the EPS at 31st December 2009.
Solution
Date Shares Months Fraction Ave
1/01/09 900,000 6/12 - 450,000
1/07/09 1,200,000 6/12 - 600,000
1,050,000
EPS = 1,000,000 / 1,050,000 = 95.24c
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Illustration 3ABC Ltd. makes a bonus issue of 1 for 6 on 1st July 2009. The year end of the entity is 31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st December 2009 was $1,000,000.
Calculate the EPS at 31st December 2009.
Solution
Date Shares Months Fraction Ave
1/01/09 900,000 6/12 7/6 525,000
1/07/09 1,050,000 6/12 525,000
1,050,000
EPS = 1,000,000 / 1,050,000 = 95.24c
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Illustration 4ABC Ltd. makes a rights issue of 1 for 3 on 1st July 2009. The current share price is $4 and the rights issue is at a price of $3 The year end of the entity is 31st December.
There were 900,000 shares in issue on 1st Jan 2009 and the profit for the year to 31st December 2009 was $1,000,000.
Last year’s 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: 4/3.75
Date Shares Months Fraction Ave
1/01/09 900,000 6/12 4/3.75 480,000
1/07/09 1,200,000 6/12 600,000
1,080,000
December 2009 EPS = 1,000,000 / 1,080,000 = 92.59c
c
December 2008 EPS (900,000 / 900,000) 100
Inverted Bonus Fraction 3.75/4
Comparable EPS 93.75
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IAS 19 - Pensions
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Illustration 1A company maintains a defined benefit pension scheme for it’s employees. The following information is relevant:
The pension assets brought forward in 20X0 $1,000 with a closing balance of $2,000.
The Discount Rate is 11%.
Calculate the expected return on Pension Assets.
Solution
Pension Assets Brought Forward 1,000
Expected Return % 11%
Expected Return on Plan Assets 110
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Illustration 2
A company maintains a defined benefit pension scheme for it’s employees. The following information is relevant:
The liabilities of the scheme were $1,400 at the start of the period and $2,600 at the end.
The discount rate is 12%.
Calculate the Interest Cost for the period.
Solution
Pension Liabilities Brought Forward 1,400
Discount Rate 12%
Interest Cost 168
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Illustration 3 - Try this yourself!The following details refer to Company A’s pension scheme.
Calculate the return on assets and the interest cost.
Solution
B/F C/F
Pension Assets 1,000 2,000
Pension Liabilities 1,400 2,600
The discount rate is 11%
Pension Assets Brought Forward 1,000
Expected Return % 11%
Expected Return on Plan Assets 110
Pension Liabilities Brought Forward 1,400
Discount Rate 11%
Interest Cost 154
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Illustration 4A company maintains a defined benefit pension scheme for it’s employees. The following information is relevant:
The pension assets brought forward in 20X0 $1,800 with a closing balance of $2,700.
The company contributes $90 per year into the scheme.
Benefits paid out in the period were $100.
The liabilities of the scheme were $1,600 at the start of the period and $2,100 at the end.
The discount rate is 12%.
The terms of the scheme have changed meaning that past service costs have arisen of $35 and the current service costs for the period are $70.
Required:
Show the treatment for the pension scheme in the financial statements of the company.
(See Video)
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IFRS 2Share Based Payments
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Illustration 1
An entity grants 1 share option to each of its 100 employees on 1 January Year 1. Each grant is conditional upon the employee working for the entity over the next three years.
The fair value of each share option as at 1 January Year 1 is $8
At the end of each year the number of employees expected to take up the options are:
Year 1: 95Year 2: 97
When the rights are taken up in year 3, 98 employees actually receive the options.
Show the treatment for the employee benefits over the three years.
Solution
Year Total Employees expected to
qualify
Value of option
Proportion of vesting
period
Total cumulative
charge
Cost for each periodDr WagesCr equity
1 95 8 1/3 253 253
2 97 8 2/3 517 517 - 253 = 264
3 98 8 3/3 784 784 - 253 - 264 = 267
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Illustration 2An entity grants 1 share option to each of its 500 employees on 1 January Year 1. Each grant is conditional upon the employee working for the entity over the next three years.
The fair value of each share option as at 1 January Year 1 is $10
On the basis of a weighted average probability, the entity estimates on 1 January that 100 employees will leave during the three-year period and therefore forfeit their rights to share options.
The following actually occurs:
– 20 employees leave during Year 1 and the estimate of total employee departures over the three-year period is revised to 70 employees
– 25 employees leave during Year 2 and the estimate of total employee departures over the three-year period is revised to 60 employees
– 10 employees leave during Year 3
Solution
Year Employee Departures
Total EXPECTED to leave
TOTAL EXPECTED TO VEST AT YEAR
END
1 20 70 430
2 25 60 440
3 10 20 + 25 + 10 (Actual) 445
Year Total Employees expected to
qualify
Value of option
Proportion of vesting
period
Total cumulative
cost
Cost for each periodDr Expense
Cr equity
1 430 10 1/3 1433 1433
2 440 10 2/3 2933 2,933 - 1,433 = 1,500
3 445 10 3/3 4450 4,450 - 2933 = 1,517
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Illustration 3
Same question with additional information of share option price at the end of each year:
Year 1 10 Year 2 12 Year 3 14
Solution
Year Total Employees expected to
qualify
Share Option Price
Proportion of vesting
period
Total cumulative
cost
Cost for each periodDr ExpenseCr Liability
1 430 10 1/3 1433 1433
2 440 12 2/3 3520 3,520 - 1,433 = 2,087
3 445 14 3/3 6230 6,230 - 3,520 = 2,710
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Illustration 4At the beginning of year 1, an entity grants 1 share options to each of its 500 employees over a vesting period of 3 years at a fair value of $15
Year 140 leave, further 70 expected to leave;
Share options now repriced (as market value of shares has fallen) as the Fair Value of the options had fallen to $5. After the repricing they are now worth $8. The modification has therefore increased the Fair Value from $5 to $8.
Year 235 leave, further 30 expected to leave
Year 328 leave
Hint!
The repricing has increased the Fair Value of the Option by $3.
This amount is recognised over the remaining two years of the vesting period, along with remuneration expense based on the original option value of $15
Solution
Year Total Employees expected to
qualify
Option Value
Proportion of vesting
period
Total cumulative
cost
Cost for each periodDr ExpenseCr Equity
1 390 15 1/3 1950 1950
2 395 15 2/3 3950 3,950 - 1,950 = 2,000
3 397 15 3/3 5955 5,955 - 3,950 = 2,005
Year Total Employees expected to
qualify
Option Value
Proportion of vesting
period
Total cumulative
cost
Cost for each periodDr ExpenseCr Equity
2 395 3 1/2 593 593
3 397 3 2/2 1191 1191 - 593 = 598
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Year Original Charge Additional Charge Total Charge in Year
1 1950 1950
2 2000 593 2593
3 2005 598 2603
Total 5955 1191 7146
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IAS 16 & 36Non Current Assets and
Impairment
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Illustration 1A company purchases a crane with a useful economic life of 15 years for $200m with an obligation to decommission at a cost of $50m. The applicable discount rate is 8%.
Show the recognition of the asset in the financial statements and the treatment over the first accounting period.
Solution
Initial Recognition DR CR
Asset (200 + (50 x 1/1.0815) 215.75
Cash 200
Liability 15.75
Year 1 Treatment DR CR
Depreciation Charge (215.75 / 15) 14.38
Accumulated Depreciation 14.38
Finance Cost to I/S (15.75 x 8%) 1.26
Dismantling Liability 1.26
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Illustration 2Ashanti 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 Ashanti’s 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 Am’t Revaluation Reserve
BF 12 12 0.0
Dep’n (12/10) -1.2 -1.2 0.0
Revaluation 2.2 2.2
CF 10.8 13 2.2
Dep’n -1.2 -1.44 -0.24
NBV 9.6 11.56 1.96
New Valuation 8
Total Impairment 3.56
Remove revaluation less dep’n 1.96
Income Statement 1.6
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Illustration 3
Property, plant & equipment with a total cost of $1m has components of a structure valued at $700,000 with a useful economic life of 20 years and plant worth $300,000 with a useful economic life of 10 years.
Show the depreciation charges in the financial statements in year 1.
Solution
Structure Plant Total
Cost 700,000 300,000 1,000,000
Depreciation (700,000 / 20) = 35,000 (300,000 /10) = 30,000 65,000
NBV 665,000 270,000 935,000
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Illustration 4
The carrying value of an item of plant in the financial statements is $400,000. By operating the plant the business expects to earn discounted cash-flows of $350,000 over the rest of it’s 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.
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Illustration 5
A company has an asset for which the following information is relevant:
Carry out the impairment review for the asset.
Solution
$‘000
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
$‘000
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.
Carrying Value 400
Recoverable Amount 341.19
Impairment 58.81
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Illustration 6
A cash generating unit has the assets outlined below. It’s recoverable amount has been assessed as $1,000. Show the treatment for any impairment.
Solution
Assets Carrying Value
Goodwill 100
PPE 800
Intangible 400
1300
Impairment 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 1000
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IFRS 5 - Assets Held For Sale and Discontinued Operations
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Illustration 1 Archie Co. committed itself at the beginning of the financial year to selling a property that is being under-utilised following the economic downturn. As a result of the economic downturn, the property was not sold by the end of the year. The asset was actively marketed but there were no reasonable offers to purchase the asset. Archie is hoping that the economic downturn will change in the future and therefore has not reduced the price of the asset.
Can Archie Co. classify the property as available for sale under IFRS 5?
SolutionAlthough Archie has a plan to sell, it is available immediately and they are trying to locate a buyer it would appear that they are not marketing the property at a reasonable price.
They have not reduced the price even though there has been a downturn that has presumably reduced prices in general so cannot classify the property under IFRS 5.
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Illustration 2 A company has a machine that cost $300,000 to buy two years ago. At the time of purchase the machine had a useful economic life of 30 years and they apply the revaluation model under IAS 16 (Revaluation less depreciation).
The company has decided to sell the machine and it’s fair value at this time is $290,000 with additional costs to sell being estimated at $5,000. The value in use of the machine has been determined as $300,000.
Although the machine has not been sold at the year end as the decision was taken that day the company is confident that it will be sold quickly and is committed to selling it having begun to market the machine to potential purchasers.
How should the machine be treated at the year end in the financial statements and at what value will it be included?
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Solution
Cost 300,000
Depreciation Year 1 (300,000 / 30) 10,000
Depreciation Year 2 (300,000 / 30) 10,000
Carrying Value of Machine (No revaluations Yet) 280,000
IFRS 5 says to apply the appropriate standard immediately prior to classification.The machine is held under the revaluation model so revalue it before classification.
Carrying Value of Machine 280,000
Fair Value 290,000
Revaluation Reserve 10,000
This revaluation is treated under IAS 16 and creates a revaluation reserve with the movement shown in OCI.We then need to impairment test the Asset under IAS 36.
New Carrying value 290,000
Recoverable Amount = Higher ofF.V. Less Costs (290,000 - 5,000)
Value In Use (300,000) so...... 300,000
No Impairment as recoverable amount is higher than carrying value.Lastly we must revalue Asset to the lower of Fair Value Less costs or Carrying Value under IFRS 5
Carrying Value of Machine 290,000
Fair Value Less Costs (290,000 - 5,000) 285,000
IFRS 5 Impairment to P/L 5,000
The impairment will reduce the carrying value of the machine to $285,000 and the charge will be written off to the income statement.The machine will no longer be depreciated.
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Illustration 3A company has two divisions each of which form a major line of business, Division A and Division B.
Mid way through the current period Division A was shut down with losses of $50,000 on the sale of the fixed assets of the business and redundancy costs of $100,000.
Division B was restructured incurring losses of $85,000.
Results in the period included the following information:
Prepare a note to the accounts showing the analysis of the discontinued operation and draft the income statement for the company for the period.
Div A Div B
$‘000 $‘000
Revenue 1,000 2,000
Cost of Sales 750 1,250
Distribution 250 300
Administration 100 50
Finance costs for the business were $40,000 in the period and the tax charge was $32,000.
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SolutionDiscontinued Operations Analysis
$‘000
Revenue 1,000
Cost of Sales 750
Gross Profit 250
Admin Expenses 100
Distribution Costs 250
Operating Loss -100
Loss on Disposal of Fixed Assets -50
Redundancy Costs -100
Total Loss -250
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IAS 40 - Investment Property
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Illustration 1Which of the following are Investment Property?
• Building used as accommodation for staff.• Land purchased as an investment. No planning consent yet.• New office building purchased for capital appreciation.
Solution
Building used as accommodation for staff. NO
Land purchased as an investment. No planning consent yet. YES
New office building purchased for capital appreciation. YES
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Illustration 2A company has purchased a building for investment purposes on 1st Jan 20X0. The building cost a total of $1.5m with the land element being estimated at $500,000.
The building has a useful life of 30 years. At the 31st December 20X0 the fair value of the building (including the land) was $2m.
Show the treatment of the property for the two methods possible under IAS 40.
Solution
Cost Model
Cost of the Property $1,500,000
Depreciation in Period (1,500,000 - 500,000) / 30 $33,333
Carrying Value at 31 December 20X0 $1,466,667
Fair Value Model
Cost of the Property $1,500,000
Depreciation in Period Not Depreciated $0
Fair Value Adjustment to Income ($2m - $1.5m) $500,000
Carrying Value at 31 December 20X0 $2,000,000
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IAS 38 - Intangible Assets
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Illustration 1Which of the following should be classified as development?
1. Lion Ltd has spent $200,000 investigating whether a particular substance, drefite, found in the Arctic Circle is resistant to heat.
2. Hoey Ltd has incurred $250,000 expenses in the course of making new material for ski-equipment which will be more durable.
3. Ryan Ltd has found that a chemical compound, mallerite, is harmful to the human body.4. Lion Ltd has incurred a further $300,000 using drefite in creating prototypes of a new
heat-resistant body-suit for humans.
Solution
2 & 4 are development
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Illustration 2
Coddy Ltd is developing a new product, the fold-up bicycle. Forecasts are as follows:
Show how the development costs should be treated if:
1. the costs do not qualify for capitalisation2. the costs do qualify for capitalisation.
Solution
Expense Costs
20X5 20X6 20X7 20X8
$ $ $ $
Revenue from other activities 500 700 800 800
Revenue from Fold-up Bicycle 500 700 900
Development costs -600
1. Expense Costs
20X5 20X6 20X7 20X8 Total
Revenue from other activities
500 700 800 800 2800
Revenue from other widgets 500 700 900 2100
Development costs -600 -600
Net Profit/Loss -100 1200 1500 1700 4300
2. Amortise Development Costs
20X5 20X6 20X7 20X8 Total
Revenue from other activities
500 700 800 800 2800
Revenue from other widgets 500 700 900 2100
Development costs 0 -143 -200 -257 -600
Net Profit/Loss 500 1057 1300 1443 4300
Working for Costs 600 x 500/2100
600 x 700/2100
600 x 900/2100
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Illustration 3A company has 3 projects in development:Project A is in development and testing of the product has proved successful. Production has begun and some sales have been made to date. The costs have been measured accurately and the project looks likely to be profitable. All costs incurred so far meet the criteria to be capitalised under IAS 38.
Project B is also in development and testing of the product has proved successful. The costs have been measured accurately and the company expects to begin production and sales next year. All costs incurred so far meet the criteria to be capitalised under IAS 38.
Project C was begun in the current period and to date there has been a feasibility study carried out which was inconclusive.
Other Information:
Show how the above will be treated in the current period accounts discussing each project individually.
A B C
Total Costs to the start of the year 600 500
Costs incurred in the period 200 100 150
Total Anticipated Revenues 20,000 30,000 Unknown
Revenue in Period 5,000 0 0
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Solution
Project A
Project A is in production and meets the criteria for capitalisation. All costs to date will be capitalised and amortisation based on sales during the period will be charged
Costs Capitalised to Date 600
Costs in the period 200
Total costs to be capitalised 800
Ammortisation in Period (800 x 5,000/20,000) 200
Intangible Asset Carried Forward 600
Project B
Project B meets the criteria for capitalisation. All costs to date will be capitalised but production has not begun meaning that no amortisation will occur.
Costs Capitalised to Date 500
Costs in the period 100
Total costs to be capitalised 600
Intangible Asset Carried Forward 600
Project C
Project C does not meet the criteria for capitalisation as it is purely research into the feasibility of the project and the outcome was uncertain. All costs to date will be written off to the income statement in the period incurred.
Costs in the period 150
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IAS 20 - Government Grants
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Illustration 1A 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 it’s 10 year life.
Show the possible accounting treatments for the government grant in the first year.
Solution
DR CR
Plant at Cost 2,000,000
Cash 2,000,000
Income Statement Depreciation 200,000
Accumulated Depreciation 200,000
Cash for Government Grant 600,000
Deferred Income 600,000
Deferred Income Recognition in Year (600,000 / 10) 60,000
Income Statement 60,000
Total charge to Income Statement (200,000 - 60,000) = $140,000
DR CR
Plant at Cost 2,000,000
Cash 2,000,000
Cash 600,000
Plant at Cost 600,000
Income Statement Depreciation ((2m - 600k) /10) 140,000
Accumulated Depreciation 140,000
Total Charge to Income Statement = $140,000
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IAS 23 - Borrowing Costs
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Illustration 1
A company is building a qualifying asset worth $2.5m and has issued a bond of the same value to do so with an effective interest rate of 6%.
The asset will take 9 months to build and for the first 3 months the company invests the proceeds of the bond and earns interest at 3%.
What borrowing costs should be capitalised?
Solution
$
Total Interest for the Year (2.5m x 6%) 150,000
For 9 months x 9/12 112,500
Temporary Investment Income (2.5m x 3%) x 3/12 -18,750
93,750
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Illustration 2A 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
Illustration 3Company 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
Total Borrowing Cost Total Cost
$1m 6% 6
$2m 8% 16
$3m At total cost 22
Average Rate therefore is (22/3) = 7.33%
We can capitalise 600,000 x 7.33% x 8/12 = $29,320
Expenses start being incurred 1 December
Borrowing costs incurred 1 February
Activities started 15 March
Start Capitalising on 15 March
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Illustration 4
Davos is building an office block and issued a $10 million unsecured loan with a coupon (nominal) interest rate of 6% on 1 April 20X9. The loan is redeemable at a premium which means the loan has an effective finance cost of 7·5% per annum.
The loan was specifically issued to finance the building of the new block which meets the definition of a qualifying asset in IAS 23. Construction of the block commenced on 1 May 20X9 and it was completed and ready for use on 28 February 2010, but did not open for trading until 1 April 20X0.
During the year trading at Davos’ was below expectations so they suspended the construction of the new block for a two-month period during July and August 20X9. The proceeds of the loan were temporarily invested for the month of May 20X9 and earned interest of $40,000.
Calculate the borrowing costs that can be capitalised under IAS 23
SolutionThe effective interest rate is 7.5% which should be used to capitalise the interest as this is a qualifying asset.
The interest cost for the year to 31/03/20X0 would therefore be ($10m x 7.5%) = $750,000.
However the building only began on 1/05/20X9 and was completed on 28/02/20X0 so one month at the start and one month at the end can’t be capitalised.
In addition there were 2 months during which construction was suspended.
8 months interest ($750,000 x 8/12) = $500,000 less the temporary investment income of $40,000 should be caplitalised.
Total = $460,000
The rest of the cost should be written off to the Income statement.
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IAS 12Deferred Tax
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Illustration 1An entity has the following assets & liabilities recorded in it’s balance sheet at 31 December 2008:
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 $2m that will not be allowed in the current year for tax purposes but will be in the future. Income tax paid is at 30%.
Required:Calculate the deferred tax provision at 31 December 20X8.
Solution
Carrying Value$m
Tax Base$m
Property 20 14
Plant & Equipment 10 8
Inventory 8 12
Trade Receivables 6 8
Trade Payables 12 12
Cash 4 4
Carrying Value$m
Tax Base$m
Temporary 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% = $600,000
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Illustration 2Show the accounting treatment in the following situations:
(i) A company treats royalties as income when receivable in accordance with IFRS. The tax regime taxes royalties when they are received. The Income Statement of the company shows $1m of royalties in the period of which $500,000 have been received.
(ii)In accordance with IFRS a company has deferred $2m of income on a long term contract. The tax rules state that the income should be recognised immediately.
(iii)Depreciation on Plant & Equipment in the period under IFRS is $4m where the tax allowable depreciation is $2m.
(iv)Depreciation on Buildings in the period under IFRS is $3m where the tax allowable depreciation is $4m.
The tax rate is 30%
Solution
Situation Financial Statements Tax Effect Deferred Tax
Royalties More Income More Tax Liability
Deferred Income Less Income Less Tax Asset
Plant & Equipment More Expense Less Tax Asset
Buildings Less Expense More Tax Liability
Situation Working Tax Deferred Tax
DR CR DR CR
Royalties (1m - 500k) x 30% 150 150
Deferred Income (2m x 30%) 600 600
Plant & Equipment (4m - 2m) x 30% 600 600
Buildings (4m - 3m) x 30% 300 300
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Illustration 3An entity granted 1,000 share options to an employee vesting 3 years later. The fair value of at the grant date was $3
Tax law allows a tax deduction of the intrinsic value at the end of the vesting period.
The intrinsic value is $1.20 at the end of year 1 and $3.40 at the end of year 2
Assume a tax rate of 30%.
Solution
Step 1 - Calculate the Options Expense.
Step 2 - Calculate the Tax Allowable Deduction
Step 3 - Treatment
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
Year No. Options
Intrinsic Value of option
Proportion Total Tax Allowable
Period Expense
1 1000 1.2 1/3 400 400
2 1000 3.4 2/3 2267 1867
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 2000 2267 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.
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IAS 37Provisions
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Illustration 1Greenie, a public limited company, builds, develops and operates airports. During the financial year to 30 November 2010, a section of an airport collapsed and as a result several people were hurt. The accident resulted in the closure of the terminal and legal action against Greenie. When the financial statements for the year ended 30 November 2010 were being prepared, the investigation into the accident and the reconstruction of the section of the airport damaged were still in progress and no legal action had yet been brought in connection with the accident. The expert report that was to be presented to the civil courts in order to determine the cause of the accident and to assess the respective responsibilities of the various parties involved, was expected in 2011.
Financial damages arising related to the additional costs and operating losses relating to the unavailability of the building. The nature and extent of the damages, and the details of any compensation payments had yet to be established. The directors of Greenie felt that at present, there was no requirement to record the impact of the accident in the financial statements.
Compensation agreements had been arranged with the victims, and these claims were all covered by Greenie’s 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 (‘more likely than not’), (iii)and the amount can be estimated reliably.
An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an enterprise having no realistic alternative but to settle the obligation [IAS 37.10].
At the date of the financial statements, there was no current obligation for Greenie. In particular, no action had been brought in connection with the accident. It was not yet probable that an outflow of resources would be required to settle the obligation. Thus no provision is required.
Greenie may need to disclose a contingent liability. IAS 37 defines a contingent liability as:
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(a) a possible obligation that has arisen from past events and whose existence will be confirmed by the occurrence or not of uncertain future events; or
(b) a present obligation that has arisen from past events but is not recognised because: (i) it is not probable that an outflow of resources will occur to settle the obligation; or (ii)the amount of the obligation cannot be measured with sufficient reliability.
IAS 37 requires that entities should not recognise contingent liabilities but should disclose them, unless the possibility of an outflow of economic resources is remote. It appears that Greenie should disclose a contingent liability. The fact that the real nature and extent of the damages, including whether they qualify for compensation and details of any compensation payments remained to be established all indicated the level of uncertainty attaching to the case. The degree of uncertainty is not such that the possibility of an outflow of resource could be considered remote. Had this been the case, no disclosure under IAS 37 would have been required.
Thus the conditions for establishing a liability are not fulfilled. However, a contingent liability should be disclosed as required by IAS 37.
The possible recovery of these costs from the insurer give rise to consideration of whether a contingent asset should be disclosed. Given the status of the expert report, any information as to whether judicial involvement is likely will not be available until 2011. Thus this contingent asset is more possible than probable. As such no disclosure of the contingent asset should be included.
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Illustration 2Grange has prepared a plan for reorganising the parent company’s 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 company’s property, plant and equipment have lost value during the period because of a decline in property prices in the region and feel that any impairment charge would relate to these assets. There is no reserve within other equity relating to prior revaluation of these non-current assets.
SolutionA provision for restructuring should not be recognised, as a constructive obligation does not exist. A constructive obligation arises when an entity both has a detailed formal plan and makes an announcement of the plan to those affected. The events to date do not provide sufficient detail that would permit recognition of a constructive obligation. Therefore no provision for reorganisation should be made and the costs and benefits of the plan should not be taken into account when determining the impairment loss. Any impairment loss can be allocated to non-current assets, as this is the area in which the directors feel that loss has occurred.
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IAS 10 - Subsequent Events
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Illustration 1
Which of the following are adjusting events for Fishcakes Ltd? The year end is 30 June 20X1 and the accounts are approved on 20 August 20X1.
1. Sales of year-end inventory on 4 July 2011 at less than cost2. Issue of new ordinary shares on 10 July 2011.3. A fire in the warehouse occurred on 16 July 2011. All stock was destroyed.4. A major credit customer was declared bankrupt on 20 July 2011.5. All of the share capital of a rival, Haggis Ltd was acquired on 22 July 2011.6. On 4 August, $700,000 was received in respect of an insurance claim dated 13
February 2011.
Which of the following are adjusting events for Fishcakes Ltd?
Solution1, 4 and 6.
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Interim Reporting (IAS 34) & First Time Adoption (IFRS 1)
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Illustration 1In the IFRS opening statement of financial position at 1 May 2009, Lockfine elected to measure its fishing fleet at fair value and use that fair value as deemed cost in accordance with IFRS 1 First Time Adoption of International Financial Reporting Standards. The fair value was an estimate based on valuations provided by two independent selling agents, both of whom provided a range of values within which the valuation might be considered acceptable. Lockfine calculated fair value at the average of the highest amounts in the two ranges provided. One of the agents’ 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 agents’ 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 agents’ 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 ‘deemed cost’ 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 agents’ estimates provided very little information about the valuation methods and underlying assumptions that they could not, in themselves, be relied upon for determining fair value in accordance with IAS 16 Property, Plant and Equipment. Furthermore it would not be prudent to value the boats at the average of the higher end of the range of values.
IFRS 1, however, does not set out detailed requirements under which fair value should be determined. Issuers who adopt fair value as deemed cost have only to provide the limited disclosures, and methods and assumptions for determining the fair value do not have to be disclosed. The revaluation has to be broadly comparable to fair value. The use of fair value as deemed cost is a cost effective alternative approach for entities which do not
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perform a full retrospective application of the requirements to IAS 16. Thus Lockfine was not in breach of IFRS 1 and can determine fair value on the basis of selling agent estimates.
In accordance with IFRS 1, an entity which, during the transition process to IFRS, decides to retrospectively apply IFRS 3 to a certain business combination must apply that decision consistently to all business combinations occurring between the date on which it decides to adopt IFRS 3 and the date of transition. The decision to apply IFRS 3 cannot be made selectively. The entity must consider all similar transactions carried out in that period; and when allocating values to the various assets (including intangibles) and liabilities of the entity acquired in a business combination to which IFRS 3 is applied, an entity must necessarily have documentation to support its purchase price allocation, extended or applied to other similar situations.
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Financial Instruments I
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Illustration 1Aron held 3% holding of the shares in Smart, a public limited company. The investment was classified as available-for-sale and at 31 May 2009 was fair valued at $5 million. The cumulative gain recognised in equity relating to the available-for-sale investment was $400,000.
On the same day, the whole of the share capital of Smart was acquired by Given, a public limited company, and as a result, Aron received shares in Given with a fair value of $5·5 million in exchange for its holding in Smart.
Show the treatment for the transaction in the accounts to the 31 May 2009:
i) Under IAS 39ii)If the asset was classified as FVOCI under IFRS 9
Solution
i)IAS 39 $m
Proceeds of Share exchange 5.5
Carrying amount of Shares 5
Gain on de-recognition 0.5
Recycle gain previously recognised in Equity 0.4
Gain to Income Statement 0.9
IFRS 9 $m
Proceeds of Share exchange 5.5
Carrying amount of Shares 5
Gain on de-recognition 0.5
Gain to Income Statement 0.5
Previous gain transferred from other reserves to retained earnings 0.4
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Illustration 2The publication of IFRS 9, Financial Instruments, represents the completion of the first stage of a three-part project to replace IAS 39 Financial Instruments: Recognition and Measurement with a new standard. The new standard purports to enhance the ability of investors and other users of financial information to understand the accounting of financial assets and reduces complexity.
Required:
Discuss the approach taken by IFRS 9 in measuring and classifying financial assets and the main effect that IFRS 9 will have on accounting for financial assets. (11 marks)
SolutionIFRS 9 Financial instruments retains a mixed measurement model with some assets measured at amortised cost and others at fair value. The distinction between the two models is based on the business model of each entity and a requirement to assess whether the cash flows of the instrument are only principal and interest. The business model approach is fundamental to the standard and is an attempt to align the accounting with the way in which management uses its assets in its business whilst also looking at the characteristics of the business. A debt instrument generally must be measured at amortised cost if both the ‘business model test’ and the ‘contractual cash flow characteristics test’ are satisfied. The business model test is whether the objective of the entity’s business model is to hold the financial asset to collect the contractual cash flows rather than have the objective to sell the instrument prior to its contractual maturity to realise its fair value changes.
The contractual cash flow characteristics test is whether the contractual terms of the financial asset give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal amount outstanding.All recognised financial assets that are currently in the scope of IAS 39 will be measured at either amortised cost or fair value. The standard contains only the two primary measurement categories for financial assets unlike IAS 39 where there were multiple measurement categories. Thus the existing IAS 39 categories of held to maturity, loans and receivables and available-for-sale are eliminated along with the tainting provisions of the standard.
A debt instrument (e.g. loan receivable) that is held within a business model whose objective is to collect the contractual cash flows and has contractual cash flows that are solely payments of principal and interest generally must be measured at amortised cost. All other debt instruments must be measured at fair value through profit or loss (FVTPL). An investment in a convertible loan note would not qualify for measurement at amortised cost because of the inclusion of the conversion option, which is not deemed to represent payments of principal and interest. This criterion will permit amortised cost measurement when the cash flows on a loan are entirely fixed such as a fixed interest rate loan or where interest is floating or a combination of fixed and floating interest rates.
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IFRS 9 contains an option to classify financial assets that meet the amortised cost criteria as at FVTPL if doing so eliminates or reduces an accounting mismatch. An example of this may be where an entity holds a fixed rate loan receivable that it hedges with an interest rate swap that swaps the fixed rates for floating rates. Measuring the loan asset at amortised cost would create a measurement mismatch, as the interest rate swap would be held at FVTPL. In this case the loan receivable could be designated at FVTPL under the fair value option to reduce the accounting mismatch that arises from measuring the loan at amortised cost.
All equity investments within the scope of IFRS 9 are to be measured in the statement of financial position at fair value with the default recognition of gains and losses in profit or loss. Only if the equity investment is not held for trading can an irrevocable election be made at initial recognition to measure it at fair value through other comprehensive income (FVTOCI) with only dividend income recognised in profit or loss. The amounts recognised in OCI are not recycled to profit or loss on disposal of the investment although they may be reclassified in equity.
The standard eliminates the exemption allowing some unquoted equity instruments and related derivative assets to be measured at cost. However, it includes guidance on the rare circumstances where the cost of such an instrument may be appropriate estimate of fair value.
The classification of an instrument is determined on initial recognition and reclassifications are only permitted on the change of an entity’s 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 39’s approach to accounting for embedded derivatives. Consequently, embedded derivatives that would have been separately accounted for at FVTPL under IAS 39 because they were not closely related to the financial asset host will no longer be separated. Instead, the contractual cash flows of the financial asset are assessed as a whole and are measured at FVTPL if any of its cash flows do not represent payments of principal and interest.
One of the most significant changes will be the ability to measure some debt instruments, for example investments in government and corporate bonds at amortised cost. Many available-for-sale debt instruments currently measured at fair value will qualify for amortised cost accounting.
Many loans and receivables and held-to-maturity investments will continue to be measured at amortised cost but some will have to be measured instead at FVTPL. For example some instruments, such as cash-collateralised debt obligations, that may under IAS 39 have been measured entirely at amortised cost or as available-for-sale will more likely be measured at FVTPL. Some financial assets that are currently disaggregated into host financial assets that are not at FVTPL will instead by measured at FVTPL in their entirety.
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IFRS 9 may result in more financial assets being measured at fair value. It will depend on the circumstances of each entity in terms of the way it manages the instruments it holds, the nature of those instruments and the classification elections it makes.Assets that are currently classified as held-to-maturity are likely to continue to be measured at amortised cost as they are held to collect the contractual cash flows and often give rise to only payments of principal and interest.
IFRS 9 does not directly address impairment. However, as IFRS 9 eliminates the available-for-sale (AFS) category, it also eliminates the AFS impairment rules. Under IAS 39 measuring impairment losses on debt securities in illiquid markets based on fair value often led to reporting an impairment loss that exceeded the credit loss that management expected. Additionally, impairment losses on AFS equity investments cannot be reversed within the income statement section of the statement of comprehensive income under IAS 39 if the fair value of the investment increases. Under IFRS 9, debt securities that qualify for the amortised cost model are measured under that model and declines in equity investments measured at FVTPL are recognised in profit or loss and reversed through profit or loss if the fair value increases.
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Financial Instruments II
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Illustration 1
A company invests $100,000 in a 3 year redeemable 12% bond.
The bond consists of interest payments and principle only and the company intends to hold it until it is redeemed.
Show the treatment for the bond over the 3 year period.
Solution
O’Bal Interest (12%)DR Financial Asset
CR Income Statement
Cash Rec’d (12% x 100,000)
DR CashCR Financial Asset
Cl’bal
100,000 12,000 -12,000 100,000
100,000 12,000 -12,000 100,000
100,000 12,000 -12,000 100,000
At the end of the term the bond is repaid and the company receives $100,000.
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Illustration 2A company invests $10,000 in a 3 year redeemable 10% bond which is redeemable at a premium of $675.
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.
Solution
O’Bal Interest (12%)DR Financial Asset
CR Income Statement
Cash Rec’d (10% x 10,000)
DR CashCR Financial Asset
Cl’bal
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 means that the company receives $10,675.
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Illustration 3A 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
O’Bal Interest (14%)DR Income StatementCR Financial Liability
Cash Paid (7% x 30,000)DR Financial Liability
CR Cash
Cl’bal
26,000 3,640 -2,100 27,540
27,540 3,856 -2,100 29,296
29,296 4,101 -2,100 31,297
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Illustration 4VB acquired 40,000 shares in another entity, JK, in March 2012 for $2.68 per share. The investment was held for trading purposes on initial recognition. The shares were trading at $2.96 per share on 31 July 2012.
Show the treatment to record the initial recognition of this financial asset and its subsequent measurement at 31 July 2012
Solution
$
As the shares are held for trading they will be classified as Fair Value through Profit & Loss
Recognition of Financial Asset (40,000 x $2.68) 107200
Fair Value on 31 July 2012 (40,000 x $2.96) 118400
Movement to Income Statement (Gain) 11200
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Illustration 5QWE issued 10 million 5% convertible $1 bonds 2015 on 1 January 2010. The proceeds of $10 million were credited to non-current liabilities and debited to bank. The 5% interest paid has been charged to finance costs in the year to 31 December 2010.
The market rate of interest for a similar bond with a five year term but no conversion terms is 7%. (The annuity rate for 5 years at 7% is 4.100 with the discount rate in year 5 being 0.713).
Show the split of the compound instrument between debt and equity and the treatment of the debt portion in the first year.
Solution
$
First Step is to calculate debt value (Present Value of interest & Capital)
Interest for 5 Years at 5% ($10m x 5%) 500,000
Discounted Cash Flows
Discount Interest Payment at effective rate (500,000 x 4.100) 2,050,000
Discount Capital Repayment ($10m x 0.713) 7130000
Total Debt Portion 9180000
The difference between the issued value of the convertible debt and the present value of the interest and capital is the EQUITY portion of the debt
Total Convertible Debt 10,000,000
Present Value of Interest and capital from above 9180000
Total Equity Portion 820000
O’Bal Interest (7%)DR Income Statement CR Financial Liability
Cash Paid (5% x 10m)
DR Financial Liability CR Cash
Cl’bal
9,180,000 642,600 -500,000 9,322,600
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Illustration 6Aron 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 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 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
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Net Value 91.46 7.54 99
Debt Equity Total
Year O’bal Interest (9.38%)
Cash Paid Cl’bal
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 difference
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Hedge Accounting
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Illustration 1
In June 20X5 ABC Co. (a jewellery manufacturer) is worried about the price of gold increasing. ABC intends to buy 1,000 ounces of gold on 31st Dec 20X5 so enters into a futures contract to buy 1,000 ounces of gold at $1,235 per ounce on 31 June 20X5.
The year end of ABC Co. is 31 October 20X5 and on that date the futures price for delivery on 31 Dec 20X5 is $1,300 per ounce.
Show the accounting entries to record the futures contract in the financial statements at the year end 31 October 20X5.
Solution
The initial cost of the futures contract is zero (one of the characteristics of a derivative).
By the year end it has moved in value creating a gain as ABC has a contract to buy at $1,235 whereas it would now have cost $1,300 so they could sell it at that price if they wanted to.
so...
DR Financial Asset (1,000 x (1,300 - 1,235)) = $65,000CR Gain in P/L $65,000
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Illustration 2
NMN is a UK based company and is receiving $400,000 from a US customer in 6 months. NMN takes out a forward contract at a rate of £1:$1.40 and by it’s year end in 3 months the spot rate is £1:$1.45.
At what value should the contract be included in the financial statements at the year end?
Solution
Forward contract amount expected (400,000 / 1.4) £285,714
Spot rate value (400,000 / 1.45) £275,862
Initial Valuation on inception = 0 (No Cost)
Increase in value of Forward (285,714 - 275,862) = £9,852 Asset
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Illustration 3
A 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.
Show the double entry to record the hedge in the financial statements
Solution
The instrument is a hedged item in a fair value hedge, this change in fair value of the instrument is recognised in profit or loss, as follows:
Dr Income statement 80,000
Cr Bond 80,000
The fair value of the swap has increased by $80,000. Since the swap is a derivative, it is measured at fair value with changes in fair value recognised in profit or loss.
Dr Swap 80,000
Cr Income statement 80,000
The changes in fair value of the hedged item and the hedging instrument exactly offset, the hedge is 100% effective and, the net effect on profit or loss is zero.
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Illustration 4
ABC intends to buy 1,000 ounces of gold on 31st Jan 20X6 at the prevailing market price on that date. The current price of gold is $1,200.
ABC is concerned that the price of gold may rise, so enters into a futures contract to buy 1,000 ounces of gold at $1,300 per ounce on 31 March 20X5.
The company designates and documents the futures contract as a hedging instrument.
The year end of ABC Co. is 31 October 20X5 and on that date the futures price for delivery on 31 March 20X6 is $1,400 per ounce. The market price of gold on that date is $1,325.
On 31 Jan 20X6 the futures contract is settled at $1,450 and the contract for the gold purchase is completed at a price of $1,350.
Show the impact of this cash flow hedge on the financial statements of ABC Co. at:
(i) 31 Oct 20X5(ii) 31 Jan 20X6
Solution
31 Oct 20X5
The gain on the futures contract of (1,000 x (1,400 - 1,300)) $100,000 will initially be recognised in reserves:
DR Financial Asset $100,000CR Reserves (OCI) $100,000
31 Jan 20X6
Now that the transaction has taken place both parts can be taken to Profit or Loss
DR Purchase of Gold (1,000 x 1,350) $1,350,000CR Cash $1,350,000CR Gain on futures contract (1,000 x (1,450 - 1,300) $150,000DR Cash $150,000
The net effect is that the cost of the gold was (1,350,000 - 150,000) $1,200,000 - which was the prevailing price when the futures contract was entered into to hedge price fluctuations.
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Illustration 5
P intends to buy 1000 barrels of oil, the current price is $95 per barrel. They hedge the risk of a rise in prices by taking out a futures contract to secure the price at $100 per barrel. By the year end the oil price is $150 per barrel and the futures price is $160.
How should the hedge be treated in the financial statements?
Solution
Movement on cashflow (150 - 95) x 1000 = $55,000 (Loss)
Gain on future (160 - 100) x 1000 = $60,000 (Gain)
The effective portion of the hedging instrument of $55,000 should go to OCI with the $5,000 remaining to P/L
so…
DR Derivative $60,000CR OCI $50,000CR P/L $5,000
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Financial Instrument Disclosures
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No Illustrations, Just Objective Test Questions
1. IFRS 7 splits financial instrument disclosures into 2 categories. Which of the following is a category of disclosure under IFRS 7?
A. Information about strategies.B. Information about significance.C. Information about hedging.D. Information about risks.E. Information about reclassification.
Answer B and D
2. Which of the following is not a required disclosure under the ‘Information about risks’ category of IFRS 7?
A. Qualitative disclosuresB. Quantitative disclosuresC. Market Risk disclosuresD. Cash flow disclosures
Answer D
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Financial Asset Impairments
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Illustration 1
On 01 January 20X4 Satchel purchased a $10m 5 year 8% bond which is redeemable at a premium of $1.22m. The effective interest rate on the bond is 10%.
It is estimated on initial recognition of the asset that there is a 0.25% risk of default in the next 12 months and that if this does occur there would be no more further payments of interest and only 60% of the capital would be repaid.
How should the bond be treated in the financial statements of Satchel?
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Solution
We need to create a 12 month allowance for expected credit losses which has 3 steps:
1. What is the cash shortfall between what was expected and what will now be received.2. Discount this shortfall at effective interest rate.3. Probability weight it.
In each year there will be (10m x 8%) $800,000 less interest received and (($10m + $1.22m) x 40%) $4.488m not returned at the end if the default occurs so…
The loss allowance of $15,000 should be set-off against the carrying value of the bond.
The interest on the bond should continue to be calculated on the gross amount i.e. not net of the loss allowance.
Year Shortfall Discount Rate Present Value
1 800 1/1.1 727
2 800 1/1.12 661
3 800 1/1.13 601
4 800 1/1.14 546
5 800 + 4,488 1/1.15 3,283
Present Value of Shortfall 5,819
Probability of Default in 12 months 0.25%
Loss Allowance 15
Year O’Bal Effective interest
Interest Received
C’Bal Loss Allowance
Carrying Amount
1 10,000 1,000 800 10,200 -15 10,185
2 10,200 1,020 800 10,420 -15 10,405
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Illustration 2
On 01 January 20X4 Satchel purchased a $10m 5 year 8% bond which is redeemable at a premium. The effective interest rate on the bond is 10%.
It is estimated on initial recognition of the asset that there is a 0.25% risk of default in the next 12 months and that if this does occur there would be no more further payments of interest and only 60% of the capital would be repaid.
On 31 December 20X4 the interest for the year has been paid but it is estimated that there has been a significant increase in the risk of default on the bond. There is now a 10% likelihood that default will occur over the life of the bond and if so no further interest will be received and only 30% of the capital would be repaid.
How should the bond be treated in the financial statements of Satchel?
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Solution
We now need to create a lifetime allowance for expected credit losses over the life of the bond which has 3 steps:
1. What is the cash shortfall between what was expected and what will now be received.2. Discount this shortfall at effective interest rate.3. Probability weight it.
In each year there will be (10m x 8%) $800,000 less interest received and (($10m + $1.22m) x 70%) $7.845m not returned at the end if the default occurs so…
The loss allowance of $14,000 should be increased to $789,000 and again set-off against the carrying value of the bond.
The interest on the bond should continue to be calculated on the gross amount i.e. not net of the loss allowance.
Year Shortfall Discount Rate Present Value
1 PAID - -
2 800 1/1.1 727
3 800 1/1.12 661
4 800 1/1.13 601
5 800 + 7,845 1/1.14 5,905
Present Value of Shortfall 7,894
Probability of Default 10%
Loss Allowance 789
Year O’Bal Effective interest
Interest Received
C’Bal Loss Allowance
Carrying Amount
1 10,000 1,000 800 10,200 -789 9,411
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Illustration 3
On 01 January 20X4 Satchel purchased a $10m 5 year 8% bond which is redeemable at a premium. The effective interest rate on the bond is 10%.
It is estimated on initial recognition of the asset that there is a 0.25% risk of default in the next 12 months and that if this does occur there would be no more further payments of interest and only 60% of the capital would be repaid.
On 31 December 20X4 the interest for the year was been paid but it was estimated that there has been a significant increase in the risk of default on the bond. There is now a 10% likelihood that default will occur over the life of the bond and if so no further interest will be received and only 30% of the capital would be repaid.
On 31 December 20X5 only interest of $400,000 was received due to financial difficulties suffered by the bond issuer. Satchel do not expect to recover any further interest but do expect to recover 50% of the capital expected at the end of the 5 years.
How should the bond be treated in the financial statements of Satchel?
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Solution
There has now been evidence that the bond is credit impaired which means it needs to be written down to the present value of the expected cash flows on the bond.
The carrying value of the bond at this point will be
Satchel now only expects (($10m + $1.22m) x 50%) $5.61m to be returned at the end if the default occurs so…
The interest on the bond will now be calculated on the impaired value…
Leaving the balance due to be received at the end as the $5.61m expected.
Year O’Bal Effective interest
Interest Received
C’Bal Loss Allowance
Carrying Amount
1 10,000 1,000 800 10,200 -15 10,185
2 10,200 1,020 400 10,820 -789 10,031
Year Shortfall Discount Rate Present Value
5 5,610 1/1.13 4,215
Current Carrying Value of Bond 10,031
Impairment 5816
Year O’Bal Effective interest
Interest Received
C’Bal Loss Allowance
Carrying Amount
3 4,215 422 0 4,637 0 4,637
4 4,637 464 0 5,100 0 5,100
5 5,100 510 0 5,610 0 5,610
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Illustration 4
On 01 January 20X4 Navel purchased a $2m 5 year 10% bond. The effective interest rate on the bond is also 10%. The bond is designated as FVOCI.
On 31 December 20X4 the interest for the year was been paid and it was estimated that there has not been a significant increase in the risk of default on the bond. The fair value of the bond on that date was $1.9m.
Therefore only a 12 month expected credit loss allowance should be made which has been determined as $40,000.
How should the bond be treated in the financial statements of Navel?
Solution
On 31 December 20X4 the bond should be revalued through OCI to it’s new fair value of $1.9m by entries…
DR OCI $100,000CR Bond $100,000
In addition a loss allowance of $40,000 should be recognised, however as the bond is classified as FVOCI the entries to do this are…
DR P/L $40,000CR OCI $40,000
The net effect is a (100,000 - 40,000) $60,000 charge to OCI.
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IFRS 16 - Leases I(Lessee)
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Illustration 1An asset is leased by a company on the 01/01/X0 over a 3 year period. They pay 3 annual payments of $25,000, the first of which is payable on 31/12/X0. In addition they have an option to extend the lease which they are reasonably certain to do for 1 additional year at a cost of $2,0000.
Direct costs of $2000 were incurred in obtaining the lease and $500 of these were reimbursed by the lessor.
The interest rate implicit in the lease is 12%
Show the treatment in the lessees financial statements over the life of the asset.
Solution
Present Value of minimum lease payments
$ Discount Rate
1 Payment 25,000 1/1.12 22,321
2 Payment 25,000 1/1.122 19,930
3 Payment 25,000 1/1.123 17,795
4 Payment 20,000 1/1.124 12,710
Lessees Liability 72,756
Lease Liability on SFP
Period Opening Bal
Interest Charge(12%)DR Income Statement
CR Lease Liability
Lease PaymentDR Lease Liability
CR Cash
Closing Bal
1 72,756 8,731 -25,000 56,487
2 56,487 6,778 -25,000 38,265
3 38,265 4,592 -25,000 17,857
4 17,857 2,143 -20,000 -0
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Right of Use Asset
Present value of minimum lease payments 72,756
Direct Costs 2,000
Reimbursement -500
Right of Use asset 74,256
The asset will be depreciated over the 4 year lease term at (74,256 / 4) $18,689 per yr.
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Illustration 2A company takes out a 5 year lease on a ship on 01/01/X0 the useful life of the ship is 20 years. $5.5m is to be paid in arrears each year. The lessor has agreed to maintain the ship for the duration of the contract
The interest rate is 6% and the standalone price of the lease on the ship is $25m of the $27.5m total payments.
Explain the treatment in the income statement and the statement of financial position for the lease contract.
Solution
Total Lease ($5.5m x 5) 27.5
Standalone Price of Ship ($5m x 5) 25
Maintenance cost (Bal) TO P/L EACH YEAR ($0.5m x 5) 2.5
Present Value of minimum lease payments
$ Discount Rate
1 Payment 5 1/1.06 4.72
2 Payment 5 1/1.062 4.45
3 Payment 5 1/1.063 4.20
4 Payment 5 1/1.064 3.96
5 Payment 5 1/1.065 3.74
Lessees Liability 21.06
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Lease Liability on SFP
Period Opening Bal
Interest Charge(6%)DR Income Statement
CR Lease Liability
Lease PaymentDR Lease Liability
CR Cash
Closing Bal
1 21.06 1.26 -5.00 17.32
2 17.32 1.04 -5.00 13.36
3 13.36 0.80 -5.00 9.16
4 9.16 0.55 -5.00 4.71
5 4.71 0.28 -5.00 -0.00
Right of Use Asset
Present value of minimum lease payments 21.06
The asset will be depreciated over the 5 year lease term at (21.06 / 5) $4.21m per yr.
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Illustration 3An asset is leased by a company on the 01/01/X0 over a 3 year period. They pay $50,000 up front then 3 annual payments of $100,000, the first of which is payable on 31/12/X0.
The lease payments are indexed to the Consumer Price Index (CPI) for the previous 12 months.
At the start of the lease the CPI is 110 and by the beginning of the second year it is 120.
The interest rate implicit in the lease is 5%
Show the treatment in the lessees financial statements over the first 2 years of the lease.
SolutionYear 1
Present Value of minimum lease payments
$ Discount Rate
Up front payments are not added to the lease liability but are added to the right of use asset.
1 Payment 100,000 1/1.05 95,238
2 Payment 100,000 1/1.052 90,703
3 Payment 100,000 1/1.053 86,384
Lessees Liability 272,325
Lease Liability on SFP
Period Opening Bal
Interest Charge(5%)DR Income Statement
CR Lease Liability
Lease PaymentDR Lease Liability
CR Cash
Closing Bal
1 272,375 13,619 -100,000 185,994
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Year 2
Right of Use Asset
Present value of minimum lease payments 272,325
Up front payment 50,000
Right of Use asset 322,325
The asset will be depreciated over the 3 yr lease term at (322,325 / 4) $107,441 per yr.
Present Value of minimum lease payments
$ Discount Rate
The remaining payments will increase to (100,000 x 120/110) = $109,091
1 Payment 109,091 1/1.05 103,896
2 Payment 109,091 1/1.052 98,949
Lessees Liability 202,845
Lease Liability on SFP
Period Opening Bal
Interest Charge(5%)DR Income Statement
CR Lease Liability
Lease PaymentDR Lease Liability
CR Cash
Closing Bal
1 272,375 13,619 -100,000 185,994
Adjust liability up to $202,845 (202845 - 185,994) 16,851
New Liability 202,845
2 202,845 10,142 -109,091 103,896
103,896 5,195 -109,091 0
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Right of Use Asset
Opening Balance 322,325
Depreciation Year 1 -107,442
Carrying Value 214,883
Lease Adjustment 16,851
New Carrying Value 231,734
Depreciation Year 2 -115,867
Carrying Value Year 2 115,867
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IFRS 16 - Leases II(Lessor)
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Illustration 1ABC Co. leases an asset to CD Co. for a term of 4 years from 1/1/2010. Annual instalments are payable in arrears of $2m. At the end of the term CD Co. can lease the asset for a secondary term of 10 years at a rent of $50,000 per year.
The expected residual value at end of the initial lease is $1m .
Interest rate implicit in the lease 6%.
Show the treatment for the lease in the financial statements of the lessor.
Solution
Present Value of minimum lease payments
$ Discount Rate
1 Payment 2 1/1.06 1.89
2 Payment 2 1/1.062 1.78
3 Payment 2 1/1.063 1.68
4 Payment 2 1/1.064 1.58
4 Residual Value 1 1/1.064 0.79
Net Investment in Lease (Receivable) 7.72
Receivable on SFP
Period Opening Bal
Interest Charge(6%)DR Receivable
CR P/L Finance Income
Lease PaymentDR Cash
CR ReceivableClosing Bal
1 7.72 0.46 -2.00 6.18
2 6.18 0.37 -2.00 4.55
3 4.55 0.27 -2.00 2.83
4 2.83 0.17 -2.00 1.00
1.00 Remaining balance is the residual value
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Illustration 2A 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.
ii.
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 period 116,667
Period Rental Received Rental Recognised
Difference to Deferred Income
Total Deferred Income
20X0 200,000 116,667 83,333 83,333
20X1 100,000 116,667 -16,667 66,666
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Income Statement 20X0 20X1
Rental Income Receivable 116,667 116,667
Depreciation ($1.1m / 30 yrs.) -36,667 -36,667
SFP 20X0 20X1
Plant at Cost 1,100,000 1,100,000
Depreciation -36,667 -73,334
Carrying Value 1,063,333 1,026,666
Non Current Liabilities Deferred Income 66,666 49,999
Current Liabilities Deferred Income 16,667 16,667
83,333 66,666
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Illustration 3A company enters into a sale and finance 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 $20,000 in arrears. Implicit interest rate of 8% (5 year annuity 3.99).
How should the lease be recognised in the financial statements of each party. Assume the lease is an operating lease from the perspective of the lessor.
Solution
Right of use Asset
PV Minimum Payments (20,000 x 3.99) 79,800
Fair Value on Sale 120,000
Carrying Value before Sale 70,000
Right of Use Asset (79,800 / 120,000) x 70,000 46,550
Gain on Sale
Total Gain (120,000 - 70,000) 50,000
Fair Value of Machine 120,000
Liability remaining 79,800
Rights Transferred to Lessor (120,000 - 79,800) 40,200
Gain to P/L 50,000 x (40,200 / 120,000) 16,750
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Entries
DR Cash Amount Received 120,000
DR Right of Use Asset W1 46,550
CR Machine W1 70,000
CR Lease Liability W1 79,800
CR P/L (120,000 - 70,000) / 120,000) 16,750
Lessor Treatment
DR Machine 120,000
CR Cash 120,000
The rental income will then be recognised straight line
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Illustration 4A company enters into a sale and finance agreement on 1/1/X1 when the Carrying Value of the asset was $8m. The sale proceeds were $10m and the fair value of the asset was $9.7m.
The lease was for 5 annual rentals of $1.5m in arrears. Implicit interest rate of 4%.
How should the lease be recognised in the financial statements of each party. Assume the lease is an operating lease from the perspective of the lessor.
Solution
W1 - Present Value of minimum lease payments
$ Discount Rate
1 Payment 1.5 1/1.04 1.44
2 Payment 1.5 1/1.042 1.39
3 Payment 1.5 1/1.043 1.33
4 Payment 1.5 1/1.044 1.28
5 Payment 1.5 1/1.045 1.23
Lessees Liability 6.68
W2 - Right of use Asset
PV Minimum Payments 6.68
Difference in FV & Sale Price ($10m - $9.7m) -0.3
Liability Created 6.38
Fair Value on Sale 9.7
Carrying Value before Sale 8
Right of Use Asset (6.38 / 9.7) x 8 5.26
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W3 - Gain on Sale
Total Gain (9.7 - 8) 1.7
Fair Value of Machine 9.7
Liability remaining 6.38
Rights Transferred to Lessor (9.7 - 6.38) 3.32
Gain to P/L 1.7 x (3.32 / 9.7) 0.58
Entries
DR Cash Amount Received 10
DR Right of Use Asset W2 5.26
CR Machine (CV) 8
CR Financial Liability (10 - 9.7) 0.3
CR Lease Liability W2 6.38
CR P/L W3 0.58
Lessor Treatment
DR Machine 9.7
DR Financial Asset 0.3
CR Cash 10
The rental income will then be recognised straight line.The lease payments will be allocated to the lease and the financial asset proportionally.
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IFRS 15 - Revenue I
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Illustration 1
Fresco sells an IT system to Dining on the first day of a new accounting period.
The package includes hardware delivered immediately and a contract for support over the next 3 years with that support worth $50,000 p/a.
The total cost of the contract is paid up front and is $300,000.
How much should Fresco recognise as revenue from the transaction in the current year?
SolutionStep 1 - Identify the Contract
Fresco has agreed to supply Dining with goods and services.
Step 2 - Identify the performance obligations
Fresco has promised to do two things:
- Supply the hardware- Supply the support
Step 3 - Determine the transaction price
The total price is $300,000
Step 4 - Allocate price to obligations
Based on the individual prices the support is worth (50,000 x 3) $150,000 leaving the rest of the $300,000 to be for the hardware (300,000 - 150,000) = $150,000.
Step 5 - Recognise the revenue when (or as) the performance obligation is satisfied
The supply of the hardware happens immediately so the revenue for it should be recognised now.
The support is provided over time so should be recognised on that basis i.e. $50,000 per year over the 3 years.
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Illustration 2
Jumbo has agreed to sell a piece of complex machinery with two years free servicing to Jet for $441,000. The machine usually sells for $420,000.
The servicing will cost Jumbo $50,000 to provide and they generally include a mark-up of 40% when setting the price to charge customers for servicing.
The two year servicing contract is not available as a stand-alone product.
How should the transaction price be allocated to the machine and servicing?
SolutionWe can see that the machine generally sells for $420,000 but there is no comparable price for the servicing contract.
Based on the cost + mark-up the servicing would be worth (50,000 x 140%) $70,000.
Therefore the total value of the performance obligations is (420,000 + 70,000) $490,000.
The fact that Jumbo is selling these for $441,000 would imply that a 10% discount has been applied.
This should be allocated proportionally to the machine and servicing so the amounts recognised should be:
Goods (420,000 x 90%) $378,000Services (70,000 x 90%) $63,000 (Recognised over 2 years)
Total (378,000 + 63,000) $441,000
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Illustration 3
Jumbo has agreed to sell a piece of complex machinery with two years free servicing to Jet for $700,000. The machine usually sells for $600,000 although a 5% discount is often applied to machines of this specification.
The servicing will cost Jumbo $100,000 to provide and they generally include a mark-up of 30% when setting the price to charge customers for servicing.
The two year servicing contract is not available as a stand-alone product but Jumbo has a policy of not offering discounts on servicing contracts.
How should the transaction price be allocated to the machine and servicing?
SolutionWe can see that the machine generally sells for $600,000 but there is no comparable price for the servicing contract.
Based on the cost + mark-up the servicing would be worth (100,000 x 130%) $130,000.
Therefore the total value of the performance obligations is (600,000 + 130,000) $730,000.
The fact that Jumbo is selling these for $700,000 would imply that a $30,000 discount has been applied.
However rather than be allocated proportionally to the machine and servicing the discount should be applied to the machine only because:
- The discount amounts to 5% of the $600,000 for the machine which is the standard discount for this item given generally.
- There is not generally a discount on servicing.
…so the amounts recognised should be:
Goods (600,000 x 95%) $570,000Services (130,000 x 100%) $130,000 (Recognised over 2 years)
Total (570,000 + 130,000) $700,000
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Illustration 4
Placo obtained a contract to sell Davo $3m worth of services over a 3 year period. Specific costs that would not have been incurred otherwise amounted to $120,000.
How should the revenue and costs be recognised?
SolutionThe revenue should be recognised in line with the contract terms over 3 years so ($3m / 3) $1m per year.
The costs should be capitalised as they are specific to the contract so…
DR Asset (Costs) $120,000CR Cash $120,000
…then recognised in line with the revenue over 3 years
DR Profit/Loss (120,000 / 3) $40,000CR Asset (Costs) $40,000
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IFRS 15 - Revenue II
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Illustration 1
Badger Co. manufactures smart phones and sells them through a contractual relationship with Bodger Co. Badger provides Bodger with the phones for a price of $150 payable once the phone is sold on to a customer.
Bodger has also agreed to a clause in the contract of sale that they cannot sell the phone for less than $200.
How should the goods and revenue be treated in the financial statements of Badger and Bodger?
SolutionWhen the goods are provided to Bodger initially they still remain the property of Badger as they have retained control of them by stipulating the price at which they should be soldr
They will stay as part of Badger’s inventory and no revenue recognised until it is sold to an end customer.
Once the goods are sold to the customer for $200 Bodger should only recognise the commission they have received on selling the goods i.e. $50.
The other $150 is paid to Badger and should be recognised as their revenue on the sale.
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Illustration 2
Johnston enters into a contract to sell a piece of plant to Paints on 01 Jan 20X6 and delivers the plant on that date for Paints to begin to use. The price agreed in the contract is $400,000 to be paid on 01 Jan 20X8.
The market rate of interest available to this customer is 10%.
How should this transaction be accounted for in the accounts of Johnston?
Solution
Discount the Revenue and recognise a receivable on the discounted amount
DR Receivable ($400,000 x 1 / 1.12) 330,578
CR Revenue 330,578
Unwind the discount over the two years
Year 1
DR Receivable (330,578 x 10%) 33,058
CR Finance Income 33,058
Year 2
DR Receivable ((330,578 + 33,058) x 10%) 36,364
CR Finance Income 36,364
Final Receivable (330,578 + 33,058 + 36,364) 400,000
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Illustration 3
Gerry has just completed a contract to supply Roses with 200 pineapple trees over the next 2 years for a set price of $40,000.
As part of the contract Gerry agreed to pay $2,000 to increase the height of the doors at Roses in order to get the trees into the store.
How much revenue should be recognised in year 1 of the contract?
SolutionThe consideration paid to Roses should be treated as a reduction in the transaction price.
The price therefore will be reduced to (40,000 - 2,000) $38,000.
This will be recognised over the term of the contract so in year 1 ($38,000 / 2) $19,000 will be recognised.
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Illustration 4
Avon has sold goods to 1000 customers at a price of $400 each. The goods are delivered and control passed to the customer immediately and they are paid for up front. Each good is currently in inventory at a value of $200.
The customers have the option to return the goods to Avon if they are not sold in the next 60 days for a full refund at which stage Avon will be able to sell them on at a profit.
Based on prior experience Avon estimates that 95% of the goods will not be returned.
SolutionBased on the amount of expected revenue Avon should recognise ((1000 x $400) x 95%) $380,000.
A refund liability for the rest ((1000 x $400) x 5%) $20,000 should be created.
The entries for this will be:
DR Cash $400,000CR Revenue $380,000CR Liability $20,000
The inventory will have been derecognised when transferred to customers but an asset should be created for the goods expected to be returned
DR Asset ((1000 x $200) x 5%) $10,000CR COS $10,000
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Construction Contracts Under IFRS 15
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Illustration 1
ABC Co. is building a football stadium under a construction contract.
The estimated costs to complete the stadium are $400,000.
The costs to date have been $350,000.
The total estimated revenue is $1,000,000.
It is estimated that the contract is 50% complete.
(i) What amounts of revenue, costs and profit will be recognised in the income statement?
(ii) If the expected revenue from the contract was $500,000 show the amounts of revenue, costs and profit that would be recognised in the income statement?
Solution
Expected Profit
$
Total Expected Revenue 1,000,000
Total Expected Costs (400,000 + 350,000) 750,000
Total Expected Profit 250,000
Recognised this year (250,000 x 50%) 125,000
Revenue (1,000,000 x 50%) 500,000
Costs (750,000 x 50%) 375,000
125,000
Total Loss expected to be recognised immediately
$
Total Expected Revenue 500,000
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Costs (400,000 + 350,000) 750,000
Loss -250,000
Revenue (500,000 x 50%) 250,000
Costs (750,000 x 50%) 375,000
Provision for loss -125,000
-250,000
Total Loss expected to be recognised immediately
$
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Illustration 2
ABC Co. is building a football stadium under a construction contract.
The estimated costs to complete the stadium are $400,000.
The costs to date have been $350,000.
It is estimated that the contract is 50% complete.
The company is not able to reliably estimate the outcome of the contract but believes it will recover all costs from the customer.
What amounts of revenue, costs and profit will be recognised in the income statement?
Solution
$
Costs to date 350,000
Revenue (Costs to be recovered) 350,000
Profit 0
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Illustration 3A construction company has the following contracts in progress:
Profit is accrued on the contracts as a percentage of completion derived by comparing work certified to the total sales value.
Contracts X and Z have been in progress for several years and the following amounts have been recognised to date:
Calculate the figures to be included in the financial statements in relation to the above contracts.
X Y Z
Costs Incurred to Date 350 200 600
Costs to complete 50 800 900
Work Certified to date 400 300 1000
Contract Price 500 600 2000
Cash Received on Contract 300 200 1200
X Z
Revenue 100 300
Costs 80 250
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SolutionStep 1 - Calculate the expected profit on each contract
Step 2 - Percentage completion
Step 3 - Profit to be recognised
X Y Z
Costs Incurred to Date 350 200 600
Costs to complete 50 800 900
Total Costs Expected 400 1000 1500
Contract Price 500 600 2000
Profit Expected 100 -400 500
X Y Z
Work Certified to date 400 300 1000
Contract Price 500 600 2000
Percentage complete 80% 50% 50%
X Y Z
Profit Expected 100 -400 500
Percentage Completion 80% 50% 50%
Profit/Loss 80 -400 250
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Step 4 - Income Statement Figures
Step 5 - Bal. Sheet Figures
X Y Z Total
Sales by % 400 300 1000 1700
Recognised to Date -100 0 -300 -400
Recognise this Year 300 300 700 1300
Costs by % 320 500 750 1570
Recognised to Date -80 0 -250
Recognise this Year 240 500 500
Provision For Loss 200
Profit/Loss 60 -400 200 -70
X Y Z
Revenue Recognised to Date 400 300 1000
Cash Received 300 200 1200
Receivable/(Payable) 100 100 -200
Costs Recognised to Date (COS) 320 500 750
Costs Incurred to Date 350 200 600
Balance (WIP if Incurred Greater) 30 - -
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Illustration 4On 1 October 20X9 Mocca entered into a construction contract that was expected to take 27 months and therefore be completed on 31 December 20X1.
Details of the contract are:$’000
Agreed contract price 12,500 Estimated total cost of contract (excluding plant) 5,500
Plant for use on the contract was purchased on 1 January 20X0 (three months into the contract as it was not required at the start) at a cost of $8 million. The plant has a four-year life and after two years, when the contract is complete, it will be transferred to another contract at its carrying amount. Annual depreciation is calculated using the straight-line method (assuming a nil residual value) and charged to the contract on a monthly basis at 1/12 of the annual charge.
The correctly reported income statement results for the contract for the year ended 31 March 20X0 were:
$‘000Revenue recognised 3,500Contract expenses recognised (2,660)Profit recognised 840
Details of the progress of the contract at 31 March 20X1 are:$’000
Contract costs incurred to date (excluding depreciation) 4,800Agreed value of work completed and billed to date 8,125Total cash received to date (payments on account) 7,725
The percentage of completion is calculated as the agreed value of work completed as a percentage of the agreed contract price.
Required:
Calculate the amounts which would appear in the income statement and statement of financial position of Mocca for the year ended/as at 31 March 20X1 in respect of the above contract.
(10 marks)
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Solution
Percentage Completion
Value of Work Completed to date 8,125
Contract Value 12,500
Percentage Completion (8,125 / 12,500) 65%
Expected Total Profit
Total Costs Expected 5,500
Depreciation (8/48 x 24) 4000
Total Costs 9,500
Total Revenue 12,500
Expected Total Profit (12,500 - 9,500) 3,000
Recognise to date (3,000 x 65%) 1,950
Recognised Last Year 840
Recognise this year (1,950 - 840) 1,110
Income Statement Extracts
Revenue (12,500 x 65%) - 3,500 4,625
Costs (9,500 x 65%) - 2,660 3,515
Gross Profit Recognised 1,110
SFP Amounts
Revenue Recognised to Date (12,500 x 65%) 8,125
Cash Received to Date 7,725
Receivable due from customers 400
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Costs Recognised to Date (9500 x 65%) 6,175
Costs Incurred to Date (8000/48 x 15) + 4800 7,300
Work In Progress 1,125
SFP Amounts
SFP Extracts
Non Current Asset (8,000 - 2,500) 5500
Receivables (8,125 - 7,725) 400
Work In Progress 1,125
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Entity Reconstructions
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Illustration 1
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.
$‘000
Assets 500
500
Equity & Liabilities
Issued Equity Shares @ $1 each 600
Share Premium 100
Retained Earnings -300
Liabilities 100
500
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Solution
DR CR
Share Premium 100
Equity Share Capital 200
Retained Earnings 300
$‘000
Assets 500
500
Equity & Liabilities
Issued Equity Shares 400
Share Premium 0
Retained Earnings 0
Liabilities 100
500
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Illustration 2
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.
$‘000
Intangible Asset (Brand) 50,000
Non Current Assets 220,000
270,000
Inventory 20,000
Receivables 30,000
320,000
Equity & Liabilities
Issued Equity Shares @ $1 each 100,000
Share Premium 75,000
Retained Earnings -100,000
75,000
Debenture Loan 125,000
Overdraft 20,000
Payables 100,000
320,000
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SolutionReconstruction Account
DR CR
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
$‘000
Intangible Asset (Brand) 0
Non Current Assets 220,000
220000
Bank (-20,000 + 75,000) Note (iii) 55,000
Inventory 20,000
Receivables 30,000
325000
Equity & Liabilities
Issued Equity Shares (125,000 + 25,000 + 75,000) 225,000
Share Premium 0
Retained Earnings 0
225,000
Debenture Loan 0
Overdraft 0
Payables 100,000
325,000
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Agriculture (IAS 41)
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Illustration 1A farmer purchased a flock of 50 5 year old sheep on 1 February 20X4 and on 31 July 20X4 purchased another flock of 20 5.5 year old sheep.
The following fair values less estimated ‘point of sale’ costs were applicable:
- 5 year old sheep at 1 February 20X4 $70.- 5.5 year old sheep at 31 July 20X4 $77.- 6 year old sheep at 31 January 20X5 $80.
Required:
Calculate the amount that will be taken to the statement of profit or loss for the year ended 31 January 20X5.
Solution
$
Purchase of 50 sheep on 1 Feb 20X4 (50 x $70) 3500
Purchase of 20 sheep on 31 July 20X4 (20 x $77) 1540
Total Purchased Value 5040
Value at 31 January 20X5 (70 x $80) 5600
Increase in FV to P/L (5,600 - 5,040) 560
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Illustration 2Jimmy owns a farm with a herd of 300 goats worth $40 each on 1 January 20X4. At 31 December 20X4 the goats have reproduced and he has 345 goats worth $42 each. At the local market the goats are sold with a commission of 3% on each sale. In addition Jimmy sold 3000 litres of goats milk at an average selling price of $1.20 per litre.
Required:
Calculate the amounts that will be taken to the statement of profit or loss for the year ended 31 December 20X4 and extracts from the Statement of Financial position.
Solution
$
Value of Goats at 1 Jan 20X4 (300 x $40) 12000
Estimated ‘point of sale’ costs (12,000 x 3%) -360
11640
Value of Goats at 31 Dec 20X4 (345 x $42) 14490
Estimated ‘point of sale’ costs (14,490 x 3%) -435
14,055
Increase in FV to P/L (14,055 - 11,640) 2,415
Sale of Milk (3,000 x $1.20) 3,600
Total to P/L 6,015
Non Current Assets
Herd of Goats 14,055
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Cash Flow Statements
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Illustration 1The group financial statements for Nasser Ltd. show the following information:
What was the dividend paid to the NCI in the year X1?
Solution
X1 X0
NCI on Statement of Financial Position 820 700
NCI share of Profit after Tax 220 130
NCI
Opening Balance 700
Closing Balance -820
Share of Profit 220
Total 100
Dividend to NCI was $100 = CASH OUTFLOW
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Illustration 2Indigo Ltd, took up a 40% holding in Violet Ltg. for consideration of $120 in 20X1. The group financial statements for Indigo Ltd. show the following information:
What amounts will be included in the group cash flow statement in the year X1?
Solution
X1 X0
Post tax Income from Associate (Income Statement)
50 0
Investment in Associate (SFP) 150 0
Loan to Associate 20 0
Associate
Opening Balance 0
Closing Balance -150
Purchase of Associate 120
Share of Profit 50
Total 20
Dividend Received from Associate was 20
Amounts for cash flow statement $
Income from Associate (Remove from profit before tax) -50
Consideration Paid (Cash paid out) -120
Dividend Received from associate 20
Loan to Associate 0 - 20 -20
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Illustration 3Extracts from the group SFP of Express Ltd are outlined below:
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:
Show the movements in cash for the 4 items outlined above.
Solution
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
Property Plant & Equipment 4,200
Inventory 1,650
Receivables 1,300
Payables 1,950
PPE INV REC PAY
Opening Balance 44,050 28,700 26,300 32,810
Closing Balance -50,600 -33,500 -27,130 -33,340
Purchase sub 4,200 1,650 1,300 1,950
Total -2,350 -3,150 470 1,420
OUT OUT IN OUT
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Illustration 4Using the information in illustration 3 show the movements in cash if Express Ltd. Had already owned the subsidiary and sold it during the period.
Solution
PPE INV REC PAY
Opening Balance 44,050 28,700 26,300 32,810
Closing Balance -50,600 -33,500 -27,130 -33,340
Sale sub -4,200 -1,650 -1,300 -1,950
Total -10,750 -6,450 -2,130 -2,480
OUT OUT OUT IN
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Illustration 5A Group has a foreign subsidiary which had the following FX Gains & Losses on translation into the Group presentational currency:
The Balances on these accounts in the Group Financial Statements were:
Depreciation in the period was $25m.
Show the cash flows arising from the above information to be included in the Group Statement of Cash-flows.
Solution
$m
PPE 30
Inventory 5
Receivables 18
Payables (7)
2011 2010
PPE 335 240
Inventory 70 50
Receivables 72 40
Payables -35 -25
PPE INV REC PAY
Opening Balance 240 50 40 25
Closing Balance -335 -70 -72 -35
FX Differences 30 5 18 7
Dep’n -25
Total -90 -15 -14 -3
OUT OUT OUT IN
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Illustration 6
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 1011
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 4667
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(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 100Receivables 110
20X2 20X1
Goodwill 52 72
Property Plant & Equipment 5,900 4,100
Inventories 950 800
Receivables 1,000 900
Cash 80 98
7982 5970
Share Capital 3,500 2,500
Retained Earnings 1,167 807
NCI 543 500
Non-Current Liabilities
Obligations under Finance Leases
225 140
Long term borrowings 1,554 1,200
Deferred Tax 278 218
Current Liabilities
Trade Payables 450 400
Accrued Interest 25 20
Income Tax 130 120
Obligations under Finance Leases
45 25
Overdraft 65 40
7982 5970
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Cash 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 it’s net assets had been $120m.
(ii) Goodwill is measured using the proportionate method
(iii)The following currency differences occurred
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 ‘Other operating expenses’.
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.
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
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Solution
W1 - Goodwill
W2 - PPE
Goodwill in Disposal Subsidiary $m
Cost of Investment 110
Net assets acquired 120 x 75% -90
Goodwill 20
Goodwill
Opening Balance 72
Closing Balance -52
Disposal -20
Total 0
PPE
Opening Balance 4,100
Closing Balance -5,900
Disposal of Sub -200
Other Disposals (Note iv) -190
Exchange Differences (Note iii) 25
Additions on Finance Leases (Note iv) 250
Depreciation -320
Total -2235
Difference is Additions - CASH OUT
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W3 - Working Capital Movements
W4 - Share Capital
Inventories Receivables Payables
O’Bal 800 900 400
Cl’Bal -950 -1,000 -450
Sub -100 -110 -80
FX 20 20 9
Movement -230 -190 -121
CASH OUT OUT IN
Net Movement OUT 299
Opening Balance 2,500
Closing Balance -3,500
Total -1,000
Shares of 1,000 issued = CASH IN
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W5 - NCI
W6 - Finance Leases
Opening Balance 500
Closing Balance -543
Share of Profit 143
Disposal of Sub (240 x 25%) -60
Total 40
Dividend to NCI was 40 = CASH OUTFLOW
Opening Balance (Current Leases) 25
Opening Balance (Non Current Leases) 140
Closing Balance (Current Leases) -45
Closing Balance (Non Current Leases) -225
New Leases in Year 250
Balance 145
The difference is the leases REPAID in the year which is a cash flow
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W7 - Long Term Borrowings
W8 - Income Tax
Opening Balance 1,200
Closing Balance -1,554
Disposal of Sub -75
Exchange Loss 10
Total -419
New Borrowings therefore of 419 - CASH IN
Opening Balance (Income Tax) 120
Opening Balance (Deferred Tax) 218
Closing Balance (Income Tax) -130
Closing Balance (Deferred Tax) -278
Disposal of Sub -25
Income Statement Charge (Increase tax due) 180
Balance 85
The difference is the tax PAID in the year which is a cash flow
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W9 - Interest Payable
Opening Balance 20
Closing Balance -25
Income Statement Charge 200
Total 195
This is interest paid - CASH OUT
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Cash Flow Statement$m
Profit Before Tax 861
Depreciation 320
FX Differences on Profit 16
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 W3 -299
Cash Generated from Operations 1040
Interest Paid W9 -195
Income Taxes Paid W8 -85
Net Cash from Operating activities 760
Cash Flow from Investing Activities
Receipts from the sale of PPE 198
Purchases of PPE (W2) -2,235
Sale of Subsidiary Less cash sold (250 - 10) 240
-1797
Cash Flow from Financing Activities
Issue of Shares (W4) 1,000
New Long Term Borrowings (W7) 419
Finance Leases Repaid (W6) -145
Dividends Paid -240
Dividend Paid to NCI (W5) -40
994
Net Decrease in Cash & Cash equivalents -43
Cash b/f (98 - 40) 58
Cash c/f (80 - 65) 15
43
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$m
Profit Before Tax 861
Depreciation 320
FX Differences on Profit 16
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 -299
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
-1797
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
�293