SCHOOL OF ACCOUNTING SCIENCES - Unisa · TEST 1 ON TUTORIAL 102: 12 MARCH 2019 PERSONNEL AND...

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Tutorial letter 102/0/2019

APPLIED FINANCIAL ACCOUNTING II

FAC4864/NFA4864/ZFA4864

Year Module

Department of Financial Governance

IMPORTANT INFORMATION:

This tutorial letter contains important information about your module.

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INDEX Page Due date 3

Personnel and contact details 3

Prescribed method of study 3

Suggested working programme 4

SAICA’s Principles of Examination 4

Exam technique 5

Learning unit 1 Consolidated and separate financial statements 8

2 Business combinations 32

3 Investments in associates and joint ventures 47

4 Disclosure of interests in other entities 60

Self assessment questions and suggested solutions 67

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DUE DATE

DUE DATE FOR THIS TUTORIAL LETTER: 19 FEBRUARY 2019 TEST 1 ON TUTORIAL 102: 12 MARCH 2019

PERSONNEL AND CONTACT DETAILS

Personnel Telephone Number

Lecturers Mr T Nkwane (Course leader) Ms S Aboobaker Mr H Combrink Ms A de Wet Mr M Hlongwane Ms T Mahuma Ms A Oosthuizen Ms T van Mourik Ms C Wright

012 429-6346 012 429-4373 012 429-4792 012 429-6124 012 429-4713 012 429-4669 012 429-8971 012 429-3549 012 429-2004

Please send all technical e-mail queries to: [email protected] Please use the module telephone number to contact the lecturers: 012 429-4720

PRESCRIBED METHOD OF STUDY 1. Firstly study the relevant chapter(s) in your prescribed textbook so that you master the basic principles

and supplement this with the additional information in the learning unit (where applicable). 2. Read the standards and interpretation(s) covered by the learning unit. 3. Do the questions in the study material and make sure you understand the principles contained in the

questions. 4. Consider whether you have achieved the specific outcomes of the learning unit. 5. After completion of all the learning units - attempt the self assessment questions (open book, but within

the time constraint) to test whether you have mastered the contents of this tutorial letter.

mailto:[email protected]

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SUGGESTED WORKING PROGRAMME

FEBRUARY 2019

WEDNESDAY THURSDAY FRIDAY SATURDAY SUNDAY MONDAY TUESDAY

6 Consolidated and separate

financial statements







10 Business

combinations

11 Business

combinations

12 Business

combinations

13 Investments in associates and joint ventures

14 Investments in

associates and joint ventures

15 Investments in

associates and joint ventures

16 Disclosure of interests in

other entities

17 Do self

assessment questions

18 Do self


19 Do self


SAICA’S PRINCIPLES OF EXAMINATION From 2018 SAICA has changed the levels of learning (Level 1, Level 2, Level 3) to the principles of examination levels as a guidance how the standards (or topics within a standard) will be examined. Throughout the study material, we will refer you to the following principles of examination levels: 1. Issues that are at a core level: An issue is at core level if: • It is based on a significant conceptual underpinning/foundation of current financial

accounting (i.e. based on identification, recognition, measurement and presentation and disclosure of elements); or

• It is prevalent (i.e. issues and industries that would be commonly encountered in practice in the course of an entry-level Chartered Accountant’s work). Here, the emphasis is on issues that are of a more general nature.

2. Issues that are at an awareness level: Awareness means that the issue is not core but it is important for an entry-level. Chartered

Accountant to know about the issue. It is important for them to be able to identify that it is an issue that potentially has significant accounting implications and requires additional or specialist IFRS knowledge.

They would need to be able to identify and describe what the accounting issue is and read up

on it futher. Students would also be expected to perform basic processing of the transaction when the numbers are given (e.g. obtained from an expert).

A good example might be borrowing costs i.e. students should be able to do the journal to

capitalise any qualifying borrowing costs to Property, Plant and Equipment when the borrowing cost amount has been supplied.

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3. Issues that are excluded. The following standards are excluded from the syllabus: • IFRS 1, First-time Adoption of International Financial Reporting Standards • IFRS 4, Insurance contracts • IFRS 6, Exploration for and Evaluation of Mineral Resources • IFRS 8, Operating Segments • IFRS 14, Regulatory Deferral Accounts • IAS 20, Government Grants • IAS 26, Accounting and Reporting by Retirement Benefit Plans • IAS 29, Financial Reporting in Hyperinflationary Economics • IAS 33, Earnings per Share • IAS 34, Interim Financial Reporting • IAS 41, Agriculture Please note the scope of all standards is at an awareness level, even if the standard is

excluded. Exclusions within any standard will be specifically identified in your study material. The treatment of any Interpetation Note will follow the principle of examination level of the related standard.

EXAM TECHNIQUE 1. Introduction

Examination technique remains the key distinguishing feature between candidates who pass and those that fail. Practice by answering questions under exam conditions by preparing the solution within the time limits and then by marking your solution. By marking your solution you will learn from your mistakes.

2. Examination technique From a review of candidates’ answers to past examination questions, the general examination

technique issues were identified. These problems affected the overall performance of candidates. Although these aspects seem like common sense, candidates who pay attention to them are likely to obtain better marks.

To improve your overall examination technique and performance take note of the following: • Discussion questions Lay the foundation of your answer by applying the relevant theory and to demonstrate

insight into the question. Identify all the issues and address all considerations in your application. Remember to

conclude at the end.

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In addition markers found that candidates used their own abbreviations (sms messaging

style) in their answers. Marks could not be awarded here as it is not up to the markers to interpret abbreviations that are not commonly used. The increased use of an sms style of writing in a professional examination is a major concern. Candidates should pay specific attention to the way in which they write their answers, and bear in mind that this is a professional examination for which presentation marks are awarded.

EXAM TECHNIQUE Please note that NO marks will be awarded for theory in a discussion question. The suggested solutions for discussion questions will however include the theory for completeness purposes, and to assist students with the application of the theory. Students should not waste time by stating the theory in the tests or the exam as no marks are awarded for theory.

• Journal entries Describe the specific accounts affected by the journals and clearly convey the

classification of the account (e.g. P/L; OCI; SFP; SCE). Ensure that the journal entries are processed the correct way around. Indicate the debit and credit of accounts clearly.

• Layout and presentation

Narrations to journals should always be provided, except for when it is stated in a question that it is not required. Candidates should allocate time to planning the layout and presentation of their answers before committing thought to paper. Very often, candidates start to write without having read the question properly, which invariably leads to, for example, parts of the same question being answered in several places or restatement of facts in different parts. Marks are awarded for appropriate presentation and candidates should answer questions in the required format, that is, in the form of a letter, memorandum or a report, if this is what is required.

The quality of handwriting is also an ongoing problem. The onus is on the candidate to

produce legible answers. • Irrelevancy Marks are awarded for quality, not quantity. Long-windedness is no substitute for clear,

concise, logical thinking and good presentation. Candidates should bear in mind that a display of irrelevant knowledge, however sound, will gain no marks.

• Calculations Always show all your calculations. Remember that your calculations should contain a

reference when used in a solution. Calculations done in pencil will NOT be marked. • Time management Use the reading time allocated to a question wisely, by highlighting important issues by

trying to envisage the required.

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Candidates are advised to use their time wisely and budget time for each question. The

marks allocated to each question are an indication of the relevant importance the examiners attach to that question and thus the time that should be spent on it. Candidates should beware of the tendency to spend too much time on the first question attempted and too little time on the last. They should never overrun on time on any question, but rather return to it after attempting all other questions.

• Recommendations / interpretations Responses to these requirements are generally poor, either because candidates are

unable to explain principles that they can apply numerically or because they are reluctant to commit themselves to one course of action. It is essential to make a recommendation when a question calls for it, and to support it with reasons. Not only the direction of the recommendation (i.e. to do or not to do something) is important, but particularly the quality of the arguments – in other words, whether they are relevant to the actual case and whether the final recommendation is consistent with those arguments. Unnecessary time is wasted by stating all the alternatives.

• Open-book examination Candidates are reminded that they MUST familiarise themselves with the open book

policy. To this end candidates are advised of the following: • No loose pages (of any kind) may be brought into the exam. • Writing on flags – Candidates are only allowed to highlight, underline, sideline and

flag in the permitted texts. Writing on flags is permitted for reference and cross-referencing purposes only, that is, writing may only refer to the name or number of the relevant discipline, standard, statement or section in the legislation.

Any contravention of this regulation will be considered to be misconduct.

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LEARNING UNIT 1 - CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS

INTRODUCTION IAS 27 prescribes accounting and disclosure requirements on how to account for the cost of an investment in the separate records of the investor for investments in subsidiaries, joint ventures and associates. IFRS 10 deals with the definition of control and establishes control as the basis for consolidation. IFRS 10 also sets out how to apply the principle of control and sets out the accounting requirements for preparation of consolidated financial statements. IFRS 10 deals with the principles that should be applied to a business combination (including the elimination of intragroup transactions, consolidation procedures, etc.) from the date of acquisition until date of loss of control.

OBJECTIVES/OUTCOMES After you have studied this learning unit, you should be able to demonstrate knowledge of: 1. Define control (IFRS 10 Appendix A and IFRS 10.5-.18). 2. Identify situations in which consolidated financial statements should be presented

and the scope of consolidated financial statements (IFRS 10.4). 3. Apply the consolidation procedures (IFRS 10.19-.24 and IFRS 10.B86-.B96)

including: 3.1 Elimination of the parent’s investment in the subsidiary; 3.2 Account for non-controlling interests in the profit or loss of consolidated

subsidiaries; 3.3 Account for non-controlling interests in the net assets of consolidated

subsidiaries; 3.4 Elimination of intragroup balances, transactions, income and expenses; 3.5 Use of uniform accounting policies; 3.6 Use of the same end of reporting period date; and 3.7 Presentation of non-controlling interests in the statement of financial position. 4. Account for a loss of control transaction (IFRS 10.25 and IFRS 10.B97-.B99).

Assessed in Learning unit 7. 5. Account for changes in ownership interest. Assessed in Learning unit 7. 6. Account for the cost of investments in subsidiaries, joint ventures and associates in

the separate financial statements of the investor (IAS 27.9, .10, .13 and .14) at cost (IAS 27.10(a)).

7. Account for dividends from subsidiaries, joint ventures and associates (IAS 27.12). 8. Disclosures in separate financial statements (IAS 27.15-.17).

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PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. Group Statements, 17th edition, Volume 1, ALL chapters 2. Group Statements, 17th edition, Volume 2, Chapter 10. 3. IAS 27 Separate Financial Statements. 4. IFRS 10 Consolidated Financial Statements.

COMMENT Please note that Group Statements, Volume 1, was covered thoroughly in your undergraduate studies and therefore this tutorial letter is only a revision of the basic consolidation principles. It is very important that you spend enough time to revise these principles.

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THE REST OF LEARNING UNIT 1 IS BASED ON THE ASSUMPTION THAT YOU HAVE ALREADY STUDIED THE RELEVANT PRESCRIBED STUDY MATERIAL.

SECTION A – SAICA’S PRINCIPLES OF EXAMINATION LEVELS From 20.18 SAICA has changed the levels of learning (Level 1, Level 2, Level 3) to the principles of examination levels as a guidance how the standards (or topics within a standard) will be examined. The principles of examination levels for IAS 27 are as follows:

Description Paragraph Level Notes

Objective 1 Core

Scope 2 – 3 Core

Definitions 4 – 8 Core 8A Excluded Investment entity matters

Preparation of separate financial

9 Core Separate financial statements

statements 10(a) Core Cost measurement 10(b) Excluded Fair value in separate AFS 10(c) Excluded Equity method in separate AFS 10E1 Core Cost measurement principles 11 – 11B Excluded Investment entity matters 12 Core Dividends received 13 – 14 Excluded Group reorganisations

Disclosure 15 – 17 Core Refer to learning unit 4 16A Excluded Investment entity matters

Effective date and transition 18 – 20 Excluded

The principles of examination levels for IFRS 10 are as follows:


Objective 1 Core 2 – 3 Core Meeting the objective

Scope 4 Awareness 4A – 4B Excluded

Control 5 – 9 Core 10 – 14 Core Power 15 – 16 Core Returns 17 – 18 Core Link between power and returns

Accounting requirements 19 – 21 Core 22 – 24 Core Non-controlling interests 25 – 26 Core Loss of control – refer to learning

unit 7 Vertical

groups Awareness I.e. The parent’s subsidiary has an

investment in a subsidiary/ associate

Change in ownership

Depends Refer to learning unit 7

IFRS 5 – Groups

Excluded Subsidiaries acquired with a view to resale and subsidiaries classified as held for sale

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Determining whether an entity is an investment entity

27 – 30 Excluded Investment entity

Investment entities: exception to consolidation

31 – 33 Excluded Investment entity

Defined terms A Core

Application guidance B1 Core B2 – B8 Core Assessing control B9 – B10 Core Power B11 – B13 Core Relevant activities B14 – B28 Core Rights that give power B29 – B33 Core Franchises B34 – B50 Core Voting rights B51 – B54 Core Power when voting or similar rights

do not have a significant effect B55 – B57 Core Exposure to variable returns B58 – B72 Excluded Link between power and returns –

Delegated power B73 – B75 Excluded Relationship with other parties B76 – B79 Excluded Control of specified assets B80 – B83 Core Continuous assessment B84 Excluded Principle/ agent B85 Core Market conditions B85A – B85W Excluded Investment entity B86 – B88 Core Accounting requirements B89 – B91 Core Potential voting rights B92 – B95 Core Reporting date B96 Core Changes in proportion held by NCI B97 – B99 Core Loss of control – refer to learning

unit 7 B99A Excluded Loss of control – not a business B100 – B101 Excluded Investment entity

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EXAMPLE

The following example illustrates the basic consolidation process: Investment in subsidiary accounted for at cost P Ltd acquired a 100% interest in S Ltd for R200 000 on 1 January 20.13 when S Ltd’s share capital and retained earnings amounted to R80 000 and R120 000 respectively. Investments in subsidiaries are accounted for at cost in terms of IAS 27.10(a).

Parent (P) Separate Financial

Statements

Subsidiary (S) Financial Statements

Total

Pro forma

journals

Consolidated Financial Statements

(P + S)

R’000 R’000 R’000 R’000 R’000 Assets Assets Assets Investment in S Ltd (cost)

200

Investments

-

200

(200)

Investment in S Ltd (cost)

-

Trade debtors 100 Trade debtors 280 380 Trade debtors 380 Equity Equity Equity Share capital (50) Share capital (80) (130) 80 Share capital (50) Retained earnings (150) Retained earnings (150) (300) 120 Retained earnings (180) Liabilities Liabilities Liabilities Long-term loan (100) Long-term loan (50) (150) Long-term loan (150)

Note 1 Note 2 Note 3

Notes 1. When a parent prepares separate financial statements, it shall account for investments in

subsidiaries at cost. Separate financial statements are prepared by the parent and are presented in addition to the consolidated financial statements.

2. Broadly speaking, the first step in preparing consolidated financial statements is to combine the

financial statements of the parent and the subsidiaries (i.e. 100% of each line-item of the subsidiary is added to each line-item of the parent).

3. Pro forma journals are prepared for consolidation purposes only and are not recognised in the

individual records of either the parent or the subsidiary. The pro forma journals eliminate common balances. The only two common items in this case is the investment in the subsidiary on the statement of financial position in the parent (P) and the portion of the equity of the subsidiary (S) held by the parent. The investment held by the parent in the subsidiary is therefore set off against the equity of the subsidiary as follows:

Dr Cr R’000 R’000

Share capital (SCE) 80 Retained earnings (SCE) 120 Investment in S Ltd (SFP) 200 At acquisition elimination journal

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SECTION B – QUESTIONS ON CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS

QUESTION 1.1 (45 marks - 68 minutes) The following trial balances at 31 December 20.12 are presented to you: Mickey

Ltd R

Minnie Ltd R

Debits Investment property - Land Factory buildings Equipment Investment in Minnie Ltd - 112 000 Ordinary shares at cost - 12 000 12% Preference shares at cost Inventory Trade receivables Bank Cost of sales Other expenses Finance costs Income tax expense Preference dividends paid (up to 30 June 20.12) Ordinary dividends - Final dividend for the year ended 31 December 20.11 (declared and paid on 29 February 20.12) - Interim dividend for 20.12: paid 30 September 20.12

-

1 200 000 236 000

140 000 26 880 80 000

114 953 90 000

1 375 000 254 320 14 000

239 260 -

- 60 000

700 000

- 125 000

- -

26 000 40 000

- 591 499 406 000

- 88 700 7 200

20 000 -

3 830 413 2 004 399

Credits Issued ordinary shares (640 000 shares; 160 000 shares) Issued 12% Preference shares (20 000 shares) Retained earnings (1 January 20.12) Deferred tax Trade payables Bank overdraft Revenue Other income

640 000

- 260 000 150 500 61 593

- 2 700 000

18 320

160 000 40 000

174 950 102 449 122 000 25 000

1 200 000 180 000

3 830 413 2 004 399

Additional information 1. Mickey Ltd obtained its interest in the non-redeemable cumulative preference shares of

Minnie Ltd on 1 January 20.12 at a cost of R26 880. Minnie Ltd is obliged to pay a preference dividend for a financial year if an ordinary dividend is declared during the financial year. You may assume that the preference shares were correctly classified as equity. The interest in the ordinary shares was also acquired on 1 January 20.12. From this date Mickey Ltd had control over Minnie Ltd as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. The details of acquisition of the interest in the ordinary shares in Minnie Ltd were as follows:

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• The purchase price agreed on, was payable in cash and a portion in shares. • A cash amount of R154 000 was payable by Mickey Ltd on 31 December 20.12. • The share portion was settled by the issue of 1 000 ordinary shares of Mickey Ltd worth

R105 000 on 1 January 20.12 and R110 000 on 31 December 20.12. • A contingent consideration of R10 000 was also payable on 30 June 20.13 if certain profits

were met. The fair value of the contingent consideration was R8 000 on 1 January 20.12 and R9 000 on 31 December 20.12.

• The agreement determined that the seller of the shares will pay the costs relating to the

agreement and valuation expenses. The amount is R10 000 and is included in the purchase price. You may assume that the tax effect of the R10 000 is correctly accounted for.

• With the exception of the items listed below, all assets and liabilities of Minnie Ltd were

deemed to be fairly valued on acquisition date:

Carrying amount R

Fair value R

Inventory Trade receivables

20 000 27 000

36 000 19 500

The fair value of inventory represents the value at which it can be purchased. 2. Mickey Ltd, a manufacturer of equipment, sold equipment to Minnie Ltd to the value of R50 000

on 1 January 20.12. Mickey Ltd sells equipment at cost plus 25%. Minnie Ltd uses the equipment in the production of inventory and depreciates equipment at 20% per annum according to the straight-line method.

3. Minnie Ltd purchases all its inventory from Mickey Ltd at a gross profit percentage of 20%.

Inventory purchased from Mickey Ltd still on hand at year end was as follows: 31 December 20.12 - R30 000 The inventory on hand at 31 December 20.12 was written down to net realisable value by

Minnie Ltd. Total sales of Mickey Ltd to Minnie Ltd for the year ended 31 December 20.12 amounted to

R80 000. 4. Minnie Ltd acquired the land on 30 June 20.12 at R550 000 for investment purposes. The land

is rented by Mickey Ltd at R5 000 per month and used as a storage facility for its inventory. Rent paid and received are included in other expenses and other income respectively. No rent was in arrears at 31 December 20.12. Minnie Ltd elected the fair value model to measure the investment property. The investment property value increased with R150 000 for the year ended 31 December 20.12.

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5. It is the group accounting policy to disclose land at revalued amounts. 6. It is the policy of Mickey Ltd to account for investments in subsidiaries at cost in accordance with

IAS 27.10(a) in its separate financial statements. 7. Mickey Ltd elected to measure non-controlling interests at fair value at acquisition for all

acquisitions. The fair value of the non-controlling interests was R100 000 on 1 January 20.12. 8. A market-related pre-tax discount rate is 10%, compounded annually. 9. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

tax on financial instruments. Ignore the effects of Dividend Tax and Value Added Tax (VAT). REQUIRED

Marks

1. Prepare the consolidated statement of profit or loss and other comprehensive income of the Mickey Ltd Group for the year ended 31 December 20.12. Income and expenditure should be indicated in terms of their function.

22

2. Prepare the consolidated statement of financial position of the Mickey Ltd Group as

at 31 December 20.12.

Communication skills: Presentation and layout

22

1 Please note: • Comparative figures are not required. • Notes are not required. • Show all your calculations. • Round all calculated amounts off to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 1.1 - Suggested solution 1. MICKEY LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 31 DECEMBER 20.12 R

Revenue [C7] Cost of sales [C8]

3 770 000 (1 862 499)

(2) (5)

Gross profit Other income [C9] Other expenses [C10] Finance costs (given)

1 907 501 -

(633 820) (14 000)

(3)

(3½) (½)

Profit before tax Income tax expense [C11]

1 259 681 (289 180)

(4)

PROFIT FOR THE YEAR 970 501

Other comprehensive income: Items that will not be reclassified to profit or loss: Gains on property revaluation [150 000 – (150 000 x 28% x 80%)] 116 400 (1) Other comprehensive income for the year, net of tax 116 400 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 1 086 901

Profit attributable to: Owners of the parent (balancing) Non-controlling interests (49 944[C2] + 1 920[C3])

918 637 51 864

(½) (1)

970 501

Total comprehensive income attributable to: Owners of the parent (balancing) Non-controlling interests (51 864 + 34 920 [C2])

1 000 117 86 784

(½) (1)

1 086 901

(22)

COMMENT The land will be recognised as investment property in the separate financial statements of Minnie Ltd, as it was acquired for investment purposes. The fair value adjustment and the deferred tax adjustment was thus recognised in profit or loss. Since the land is rented by Mickey Ltd (parent), it now becomes owner occupied property, plant and equipment in the group financial statements (IAS 40.15). The fair value adjustment and deferred tax adjustment recognised in profit or loss by Minnie Ltd must thus be reversed. It is the group accounting policy to measure land in accordance with the revaluation model. The increase in fair value of R150 000 must thus be recognised in other comprehensive income, net of deferred tax.

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2. MICKEY LTD GROUP CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.12

R ASSETS Non-current assets

Property, plant and equipment* Goodwill [C1]

2 253 000 6 730

(3) (7)

2 259 730

Current assets Inventory (80 000 + 26 000 - 2 000[C5]) Trade receivables (114 953 + 40 000) Cash and cash equivalents

104 000 154 953 90 000

(1½) (1)

(½)

348 953

Total assets 2 608 683

EQUITY AND LIABILITIES

Equity attributable to owners of the parent Share capital (640 000 + 105 000[C6]) Retained earnings (260 000 + 918 637 (from 1 above) – 60 000 (div)) Other components of equity [C2]

745 000 1 118 637

81 480

(1) (1½)

(1)

1 945 117 Non-controlling interests (178 864[C2] + 16 000[C3]) 194 864 (1)

Total equity 2 139 981

Non-current liabilities Deferred tax (150 500 + 102 449 - 2 240[C4] - 560[C5])

250 149

(2)

250 149

Current liabilities Bank overdraft Trade payables (61 593 + 122 000 + 9 000[C6] (J2 Mickey)) Dividends payable [C3]

25 000 192 593

960

(½) (1½) (½)

218 553

Total liabilities 468 702

Total equity and liabilities 2 608 683

Communication skills: Presentation and layout (22) (1)

* Land (550 000 + 150 000)

Factory buildings Equipment (236 000 + 125 000 – 8 000 [C4])

700 000

1 200 000 353 000

2 253 000

COMMENT

Note that the investment in Minnie Ltd was only carried at R140 000 in the trial balance of Mickey Ltd, which thus indicates that the share issue, the contingent consideration and the acquisition costs have not yet been recorded in the records of Mickey Ltd.

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CALCULATIONS C1. Goodwill

Purchase price (243 000)

Share issued (1 000 x 105) Fair value of contingent consideration Acquisition costs Cash (FV = 154 000; n = 1; I = 10%; PV = 140 000)

105 000 8 000

(10 000) 140 000

[1] [½] [½]

[1½]

Equity at acquisition: 336 270

- Share capital - Retained earnings

160 000 176 270

[½]

- Given - Preference dividend - Inventory (16 000 x 72%) - Trade debtors (7 500 x 72%)

174 950 (4 800) 11 520 (5 400)

[½] [1] [½] [½]

Non-controlling interests (100 000) [½]

Goodwill 6 730

[7]

COMMENT Preference dividend The preference dividend paid of R7 200 up to 30 June 20.12 relates to a dividend for the year ended 31 December 20.11 amounting to R4 800 (R40 000 x 12%). This amount has to be accrued for at acquisition, since the preference shares are cumulative. The remaining R2 400 (R7 200 – R4 800 or R40 000 x 12% x 6/12) relates to the six month period ended 30 June 20.12. An amount of R2 400 must thus still be accrued for the last six months, refer to [C3]. Inventory and trade debtors The IFRS 3 fair value adjustments made to trade debtors and inventory at acquisition must again be reversed when the underlying assets are derecognised. Since trade receivables and inventory are current assets, they are expected to realise within 12 months if no other information is provided. These fair value adjustments are therefore reversed at year end.

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C2. Analysis of owners’ equity of Minnie Ltd – ordinary shares

Total

Mickey Ltd (70%) NCI

At Since

At acquisition Share capital Retained earnings:

160 000

Balance given Debtors (7 500 x 72%) Inventory (16 000 x 72%) Preference dividend in arrears

174 950 (5 400) 11 520 (4 800)

Equity represented by goodwill

336 270 6 730

235 389 7 611

100 881 (881)

Consideration and NCI 343 000 243 000 100 000

Since acquisition Current year

Profit (1 200 000 – 591 499 – 406 000 + 180 000 – 150 000 [J13] – 88 700 + 33 600 [J14]) Profit attributable to PSH Debtors Inventory

177 401 (4 800) 5 400

(11 520)

Total current year profit Revaluation – land [150 000 x (100% - (80% x 28%))] Dividend

166 481

116 400 (20 000)

116 537

81 480 (14 000)

49 944

34 920 (6 000)

605 881 184 017 178 864

C3. Analysis of owners’ equity of Minnie Ltd – preference shares

Total

Mickey Ltd (60%) NCI

At Since

At acquisition Share capital Dividend in arrears

40 000 4 800

24 000 2 880

16 000 1 920


Since acquisition Current year Profit attributable to PSH (40 000 x 12%) Dividend Dividend accrued

4 800 (7 200) (2 400)

2 880 (4 320) (1 440)

1 920 (2 880)

(960)

40 000 (2 880) 16 000

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COMMENT Preference shares have a preference to dividends over ordinary shares. The profit attributable to preference shareholders of R4 800 is the preference dividend for the current year. Please note that this profit attributable to preference shareholders is deducted in the analysis of ordinary shares to ensure we don’t double account. The preference dividend that was paid of R7 200 (as per the trial balance) is preference dividends up to 30 June 20.12 only. The preference dividend for the period 1/7/20.12 – 31/12/20.12 is R2 400 which is calculated as R4 800 x 6/12. The parent thus has to accrue for this as preference dividends as the amount is owed to the preference shareholders at year end.

C4. Equipment sold by Mickey Ltd to Minnie Ltd

Minnie Ltd

Group

Dif- ference

Tax

Unrealised profit (50 000 x 25/125) Depreciation (10 000 x 20%) Deferred taxation at 28% Net

50 000

40 000

10 000

2 000 8 000

2 240 5 760

2 800

(560) 2 240

C5. Unrealised profit in inventory Closing balance: (30 000 x 20%) = R6 000 limited to R2 000* Taxation effect: (2 000 x 28%) = R560 * The inventory was already written-off from R30 000 to R26 000 (per trial balance) by

Minnie Ltd, an adjustment of R4 000. Therefore the remaining unrealised profit for group statement purposes is R2 000 (R6 000 – R4 000).

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C6. Journals in the records of Mickey Ltd

Dr R

Cr R

J1 Investment in Minnie Ltd (SFP) Share capital (SCE)

105 000 105 000

J2 Investment in Minnie Ltd (SFP) Contingent consideration liability (SFP) Fair value adjustment (P/L)

8 000

1 000*

9 000

J3 Acquisition costs (P/L) Investment in Minnie Ltd (SFP)

10 000# 10 000

* Not tax deductible. # The given information states that you may assume that the tax effect of the R10 000 is

correctly accounted for.

COMMENT Transaction costs should be carefully analised as the accounting treatment for transaction costs are not all the same. Acquisition-related costs (finder’s fees, advisory, legal, valuation, professional fees, administration fees) should be expensed in profit or loss in the consolidated financial statements of the acquirer in accordance with IFRS 3.53. Costs to issue debt or equity are not acquisition-related costs as defined in accordance with IFRS 3. Share issue costs shall be accounted for as a deduction from equity in terms of IAS 32.35 in the separate and consolidated financials of the acquirer. The parent will measure its investments in subsidiaries at cost in accordance with IAS 27.10(a) in its separate financial statements. Acquisition-related costs in the separate financial statements of the parent should thus also be expensed. Students should read carefully how the parent treated the transaction costs in its separate financial statements. In this question, acquisition-related costs of R10 000 will be paid by the seller of the shares (Minnie Ltd) and is included in the purchase price to be paid by Mickey Ltd. In accordance with IFRS 3.53, these costs should however be expensed.

C7. Revenue

Mickey 2 700 000 [½] Minnie 1 200 000 [½] Total intragroup sales (80 000) [½] Intragroup equipment sold [C4] (50 000) [½] 3 770 000

[2] C8. Cost of sales

Mickey (1 375 000) [½] Minnie (591 499) [½] Total intragroup sales 80 000 [½] Intragroup equipment sold [C4] 40 000 [½] Depreciation on intragroup equipment [C4] 2 000 [1] Unrealised profit – closing inventory [C5] (2 000) [1½] Reversal of at acquisition inventory adjustment [C2] (16 000) [½] (1 862 499)

[5]

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COMMENT The depreciation on the intragroup equipment will be included in cost of sales instead of operating expenses as the specific machine is used in the production of inventory.

C9. Other income

Mickey 18 320 [½] Minnie 180 000 [½] Intragroup rent paid (30 000) [½] Reversal of fair value adjustment on investment property (150 000) [½] Ordinary dividend elimination [C2] (14 000) [½] Preference dividend elimination [C3] (4 320) [½] -

[3] C10. Other expenses

Mickey (254 320) [½] Minnie (406 000) [½] Fair value adjustment on contingent consideration [C6] (1 000) [1] Acquisition cost [C6] (10 000) [½] Reversal of at acquisition debtors adjustment [C2] 7 500 [½] Intragroup rent paid 30 000 [½] (633 820)

[3½] C11. Income tax expenses

Mickey (239 260) [½] Minnie (88 700) [½] Deferred tax on unrealised profit [C4] 2 800 [½] Deferred tax on depreciation [C4] (560) [½] Deferred tax on unrealised profit [C5] 560 [½] Deferred tax on reversal of at acquisition inventory adjustment [C2] 4 480 [½] Deferred tax on reversal of at acquisition debtors adjustment [C2] (2 100) [½] Reversal of deferred tax on fair value adjustment on investment property 150 000 x 80% x 28%

33 600

[½]

(289 180)

[4]

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C12. Pro forma consolidation journals

The pro forma journals are provided for completeness only and should explain the adjustments made to the statement of profit or loss and other comprehensive income.

Dr R

Cr R

Investment in ordinary shares J1 Share capital (SCE) 160 000 Retained earnings (SCE) (174 950 – 4 800) 170 150 Inventory (SFP) 16 000 Debtors (SFP) 7 500 Deferred tax (SFP) [(16 000 - 7 500) x 28%] 2 380 Investment in Minnie (SFP) 243 000 Non-controlling interests (SCE/SFP) 100 000 Goodwill (SFP) (balancing) 6 730 At acquisition elimination journals J2 Cost of sales (P/L) 16 000 Inventory (SFP) 16 000 Reversal of fair value adjustment at acquisition J3 Debtors (SFP) 7 500 Other expenses (P/L) 7 500 Reversal of fair value adjustment at acquisition J4 Deferred tax (SFP) [(16 000 - 7 500) x 28%] 2 380 Income tax expense (P/L) 2 380 Reversal of deferred tax on fair value adjustments at

acquisition J5 Revenue (Mickey) (P/L) (50 000 x 25/125) 50 000 Cost of sales (Mickey) (P/L) (50 000 x 100/125) 40 000 Equipment (Minnie) (SFP) 10 000 Elimination of unrealised profit on intragroup equipment

sale J6 Deferred tax (SFP) (10 000 x 28%) 2 800 Income tax expense (P/L) 2 800 Deferred tax on intragroup sales J7 Accumulated depreciation (Minnie) (SFP)

(10 000 x 20%) 2 000 Cost of sales (Depreciation) (Mickey) (P/L) 2 000 Elimination of intragroup depreciation J8 Income tax expense (P/L) (2 000 x 28%) 560 Deferred tax (SFP) 560 Deferred tax on intragroup depreciation J9 Sales (Mickey) (P/L) 80 000 Cost of sales (Minnie) (P/L) 80 000 Elimination of intragroup sales J10 Cost of sales (Mickey) [(30 000 x 20%) - 4 000] 2 000 Inventory (Minnie) (SFP) 2 000 Elimination of unrealised profit on intragroup sales J11 Deferred tax (SFP) (2 000 x 28%) 560 Income tax expense (P/L) 560 Deferred tax on intragroup unrealised profit J12 Other income (rental income) (Minnie) (P/L) (5 000 x 6) 30 000 Other expenses (rental expense) (Mickey) (P/L) 30 000 Elimination of intragroup rental income and expense

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Dr R

Cr R

J13 Other income (fair value adjustment) (P/L) 150 000 Investment property (SFP) 150 000 Reversal of the fair value adjustment on land included in

P/L J14 Deferred tax (SFP) (150 000 X 28% X 80%) 33 600 Income tax expense (P/L) 33 600 Reversal of deferred tax raised on the fair value

adjustment J15 Property, plant and equipment (SFP) 550 000 Investment property (SFP) 550 000 Reclassification of the land to owner occupied PPE J16 Property, plant and equipment (SFP) 150 000 Revaluation surplus (OCI) 150 000 Recognising the increase in the fair value of the owner

occupied land J17 Deferred tax (OCI) (150 000 x 28% x 80%) 33 600 Deferred tax (SFP) 33 600 Deferred tax on the revaluation surplus J18 Non-controlling interests (P/L) 49 944 Non-controlling interests (SCE/SFP) 49 944 NCI's share of profit for the year J19 Non-controlling interests (OCI) 34 920 Non-controlling interests (SCE/SFP) 34 920 NCI's share of other comprehensive income for the year J20 Other income (dividend received) (P/L) 14 000 Non-controlling interests (SCE/SFP) 6 000 Dividends paid (SCE) 20 000 Elimination of dividends paid

Investment in preference shares J21 Share capital (SCE) 40 000 Retained earnings (SCE) 4 800 Non-controlling interests (SCE/SFP) 17 920 Investment in Minnie (SFP) 26 880 At acquisition elimination journals J22 Non-controlling interests (P/L) 1 920 Non-controlling interests (SCE/SFP) 1 920 NCI's share of profit for the year J23 Other income (dividend received) (P/L) 4 320 Non-controlling interests (SCE/SFP) 2 880 Dividends paid (SCE) 7 200 Elimination of dividends paid J24 Non-controlling interests (SCE/SFP) 960 Dividends payable (SFP) 960 Reclassification of dividends payable

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QUESTION 1.2 (31 marks – 47 minutes) Great White Ltd was established in 20.3 and their main business is to take tourists on shark cage diving expeditions in Gansbaai. Great White Ltd has several investments as indicated below: Whales Ltd On 1 March 20.10 Great White Ltd acquired 60% of the issued share capital of Whales Ltd, a company that is in the industry of arranging whale watching expeditions in the Hermanus area. One voting right is attached to each share. The remaining 40% of the issued share capital is owned by Mr Lombard, the managing director of the company. Mr Lombard is a meteorologist and an expert in predicting weather patterns. According to a contractual agreement, Mr Lombard has rights to refuse the boats of Whales Ltd to go out onto the sea when he expects severe weather conditions that may damage the boats and/or place the lives of the crew and tourists in danger. Great White Ltd has the rights to make all other decisions regarding operating activities. Dolphins Ltd Great White Ltd acquired 50% of the issued share capital of Dolphins Ltd on 1 September 20.12, a company situated in Ballito. Dolphins Ltd organises dolphin watching expeditions on the North Coast. One voting right is attached to each share. Mrs Yen, a retired widow, acquired the remaining 50% interest. Mrs Yen lives in Japan along with her children and rarely visits South Africa and Dolphin Ltd. Mrs Yen has the rights to make decisions regarding the investment of surplus funds. Great White Ltd has the rights to make decisions regarding the purchase and disposal of boats, organising expeditions and appointing staff. Rent-a-Boat Ltd On 1 November 20.12, a new company was formed in Gansbaai, namely Rent-a-Boat Ltd, which rents out charter boats. Hundred percent (100%) of the issued share capital is held by Mrs van Riebeeck, a local business woman in the Gansbaai area. In terms of a contractual agreement, Rent-a-Boat Ltd must have boats available for Great White Ltd at any given period. Great White Ltd also has the rights to determine the accounting policies and to appoint the directors in terms of the contractual agreement.The customers of Rent-a-Boat Ltd other than Great White Ltd contribute a very small fraction of the revenue. Mrs van Riebeeck has the rights to decide which suppliers are used for the purchase of boats. REQUIRED

Marks

Discuss, with reasons, whether or not each of the companies indicated above is a subsidiary of Great White Ltd for the year ended 31 December 20.12. Your answer should address: (a) Whales Ltd (b) Dolphins Ltd (c) Rent-a-Boat Ltd Please note: • Your answer must comply with International Financial Reporting Standards (IFRS).

12 9 10

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QUESTION 1.2 – Suggested solution General theory Great White Ltd as the investor has to determine whether it is a parent by assessing whether it controls the investee, Whales Ltd (IFRS 10.5).

(½)

An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee (IFRS 10.6).

(a) Whales Ltd

An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, thus the activities that significantly affect the investee’s returns (IFRS 10.10).

The power that Great White Ltd has over Whales Ltd results from the voting rights of 60%, which are the majority voting rights.

(1)

Mr Lombard has the rights to refuse the boats to go out to sea when he suspects adverse weather conditions, due to his technical expertise as a meteorologist.

(1)

Mr Lombard can only protect the company and its assets and thus his own interest in the company by refusing boats to go out in severe weather conditions, as boats might be damaged and crew and tourists’ lives may be in danger should Mr Lombard not exercise his rights.

(1)

(1)

The rights that Mr Lombard has are deemed to be protective rights, as it is rights designed to protect the interest of Mr Lombard without giving him power over Whales Ltd (IFRS 10 Appendix A).

(1) (1)

Great White Ltd has the rights to make decisions regarding all other operating activities, which is thus seen as the relevant activities, as it is the activities of Whales Ltd that significantly affect the returns (IFRS 10 Appendix A).

(1)

Great White Ltd has, in terms of the 60% voting rights together with the rights to make decisions regarding relevant activities of Whales Ltd, power over Whales Ltd.

(1) (½)

Great White Ltd has rights to variable returns in the form of dividends due to its involvement with Whales Ltd as a shareholder.

(1)

The power, together with the exposure to variable returns and the ability to affect the amount of the returns, results in Great White Ltd having control over Whales Ltd.

(1)

Whales Ltd is thus a subsidiary of Great White Ltd. (1) (12)

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(b) Dolphins Ltd

Great White Ltd owns 50% of the voting rights of Dolphins Ltd, which does not constitute the majority voting rights.

(1)

Great White Ltd has the rights to make decisions regarding the purchase and disposal of boats, organising expeditions and appointing staff.

(1)

These activities are deemed to be relevant activities, as it significantly affects the returns of Dolphins Ltd. This results in Great White Ltd having power over Dolphins Ltd.

(1) (½)

Mrs Yen has the rights to make decisions regarding the investment of surplus funds, which is not deemed to be relevant activities.

(1)

Mrs Yen does thus not have power over Dolphins Ltd.

(1)

Great White Ltd has exposure, or rights, to variable returns from its involvement with the investee by means of the dividends received from the shares owned.

(1)

The power, together with the exposure to variable returns and the ability to affect the amount of the returns, results in Great White Ltd having control over Dolphins Ltd.

(1) (½)

Dolphins Ltd is thus a subsidiary of Great White Ltd. (1) (9)

(c) Rent-a-Boat Ltd

Great White Ltd does not own any voting rights from shares in Rent-a-Boat Ltd and does not have power in terms of voting rights.

(1)

Great White Ltd has the rights, in terms of a contractual agreement, to make decisions regarding the accounting policies and appointment of directors of Rent-a-Boat Ltd, which is deemed to be relevant activities as it significantly affects the returns of Rent-a-Boat Ltd.

(1)

(1)

Mrs van Riebeeck has the rights to decide which suppliers are used for the purchase of boats, which also constitutes relevant activities.

(1)

If two or more investors each have existing rights that give them the unilateral ability to direct different relevant activities, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee, has power over the investee (IFRS 10.13).

The rights that Great White Ltd has regarding the relevant activities together with the contractual agreement that grants them almost exclusive use of Rent-a-Boat Ltd’s boats, constitutes power over Rent-a-Boat Ltd.

(1)

(1)

Great White Ltd has exposure, or rights, to variable returns from its involvement with the investee by means of the contractual agreement stating that Rent-a-Boat Ltd must supply boats to Great White Ltd (ifrs 10.B57(c)).

(1)

(½)

The power, together with the exposure to variable returns and the ability to affect the amount of the returns by means of the contract, results in Great White Ltd having control over Rent-a-Boat Ltd.

(1)

(½)

Rent-a-Boat Ltd is a structured entity as defined and a subsidiary of Great White Ltd. (1) (10)

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QUESTION 1.3 (11 marks – 17 minutes) Luke Ltd Luke Ltd is primarily involved in astrological observation and research, from its base at the South African Large Telescope in Sutherland in the Western Cape. Luke Ltd tenders for various contracts and is commissioned for international astrological projects. The majority of Luke Ltd's funding for projects is provided by a consortium of international investors from South Africa, the United States, Germany, Poland and India. Luke Ltd is busy expanding its operations and has identified Leia Ltd as a perfect synergistic investment. Luke Ltd and its subsidiaries have a February year end. Leia Ltd Leia Ltd is a company started by three Unisa computer engineering students with exceptional data processing skills and registered patents. The company’s relevant activities are the development of data processing and analysis software, which will come in very handy with the amount of data streams that the scientists at Luke Ltd are creating. Leia Ltd’s share capital consists of 100 issued ordinary shares. Each share carries one voting right. Luke Ltd acquired 49 of the ordinary shares of Leia Ltd on 1 January 20.16. The StarCon Consortium holds the remainder of the voting rights. An extract of the shareholders’ agreement between Luke Ltd and the StarCon Consortium is as follows: (a) Luke Ltd and the StarCon Consortium each have the right to appoint two of the four directors. (b) Luke Ltd has the right to establish Leia Ltd’s operating and capital decisions and policies. (c) The StarCon Consortium has the right, as a lender and provider of funds, to seize Leia Ltd’s

assets if Leia Ltd fails to meet the specified loan repayment conditions. REQUIRED

Marks

Discuss, in terms of IFRS 10 Consolidated Financial Statements, whether Leia Ltd should be consolidated in the consolidated financial statements of Luke Ltd for the year ended 29 February 20.16.

Communication skills: Conclusion and logical flow Please note: • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

10

1

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QUESTION 1.3 - Suggested solution Discussion whether Leia Ltd should be consolidated Required to consolidate? A subsidiary is an entity that is controlled by another entity (known as the parent). Luke Ltd will need to consolidate Leia Ltd if control exists (IFRS 10 Appendix A).

(1)

Control An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee (IFRS 10.6-7).

Power over the investee (IFRS 10.7(a))

To have power over an investee, an investor must have existing rights that gives it the current ability to direct relevant activities (IFRS 10.B9).

Direct relevant activities Establishing operating and capital decisions of the investee (IFRS 10.B12(a)).

According to the shareholders’ agreement, Luke Ltd can establish the operating and capital policies of Leia Ltd. This indicates that Luke Ltd has the ability to direct relevant activities.

(1)

Appointing and remunerating an investee’s key management personnel (IFRS 10.B12(b)).

According to the shareholders’ agreement, Luke Ltd and the StarCon Consortium can each appoint two members of the Leia Ltd’s key management. This indicates that Luke Ltd and the StarCon Consortium have the ability to direct relevant activities.

(1)

(1)

An investor can have power over an investee even if other entities have existing rights that give them the current ability to participate in the direction of the relevant activities. However, an investor that holds only protective rights does not have power over an investee and consequently does not control the investee. (IFRS 10.14)

According to the shareholders’ agreement, The StarCon Consortium can seize Leia Ltd’s assets if Leia Ltd fails to meet the specified loan repayment conditions. This indicates that The StarCon Consortium has a protective right but not power over Leia Ltd.

(1)

(1)

1B. Exposure/rights to variable returns (IFRS 10.7(b)) Luke Ltd and the StarCon Consortium have rights to variable returns in the form of dividends due to its 49% and 51% shareholding in Leia Ltd respectively.

(1)

1C. Link between power and returns (IFRS 10.7(c)) …but also has the ability to use its power to affect the investor’s returns from its involvement with the investee

By establishing the operating and capital decisions of Leia Ltd, the StarCon Consortium can use its power to affect its returns from Leia Ltd.

(1)

By appointing Leia Ltd’s key management personnel, Luke Ltd can use its power to affect its returns from Leia Ltd.

(1)

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Conclusion • Both entities have the right to direct the relevant activities of Leia Ltd but Luke Ltd has the

right to establish the operating and capital policies of Leia Ltd as well. • The StarCon Consortium holds the majority of the shares. • The StarCon Consortium doesn’t have power over Leia Ltd because it has protective and

not substantive rights. • Both entities have exposure/rights to variable returns. • Both entities have the power to affect its returns from its involvement with Leia Ltd. • StarCon Consortium is the majority shareholder but Luke has control over Leia Ltd. • Luke will be required to consolidate Leia Ltd.

(1) (1)

Total (11) Maximum (10)

Communication skills: Conclusion and logical flow (1)


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LEARNING UNIT 2 - BUSINESS COMBINATIONS

INTRODUCTION IFRS 3 deals with accounting for a business combination on date of acquisition and outlines the principles on how to account for identifiable assets acquired and liabilities assumed, non-controlling interests and goodwill or gain from a bargain purchase taking into account certain exceptions to recognition, measurement and classification principles as established in other IFRS standards.

OBJECTIVES/OUTCOMES After you have studied this unit, you should be able to demonstrate knowledge of: 1. Identify a business combination. 2. Account for business combinations by applying the acquisition method. 3. Account for a business combination in which control is achieved in stages. 4. Account for measurement period adjustments. 5. Determine what forms part of a business combination. 6. Recognition and subsequent measurement of particular assets acquired in terms of

IFRS 3. 7. Test goodwill for impairment annually, or more frequently if events or changes in

circumstances indicate that the asset might be impaired in accordance with IAS 36.10(b).

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. IFRS 3 Business Combinations. 2. Group Statements, 17th edition, Volume 1, Chapter 2. 3. Group Statements, 17th edition, Volume 2, Chapter 9.

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SECTION A - SAICA’S PRINCIPLES OF EXAMINATION LEVELS From 20.18 SAICA has changed the levels of learning (Level 1, Level 2, Level 3) to the principles of examination levels as a guidance how the standards (or topics within a standard) will be examined. The principles of examination levels for IFRS 3 are as follows:


Objective 1 Core

Scope 2(a) – 2(b) Core 2(c) Awareness 2A Excluded

Identifying a business combination

3 Core

The acquisition method 4 – 5 Core 6 – 7 Core Identify the acquirer 8 – 9 Core Determine the acquisition date 10 – 28 Core Recognise and measure assets,

liabilities and NCI 28A – 28B Core Leases in which the acquiree is the

lessee 29 Excluded Reacquired rights 30 Excluded Share-based payment trans-

actions 31 Core Assets held for sale 32 Core Goodwill or gain from bargain

purchase 33 Excluded Exchange of only equity interests 34 – 36 Core Bargain purchases 37 – 40 Core Consideration transferred 41 – 44 Core Particular types of combinations 45 – 50 Core Measurement period 51 Core What is included in transaction 52(a) Excluded Pre-existing relationships 52(b) – 52(c) Core Separate transactions 53 Core Transaction costs

Subsequent measurement and 54 Core accounting 55 Excluded Reacquired rights 56 Core Contingent liabilities 57 Core Indemnification assets 58 Core Contingent consideration

Disclosures 59 – 63 Core Refer to learning unit 4


Reference to IFRS 9 67A Excluded

Withdrawal of IFRS 3 (2004) 68 Excluded

Defined terms Core

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Application guidance B1 – B4 Excluded Entities under common control B5 – B6 Awareness Identify a business combination B7 – B12 Awareness Definition of a business B13 – B18 Excluded Identifying the acquirer B19 – B27 Excluded Reverse acquisitions B28 – B30 Deleted B31 – B34 Core Intangible assets B35 – B36 Excluded Reacquired rights B37 – B40 Core Assembled workforce and other

items that are not identifiable E5 (B38) Excluded Put options to NCI B41 – B45 Core Fair value of particular assets and

NCI B46 Core Goodwill or gain from bargain

purchase B47 – B49 Excluded Combinations of mutual entities B50 Core What is included in transaction B51 – B53 Excluded Pre-existing relationship

settlement B54 – B55 Core Contingent payments to

employees or selling shareholders B56 – B62 Excluded Share-based payment awards

exchanged for acquiree’s awards B62A – B62B Excluded Equity-settled share-based

payment transactions of acquiree B63 Core Other IFRSs that provide guidance B64 – B67 Core Disclosure - refer to learning unit 4 B68 – B69 Excluded Transitional provisions

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ACQUISITION METHOD

Who is the acquirer?

The entity that obtains control of the acquiree (IFRS 3.6-.7). See control as defined in IFRS 10.5-.18

When did the acquisition

occur?

The date on which the acquirer obtains control of the acquiree (IFRS 3.8-.9).

Recognise the

identifiable assets and liabilities acquired in the business combination

Recognition criteria: To qualify for recognition the: • Assets and liabilities should meet the definitions of the

Conceptual Framework. • Assets and liabilities must be part of what is exchanged in the

business combination (not a separate transaction) Exceptions:

• Contingent liabilities should be recognised if there is a present

obligation and its fair value can be measured reliably (IFRS 3.22-.23).

• Recognise indemnification asset (debtor) only if indemnifi-cation item (liability) is recognised on acquisition date (IFRS 3.27-.28).

Note that the acquiree may not have recognised certain assets and

liabilities in its own financial statements that do qualify for recognition in the group financial statements. Examples are: • Identifiable intangible assets not recognised by the acquiree

(IFRS 3.13). • Restructuring provisions (meeting the liability definition).

Measure the assets and liabilities acquired in the business combination

Measurement criteria: Assets and liabilities acquired should be measured at their fair values at acquisition date. Remember: • Restatement of assets and liabilities to fair value has deferred

tax implications for the business combination. • The restatement of assets to fair value may also result in an

additional depreciation/amortisation charge in the consolidated financial statements (and again deferred tax implications)

Step 1

Step 2

Step 3

Step 4

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Recognise and measure

NCI

Measure NCI at (IFRS 3.19): • Fair value or • The proportionate share of the acquiree’s identifiable net

assets.

Measure consideration transferred

Consideration is measured at fair value on acquisition date (except for share based payments) Consideration includes: • Assets transferred • Liabilities incurred • Equity interests issued

Recognise and measure goodwill

Goodwill = Consideration transferred + NCI - net assets acquired Goodwill is recognised as an asset and tested annually for impairment. Gain on bargain purchase is recognised as a gain in profit or loss on acquisition date.

Note: If the transferred asset remains within the group, the asset should be measured at its carrying amount at acquisition date.

Step 5

Step 6

Step 7

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SECTION B - QUESTION ON BUSINESS COMBINATIONS

QUESTION 2.1 (45 marks – 68 minutes) Italia Ltd is a glass manufacturing company operating in Johannesburg. The management of Italia Ltd has identified external acquisition as an area of expansion. As a result, Italia Ltd purchased a 60% interest in Colour Ltd on 1 January 20.11. On this date Italia Ltd obtained control over Colour Ltd when the share capital and retained earnings of Colour Ltd amounted to R800 000 and R1 050 000 respectively. All the companies in the group have a 31 December year end. The following matters were identified to be taken into account in calculating the identifiable assets and liabilities of Colour Ltd at fair value at the acquisition date: 1. The fair value of the non-controlling interests was R805 000 on 1 January 20.11. 2. Machinery was valued at R300 000 more than the carrying amount. The remaining useful life

from the date of acquisition is four years. Colour Ltd continued to account for machinery in accordance with the cost model as per IAS 16.

3. Land with a cost price of R300 000 had a fair value of R400 000 on 1 January 20.11. The value

of the land has increased to R450 000 at 31 December 20.11. It is the policy of Colour Ltd to account for land in accordance with the cost model as per IAS 40 Investment Property.

4. Colour Ltd disclosed a contingent liability of R450 000 in their financial statements on

1 January 20.11 relating to a court case involving a patent right not meeting industry standards. The claim represents a present obligation but at this point in time the attorneys of Colour Ltd are of the opinion that it is unlikely to lead to an outflow of economic benefits due to a lack of evidence to support the claim. The R450 000 is the fair value of the claim taking into account all possible outcomes on 1 January 20.11.

As part of the purchase agreement by Italia Ltd, the shareholders have guaranteed to reimburse

Italia Ltd 40% of the claim, should it be successful. On 31 December 20.11 the court case has progressed to such an extent that it is virtually certain

that Colour Ltd will have to pay R550 000. Colour Ltd recognised a provision of R550 000 in its financial statements on 31 December 20.11. The related transaction have been recorded correctly in Colour Ltd’s financial statements.

The claim will not be deductible for taxation purposes should it succeed.

5. Details of the consideration transferred to the shareholders of Colour Ltd are as follows: • Cash consideration of R620 000 was paid on 1 January 20.11 into the lawyer’s trust

account. • Italia Ltd will make a cash payment of R225 060 on 31 December 20.12. The South African

Revenue Services agrees with the accounting treatment and will allow the tax deduction for interest expense.

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• Italia Ltd issued 1 000 ordinary shares to the shareholders of Colour Ltd. The fair value of

the shares was R460 each on 1 January 20.11. On registration date of the shares on 22 January 20.11, the shares were valued at R465 each. The total number of shares in issue by Italia Ltd was 1 000 000 at 1 January 20.11.

• Italia Ltd is required to make an additional cash payment of R150 000 on 30 June 20.13 if the share price of Colour Ltd increases by more than 20%. The fair value of the contingent consideration was estimated to be R60 000 on 1 January 20.11 and R85 000 on 31 December 20.11. The share price of Colour Ltd had increased by 32% by 31 December 20.11. The changes in fair values on the contingent consideration is as a result of after acquisition date events.

Included in the cash consideration paid is acquisition related costs in respect of valuations and

lawyer’s fees of R120 000 which was paid by Italia Ltd. 6. Colour Ltd has a licensed customer list on 1 January 20.11. The agreements relating to the

customer list does not prohibit the selling or leasing thereof. The useful life of the customer list is four years on 1 January 20.11 and the fair value is R175 794. Colour Ltd has not recognised an asset in this regard.

7. The abridged statement of profit or loss and other comprehensive income of Italia Ltd and Colour

Ltd for the year ended 31 December 20.11 is as follows (before taking the above information into account):

Italia Ltd

R Colour Ltd

R Statement of profit or loss and other comprehensive income Profit for the year after tax

2 600 000

601 876

Dividends paid on 31 December 20.11 150 000

Additional information • It is the group’s policy to measure investment property using the fair value model as per IAS 40

Investment Property. • Intangible assets are accounted for using the cost model as per IAS 38 Intangible Assets. • Italia Ltd elected to measure the non-controlling interests in Colour Ltd at fair value. • Investments in subsidiaries are accounted for at cost in terms of IAS 27.10(a). • The normal income tax rate is 28% and the capital gains tax inclusion rate is 80%. Ignore

Value Added Tax (VAT) and Dividend Tax. • A market-related interest rate (before tax) is 10%, compounded annually.

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REQUIRED

Marks

(a) Prepare the journal entries in the separate records of Italia Ltd for the year ended 31 December 20.11, relating to the information in the question. Journal entries relating to deferred taxation are also required.

12

(b) Prepare the pro forma journal entries for the Italia Ltd Group for the year ended 31 December 20.11. Journal entries relating to deferred taxation are also required.


32

1

Please note: • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 2.1 - Suggested solution (a) Journal entries in the accounting records of Italia Ltd

Dr Cr R R

1 January 20.11

J1 Investment in Colour Ltd (SFP) (balancing or [C1]) 1 206 000

(½)

Acquisition cost (P/L) (given) 120 000

(1) Share capital (SCE) (1 000 x R460) 460 000 (1½) Contingent consideration (SFP) (given)

60 000 (1)

Deferred consideration (SFP) [C6]

186 000 (2½) Bank (SFP)

620 000 (1)

Accounting for the investment in Colour Ltd

COMMENT Transaction costs should be carefully analised as the accounting treatment for transaction costs are not all the same. Acquisition-related costs (finder’s fees, advisory, legal, valuation, professional fees, administration fees) should be expensed in profit or loss in the consolidated financial statements of the acquirer in accordance with IFRS 3.53. Costs to issue debt or equity are not acquisition-related costs as defined in accordance with IFRS 3. Share issue costs shall be accounted for as a deduction from equity in terms of IAS 32.35 in the separate and consolidated financials of the acquirer. The parent will measure its investments in subsidiaries at cost in accordance with IAS 27.10(a) in its separate financial statements. Acquisition-related costs in the separate financial statements of the parent should thus also be expensed. Students should read carefully how the parent treated the transaction costs in its separate financial statements. In this question, acquisition-related costs of R120 000 was paid by the acquirer and included in the cash payment of R620 000 that was paid on 1 January 20.11. The acquisition-related costs should thus be expensed in accordance with IFRS 3.53.

31 December 20.11

J2 Fair value adjustment (P/L) (85 000 - 60 000) 25 000

(1½) Contingent consideration (SFP)

25 000 (½)

Fair value adjustment on contingent consideration payable

COMMENT

As part of the acquisition of the subsidiary, a contingent consideration is due if the share price of the subsidiary, Colour Ltd, increase by more than 20% at 30 June 20.13. In terms of IFRS 3.39 this contingent consideration is recognised at the acquisition date fair value of R60 000. Subsequently, the contingent consideration is measured at fair value and the liability needs to be remeasured to fair value at year end, R85 000.

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Dr Cr R R

J3 Finance costs (P/L) (10% x R186 000 (J1)) 18 600

(1) Deferred consideration (SFP)

18 600 (½)

Interest on the deferred payment

J4 Bank (SFP) (150 000 x 60%) 90 000 (1) Other income (P/L) 90 000 (½) Dividends received from Colour Ltd

Total (12½) Maximum (12)

COMMENT

The carrying amount and the tax base of the liability are equal since the interest on the liability is deductible for tax purposes. There are therefore no deferred tax implications on journals 2 and 3. No journals are necessary in the records of Colour Ltd as the transaction by Italia Ltd to acquire the shareholding involves the previous shareholders of Colour Ltd. It therefore does not have an impact on the issued share capital of Colour Ltd.

(b) Pro forma journal entries in the group’s accounting records

Dr Cr

1 January 20.11

R R

J1 Share capital (SCE) (given) 800 000

(½) Retained earnings (SCE) (given) 1 050 000

(½)

Machinery (SFP) (given) 300 000

(1) Land (SFP) (400 000 – 300 000) 100 000

(1)

Intangible asset – customer list [C2] (SFP) 175 794

(1) Goodwill (SFP) [C3] or (balancing) 10 828

(½)

Indemnification asset (SFP) (450 000 x 40%) 180 000

(1½) Non-controlling interests (SFP/SCE) (given)

805 000 (½)

Recognised contingent liability (SFP) (given)

450 000 (1) Deferred tax (SFP) [C4]

155 622 (3½)

Investment in Colour Ltd (SFP) (part (a))

1 206 000 (½) Elimination of investment – at acquisition journal

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COMMENT Italia Ltd recognises and measures all identifiable assets acquired and the liabilities assumed in the business combination at their acquisition date fair values. Take note of the group’s policy in terms of the measurement of non-controlling interests (NCI). In this case, it is mentioned in the information that the NCI is measured at fair value and it is given as R805 000 at acquisition date. The contingent liability in respect of the legal claim is recognised as a liability assumed in a business combination since it is a present obligation resulting from past events and its fair value can be measured reliably (IFRS 3.23). Also take note that the indemnification asset (debtor) may only be recognised if the indemnification item (in this case the contingent liability) was recognised on acquisition date (IFRS 3.27). The indemnification asset should be measured on the same basis as the indemnification item (fair value in this case).

COMMENT Deferred tax on contingent liability The tax base of a liability is the carrying amount, less any amount that would be deductible for tax purposes in future periods. The question states that the claim will not be deductible for taxation purposes should it succeed. This will result in the tax base being the carrying amount. There is thus no temporary difference and deferred tax will not be provided.

Dr Cr

R R

31 December 20.11

J2 Depreciation (P/L) (300 000 x ¼) 75 000

(1½) Accumulated depreciation (SFP)

75 000 (½)

Provision for depreciation on machinery revalued

J3 Deferred tax (SFP) (75 000 x 28%) 21 000 (1)

Income tax expense (P/L) 21 000 (½)

Taxation on depreciation adjustment

COMMENT

At acquisition, the fair value of machinery was R300 000 higher than the carrying amount in the separate records of Colour Ltd. Colour Ltd recognised depreciation in its separate financial statements on the cost price of the machinery (this is in terms of its accounting policy). At consolidation however, the value of the machinery is R300 000 higher resulting in an additional depreciation charge that is calculated over the remaining useful life (four years) of the machinery.

J4 Contingent liability (SFP) (given) 450 000

(½)

Indemnification asset (SFP) 180 000 (½) Legal expense (P/L)

270 000 (½)

Reversal of contingent liability raised at acquisition

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COMMENT Colour Ltd raised a provision in its own accounting records of R550 000 at 31 December 20.11 relating to the legal claim. A contingent liability was also recognised as a liability (in respect of the legal claim) in the consolidated financial statements at acquisition date (R450 000). This contingent liability and indemnification asset previously recognised in the group’s financial statements (J1) on acquisition date must now be reversed in order to avoid “double accounting” for this liability.

Dr Cr

R R

J5 Amortisation – customer list (P/L) (175 794 [C2] / 4) 43 949

(1) Intangible asset – customer list (SFP)

43 949 (½)

Amortisation of customer list

J6 Deferred tax (SFP) (43 949 x 28%) 12 306 (1) Income tax expense (P/L) 12 306 (½) Taxation on amortisation

COMMENT The customer list is recognised as an intangible asset and is accounted for in accordance with IAS 38. We therefore amortise the intangible asset over the useful life of the asset.

J7 Land (SFP) (450 000 - 400 000) 50 000

(1)

Fair value remeasurement (P/L)

50 000 (½) Remeasurement in terms of IAS 40

J8 Income tax expense (P/L) (50 000 x 28% x 80%) 11 200 (1)

Deferred tax (SFP) 11 200 (½)

Taxation on fair value adjustment

COMMENT

Land is carried at cost in the separate records of Colour Ltd. However, it is the group’s policy to account for investment property (which includes land) in accordance with the fair value model as per IAS 40. We therefore need to account for the fair value movement in the value of land at year end. In this case we use the CGT inclusion rate of 80% as the fair value adjustment is higher than the original cost price.

J9 Non-controlling interests (P/L) [C5] 330 013

(5)

Non-controlling interests (SFP/SCE)

330 013 (½) NCI share of profits

COMMENT

At consolidation, we add 100% of the line items of the statement of profit or loss and other comprehensive income of the subsidiary to the statement of profit or loss and other comprehensive income of the parent to calculate the consolidated figures. However, we are only entitled to 60% of the line items of the statement of profit or loss and other comprehensive income of the subsidiary. We therefore allocate the 40% share of the non-controlling interests via one line item: non-controlling interests (P/L).

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Dr Cr

R R

J10 Other income - dividends received (P/L) (150 000 x 60%) 90 000 (1½)

Non-controlling interests (SFP/SCE) (150 000 x 40%) 60 000 (1½)

Dividends paid (SCE) (given) 150 000 (1) Elimination of intragroup dividends

Total (32) Communication skills: Presentation and layout (1)

CALCULATIONS C1. Consideration transferred

Cash (given) 620 000 Shares (1 000 x R460) 460 000 Deferred consideration [C6] 186 000 Contingent consideration (given) 60 000 Acquisition costs paid (given) (120 000)

1 206 000 [½]

C2. Customer list

Intangible asset – customer list (given) 175 795 [1] C3. Calculation of goodwill (IFRS 3.32)

+ Consideration transferred [C1] 1 206 000 + Non-controlling interests (given) 805 000

2 011 000 -Net identifiable assets acquired 2 000 172

Share capital (given) 800 000 Retained earnings (given) 1 050 000 Adjustments to the net assets (J1)

Contingent liability recognised (J1) (450 000)

Machinery – revaluation surplus (J1) 300 000 Land – fair value adjustment (J1) 100 000 Indemnification asset raised recognised (J1) 180 000 Intangible asset (customer list) (J1) 175 794 Deferred tax [C4] (155 622)

Goodwill 10 828

C4. Deferred tax

Machinery (300 000 x 28%) 84 000 [1] Land (100 000 x 28% x 80%) 22 400 [1] Intangible asset – customer list (175 794 x 28%) 49 222 [1] Indemnification asset - Recognised contingent liability (indemnified item) -

155 622

[3]

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COMMENT A deferred tax liability is recognised on the customer list (intangible asset) since the carrying amount of the customer list exceeds its tax base (the tax base of the customer list is nil as no amounts in respect of this asset will be deductible for tax purposes in the future against any taxable economic benefits) (IAS 12.7). Deferred tax is not recognised on the indemnification asset since the carrying amount and tax base of the indemnification asset is equal (the economic benefits from the indemnification asset will not be taxable in the future) (IAS 12.7). Deferred tax is not recognised on the recognised contingent liability (indemnification item) since the carrying amount and tax base of the liability is equal. The tax base of the contingent liability is its carrying amount minus amounts that will be tax deductible in the future. In this case no amounts will be deductible in the future in respect of this liability, therefore the carrying amount and tax base is equal (IAS 12.8).

C5. Non-controlling interests

Profit for the year (given) 601 876 [½] Depreciation on machinery (J2) (75 000) [½] Income tax on depreciation (J3) 21 000 [½] Legal expense (J4) 270 000 [½] Amortisation (J5) (43 949) [½] Income tax on amortisation (J6) 12 306 [½] Fair value remeasurement on land (J7) 50 000 [½] Income tax on fair value remeasurement (J8) (11 200) [½]

825 033

NCI for the year = 825 033 x 40% = 330 013 [½] [4½] C6. Deferred consideration

HP 10BII SHARP EL-733A SHARP EL-738

1. 2nd F C (Clear All) 1. 2nd FC (Clear All) 1. 2ndF MODE (Clear All)

2. 0 PMT 2. 0 PMT 2. 0 PMT

3. 10 I/YR 3. 10 i 3. 10 I/Y [½]

4. 2 N 4. 2 n 3. 2 N [½]

5. 225 060 FV 5. 225 060 FV 5. 225 060 FV [½]

6. PV 186 000 6. Comp PV 186 000 6. Comp PV 186 000 [½]

[2]

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C7. Analysis of owners’ equity of Colour Ltd

Total

Italia Ltd 60% NCI

At Since

At acquisition Share capital 800 000 Retained earnings 1 050 000 Equity (Contingent liability) (450 000) Equity (Machinery) 300 000 Deferred tax (84 000) Equity (Land) 100 000 Deferred tax (22 400) Equity (Indemnification asset) 180 000 Intangible asset (customer list) 175 794 Deferred tax (49 222) 2 000 172 1 200 103 800 069 Equity represented by goodwill 10 828 5 897 4 931

Consideration and NCI 2 011 000 1 206 000 805 000

Since acquisition Current year Comprehensive income for the year 601 876 Depreciation on machinery (75 000) Income tax on depreciation 21 000 Legal expense 270 000 Amortisation (43 949) Income tax on amortisation 12 306 Fair value adjustment on land 50 000 Income tax on fair value adjustment (11 200)

Total current year profit 825 033 495 020 330 013 Dividends (150 000) (90 000) (60 000)

2 686 033 405 020 1 075 013

EXAM TECHNIQUE It was not necessary to make use of an owners’ equity analysis in this question. Nonetheless, one is provided for those students who make use of the analysis method.

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LEARNING UNIT 3 – INVESTMENTS IN ASSOCIATES AND JOINT VENTURES

INTRODUCTION IAS 28 deals with the accounting for investments in associates and joint ventures and specifies the use of the equity method. The accounting treatment of the investments in associates and joint ventures in the separate financial statements of an investor is prescribed in IAS 27. The method to follow in determining whether a joint arrangement must be classified as a joint venture is discussed in IFRS 11 and will be covered in learning unit 5.

OBJECTIVES/OUTCOMES After you have studied this learning unit, you should be able to do the following: 1. Define an associate in accordance with IAS 28. 2. Discuss the existence or absence of significant influence in an investment held and

the appropriate accounting treatment of the investment. 3. Identify evidence of existence of significant influence in cases where an investor

holds directly or indirectly less than 20% of the voting power of the investee. 4. Apply the equity method in accounting for investments in associates and joint

ventures in the consolidated or group financial statements of the investor. 5. Account for the investment in associate or joint venture in the separate financial

statements of the investor at cost (IAS 27.10(a)).

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. Group Statements, 17th edition, Volume 2, Chapter 11. 2. IAS 28 Investments in Associates and Joint Ventures.

COMMENT The disposal of interests in investees and piecemeal acquisition of interests in investees will only be covered and assessed in tutorial letter 104 and test 3.

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SECTION A – SAICA’S PRINCIPLES OF EXAMINATION LEVELS From 20.18 SAICA has changed the levels of learning (Level 1, Level 2, Level 3) to the principles of examination levels as a guidance how the standards (or topics within a standard) will be examined. The principles of examination levels for IAS 28 are as follows:


Objective 1 Core

Scope 2 Awareness

Definitions 3 – 4 Core

Significant influence 5 – 7 Core

Equity method 10 – 15 Core

Application of equity method 16 – 17 Core

18 – 19 Excluded Venture capital organisation or similar

20 – 21 Excluded Classifications as held for sale

22 – 24 Core Discontinuing the use of equity

method

25 Excluded Change in ownership – Interest

remains an associate or joint venture

IFRS 5 –

Groups

Excluded Classification as held for sale

26 – 36 Core Equity method procedures

36A Excluded Investment entity matters

37 – 39 Core Equity method procedures

40 – 43 Core Impairment losses

Separate financial statements 44 Core


Withdrawal of IAS 28 (2003) 47 Excluded

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EXAMPLE

The following example illustrates the basic equity accounting procedures: Investment in associate accounted for at cost On 1 January 20.17 I Ltd acquired a 30% interest in A Ltd for R200 000 and exercised significant influence over the financial and operating policy decisions of A Ltd from that date. I Ltd accounts for investments in associates at cost in terms of IAS 27.10(a). A Ltd recorded profit after tax of R500 000 and other comprehensive income after tax (revaluation surplus) of R100 000 for the year ended 31 December 20.17.

Investor (I) Separate financial statements

Pro forma

journals

Group financial statements

R’000 R’000 R’000 Assets Assets Investment in A Ltd (cost) 200 180 Investment in A Ltd 380 Trade debtors 100 Trade debtors 100 Equity Equity Share capital (50) Share capital (50) Retained earnings (120) (150) Retained earnings (270) Revaluation surplus (30) (30) Revaluation surplus (60) Liabilities Liabilities Long-term loan (100) Long-term loan (100)

Note 1 Note 2

Notes 1. When an investor prepares separate financial statements, it shall account for investments in

associates at cost (IAS 27.10). 2. Pro forma journals are prepared in order to equity account for the investment in associate in the

group financial statements. I Ltd’s share of A Ltd’s profits and other comprehensive income for the current and prior years must thus be recognised in the group financial statements. The pro forma journal will be as follows:

Dr Cr R’000 R’000

Investment in A Ltd (SFP) 180 Share of profit of associate (P/L) (500 000 x 30%) 150 Share of other comprehensive income of associate (OCI) (100 000 x 30%)

30

Equity accounting of investment in associate for the current year

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SECTION B – QUESTION ON INVESTMENTS IN ASSOCIATES AND JOINT VENTURES

QUESTION 3.1 (40 marks – 60 minutes) Furnit-Your-World Ltd is a retailer of office and household furniture and was established in 19.9 by Mr Brian Pillay. The company has a number of high-profile customers, such as hotels and banks. On 1 March 20.4 Furnit-Your-World Ltd acquired 120 000 shares of Urban Drapes Ltd, a company that manufactures and retails drapes, curtains and bedding, for an amount of R3 766 000 which was paid in cash. Furnit-Your-World Ltd obtained control of Urban Drapes Ltd in accordance with IFRS 10 Consolidated Financial Statements. The assets and liabilities were fairly valued on the date of acquisition. No additional assets, liabilities or contingent liabilities were identified at that date. Furnit-Your-World Ltd has been making every effort to expand their customer base during the last year. The company aims to be a "one-stop shop" for large corporate companies by supplying them with all their furniture, curtains and electronic appliances. As a result of this objective, the company purchased 75 000 shares in Digital Decor Ltd, a company that retails electronic equipment, on 1 August 20.11 for an amount of R485 000 which was settled in cash. Since the need for electronic equipment in buildings such as hotels and banks are immense, Furnit-Your-World Ltd identified this as a gap in their market. From 1 August 20.11 Furnit-Your-World Ltd exercised significant influence over the financial and operating policy decisions of Digital Decor Ltd. The assets and liabilities of Digital Decor Ltd were deemed to be fairly valued on 1 August 20.11. No additional assets or liabilities were identified at that date. You may assume that no excess arose on the acquisition of Digital Decor Ltd. The following was extracted from the trial balances of Furnit-Your-World Ltd, Urban Drapes Ltd and Digital Decor Ltd for the year ended 31 March 20.12:

Furnit-Your-World Ltd

R

Urban Drapes Ltd

R

Digital Decor Ltd

R Debits

Cost of sales 12 865 000 5 450 000 8 721 000 Other expenses 1 289 000 412 000 571 000 Finance costs 104 500 31 600 58 200 Income tax expense 631 058 246 954 230 196 Credits

Ordinary share capital

- 500 000 shares 1 300 000

- 200 000 shares

450 000

- 300 000 shares

300 000 Revenue 16 081 250 6 812 500 10 203 570 Other income 514 500 13 000 32 000 Mark-to-market reserve - 31 March 20.12 333 500 16 000 12 200 Mark-to-market reserve - 1 April 20.11 213 600 14 800 10 700

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Furnit-Your-World Ltd has other equity investments (apart from its investments in Urban Drapes Ltd and Digital Décor Ltd), but does not hold a shareholding of more than 5% in each of those investments. Additional information 1. Relevant accounting policies Furnit-Your-World Ltd has the following relevant accounting policies: • Investments in subsidiaries and associates are measured at cost in the separate financial

statements.

• Equity investments are accounted for in accordance with IFRS 9 Financial Instruments in its separate financial statements. Furnit-Your-World Ltd irrevocably elected to present subsequent changes in the fair value of its equity investments in other comprehensive income in a mark-to-market reserve.

• Other comprehensive income is disclosed net of tax in the statement of profit or loss and

other comprehensive income. • Furnit-Your-World Ltd elected to measure non-controlling interests at the proportionate

share of the acquiree’s identifiable net assets at the acquisition date. 2. Dividends Urban Drapes Ltd declared and paid a dividend on 31 May 20.11 amounting to R40 000. Digital Decor Ltd declared and paid a dividend on 28 February 20.12 amounting to R44 000. 3. Group transactions

During June 20.11 Furnit-Your-World Ltd redecorated their office and purchased curtains from Urban Drapes Ltd to the amount of R54 000 on 30 June 20.11. This was sold at a gross profit percentage of 15% to Furnit-Your-World Ltd. Furnit-Your-World Ltd depreciates the curtains over the useful life of six years on a straight-line basis. During February 20.12 Urban Drapes Ltd received a large order from a customer in Swaziland. The customer has been dealing with Urban Drapes Ltd for a number of years and prefers to deal with this company rather than any other South African company. The customer requested Urban Drapes Ltd to sell beds to him, in addition to the bedding required. In order to accommodate this established customer, Urban Drapes Ltd purchased several beds from Furnit-Your-World Ltd for an amount of R89 000 in February 20.12, at a mark-up of 20% on cost. At year end, not all the beds have been delivered to Swaziland and beds to the value of R23 000 were still on hand. From the date of acquisition, Digital Decor Ltd purchased inventory from Furnit-Your-World Ltd. Furnit-Your-World Ltd sold the inventory to Digital Decor Ltd at a mark-up of 25% on cost. Total sales amounted to R620 000 for the current financial year. Inventory of R130 000 was still on hand in the records of Digital Decor Ltd at year end.

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4. Redeemable preference shares

Furnit-Your-World Ltd issued compulsory redeemable preference shares amounting to R100 000 to Urban Drapes Ltd on 1 November 20.11 at a premium of 8%. It is redeemable on 31 October 20.14 at the nominal value. A payment of R9 000 is made annually on 31 October. Furnit-Your-World Ltd classified the redeemable preference shares as debt and both companies accounted for the dividends as interest (you may assume that this classification is correct).

5. Digital Decor Ltd

The retained earnings of Digital Decor Ltd amounted to R1 620 000 on 1 August 20.11. Digital Decor Ltd earned its profits evenly throughout the year, with the exception of machinery with a carrying amount of R90 000 that was sold on 1 August 20.11. The machinery was sold for R93 500 to an employee. The employee settled the purchase price on 31 January 20.12 in terms of an arrangement that he had with the company. Digital Decor Ltd recognised a profit on sale of machinery of R3 500 which was included in other income. You must assume that 6 months is a significant amount of time.

All Digital Decor Ltd's other comprehensive income for the 20.12 financial year was earned after the acquisition by Furnit-Your-World Ltd.

6. Taxation

Assume an income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore Value Added Tax (VAT) and Dividend Tax. You may assume that the income tax expense given is correctly calculated before any adjustments related to the above information are made. The income tax expense of Digital Decor Ltd attributable to the first four months was R80 320 and the remaining balance is attributable to the last eight months. You may assume that this is correct and that no adjustments are necessary.

7. General All the companies in the group have a year end of 31 March 20.12. A market-related pre-tax discount rate is 9% per annum compounded annually. There have been no changes in the issued ordinary share capital of any of the companies in the

group since incorporation.

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REQUIRED

Marks

(a) Prepare the correcting and/or additional journal(s) required to account for the profit or loss on sale of machinery to the employee in the separate financial statements of Digital Decor Ltd for the year ended 31 March 20.12. Journal narrations are not required.

5

(b) Prepare the consolidated statement of profit or loss and other comprehensive income of the Furnit-Your-World Ltd Group for the year ended 31 March 20.12. Income and expenditure should be presented in terms of their function.


33

2

Please note: • Comparative figures are not required. • The allocation of profit attributable to owners of the parent and non-controlling

interests is not required. • Round off all amounts to the nearest Rand and percentages to two decimal points. • Notes to the consolidated financial statements are not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 3.1 – Suggested solution (a) Correcting journal entry

Dr R

Cr R

Profit on sale of equipment (other income) (P/L) (given) 3 500 (½) Loss on sale of equipment (other expenses) (P/L) [C7] 443 (3) Interest received (P/L) [C7] 3 943 (1½) Correction of sale of equipment to include interest effect

(5) (b) FURNIT-YOUR-WORLD LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 31 MARCH 20.12

20.12 R

Revenue (16 081 250 + 6 812 500 - 54 000 [C4] - 89 000 [C1] – 32 500 [C5])

22 718 250

(3)

Cost of sales (12 865 000 + 5 450 000 - 89 000 [C1] + 3 833 [C1] - 45 900 [C4] – 26 000 [C5])

(18 157 933)

(4½)

Gross profit 4 560 317

Other income (514 500 + 13 000 - 24 000 [C2] - 11 000 [C2] - 2 705 [C3])

489 795

(6)

Other expenses (1 289 000 + 412 000 - 1 013 [C4]) (1 699 987) (2) Finance costs (104 500 + 31 600 - 2 705 [C3]) (133 395) (1½) Share of profit of associate [C6] 110 384 (6½)

Profit before tax 3 327 114 Income tax expense (631 058 + 246 954 - 1 073 [C1] - 2 268 [C4] + 284 [C4] – 1 820 [C5])

(873 135)

(3)

PROFIT FOR THE YEAR 2 453 979

Other comprehensive income: Items that will not be reclassified to profit or loss: Mark-to-market reserve [(333 500 – 213 600) + (16 000 - 14 800)] Share of other comprehensive income of associate [(12 200 - 10 700) x 25%]

121 100

375

(5)

(1½)

Other comprehensive income for the year, net of tax 121 475

TOTAL COMPREHENSIVE INCOME FOR THE YEAR 2 575 454


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COMMENT

Furnit-Your-World Ltd has two main equity investments during the current financial year, an investment in a subsidiary, Urban Drapes Ltd, and an investment in an associate, Digital Decor Ltd. In accordance with IFRS 10.B86 Furnit-Your-World Ltd will combine its trial balance with the trial balance of Urban Drapes Ltd by combining all like items (i.e. add the revenue of Furnit-Your-World Ltd of R16 081 250 to the revenue of Urban Drapes Ltd of R6 812 500 etc.). In accordance with IAS 28.10 Furnit-Your-World Ltd will apply the equity method to account for Digital Decor Ltd by recognising its share of the profits of Digital Decor Ltd in the line item “share of profit of associate” and the share of other comprehensive income in “share of other comprehensive income of associate”.

CALCULATIONS

C1. Calculation of unrealised profit in inventory

Sales price of inventory on hand at year end (given) 23 000

Unrealised profit (23 000 x 20/120) 3 833 [1] Decrease in deferred tax expense / increase in deferred tax asset (3 833 x 28%)

1 073

[½]

[1½] Pro forma journals (for completeness purposes only)

Dr R

Cr R

J1 Revenue (P/L) (Furnit-Your-World) Cost of sales (P/L) (Urban Drapes) Elimination of intragroup sales

89 000 89 000

J2 Cost of sales (P/L) (Furnit-Your-World) (23 000 x 20/120) Inventory (SFP) (Urban Drapes) Elimination of unrealised profit in closing inventory of Urban Drapes Ltd

3 833

3 833

J3 Deferred tax (SFP) (3 833 x 28%) Income tax expense (P/L) (Furnit-Your-World) Tax implication of unrealised profit in closing inventory of Urban Drapes Ltd

1 073 1 073

C2. Calculation of elimination of dividends

Dividend declared by Urban Drapes Ltd (given) 40 000

Dividend attributable to Furnit-Your-World Ltd (40 000 x 60%) 24 000 [1] Dividend declared by Digital Decor Ltd (given) 44 000

Dividend attributable to Furnit-Your-World Ltd (44 000 x 25%) 11 000 [1]

[2]

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Pro forma journals (for completeness purposes only)

Dr R

Cr R

J1 Other income (P/L) (40 000 x 60%) Non-controlling interests (SFP/SCE) Dividends paid (SCE) Elimination of intragroup dividends (Urban Drapes)

24 000 16 000

40 000

J2 Other income (P/L) (44 000 x 25%) Investment in associate (SFP) Elimination of intragroup dividends (Digital Decor)

11 000 11 000

C3. Calculation of elimination of intragroup preference dividends

HP 10 B11 Sharp EL 733A Sharp EL 738

• 2ndF C (Clear All) • 2ndF C.CE (Clear All) • 2ndF MODE (Clear All) • 3 N • 3 n • 3 N [½] • -9 000 PMT • -9 000 PMT • -9 000 PMT [½] • -100 000 FV • -100 000 FV • -100 000 FV [½] • 108 000 PV • 108 000 PV • 108 000 PV [½] • I/YR ⇒ 6,01% • COMP i ⇒ 6,01% • COMP I/Y ⇒ 6,01%

COMMENT Furnit-Your-World Ltd issued compulsory redeemable preference shares amounting to R100 000 at a premium of 8%. The present value is thus R108 000 (R100 000 x 1,08).

1 November 20.11 Capital Interest Payment Closing balance

Interest 31 March 20.12 (108 000 x 6,01% x 5/12)

108 000

2 705

-

110 705

[1]

Payment 31 October 20.12 110 705 3 786 (9 000) 105 491

Interest 31 March 20.13 105 491 2 642 - 108 132

Payment 31 October 20.13 108 132 3 698 (9 000) 102 831

Interest 31 March 20.14 102 831 2 575 - 105 406

Payment 31 October 20.14 105 406 3 605 (9 000) 100 011

The rounding difference of R11 is due to the rounding of the interest rate to two decimal

points. [3] Pro forma journal (for completeness purposes only)

Dr R

Cr R

J1 Interest received (P/L) Finance costs (P/L) Elimination of intragroup preference dividends classified as a liability

2 705

2 705

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C4. Calculation of unrealised profit in curtains (property, plant and equipment)

Sales price (given) 54 000

Gross profit / unrealised profit [54 000 x 15% (gross profit %)] 8 100 [1] Cost price (54 000 - 8 100) 45 900 [½] Decrease in deferred tax expense / increase in deferred tax asset (8 100 x 28%)

2 268

[½]

Depreciation on unrealised profit [(8 100 / 6) x 9/12] 1 013 [1] Increase in deferred tax expense / increase in deferred tax liability (1 013 x 28%)

284

[½]

[3½] Pro forma journals (for completeness purposes only)

Dr R

Cr R

J1 Revenue (P/L) (Urban Drapes) Cost of sales (P/L) (Urban Drapes) (54 000 x 85%) Property, plant and equipment (SFP) (54 000 x 15%) Elimination of unrealised profit in closing PPE of Furnit-Your-World Ltd

54 000

45 900 8 100

J2 Deferred tax (SFP) (8 100 x 28%) Income tax expense (P/L) (Urban Drapes) Tax implication of unrealised profit in closing PPE of Furnit-Your-World Ltd

2 268 2 268

J3 Accumulated depreciation (SFP) (8 100/6 x 9/12) Depreciation (P/L) (Urban Drapes) Realisation of unrealised profit

1 013

1 013

J4 Income tax expense (P/L) (Urban Drapes) (1 013 x 28%) Deferred tax (SFP) Tax implication of realisation of unrealised profit

284 284

C5. Calculation of unrealised profit on inventory

Inventory in the records of Digital Decor Ltd 130 000

Unrealised profit (130 000 x 25/125) 26 000

Furnit-Your-World Ltd has a 25% interest in the associate:

Revenue (130 000 x 25%) 32 500 [1] Cost of sales (130 000 x 100/125 x 25%) (26 000) [1½] Unrealised profit (OR 26 000 x 25%) 6 500

Income tax expense (6 500 x 28%) 1 820 [½]

[3]

COMMENT Note that the curtains will form part of Urban Drapes Ltd’s inventory, as the company sells curtains. However, in the records of Furnit-Your-World Ltd, the curtains will be property, plant and equipment, as they will be used in the company’s office.

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Pro forma journals (for completeness purposes only)

Dr R

Cr R

J1 Revenue (P/L) (130 000 x 25%) Cost of sales (P/L) (130 000 x 100/125 x 25%) Investment in associate (SFP) (130 000 x 25/125 x 25%) Elimination of unrealised profit in closing inventories of Digital Decor Ltd

32 500

26 000 6 500

J2 Deferred tax (SFP) (6 500 x 28%) Income tax expense (P/L) Tax implication of unrealised profit in closing inventories of Digital Decor Ltd

1 820 1 820

C6. Calculation of share of profit of associate

8 months from

1 August 20.11

Profit before tax excluding profit on sale of equipment [(10 203 570 + 32 000 - 8 721 000 - 571 000 - 58 200 - 3 500) x 8/12]

587 913

[4½] Other income - interest received on sale of machinery [C7] 3 943 [½] Other expenses - loss on sale of machinery [C7] (443) [½] Income tax expense (230 196 (year) - 80 320 (four months given on p 14))

(149 876)

[½]

Profit after tax 441 537

Share of profit of associate (441 537 x 25%) 110 384 [½]

[6½] OR

Profit before tax excluding profit on sale of equipment 587 913 [4½] Profit on sale of machinery not apportioned 3 500 [1] Income tax expense (230 196 (year) – 80 320 (four months)) (149 876) [½]

Profit after tax 441 537

Share of profit of associate (441 537 x 25%) 110 384 [½]

[6½]

COMMENT The investor sold inventory to the associate (downstream transaction). The investor thus made the unrealised profit in P/L and the unrealised profit is included in the inventory of the associate. The unrealised profit thus has to be eliminated against revenue and cost of sales of the parent, as well as the investment in associate (SFP) account. The share of profit of associate (P/L) is thus not affected. Should the associate sell to the investor, then the unrealised profit will affect the share of profit of associate (P/L). Also note that the total sales and cost of sales of R620 000 related to the intragroup sales for the year are not eliminated when an associate is involved, as only unrealised profit is eliminated (IAS 28.28).

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C7. Calculation of sale of machinery


• 2ndF C (Clear all) • 2ndF C.CE (Clear all) • 2ndF MODE (Clear all)

• 1 2ndF PMT (1 P/YR) • 93 500 FV • 93 500 FV [½] • 93 500 FV • 0,5 n • 0,5 N [½] • 0,5 N • 9% I/YR • 9% i • 9% I/YR [½] • PV ⇒ 89 557 • COMP PV ⇒ 89 557 • COMP PV ⇒ 89 557 [½]

Discounted proceeds 89 557

Carrying amount of machinery 90 000 [½]

Loss on sale of machinery (443) [2½]

Undiscounted proceeds 93 500 [½]

Discounted proceeds 89 557 [½]

Interest received on sale of machinery 3 943

[1]

COMMENT The profit or loss on sale of equipment was recorded after the acquisition by Furnit-Your-World Ltd. It must thus be subtracted when calculating the apportioned profit for the eight months, as it has to be included in full, and not only apportioned for eight months.

COMMENT For this question, the present value of the proceeds must be calculated, as it will only be settled in six months, which is considered to be a significant period that affects the time value of money. If a question is silent in this regard, the default time to be considered significant is 12 months and longer.

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LEARNING UNIT 4 - DISCLOSURE OF INTERESTS IN OTHER ENTITIES

INTRODUCTION IFRS 12 deals with the disclosure requirements to enable users of financial statements to evaluate its interest in other entities.

OBJECTIVES/OUTCOMES After you have studied this learning unit, you should be able to demonstate knowledge of: 1. Disclosures in the consolidated or group financial statements: 1.1 Disclose significant judgements and assumptions that an entity made in

determining that it has control of another entity, joint control of an arrangement or significant influence over another entity.

1.2 Disclose significant judgements and assumptions that an entity made in determining the type of joint arrangement (i.e. joint operation or joint venture).

1.3 Disclose an entity’s interests in subsidiaries, interests in joint arrangements and associates and interests in unconsolidated structured entities.

2. Disclose the following for an interest in a subsidiary: 2.1 The interest that non-controlling interests have in the group’s activities and

cash flows. 2.2 The nature and extent of significant restrictions. 2.3 Nature of the risks associated with an entity’s interests in consolidated

structured entities. 2.4 Consequences of changes in a parent’s ownership interest in a subsidiary that

do not result in a loss of control. 2.5 Consequences of losing control of a subsidiary during the reporting period. 3. Disclose the following for interests in joint arrangements and associates: 3.1 Nature, extent and financial effects of an entity’s interests in joint

arrangements and associates. 3.2 Risks associated with an entity’s interests in joint ventures and associates. 4. Disclose the following for interests in unconsolidated structured entities: 4.1 Nature of interests. 4.2 Nature of risks.

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this learning unit: 1. IFRS 12 Disclosure of Interests in Other Entities.

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SECTION A - SAICA’S PRINCIPLES OF EXAMINATION LEVELS From 20.18 SAICA has changed the levels of learning (Level 1, Level 2, Level 3) to the principles of examination levels as a guidance how the standards (or topics within a standard) will be examined. The principles of examination levels for IFRS 12 are as follows:


Objective 1 Core 2 – 4 Core Meeting the objective 2(a)(iii) Excluded Investment entity

Scope 5 – 6 Core 6(b)(ii) Excluded Investment entity

Significant judgements and 7 – 9 Core assumptions 9A – 9B Excluded Investment entity status

Interests in subsidiaries 10 – 11 Core 12 Core The interest of NCI 13 Core Significant restrictions 14 – 17 Core Nature of the risks 18 Core Changes in ownership interest that do

not result in a loss of control 19 Core Losing control of a subsidiary

Interests in unconsolidated subsidiaries

19A – 19G Excluded Investment entities

Interests in joint arrangements

20 Core

and associates 21 - 22 Core Nature, extent and financial effects 21A Excluded Investment entity 23 Core Risks associated with the interests

Interests in unconsolidated 24 – 25 Core structured entities 25A Excluded Investment entity 26 – 28 Core Nature of interests 29 Core Nature of risks

Defined terms A Core

Application guidance B1 Core B2 – B6 Core Aggregation B7 – B9 Core Interests in other entities B10 – B17 Core Summarised financial information B18 – B20 Core Commitments for joint ventures B21 – B26 Core Unconsolidated structured entities

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SECTION B – QUESTIONS ON DISCLOSURE OF INTERESTS IN OTHER ENTITIES

QUESTION 4.1 (11 marks - 17 minutes) Energise Ltd was formed in Johannesburg in 20.1 and its purpose is to sell pre-paid electricity, both locally and internationally. Energise Ltd has acquired many interests in foreign entities and concluded many contractual arrangements with foreign entities, due to the increasing demand for pre-paid electricity in foreign countries. Energise Ltd has a financial year end of 31 March. The following information is available relating to Energise Ltd’s foreign interest: Power LLC On 1 April 20.4, Energise Ltd formed Power LLC, a company that is located and operated in Iran. Energise Ltd did not acquire any of the share capital of Power LLC. A contractual arrangement was entered into between Energise Ltd and the shareholders of Power LLC, stating that voting rights relate to administrative tasks only and the relevant activities are directed by means of the contractual arrangement. Power LLC was formed in order to construct power plants in Iran. All the electricity generated will be sold to Energise Ltd, which will sell and distribute it throughout Iran. The construction of power plants is expected to continue until 20.24. As a result of the current ongoing sanctions against Iran, Power LLC have been experiencing difficulties in acquiring parts required in the construction of the power plants that has to be imported. This resulted in a delay in the construction of several power plants. As Power LLC cannot sell the unfinished power plants to Energise Ltd but is still incurring operating expenses, Power LLC has almost depleted their funds. The initial contractual arrangement between Energise Ltd and Power LLC did not make any provision for financial support, as it was not deemed necessary at that stage. However, Energise Ltd has noted that Power LLC requires drastic intervention. Energise Ltd provided a loan to Power LLC amounting to R1,2 billion on 1 January 20.12. A portion of the loan is secured by the power plants which amounted to R500 million. The remainder of the loan is unsecured. No repayments have yet been arranged. The entire loan carries interest at 10% per annum. Energise Ltd did not consolidate Power LLC in its consolidated financial statements for the year ended 31 March 20.12. There are currently no indications that the sanctions against Iran will be lifted. You may assume that the terms of the contractual agreement did not meet the criteria for control in accordance with IFRS 10, joint control in accordance with IFRS 11 or significant influence in accordance with IAS 28. REQUIRED Marks

Prepare the unconsolidated structured entity note to the consolidated financial statements of the Energise Ltd Group for the year ended 31 March 20.12.

Communication skills: Presentation and layout Please note: • Accounting policies are not required. • Comparative figures are not required. • Your answer must comply with International Financial Reporting Standards

(IFRS).

10

1

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QUESTION 4.1 - Suggested solution ENERGISE LTD GROUP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 MARCH 20.12 1. Unconsolidated structured entity

IFRS 12.26 Energise Ltd is involved with an unconsolidated structured entity through a contractual arrangement with the shareholders of Power LLC. Energise Ltd does not own any of the share capital of Power LLC. Energise Ltd entered into a contractual arrangement with the shareholders of Power LLC, stating that voting rights relate to administrative tasks only and the relevant activities are directed by means of the contractual arrangement. Power LLC was set up to construct power plants in Iran, which will generate electricity that will be sold to Energise Ltd.

(3) IFRS 12. B26(f)

As a result of the current ongoing sanctions against Iran, Power LLC have been experiencing difficulties in acquiring parts required in the construction of the power plants that has to be imported. This resulted in a delay in the construction of several power plants and in Power LLC's funds being depleted.

(1) IFRS 12.30

Energise Ltd granted a loan of R1,2 billion to Power LLC as a result of the delay. The loan provided to Power LLC has no fixed repayment terms and carries interest at 10% per annum. The capital portion of the loan was secured by Power LLC’s power plants to the value of R500 million.

(2) IFRS 12. B26(c)

Energise Ltd earned interest income (included in other income) from its involvement with Power LLC during the financial year.

(1) The following table summarises the carrying values recognised in the statement of financial position and maximum exposure to loss from its involvement at 31 March 20.12 with the structured entity:

Description Carrying amount R’000

Maximum exposure to loss

R’000

Line item in the statement of

financial position

Long term loan to Power LLC

* 1 230 000

1 230 000

Financial investments

(3)

* (1 200 + 30 interest) IFRS 12.29(a) IFRS 12.29(c) IFRS 12.29(b) (10)

Communication skills: Presentation and layout (1)

EXAM TECHNIQUE Please note that you do not have to show the references to the standard in your suggested solution.

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QUESTION 4.2 (18 marks – 27 minutes) Olympian Ltd was incorporated in 19.0 and provides training to a wide range of athletes intending to compete in the Olympic Summer and Winter Games. Olympian Ltd acquired an interest in Dive Ltd. Olympian Ltd has a 31 December financial year end. The following information is provided for Dive Ltd: At the start of the new millennium, Olympian Ltd noted that it cannot meet all the requirements of all the athletes anymore, due to an increase in the number and variety of sports events. In 20.0, four additional synchronised diving events were introduced, resulting in Olympian Ltd purchasing 40% of the share capital and voting rights of Dive Ltd on 1 January 20.0. From this date Olympian Ltd had control of Dive Ltd. All the diving training will transfer to Dive Ltd. Olympian Ltd concluded a contractual arrangement with Dive Ltd, stipulating that Dive Ltd is prohibited from providing training to athletes other than those of Olympian Ltd. According to the contractual arrangements, Olympian Ltd will also receive an amount from Dive Ltd per athlete trained. Dive Ltd has a financial year end of 28 February, due to the change in season from March, which affects the type of swimming pools used. It is more practical for Dive Ltd to have a financial year end of 29 February 20.12, as it coincides with all of the yearly maintenance contracts, the largest expense of Dive Ltd. Dive Ltd is located and operates in Durban. The following trial balance of Dive Ltd is presented as at 31 December 20.11, adjustments have been made to align with the financial year end of Olympian Ltd and no additional adjustments are required: R

Profit for the period 1 January 20.11 to 31 December 20.11 (850 400) Gain on revaluation of land (10 800) Revaluation surplus - 1 January 20.11 (43 200) Dividend paid on 31 December 20.11 100 000 Property, plant and equipment 1 200 000 Trade and other receivables 550 000 Cash and cash equivalents 300 000 Long-term loan (750 000) Deferred tax liability (21 000) Trade and other payables (474 600)

The accumulated non-controlling interests of Dive Ltd in the consolidated financial statements of Olympian Ltd amounted to R960 300 at 1 January 20.11. Revenue amounting to R1 520 000 was recorded for the current financial year.

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REQUIRED

Marks

Prepare the investment in Dive Ltd note to the consolidated financial statements of the Olympian Ltd Group for the year ended 31 December 20.11. Please note: • Ignore the disclosure requirements in terms of IFRS 3.B64-.B67.


17

1 Please note: • Comparative amounts are not required. • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 4.2 – Suggested solution OLYMPIAN LTD GROUP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.11 1. Investment in Dive Ltd

Name of subsidiary: Dive Ltd (½) Principal place of business: Durban (½) Proportion of ownership interests and voting rights held by non-controlling interests:

60%

(1)

Profit allocated to non-controlling interests of the subsidiary during the reporting period: (850 400 x 60%)

R510 240

(1)

Accumulated non-controlling interests of the subsidiary at the end of the reporting period: [960 300 (given) + 510 240 + (10 800 x 60%) - (100 000 x 60%)]

R1 417 020

(3) Dividend paid to non-controlling interests: (100 000 x 60%) R60 000 (1)

A contractual arrangement stipulates that all diving training provided to Olympian Ltd's athletes will transfer to Dive Ltd. Dive Ltd is prohibited from providing training to athletes other than those of Olympian Ltd according to the contractual arrangement. Olympian Ltd receives an amount from Dive Ltd for every athlete trained. Due to these conditions, Olympian Ltd is deemed to have control of Dive Ltd, even though it holds only 40% of the voting rights of Dive Ltd.

(1)

(1)

(1)

Dive Ltd has a financial year end of 29 February. The reason for the different financial year end is due to the change in season from March, which affects the type of swimming pools used. It is more practical for Dive Ltd to have a financial year end of 29 February, as it coincides with all of the yearly maintenance contracts, the largest expense for Dive Ltd (IFRS12.11)

(1)

(1)

Summarised financial information of Dive Ltd for the year ended 31 December 20.11:

R

Current assets (330 000 + 550 000) 850 000 (1) Non-current assets 1 200 000 (½) Current liabilities (474 600) (½) Non-current liabilities (750 000 + 21 000) (771 000) (1) Revenue (1 520 000) (½) Profit for the period (850 400) (½) Total comprehensive income (850 400 + 10 800) (861 200) (1) (17)

Communications skills: Presentation and layout (1)

COMMENT All of the above information is disclosed in terms of IFRS 12.7(a), IFRS 12.9(b) and IFRS 12.11 -12.

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SELF ASSESSMENT QUESTIONS AND SUGGESTED SOLUTIONS

Question Question name Source Marks Topics covered Page

1 Smart Ltd FAC4864 Test 1 of 2012

35 • Discussion on acquisition date and control (IFRS 3 and IFRS 10)

• Business combination journal entries when acquiring assets and liabilities

• Contingent liability and indemnification asset discus-sion (IFRS 3)

69

2 Pepadew Ltd FAC4864 Test 1 of 2013

36 • Calculation of goodwill • Journal entries in the

separate accounting records of the parent

• Discussion on control (IFRS 10)

• Impairment of investment in subsidiary journals in the separate accounting records of the parent

77

3 Trading Auto Ltd FAC4864 Test 1 of 2014

40 • Pro forma journal entries – subsidiary


85

4 Amalgamated Fast Foods Ltd

FAC4864 Test 1 of 2015

40 • Discussion on NCI (IFRS 10) • Presentation of consolidated

statement of profit or loss and other comprehensive income

• Disclosure of investment in subsidiary note (IFRS 12)

96

5 Rich DotCom Ltd FAC4864 Test 1 of 2016

40 • Pro forma journal entries – subsidiary

• Discussion on control (share trust) (IFRS 10)

• Discussion on what forms part of a business combination (IFRS 3)

108

6 Chevy Ltd FAC4864 Test 1 of 2017

40 • Presentation of consolidated statement of profit or loss and other comprehensive income

• Discussion on a business combination in the separate accounting records (IFRS 3)

116

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Question Question name Source Marks Topics covered Page

7 Working Fire Ltd FAC4864 Test 2 of 2013

25 • Pro forma journal entries – subsidiary and joint venture

• Discussion on associates (IAS 28)

126

8 PlantWorld Ltd FAC4864 Test 2 of 2014 and 2015

40 • Pro forma journal entries – associate (including loss of an associate)

• Pro forma journals – intragroup transactions between investor and associate

• Calculation of the carrying amount of an investment in associate

133

9 Beauty Ltd FAC4864 Test 2 of 2015 and 2016

40 • Pro forma journal entries –associate and joint venture

• Disclosure of investment in associate note (IFRS 12)

• Discussion on associate (IAS 28 and IFRS 9)

• Calculation of the carrying amount of an investment in associate

142

10 Iphepha SA Ltd FAC4864 Test 2 of 2017

40 • Pro forma journal entries – intragroup transactions

• Prepare a reconciliation between the net asset value and the carrying amount of a joint venture (IFRS 12)

• Pro forma journal entries – joint venture

• Calculation of the carrying amount of an investment in an associate

• Discussion on acquisition-related costs (IFRS 3 and IAS 28)

• Discussion on losses of an associate (IAS 28)

153

11 Mouth Watering Meats Ltd

FAC4864 Test 1 of 2018

40 • Pro forma journal entries – subsidiary and associate

• Discussion on power (IFRS 10)


163

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QUESTION 1 35 marks

YOU HAVE 13 MINUTES TO READ THIS QUESTION

Smart Ltd (Smart) is an independent supplier of furniture with various manufacturing operations throughout South Africa. Smart Ltd’s most recent financial reporting date was 30 June 20.10. Background

Smart recently established that they are underperforming in the Western Cape. The management of Smart established that the reason for the poor performance is due to the lack of labour and frequent labour disputes. The management of Smart decided to increase their performance by means of corporate activity and entered into an agreement with Doors Ltd (Doors) to purchase their Western Cape division. The transaction between Doors and Smart constitutes a “business combination” as defined in IFRS 3 Business Combinations. Western Cape division

The purchase agreement between Smart and Doors was signed and finalised by management on 1 January 20.10. Smart, in accordance with the agreement, is liable to transfer the purchase consideration on 1 January 20.10 and will therefore in turn acquire the assets and assume the liabilities on this date. The agreement however stipulates that there will be a transition phase for 12 months. The purpose of this phase is to carry over knowledge and expertise from Doors’ management to Smart’s management. The management of Doors will still be responsible for the implementation of the financial and operating policies during the transition phase. The Western Cape division will unconditionally be handed over to Smart’s management on 1 January 20.11 and from this date Smart will have control over the Western Cape division as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. Consideration transferred

Smart transferred R2 million in cash to the sellers, Doors, on 1 January 20.10. Assets acquired and liabilities assumed of the Western Cape division The following assets were acquired and liabilities assumed of the Western Cape division:

Notes Carrying Amount

01/01/20.11 R

Carrying amount

01/01/20.10 R

Fair value 01/01/20.10

R

Fair value 01/01/20.11

R

Machinery 770 000 800 000 850 000 820 000 Plant 1 000 000 1 200 000 990 000 1 200 000 Creditors (290 000) (300 000) (280 000) (300 000) Work force 1 - - 300 000 450 000 Labour dispute (fair value of claims)

2

-

-

(80 000)

(100 000)

Net assets and liabilities 1 480 000 1 700 000 1 780 000 2 070 000

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Notes to the assets acquired and liabilities assumed 1. One of the main reasons why Smart purchased the Western Cape division from Doors was

attributable to the effective work force already established by Doors in their Western Cape division. The fair values were determined by an independent consultant. Management of Smart is of the opinion that the work force will add a lot of value to their existing division in the Western Cape.

2. Labour unrest increased after the recent dismissal of a number of Doors’ employees in the

Western Cape division. The trade unions to which these employees belong have instituted a legal claim against Doors on behalf of the employees. The financial manager of Doors did not include any amount relating to the legal claim in the net assets. Should such a claim be successful, any amount paid by Doors will not be deductible for tax purposes. The fair value of the claims as above was reliably determined by an independent actuary.

3. Doors contractually agreed to reimburse Smart Ltd for 75% of the damages payable relating to

the legal claim against Doors as a result of the dismissal. 4. Doors’ Western Cape division incurred research and development costs during the periods

20.10 and 20.9 aimed at reducing redundant manufacturing costs. The financial manager of Doors expects an annual cost saving of R250 000 per annum from 1 January 20.11 to 31 December 20.14. It is the opinion of the financial manager that the cost saving will only be 50% probable. Doors did not recognise an intangible asset in terms of IAS 38 Intangible Assets. The development cost was expensed when incurred.

Additional information 1. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

Value Added Tax (VAT) and Dividend Tax. Where appropriate and unless stated otherwise, the South African Revenue Service (SARS) accepts the acquisition date fair values of assets and liabilities for taxation purposes.

2. Assume a market related pre-tax interest rate of 12% per annum, compounded annually. 3. The remaining useful life of the machinery and plant was three years on 1 January 20.10.

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REQUIRED

YOU HAVE 53 MINUTES TO ANSWER THIS QUESTION

Marks

PART A (a) Prepare a report to the management of Smart Ltd in which you discuss, with

reasons, the following items with regard to the acquisition of the Western Cape division of Doors Ltd:

(i) The appropriate acquisition date; (ii) The recognition of the legal claim againsts Doors Ltd and possible

reimbursement of the damages. You do not have to address subsequent measurement in your report.

Communication skills: Conclusion, logical flow and format

(b) Prepare all the journal entries that should be processed by Smart Ltd for the year

ended 30 June 20.11 in respect of the acquisition of the Western Cape division. Your solution must include the calculations of the deferred tax consequences of all

assets and liabilities recognised.

3 7

1

24

Please note: • Journal narrations are not required • Your answer must comply with the requirements of International Financial Reporting

Standards (IFRS).

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QUESTION 1 – Suggested solution (a) REPORT FORMAT

COMMENT Remember that IFRS 3 is not only applicable to the acquisition of an interest in subsidiary but also the acquisition of assets and liabilities that constitute a business. IFRS 3 can therefore also be applicable to the separate financial statements of an investor.

DATE: 10 March 20.12 TO: The Chief Financial Officer of Smart Ltd FROM: CTA Student RE: Acquisition of Western Cape Division

(i) Appropriate acquisition date

• The date of acquisition is the date on which the acquirer, Smart Ltd, obtains control of the acquiree's business, which is in this case the Western Cape Division (IFRS 3.8).

(1) • The date the acquirer obtains control of the acquirer’s business is generally

when the acquirer transfers the consideration, acquires the assets and assumes the liabilities – closing date, which in this case is on 1 January 20.10. However, the acquirer might obtain control on a date that is either earlier or later than the closing date (IFRS 3.9).

(1) • Smart Ltd will have control of the Western Cape Division from

1 January 20.11. Doors Ltd’s management therefore have power over the relevant activities as they govern the operating and financial policies from 1 January 20.10 to 31 December 20.10.

(1) • The date of acquisition is 1 January 20.11 as this is the date when control

is obtained by Smart Ltd over the Western Cape Division.

(1) Total (4)

Maximum (3)

(ii) Reimbursement of Doors

• The acquirer shall recognise as of the acquisition date a contingent liability assumed in a business combination if it is a present obligation that arises from past events and the fair value can be measured reliably (IFRS 3.23).

An acquirer recognises a contingent liability at fair value at the date of acquisition.

• A contingent liability for the labour dispute should be recognised as there is a present obligation (damages payable) as a result of past event (unfair dismissals).

The fair value was determined by an independent actuary on the date of acquisition, 1 January 20.11. A contingent liability needs to be recognised of R100 000.

(1)

(1) • The seller in a business combination may contractually indemnify the

acquirer for the outcome of a contingency related to all or part of a specific asset or liability (IFRS 3.27).

The acquirer shall recognise an indemnification asset at the same time that it recognises the indemnified item measured on the same basis as the indemnified item (IFRS 3.27).

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(b) Journal entries for the year ended 30 June 20.11 Dr

R Cr R

1 January 20.11 J1 Machinery (SFP) (given) 820 000 (1) Plant (SFP) (given) 1 200 000 (1) Indemnification asset (SFP) (R100 000 x 75%) 75 000 (1½) Intangible asset (SFP) [C2] 379 669 (2½) Investment/Receivable (SFP) [C1] 2 240 000 (2) Contingent liability (SFP) (given) 100 000 (1) Deferred tax (SFP) [C3] 106 307 (4) Creditors (SFP) (given) 300 000 (1) Goodwill (SFP) (balancing) 271 638 (½) At acquisition recognition of assets acquired and

liabilities assumed

J2 Unearned finance income (SFP) ((2 240 000 – 2 00 000) x 6/12)

120 000

(2)

Interest received (P/L) 120 000 (½) Recognition of unearned finance income to profit or

loss

30 June 20.11 J3 Amortisation: Intangible asset (P/L)

(R379 669/4 x 6/12)

47 459

(2) Accumulated amortisation: Intangible asset

(SFP) 47 459 (½)

Recognition of amortisation on intangible asset J4 Deferred tax (SFP) (R47 459 x 28%) 13 289 (1) Income tax expense (P/L) 13 289 (½) Recognition of deferred tax on amortisation J5 Depreciation (P/L) ((R820 000 + R1 200 000) x

6/24) Accumulated depreciation: Machinery (SFP) Accumulated depreciation: Plant (SFP) Recognition of depreciation on PPE

505 000 205 000 300 000

(2) (½) (½)

Total (24)

• The reimbursement that Doors Ltd contractually agreed to relates to a liability, labour disputes (R100 000), recognised at the acquisition date which was measured at acquisition date fair value.

Smart Ltd shall therefore recognise an indemnification asset at the acquisition date measured at fair value for the reimbursement payable by Doors Ltd.

(1)

(1)

• The fair value of the indemnification asset to be recognised at acquisition date by Smart Ltd will be R75 000 (75% x R100 000).

(1)

• There will be no deferred tax implications on contingent liability as the South African Revenue Service (SARS) will not allow any deductions on the liability, therefore it is exempt at initial recognition.

• The indemnification asset should be recognised using the same basis of measurement. Therefore the indemnification asset will also have no deferred tax as the contingent liability does not have deferred tax (IFRS 3.57).

(1)

(1) (7)

Communication skills: Conclusion, logical flow and format (1)

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COMMENT Why was the work force of R450 000 not included as an intangible asset at acquisition as part of identified assets acquired and liabilities assumed in the business combination? Intangible assets shall be recognised separately from goodwill, if they are identifiable. In terms of IAS 38, an intangible asset is identifiable if it meets either the separability criteria or the contractual/legal criteria. The workforce does not meet the above criteria as: • It is not controlled by a legal contract (the Western Cape Division does not have

a contract with the collection of employees as a whole); and • The workforce cannot be sold separately and does not meet the separability

criteria. Therefore, the workforce is not separately recognised as an intangible asset. Also refer to IFRS 3.B37-.B40.

COMMENT The tax base of an asset is any amount that would be deductible for tax against future economic benefits. As IFRS 3 adjustments are recorded in the consolidated records and NOT the separate records of the subsidiary, the recognition of intangible assets at acquisition in accordance with IFRS 3 will give rise to a temporary difference. This is due to the tax treatment (and therefore the tax base) of the asset being unaffected in the separate records of the subsidiary. The tax rate used will be based on the manner of recovery of the carrying amount of the intangible asset. If it is amortised, we the normal tax rate is used whereas if the useful life is indefinite, it can only be recovered through sale and the CGT rate is used.

CALCULATIONS C1. Amount of cash paid on 1 January 20.10, determining fair value


1. 2nd F C (Clear All) 2. 1 2nd F PMT/YR 3. 0 PMT 4. 12 I/YR 5. 1 N 6. 2 000 000 PV 7. FV 2 240 000

1. 2nd FC (Clear All) 2. 0 PMT 3. 12 i 4. 1 n 5. 2 000 000 PV 6. Comp FV 2 240 000

1. 2ndF MODE (Clear All) 2. 0 PMT 3. 12 I/Y 3. 1 N 4. 2 000 000 PV 5. COMP FV 2 240 000

[1½]

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COMMENT

Consideration transferred in a business combination shall be measured at fair value, which shall be calculated as the sum of the acquisition-date fair values. The R2 000 000 was paid in cash on 1 January 20.10. The acquisition date is only on 1 January 20.11, therefore the FV (future value) needs to be calculated in order to determine the fair value of consideration transferred at acquisition date. On 1 January 20.10 the following journal would have been processed in the accounting records of Smart Ltd: Dr

R Cr R

Investment in Western Cape Division (SFP) (2 000 000 + 240 000)

2 240 000

Bank (SFP) 2 000 000 Unearned finance income (SFP) 240 000

C2. Development costs


1. 2nd F C (Clear All) 2. 125 000 PMT 3. 12 I/YR 4. 4 N 5. 0 FV 6. PV 379 669

1. 2nd FC (Clear All) 2. 125 000 PMT 3. 12 i 4. 4 n 5. 0 FV 6. Comp PV 379 669

1. 2ndF MODE (Clear All) 2. 125 000 PMT 3. 12 I/Y 3. 4 N 4. 0 FV 5. COMP PV 379 669

[2]

C3. Deferred tax

Carrying amount

Tax base Temporary differences

Machinery 820 000 820 000 - [½] Intangible asset: Development costs 379 669 - 379 669 [½] Plant 1 200 000 1 200 000 - [½] Indemnification asset 75 000 75 000 - [½] Creditors (300 000) (300 000) - [½] Contingent liability (100 000) (100 000) - [½] Total temporary differences 379 669 Deferred tax at 28% 106 307 [½]

[3½]

PMT calculated as follows: R250 000 x 50% = R125 000 [1]

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COMMENT Why is it that machinery, plant and creditors have a tax base equal to the carrying amount for the deferred tax calculation if there is a difference between the fair value and carrying amount? A business combination that involves the purchase of the net assets (as in Western Cape Division that was purchased as a going concern) of another entity rather than the purchase of the shares in the other entity, does not result in a parent-subsidiary relationship. In such circumstances, the acquirer applies IFRS 3 in its separate or individual financial statements by including the assets/liabilities purchased instead of recognising an equity share investment in Doors Ltd. Due to the above, the SARS will deem the tax base on initial recognition to be the same as the fair value of the assets and liabilities acquired. However the development cost (intangible asset) is an asset that was created at acquisition date as a result of IFRS 3. The intangible assets were not acquired by means of a purchase transaction. The SARS will not recognise these assets (no future deduction against taxable income) and thus the tax base will be equal to zero. Therefore all these items will result in temporary differences. Note that if shares in Doors Ltd was acquired instead of the net assets then the deferred tax calculation and adjustment on group level for deferred tax would have included the existing assets and liabilities which had a fair value adjustment as a result of applying IFRS 3 and new assets and liabilities recognised on group level as a result of IFRS 3.

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QUESTION 2 36 marks


Pepadew Ltd (Pepadew) is a company founded in South Africa with a 30 September 20.12 current financial year end. Pepadew's main business is to export high-quality South African fruit to South East Asia. The company is listed on the JSE Limited. You are the senior group accountant of Pepadew and responsible for the year end consolidation. The financial director, Mr Clueless, approached you to assist with the finalisation of certain aspects and transactions about which he is uncertain. The information that follows relates to these outstanding items. Transaction 1: Broccoli Ltd (Broccoli) In order to further diversify their business, Pepadew acquired 80% of the ordinary shares in Broccoli on 30 April 20.12. From this date Pepadew had control over Broccoli as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. Broccoli distributes vegetables locally as well as internationally. On 30 April 20.12, the issued share capital of Broccoli was R400 000 (200 000 ordinary shares), while the retained earnings amounted to R1 500 000. The fair value of the net identifiable assets was equal to the carrying amount thereof at the acquisition date, except as differently indicated in the information below. The following three items were not recorded in the records of Broccoli: Fair value

R • Customer contracts - renewable, not separable (manner of recovery of carrying

amount– through use)

140 000 • Internally generated client lists - contingent on a privacy agreement and cannot

be sold (manner of recovery of carrying amount– through use)

210 000 • Internally generated trademark – separable (manner of recovery of carrying

amount– through use)

90 000 The net identifiable assets at 30 April 20.12 include land that is carried at R500 000, which represents the original cost. The land was valued by an independent valuer on 30 April 20.12. The valuation report which was received on 15 June 20.12, shows that the land had a fair value of R430 000 at the date of valuation. On 1 April 20.12 Broccoli offered packages to their employees who do not wish to be employed by the Pepadew Group. By 30 April 20.12 it was estimated that five of the employees of Broccoli will accept the package and will receive a cash payment of R15 000 each on 30 September 20.12. The transaction has not been recorded in the records of Broccoli. The package payments will not be deductible for tax. The former shareholders of Broccoli were Veggie Ltd and Mr Green, an employee of Broccoli. Pepadew settled the purchase price of the interest as follows:

• Issued 60 000 and 40 000 Pepadew ordinary shares respectively to Veggie Ltd and Mr Green

on 30 September 20.12.

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• A cash payment of R600 000 to Veggie Ltd on 30 April 20.12. • During February 20.12 Pepadew was sued for an amount of R100 000 by Veggie Ltd (in respect

of the infringement of a patent). The claim was settled as part of the consideration to buy the shares in Broccoli. The fair value of the claim was R80 000 on 30 April 20.12.

• A cash payment of R600 000 to Mr Green to be made on 30 April 20.13. Under the acquisition

agreement, 10% of this payment will be refunded to Pepadew by Mr Green if the profits of Broccoli decline to less than R450 000 per year in the 20.13 or 20.14 financial years. On 30 April 20.12, the fair value of the amount receivable by Pepadew is estimated at R15 000.

• An amount of R5 000 per month will be paid to Mr Green for a period of 24 months (commencing

1 May 20.12), when and if the monthly income of Broccoli exceeds R85 000 per month during this period. Mr Green will act as the financial manager of Broccoli during this period, at a lower than market related salary.

Transaction 2: Mango Ltd (Mango) Pepadew purchased a 15% interest in Mango on 1 July 20.8 (the date of incorporation of Mango) for R3 500 000. Pepadew acquired a further 55% interest in Mango for R9 270 000 on 30 June 20.12. From this date, Pepadew had control over Mango as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. The carrying amount of the previously held investment on 30 June 20.12 was R3 900 000, which is the fair value. The statement of financial position of Mango as at 30 June 20.12 was as follows: Dr

R’000

Cr R’000

Share capital (500 000 shares) Retained earnings Net assets

- -

24 000 24 000

14 000 10 000 - 24 000

On 30 June 20.12 the following matters were identified to be taken into account in calculating the purchase consideration: • Included in the purchase price of R9 270 000 is acquisition related costs in respect of valuations

and agreements of R100 000 which was paid by Pepadew. • Pepadew settled the purchase price of R9 270 000 by issuing 100 000 ordinary shares at fair

value and R8 500 000 cash payable on 30 June 20.13. A contingent consideration of R500 000 was also payable on 30 June 20.13 if certain profit targets were met. The fair value of the contingent consideration was R320 000 on 30 June 20.12 and R350 000 on 30 September 20.12.

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Transaction 3: Strategic investment in Litchi Ltd (Litchi) Some years ago Pepadew made a strategic investment in Litchi. The objective of Litchi’s incorporation was to transfer ownership of agricultural land to previously disadvantaged farm workers on litchi farms. Pepadew paid R500 000 for 15% voting rights in the company as well as an option that, if exercised, will entitle Pepadew to an additional 40% of the voting rights in Litchi. The relevant activities of Litchi are directed solely by means of voting rights. The option is currently exercisable and there are no barriers to the exercise of the option. Mr Clueless initially expensed the R500 000 paid as Black Economic Empowerment cost. However the external auditors are questioning whether this was the correct accounting treatment in terms of IFRS 10 Consolidated Financial Statements. Transaction 4: Dividend received from Apple Ltd (Apple) Pepadew acquired the 60% interest in the share capital and voting rights of Apple on 1 September 20.11 at a cost of R780 000. From this date, Pepadew had control over Apple as per the definition of control in terms of IFRS 10 Consolidated Financial Statements. On 30 September 20.12 (date dividends were declared and paid) Pepadew received a dividend payment from Apple of R30 000. Apple’s equity consisted of the following reserves on the specific dates: At

acquisition R

30 Sept 20.11

R

30 Sept 20.12

R

Share capital (500 000 shares) Retained earnings Net assets

500 000 800 000 1 300 000

500 000 810 000 1 310 000

500 000 730 000 1 230 000

Mr Clueless processed only the following journal with regard to the dividend received from Apple: Dr

R Cr R

30 September 20.12 Bank (SFP) 30 000 Investment in Apple (SFP) 30 000 Recognition of dividend received

Additional information • The fair value of the Group’s shares were as follows on the respective dates:

Pepadew

R Broccoli

R Apple

R

30 April 20.12 5,90 7,35 - 30 June 20.12 6,70 7,60 - 30 September 20.12 6,00 7,95 1,48

• It is the accounting policy of Pepadew Ltd to account for all investments in subsidiaries at cost in accordance with IAS 27 Separate Financial Statements and all other equity investments at fair value through profit or loss in terms of IFRS 9 Financial Instruments.

• Assume that the normal income tax rate is 28% and that the capital gains tax inclusion rate is

80%. Ignore Dividend Tax and Value Added Tax (VAT). • Assume that a market related pre-tax interest rate of 9% per annum is applicable.

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REQUIRED


Marks

Prepare a memorandum to Mr Clueless to assist with the finalisation of certain aspects and transactions relating to the Pepadew Ltd Group, as listed below, for the year ended 30 September 20.12: (a) Mr Clueless is uncertain if the Pepadew Ltd Group should measure non-controlling

interests in Broccoli Ltd at fair value or at the proportionate share of net assets of Broccoli Ltd and what the effect thereof on goodwill will be. Calculate the goodwill on the purchase of Broccoli Ltd as at 30 April 20.12 based on non-controlling interests in Broccoli Ltd being measured at fair value (transaction 1).

(b) Calculate the goodwill on the purchase of Broccoli Ltd as at 30 April 20.12 based

on non-controlling interests in Broccoli Ltd being measured at the proportionate share of net assets of Broccoli Ltd (transaction 1).

(c) Prepare the journal entries in order to account for the further investment made in

Mango Ltd in the separate accounting records of Pepadew Ltd for the year ended 30 September 20.12 (transaction 2).

(d) Advise Mr Clueless if the investment in Litchi Ltd should be consolidated in the

financial statements of the Pepadew Ltd Group for the year ended 30 September 20.12 in terms of IFRS 10 Consolidated Financial Statements (transaction 3).

(e) Prepare the correcting journal entries relating to the dividends received from

Apple Ltd in the separate accounting records of Pepadew Ltd for the year ended 30 September 20.12 (transaction 4).

Please note: • Ignore any taxation effects for part (e) of this question.

Communication skills: Presentation and layout Please note: • No discussion of the measurement of non-controlling interests is required for part a

and part b, only calculations. • Journal narrations are not required. • Round off all amounts to the nearest Rand. • Show all calculations. • Your answer must comply with International Financial Reporting Standards (IFRS).

10½

1½

10

6

6

2

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QUESTION 2 - Suggested solution

MEMORANDUM TO: Mr Clueless FROM: CTA Student DATE: 9 March 20.13 SUBJECT: Finalisation of outstanding transactions relating to the Pepadew Ltd Group (2) Attached please find my comments regarding each transaction as requested. (a) Goodwill/Gain from bargain purchase if non-controlling interests are measured at fair

value R

Consideration transferred [C1] 1 645 459 (4) Plus: Non-controlling interests (20% x 200 000 x R7,35) 294 000 (1½) Minus: Net asset value [C2] (1 936 280) (5) Goodwill 3 179

(10½) (b) Goodwill/Gain from bargain purchase if non-controlling interests are measured at the

proportionate share of net assets R Consideration transferred (above) 1 645 459 (½) Plus: Non-controlling interests (20% x 1 936 280) 387 256 (½) Minus: Net asset value (above) (1 936 280) (½) Goodwill 96 435

(1½)

EXAM TECHNIQUE Goodwill could also have been calculated as follows: Consideration transferred (above) R1 645 459 Minus: 80% of net asset value (1 936 280 x 80%) (R1 549 024) R96 435

(c) Journal entries in the separate accounting records of Pepadew Ltd

Dr R

Cr R

J1

30 June 20.12 Capital/Equity (SCE) (100 000 x 6,70) Loan (SFP) (8 500 000/1,09) Contingent consideration (SFP) Investment in Mango Ltd (SFP) Acquisition cost (P/L) Investment in Mango Ltd (SFP) (balancing) Accounting for the investment in Mango Ltd

100 000 12 588 165

670 000

7 798 165 320 000

3 900 000

(1½) (1½)

(1) (½) (1)

(½)

J2

30 September 20.12 Fair value adjustment (P/L) (350 000 – 320 000) Contingent consideration (SFP) FV adjustment on contingent consideration payable

30 000

30 000

(1½) (½)

J3 Interest on loan (P/L) (9% x 3/12 x 7 798 165 (J1)) Loan (SFP) Interest on the deferred payment

175 459 17 459

(1½) (½)

(10)

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(d) Discussion whether Litchi Ltd should be consolidated

• An entity that is a parent shall present consolidated financial statements. • In terms of IFRS 10.5 an investor shall determine whether it's a parent by assessing

whether it controls the investee.

• An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee [IFRS 10.6].

• Pepadew Ltd has rights to variable returns in the form of dividends due to its involvement with Litchi Ltd as a 15% shareholder.

(1)

• To have power over an investee, an investor must have existing rights that give it the current ability to direct the relevant activities [IFRS 10.B9].

• When assessing control, an investor considers its potential voting rights as well as potential voting rights held by other parties to determine whether it has power [IFRS 10.B47].

• Potential voting rights are considered only if the rights are substantive [IFRS 10.B47]. • For a right to be substantive, the holder must have the practical ability to exercise

that right [IFRS 10.B22].

• The options are currently exercisable and there are no barriers to the exercise of the option, therefore the rights are substantive. Therefore the option should be taken into account when assessing control.

(1)

(1) • Pepadew Ltd has the option to acquire an additional 40% of the voting rights, which

will result in Pepadew Ltd having the majority of the shares and thus majority of the voting rights.

(1)

(1) • Based on the inclusion of the option which is currently exercisable, Pepadew Ltd

controls Litchi Ltd. Litchi Ltd is thus a subsidiary of Pepadew Ltd and therefore Pepadew Ltd should consolidate Litchi Ltd.

(2) Total

Maximum (7) (6)

(e) Correcting journal entries in the separate accounting records of Pepadew Ltd

Dr R

Cr R

30 September 20.12 J1 Investment in Apple (SFP) (given) 30 000 (1) Dividends received/Other income (P/L) 30 000 (½) Recognise dividend received

J2 Impairment loss (P/L) [C3] 336 000 (4) Investment in Apple (SFP) 336 000 (½) Impairment of investment in Apple

(6)

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CALCULATIONS C1. Consideration transferred - Share capital (100 000 x R5,90) 590 000 [1]

- Cash to Veggie Ltd 600 000 [½] - Veggie Ltd claim (100 000 – 20 000) (80 000) [1] - Cash to Mr Green (600 000/1,09) 550 459 [1] - Financial asset (15 000) [½] - Salary of Mr Green -

1 645 459

[4]

COMMENT The journal entry for the consideration paid in the separate accounting records of Pepadew Ltd would have been as follows:

Notes Dr R

Cr R

J1 Investment in subsidiary (SFP) 1 1 645 459 Veggie Ltd claim liability (SFP) 2 80 000 Contingent consideration - asset (SFP) 3 15 000 Bank (SFP) 600 000 Share capital (SCE) 4 590 000 Deferred payment (SFP) 5 550 459 Salary payable to Mr Green (SFP) 6 -

Notes: 1 Balancing amount. 2 This is a transaction that does not relate to the business combination, it is a liability

that existed before the business combination and was only settled during the business combination accounting. The acquirer owed money to the previous shareholder Veggie Ltd as a result of a prior claim. IFRS 3.51 indicates that items that do not form part of the business combination (such as this prior claim) must be excluded from the business combination accounting. Therefore the payment of R80 000 to the prior owner Veggie Ltd should be deducted from the consideration, in order to only result in consideration that directly relates to the business combination.

3 Note the contingent consideration is an asset and not a liability in this scenario. The question states that the amount will be refunded to Pepadew Ltd should certain targets not be met.

4 Although the shares were only issued on 30 September 20.12, the share price as at 30 April 20.12 (acquisition date) will be used to calculate the consideration paid. IFRS 3.37 states that the consideration transferred shall include the acquisition date fair values of equity interests issued by the acquirer.

5 The deferred payment will be discounted to a present value as at the acquisition date to calculate the fair value of the consideration transferred.

6 Mr Green will act as financial manager of Broccoli Ltd in exchange for a salary that is low in comparison to the market. This indicates that the additional amount of R5 000 per month (payable to him if the monthly earnings exceed R85 000) represents remuneration for services and not consideration transferred (IFRS 3.B55(c)).

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C2. Net asset value

- Share capital 400 000 [½] - Retained earnings 1 500 000 [½] - Customer contracts (140 000 x 72%) 100 800 [1] - Client lists (not separable) - - Internally generated trademarks (90 000 x 72%) 64 800 [1] - Land [500 000 - 430 000 x (100% - (80% x 28%))] (54 320) [1] - Provision for packages (15 000 x 5) (75 000) [1]

1 936 280

[5]

COMMENT The payment of packages to employees will occur within 12 months from acquisition date, therefore the amount of R75 000 does not need to be discounted to a present value.

C3. Possible impairment of investment of Apple

Impairment indicator? Perform IAS 36.12 (h) test:

Carrying amount in separate > Carrying amount in Group 780 000 (given) > 738 000 (1 230 000 x 60%) [1½] Carrying amount in group

Cost Since reserves (800 000 – 730 000) x 60%

780 000 (42 000)

738 000

OR Dividend received > Total comprehensive income for the year 100%: R50 000 (30 000 / 60%) > (R30 000) (810 000 – 50 000 - 730 000) [1½] 60%: R30 000 (given) > (R18 000) (30 000 x 60%) Impairment indicator = Yes

[½]

Recoverable amount (1,48 x 500 000 x 60%) Carrying amount in separate (given)

444 000 (780 000)

[1] [½]

Impairment (336 000)

[3½]

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QUESTION 3 40 marks


This question consists of two independent parts. PART A 32 marks Trading Auto Ltd is a retailer of new and previously owned vehicles. Trading Auto Ltd owned shares in Cars Ltd at 31 December 20.13, the financial year end of the group. Cars Ltd Trading Auto Ltd acquired a 60% interest in the share capital and voting rights of Cars Ltd, a retailer of previously owned vehicles, on 1 August 20.12. From that date Trading Auto Ltd is exposed to variable returns from its involvement with Cars Ltd and has the ability to affect those returns through its power over Cars Ltd. The shares purchased in Cars Ltd were newly issued ordinary shares. Cars Ltd had the following equity balances in its accounting records on the relevant dates:

01/08/20.12 31/12/20.12 31/12/20.13

R R R

Ordinary share capital (10 000 shares) 750 000 750 000 750 000 Retained earnings 20 000 180 000 320 000 Revaluation surplus 32 000 32 000 18 000

802 000 962 000 1 088 000

All the assets and liabilities of Cars Ltd were deemed to be fairly valued, with the exception of the following: • In 20.10, Cars Ltd internally developed a new design used to produce paint for spray painting

the body work of slightly damaged vehicles. Cars Ltd has not yet patented this design and has never recognised an asset related to this design. The fair value of this design amounted to R420 000 on 1 August 20.12, based on similar market conditions, and is expected to have an indefinite useful life. The South African Revenue Service (SARS) does not allow any deductions against taxable income in respect of this design.

• Land with a carrying amount of R130 000 on 1 August 20.12 had a fair value of R143 000 on

the same date. Land is disclosed as part of property, plant and equipment. Cars Ltd did not remeasure the land in its separate financial statements. This land was sold on 1 December 20.12 for an amount of R150 000, which equalled the fair value on that date.

No additional assets, liabilities or contingent liabilities were identified on the acquisition date. The consideration and other costs relating to the acquisition of the investment in Cars Ltd consisted of the following: • A cash amount of R210 500 paid on 1 August 20.12 to the transacting attorneys. • A liability amounting to R45 500 payable to the SARS by Cars Ltd was settled by

Trading Auto Ltd on 1 August 20.12.

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• The transfer of a previously owned vehicle to Cars Ltd to be used for business purposes by the

Chief Executive Officer (CEO) of Cars Ltd, with a carrying amount of R275 000 and a fair value of R247 000 on 1 August 20.12.

• Costs directly related to the internal division of Trading Auto Ltd that specialises in business combinations amounted to R34 000 and was included in the cash payment on 1 August 20.12.

• 500 Ordinary shares of Trading Auto Ltd were issued to Cars Ltd. • Included in the cash amount paid on 1 August 20.12 were R13 000 share issue costs related to

the 500 issued ordinary shares. • An amount of R53 000 to be refunded to Trading Auto Ltd by Cars Ltd should the operating profit

for the four months ended 30 November 20.12 not increase by 13%. This amount must then be refunded to Trading Auto Ltd on 31 December 20.12 if the target was not met. The fair value of this consideration amounted to R36 000 on 1 August 20.12 taking into account all possible outcomes. The operating profit increased by 11% for the four months ended 30 November 20.12.

The contract for this acquisition was drafted on 15 July 20.12. Due to an administrative delay, the 500 ordinary shares were only issued to Cars Ltd on 5 August 20.12. The change in the share price over this period was as a result of normal market fluctuations. On 1 February 20.13 the accountant of Trading Auto Ltd confirmed that the following item relating to the business combination is yet to be finalised in the accounting records: • A lump sum of R90 000 was paid to the CEO in a separate transaction on 1 August 20.12 as an

incentive for the CEO to remain with the company after the acquisition by Trading Auto Ltd. On 1 August 20.12 the contract with the CEO was signed, but it was not made available to the accountant. This lump sum was provisionally included in the payroll of Trading Auto Ltd as an incentive bonus to a future employee, since the intention of this payment was not clear due to the absence of the contract. The contract was made available to the accountant on 1 February 20.13; when he noted that the CEO does not need to repay this amount should he resign at any time after 1 August 20.12. You may assume that this is material and has been corrected in the separate financial statements on 1 February 20.13. This matter will also conclude the accounting of the acquisition.

On 1 November 20.12 Cars Ltd sold a previously owned vehicle to Trading Auto Ltd for an amount of R62 000. The vehicle will be used for company purposes by the financial manager of Trading Auto Ltd. Cars Ltd charges a gross profit percentage of 30% on sales. The vehicle had an estimated remaining useful life of four years on 1 November 20.12, which corresponded to the wear and tear allowance claimable as a taxation deduction. A dividend amounting to R50 000 was declared by Cars Ltd on 31 December 20.13. This dividend was paid on 31 January 20.14. The share prices of the two companies' shares amounted to the following on the various dates:

15/07/20.12 01/08/20.12 05/08/20.12

R R R

Share price of one Trading Auto Ltd share 560 530 590 Share price of one Cars Ltd share 123 119 115

Additional information 1. It is the accounting policy of Trading Auto Ltd to account for investments in subsidiaries at cost

in its separate financial statements.

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2. Trading Auto Ltd elected to measure non-controlling interests at fair value on acquisition date

for all acquisitions. 3. It is the accounting policy of Trading Auto Ltd and Cars Ltd to measure land and buildings in

accordance with the revaluation model. 4. It is the accounting policy of Trading Auto Ltd and Cars Ltd to measure vehicles in accordance

with the cost model. 5. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

the effects of Dividend Tax and Value Added Tax (VAT). PART B 8 marks Samoosas Ltd is a franchisor of Indian cuisine take-away restaurants and is located in Umhlanga. Samoosas Ltd sold an existing franchise, Samoosas Ltd Greytown (Greytown), to equal owners Tandoori Ltd and Naan Ltd. Tandoori Ltd has the rights to prepare the budgets and to appoint all employees of Greytown and Naan Ltd has the rights to direct the petty cash and the sanitation of the restaurant. Samoosas Ltd has the right to make changes to the trademark of the franchise and force Greytown to adapt to such changes. Samoosas Ltd also stipulates in the franchise agreement that the spices used in the production processes must be purchased from Samoosas Ltd in order to protect the image of Samoosas Ltd's franchises.

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REQUIRED


Marks

PART A Prepare the pro forma journal entries for the Trading Auto Ltd Group for the year ended 31 December 20.13. Journal entries related to deferred taxation are also required.


31

1

Please note: • Journal narrations are required. • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

PART B Discuss, with reasons, which entity exercises control over Samoosas Ltd Greytown.

Communication skills: Logical flow and conclusion

7

1

Please note: • Discussions regarding appropriate accounting treatment is not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 3 – Suggested solution PART A

Pro forma consolidation journal entries Dr Cr R R

J1 Share capital (SCE) (given) 750 000 (½)

Retained earnings (SCE) (given) 20 000 (½) Revaluation surplus (SCE) (given) 32 000 (½) Intangible asset (SFP) (given) 420 000 (1) Land (SFP) (143 000 - 130 000) 13 000 (1½) Goodwill (SFP) (balancing) 140 992 (½) Deferred tax (SFP) [(420 000 + 13 000) x 28% x 80%] 96 992 (1½) Non-controlling interests (SCE/SFP) (10 000 x 40% x R119) 476 000 (2) Investment in Cars Ltd (SFP) [C1] 803 000 (5) Elimination of at acquisition equity

J2 Retained earnings (Cars Ltd) (SCE) ([C2] or balancing) 12 834 (½) Deferred tax (SFP) (5 208 [C2] - 217 [C2]) 4 991 (1½) Accumulated depreciation (Trading Auto Ltd) (SFP) [C2] 775 (1½) Motor vehicle (Trading Auto Ltd) (SFP) [C2] 18 600 (1½) Reversal of intragroup unrealised profit and depreciation in 20.12

J3 Deferred tax (SFP) (13 000 x 28% x 80%) 2 912 (½) Retained earnings (SCE) (balancing) 10 088 (½) Land (SFP) (J1) 13 000 (½) Reversal of fair value adjustment on land upon disposal J4 Retained earnings (SCE)

[(180 000 - 20 000 - 10 088 [C3] - 12 834 (J2)) x 40%] 54 831 (2½) Non-controlling interests (SFP/SCE) 54 831 (½) Accounting for non-controlling interests' share of since acquisition reserves

J5 Accumulated depreciation (Trading Auto Ltd) (SFP) [C4] 4 650 (1) Other expenses (depreciation) (Cars Ltd) (P/L) 4 650 (½) Realisation of unrealised profit included in equipment

EXAM TECHNIQUE

Journal 1 could also have been prepared as follows:

Alternative: Dr

R Cr R

J1.1 Share capital (SCE) (given) 750 000 (½) Retained earnings (SCE) (given) 20 000 (½) Revaluation surplus (SCE) (given) 32 000 (½) Intangible asset (SFP) (given) 420 000 (1) Land (SFP) (143 000 - 130 000) 13 000 (1½) Goodwill (SFP) (balancing) 50 992 (½) Deferred tax (SFP)

[(420 000 + 13 000) x 28% x 80%] 96 992 (1½) Non-controlling interests (SFP)

(10 000 x 40% x R119) 476 000 (2) Investment in Cars Ltd (SFP) [C1] 713 000 (4½) Elimination of at acquisition equity

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EXAM TECHNIQUE Dr

R Cr R

J1.2 Goodwill (SFP) (given) 90 000 Investment in Cars Ltd (SFP) 90 000 (½) Accounting for lump sum payment as part of

consideration

Dr R

Cr R

J6 Income tax expense (Cars Ltd) (P/L) [C4] 1 302 (1)

Deferred tax (SFP) 1 302 (½) Tax implication of the realisation of the unrealised profit included in equipment

J7 Non-controlling interests (P/L) [(320 000 - 180 000 + 50 000 dividend + 4 650 (J5) - 1 302 (J6)) x 40%] 77 339 (3)

Non-controlling interests (OCI) [(18 000 - 32 000) x 40%] 5 600 (1½) Non-controlling interests (SFP/SCE) 71 739 (½) Accounting of non-controlling interests' share of the current year's profit

J8 Other income (P/L) (50 000 x 60%) 30 000 (1½) Non-controlling interests (SFP/SCE) (50 000 x 40%) 20 000 (1) Dividend declared (SCE) (given) 50 000 (½)

Elimination of dividend declared by subsidiary J9 Shareholders for dividends (SFP) (J8) 30 000 (1)

Dividend receivable (SFP) 30 000 (½) Elimination of intragroup dividend receivable and payable at year end Total (35)

Maximum (31) Communication skills: Presentation and layout (1)

CALCULATIONS C1. Consideration transferred

Cash amount paid (given) 210 500 [½] Costs directly related to issue of shares (given) (13 000) [½]

Settlement of liability payable by Cars Ltd (given) 45 500 [½] Carrying amount of vehicle transferred (given)(remains within the group) 275 000 [½] Costs directly related to maintenance of internal acquisitions department (given) (34 000) [½] Issue of shares (500 x R530) 265 000 [1] Contingent consideration asset (given) (36 000) [½]

713 000 [4]

Measurement period adjustment - lump sum payment to CEO, part of consideration (given) 90 000 [½] Total consideration paid 803 000

[4½]

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COMMENT The journal entry for the consideration paid in the separate accounting records of Trading Auto Ltd would have been as follows:

Notes Dr R

Cr R

J1 Investment in subsidiary (SFP) 1 803 000 Share capital/Retained earnings (SCE) 2 13 000 Acquisition costs (P/L) 2 34 000 Contingent consideration - asset (SFP) 3 36 000 Bank (SFP) 210 500 Share capital (SCE) 265 000 SARS liability/Bank (SFP) 45 500 Lump sum payable/Bank (SFP) 4 90 000 Vehicles (SFP) 5 275 000

Notes: 1 Balancing amount. 2 In this question the cash amount paid included acquisition related costs and share

issue costs. As explained in question 4 acquisition related costs should be expensed in profit or loss and share issue costs shall be accounted for as a deduction from equity.

3 Note the contingent consideration is an asset and not a liability in this scenario. The question states that the amount will be refunded to Trading Auto Ltd should certain targets not be met.

4 The lump sum payment to the CEO is included in the consideration transferred as the payment is not affected by employment termination (IFRS 3.B55(a)).

5 The consideration transferred may include assets of the acquirer that have carrying amounts that differ from their fair values at the acquisition date. If so, the acquirer shall remeasure the transferred assets or liabilities to their fair values and recognise the resulting gains or losses in profit or loss. However, sometimes the transferred assets remain within the combined entity after the business combination and the acquirer therefore retains control of them. In this situation the acquirer shall measure those assets at their carrying amounts immediately before the acquisition date and shall not recognise a gain or loss.

C2. Unrealised profit and depreciation - 20.12

Revenue (given) 62 000 [½] Cost of sales (62 000 x 70%) (43 400) [½] Unrealised profit in motor vehicle (alternative: 62 000 x 30%) 18 600 Depreciation 20.11 (18 600 / 4 x 2/12) (775) [1] Deferred tax expense (18 600 x 28%) (5 208) [½] Deferred tax expense (775 x 28%) 217 [½] Decrease in retained earnings - 20.12 12 834

[3]

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C3. Land

Carrying amount on 1 August 20.12 (given) 130 000 Fair value on 1 August 20.12 (given) 143 000 Revaluation surplus movement in consolidated financial statements 13 000 [½] Reconciliation

Profit on sale in separate financial statements

Carrying amount (given) 130 000

Proceeds (given) 150 000

20 000

Profit on sale in consolidated financial statements

Carrying amount (given) 143 000

Proceeds (given) 150 000

7 000

Difference to be reversed (20 000 - 7 000) 13 000 Deferred tax effect (13 000 x 28% x 80%) (2 912) [½]

10 088 [1]

C4. Unrealised profit and depreciation - 20.13

Unrealised profit in motor vehicle [C2] 18 600

Depreciation (18 600 / 4) 4 650 [½] Deferred tax expense (4 650 x 28%) (1 302) [½] Increase in profit for the year – 20.13 3 348

[1] C5.

Analysis of owners’ equity of Cars Ltd

Total Trading Auto Ltd

(60%) NCI

At Since

At acquisition Share capital (given) 750 000

Retained earnings (given) 20 000

Revaluation surplus (given) 32 000

Intangible asset adjustment 420 000

Deferred tax adjustment (420 000 x 28% x 80%) (94 080)

Land adjustment (143 000 - 130 000) 13 000

Deferred tax adjustment (13 000 x 28% x 80%) (2 912)

1 138 008 682 805 455 203

Equity represented by goodwill 50 992 30 195 20 797

Consideration and NCI [C1]; (10 000 x 40% x 119) 1 189 000 713 000 476 000

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Total

Trading Auto Ltd (60%) NCI

At Since

Measurement period adjustment Net asset value (from above) 1 138 008 682 805 455 203

Equity represented by goodwill 140 992 120 195 20 797

Consideration and NCI [713 000 [C1] + 90 000 (given)] 1 279 000 803 000 476 000

Since acquisition until beginning of year

Retained earnings (180 000 - 20 000 – 10 088 [C3] - 12 834 [C2]) 137 078 82 247 54 831

Current year

Profit for the year (320 000 - 180 000 + 50 000 dividend + 3 348 [C4]) 193 348 116 009 77 339

Revaluation surplus (18 000 - 32 000) (14 000) (8 400) (5 600)

Dividend (given) (50 000) (30 000) (20 000)

1 545 426 159 856 582 570

COMMENT Tax rate used for deferred tax The tax rate used for the calculation of deferred tax is in accordance with the manner in which the asset’s carrying amount will be recovered. If the carrying amount is recovered through depreciation (plant, equipment, etc.) or amortisation (intangible asset with definite useful life) the rate used will be 28%. If the carrying amount of the asset is recovered through sale (land, intangible asset with indefinite useful life) then the rate will be the capital gains tax rate. In this question, the intangible asset has an indefinite useful life and therefore the capital gains tax rate is used. Calculating profit for the year The information given did not provide the profit for the current year, therefore it should be calculated by reconciling the retained earnings general ledger account: Retained

earnings R

Opening balance 1 January 20.12 180 000 Plus profit for the year x Minus dividends paid (50 000)

Closing balance 31 December 20.13 320 000

x = R190 000

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PART B Control definition An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee [IFRS 10.6]. Both companies are exposed to variable returns of the entity in the form of dividends, due to their capacity as shareholders.

(1)

Power and rights An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, ie the activities that significantly affect the investee’s returns [IFRS 10.10]. Power arises from rights [IFRS 10.11]. Tandoori Ltd and Naan Ltd are equal shareholders. (1) Relevant activities If two or more investors each have existing rights that give them the unilateral ability to direct different relevant activities, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee has power over the investee [IFRS10.13]. Tandoori Ltd has the rights to prepare the budgets and to appoint all employees of Greytown and Naan Ltd has the rights to direct the petty cash and the sanitation of the restaurant. (1) The preparation of the budgets and the appointment of employees will be the relevant activities, as it will significantly affect the returns. (1) The direction of the petty cash and the sanitation of the restaurant will not be deemed to be relevant activities. (1) Protective rights An investor that holds only protective rights does not have power over an investee, and consequently does not control the investee [IFRS 10.14]. Protective rights are rights that are designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate [IFRS 10 Appendix A]. Samoosas Ltd has the rights to make changes to the logo of the franchise and force Greytown to adapt to such changes. (1) Samoosas Ltd also stipulates that the spices used in the production processes must be purchased from Samoosas Ltd in order to protect the image of Samoosas Ltd's franchises. (1)

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These rights are considered to be protective rights as it was only designed to protect the interest of Samoosas Ltd and does not give Samoosas Ltd power. (1) Conclusion Tandoori Ltd thus has the power to direct the relevant activities of Greytown and Tandoori Ltd thus controls Greytown. (1)


Communication skills: Logical flow and conclusion (1)

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QUESTION 4 40 marks


Amalgamated Fast Foods Ltd (AFF) is a public company listed on the JSE Limited in South Africa. The company is Africa's leading fast food restaurant franchisor. In order to expand their business, AFF purchased an 85% shareholding in Shisa Nyama Ltd (Shisa Nyama) on 1 March 20.14. Each share entitles the shareholder to one vote. Shisa Nyama is a franchise fast food restaurant specialising in flamed-grilled meals. Shisa Nyama’s restaurants are located all over South Africa. From 1 March 20.14, AFF had control of Shisa Nyama in accordance with IFRS 10 Consolidated Financial Statements. Both companies have a 28 February year end. The following trial balances as at 28 February 20.15 are presented to you (you may assume that the amounts are correct, except where otherwise indicated in the information below): AFF Shisa

Nyama R R Debits Other investments 6 014 679 - Equipment 672 021 1 436 994 Investment in Shisa Nyama 300 000 - Inventory 254 481 241 976 Trade receivables 667 933 - Cash and cash equivalents 234 791 214 000 Cost of sales 2 187 948 555 104 Other expenses 1 041 169 587 032 Income tax expense 664 249 66 714 Finance costs - 54 688 Dividend paid (paid on 28 February 20.15) 81 000 35 000

12 118 271 3 191 508

Credits Issued ordinary share capital 500 000 250 000 Retained earnings – 1 March 20.14 5 255 028 345 871 Long-term loan - 546 880 Deferred tax 321 864 132 479 Trade payables 479 877 428 517 Revenue 5 469 871 1 487 761 Other income 91 631 -

12 118 271 3 191 508

Investment in Shisa Nyama The purchase agreement stipulated that the consideration for the 85% interest in Shisa Nyama consisted of the following: • A cash amount of R250 000 which was paid on 1 March 20.14.

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• 500 ordinary shares issued by AFF. The market price of AFF’s shares was R800 per share on

1 March 20.14, and R850 per share on 28 February 20.15. The share issue costs amounted to R50 000. AFF’s accountant, Mr Clueless, debited the investment in Shisa Nyama account with the R50 000 share issue costs.

• A further R300 000 will be paid to the former shareholders on 1 March 20.18. • The consideration also includes an amount of R375 000 to be paid in cash to the former

shareholders on 1 March 20.17, if the profits generated by Shisa Nyama during the period 1 March 20.14 to 28 February 20.17 increase by 120% above the current level. The fair value of this obligation on acquisition date, taking into account the probability and time value of money, was R285 620. At 28 February 20.15, the sales of Shisa Nyama declined slightly and the fair value was re-estimated at R275 654.

• An amount of R35 620 was paid to an attorney to draw up the purchase agreement as well as the valuation of the shares. These costs were already included in the cash amount of R250 000 paid by AFF on 1 March 20.14.

Mr Clueless was unsure how to account for the acquisition of Shisa Nyama and consequently only accounted for the cash payment of R250 000 and share issue costs in the separate financial statements of AFF. All the assets and liabilities of Shisa Nyama were deemed to be fairly valued on acquisition date, with the exception of the following: • Braai equipment with a carrying amount of R761 626 had a fair value of R850 000 on

1 March 20.14. AFF however indicated that after the acquisition they intend to stop the use of this specific braai equipment due to the equipment’s carbon emissions, and subsequently valued the braai equipment only at R800 000 on 1 March 20.14. The equipment was originally purchased on 1 September 20.12 and had a useful life of five years on this date. This estimate has not changed since the acquisition of the braai equipment.

• Shisa Nyama also distributes bottles of their braai sauce to retailers. Due to a nationwide shortage of the braai sauce’s secret ingredient, Shisa Nyama had a contractual order backlog for 60 boxes of sauce on 1 March 20.14. The fair value of this order backlog amounted to R45 000 on 1 March 20.14. The order backlog was completed and distributed by the end of November 20.14. The price for a box of sauce remained unchanged for the duration of the current financial year.

• No additional assets, liabilities or contingent liabilities were identified at the acquisition date. Shisa Nyama has a licensed customer list on 1 March 20.14. The agreements relating to the customer list does not prohibit the selling or leasing thereof. The useful life of the customer list was five years on 1 March 20.14 and the fair value is R403 169. Shisa Nyama has not recognised an asset in this regard. Shisa Nyama pays an annual market related fee of R55 755 to AFF for a potato mash recipe. The following intragroup transactions took place within the group during the year ended 28 February 20.15: • From 1 July 20.14, AFF purchased braai sauce from Shisa Nyama at cost plus 33,33%. Included

in the closing inventory of AFF on 28 February 20.15 was inventory amounting to R89 657 that was purchased from Shisa Nyama. At the AFF stock count on 28 February 20.15 the auditors identified three boxes of sauce that has already reached their expiry date and therefore cannot be sold. The inventory balance in the separate accounting records of AFF was adjusted with the write-off of the sauce.

• Total intragroup sales for the 20.15 financial year amounted to R120 000.

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Investment in Pop Tart Ltd (Pop Tart) On 1 December 20.14, AFF entered into negotiations to acquire the controlling interest in Pop Tart, a South African company specialising in the importation and distribution of popular American treats. The current offer on the table would require AFF to acquire 7 000 ordinary shares from the current shareholders. Pop Tart’s shares consist of 10 000 issued ordinary shares and 1 000 issued preference shares. The preference shares have a nominal value of R100 each. The preference shares give their holders the right to a preferential dividend before the payment of any dividend to the ordinary shareholders. On liquidation of Pop Tart, the preference shareholders are entitled to receive R100 per share before the remainder of the net assets are distributed to the ordinary shareholders. The preference shareholders do not have any further rights on liquidation. Each ordinary share entitles the shareholder to one vote and the preference shareholders do not have any voting rights. The purchase agreement was signed and finalised by management on 28 February 20.15. AFF, in accordance with the agreement, purchased the ordinary shares on 28 February 20.15 and therefore obtained control of Pop Tart in accordance with IFRS 10 Consolidated Financial Statements. The fair value of Pop Tart’s shares was as follows on 28 February 20.15: Ordinary

shares Preference

shares R R

Last traded share price 210 162 Price agreed upon in the purchase agreement 221 -

Additional information 1. Investments in subsidiaries are accounted for at cost in accordance with IAS 27.10(a). 2. The acquisition of Shisa Nyama and Pop Tart resulted in the recognition of goodwill in the

consolidated financial statements of the group. 3. It is the accounting policy of AFF to account for property, plant and equipment using the cost

model in accordance with IAS 16 Property, Plant and Equipment. 4. The AFF Group provides depreciation on property, plant and equipment items using the straight-

line method over the asset’s remaining useful life. 5. There was no change in the issued ordinary share capital of Shisa Nyama during the 20.15

financial year. 6. You may assume that all income tax related entries have been correctly accounted for in the

separate accounting records of AFF. 7. Unless stated otherwise, assume a market related after-tax discount rate of 6,84% per annum,

compounded annually. 8. AFF has elected to measure the non-controlling interests of Shisa Nyama at fair value on

acquisition date. The fair value of the non-controlling interests of Shisa Nyama amounted to R200 000 on 1 March 20.14.

9. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore Value Added Tax (VAT) and Dividend Tax.

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REQUIRED


Marks

(a) Advise Mr Clueless on the correct measurement of the non-controlling interests in Pop Tart Ltd at the acquisition date in the consolidated financial statements of the Amalgamated Fast Foods Ltd Group.

(b) Prepare the consolidated statement of profit or loss and other comprehensive

income of the Amalgamated Fast Foods Ltd Group for the year ended 28 February 20.15. Income and expenditure should be presented in terms of their function.


(c) Prepare the investment in Shisa Nyama Ltd note, in terms of IFRS 12 Disclosure of

Interests in Other Entities, to the consolidated financial statements of the Amalgamated Fast Foods Ltd Group for the year ended 28 February 20.15.

You may assume that the non-controlling interests of Shisa Nyama Ltd are material

to Amalgamated Fast Foods Ltd. For the summarised financial information you only have to disclose the following line-items:

• Current assets • Current liabilities • Revenue • Profit for the year

10

22

1

7

Please note:

• Comparative figures are not required.

• Notes to the consolidated statement of profit or loss and other comprehensive income are not required.

• Show all your calculations.

• The allocation of total comprehensive income for the period attributable to owners of the parent and non-controlling interests as per IAS 1.81B are not required.

• Round off all amounts to the nearest Rand.

• Round off all percentages to the nearest two decimals.

• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 4 - Suggested solution (a) Measurement of the non-controlling interests in Pop Tart Ltd at the acquisition

date Theory IFRS 3.19 states that for each business combination, the acquirer shall measure at the acquisition date components of non-controlling interests in the acquiree that are present ownership interests and entitle their holders to a proportionate share of the entity’s net assets in the event of liquidation at either: (a) fair value; or (b) the present ownership instruments’ proportionate share in the recognised

amounts of the acquiree’s identifiable net assets. All other components of non-controlling interests shall be measured at their acquisition-date fair values, unless another measurement basis is required by IFRSs.

Application The non-controlling interests in Pop Tart Ltd should be separated into two components namely ordinary share capital and preference share capital and measured separately. Both components will however be recognised in one line-item in equity namely non-controlling interests. The non-controlling interests in Pop Tart Ltd also do not have to be measured at fair value merely because the non-controlling interests in Shisa Nyama Ltd are measured at fair value. The measurement choice can be applied on a subsidiary by subsidiary basis, thus for each business combination. Conclusion Amalgamated Fast Foods Ltd will take up 7 000 of the 10 000 shares, thus the remaining 3 000 shares (30%) will be allocated to NCI. Amalgamated Fast Foods Ltd will not take up any of the preference shares, therefore the entire preference share capital will be allocated to NCI. Measurement of ordinary share capital Pop Tart Ltd’s ordinary share capital presents an ownership interest as each share entitles a shareholder to one vote. Amalgamated Fast Foods Ltd will also receive a proportionate share of Pop Tart Ltd’s net assets in the event of liquidation.

(1)

(1)

(1)

(1)

(1)

(1)

(1)

Therefore Mr Clueless will have a choice to measure the 30% non-controlling interests in ordinary share capital at the proportionate share of Pop Tart Ltd’s identifiable net assets or at fair value at acquisition date.

(1)

The fair values of the acquirer’s interest in the acquiree and the non-controlling interests on a per-share basis might differ. The main difference is likely to be the inclusion of a control premium in the per-share fair value of the acquirer’s interest in the acquiree (IFRS 3.B45).

If Mr Clueless chooses to measure the non-controlling interests in ordinary share capital at fair value, the last traded share price of R210 should be used, resulting in non- controlling interests of R630 000 (10 000 x 30% x R210) for the ordinary shares.

(1)

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Measurement of preference share capital

The non-controlling interests that relate to Pop Tart Ltd’s preference shares do not qualify for the measurement choice in paragraph 19 because they do not entitle their holders to a proportionate share of Pop Tart Ltd’s net assets in the event of liquidation. The preference shareholder also do not have any voting rights and therefore do not have a present ownership interest.

(2)

Therefore Mr Clueless will have to measure the 100% non-controlling interests in the preference shares at their acquisition-date fair value of R162, resulting in non- controlling interests of R162 000 (1 000 x R162) for the preference shares.

(1) Total (12) Maximum (10) (b) AMALGAMATED FAST FOODS LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.15

R Revenue (5 469 871(AFF) [½] + 1 487 761(SN) [½] –

120 000 (intragroup sales) [½])

6 837 632

(1½) Cost of sales [C1] (2 666 215) (4)

Gross profit 4 171 417 Other income [C4] 16 092 (2½) Other expenses [C6] (1 733 700) (5) Finance costs (54 688 (SN) [½] + 19 824 [C8] [2]) (74 512) (2½)

Profit before tax 2 379 297 Income tax expense [C9] (683 699) (3)

PROFIT FOR THE YEAR 1 695 598 Other comprehensive income for the year, net of tax -


Profit attributable to: Owners of the parent (balancing) 1 680 194 (½) Non-controlling interests [C10] 15 404 (3½)

1 695 598

Total (22½) Maximum (22) Communication skills: Presentation and layout (1)

(c) AMALGAMATED FAST FOODS LTD GROUP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR

ENDED 28 FEBRUARY 20.15

Investment in subsidiary Subsidiary name: Shisa Nyama Ltd (½) Principal place of business: South Africa (½) Proportion of ownership interest held by

non-controlling interests:

15%

(½)

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20.14

R

Profit allocated to non-controlling interests of the subsidiary during the reporting period (from part b)

15 404

(½)

Accumulated non-controlling interests of the subsidiary at the end of the reporting period (200 000 + 15 404 – 5 250)

210 154

(1½)

Dividends paid to non-controlling interests 5 250 (½) Summarised financial information about the subsidiary The following is summarised financial information for Shisa Nyama Ltd,

prepared in accordance with IFRS, modified for fair value adjustments on acquisition. The information is before intragroup eliminations.

Current assets (241 976 + 214 000) 455 976 (1) Current liabilities (given) (428 517) (½) Revenue (given) (1 487 761) (½) Profit for the year (224 223 [C10] – 18 180 [C10] – 58 056 [C10] –

32 400 [C10]) or (102 690 [C10] + 12 897 [C10])

(115 587)

(2) Total (8) Maximum (7)

CALCULATIONS C1. Cost of sales

Amalgamated Fast Foods Ltd (given) 2 187 948 [½] Shisa Nyama Ltd (given) 555 104 [½] Elimination of intragroup sales for 20.15 (120 000) [½] Elimination of unrealised intragroup profit [C2] 17 913 [1½] Depreciation on the revalued equipment [C3] 25 250 [1]

2 666 215

[4]

COMMENT The additional depreciation on the “braai equipment” is included in cost of sales as the equipment is used in the production of “inventory”. If it was office equipment the additional depreciation would have been included in other expenses.

C2. Unrealised profit in inventory

Inventory on hand at 28 February 20.15 89 657 Unrealised profit (33,33 / 133,33 x 89 657) 22 413 [1] Inventory written down to net realisable value (1 500 x 3) (4 500) [½]

17 913 [1½] Deferred tax expense – 20.15 (17 913 x 28%) (5 016)

Adjustment for 20.15 12 897

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C3. Depreciation on the revalued equipment

Fair value on 1 March 20.14 (given) 850 000 Carrying amount on 1 March 20.14 (given) (761 626)

Revaluation at acquisition date 88 374 Remaining useful life 3,5 years Depreciation for 20.15 (88 374 / 3,5) or (88 374 / 42 x 12) 25 250 [1] Deferred tax expense – 20.15 (25 250 x 28%) (7 070)


C4. Other income

Amalgamated Fast Foods Ltd (given) 91 631 [½] Fair value adjustment of contingent consideration (285 620 – 275 654) 9 966 [1] Elimination of intragroup dividends (35 000 x 85%) (29 750) [½] Elimination of potato mash recipe fee received (55 755) [½] 16 092

[2½] C5. Customer list

Market

fee

Customer list (given)

403 169

[1]

C6. Other expenses

Amalgamated Fast Foods Ltd (given) 1 041 169 [½] Shisa Nyama Ltd (given) 587 032 [½] Acquisition related costs not correctly processed in separate records 35 620 [½] Reversal of order backlog 45 000 [1] Amortisation of intangible asset (customer list) [C7] 80 634 [2] Elimination of potato mash recipe fee paid (55 755) [½] 1 733 700

[5]

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COMMENT At acquisition the order backlog will be recognised as an intangible asset in terms of IFRS 3.13. Also refer to IFRS 3.IE25 for further guidance on the recognition of intangible assets not previously recognised by the acquiree. Note the journal entries relating to the order backlog included in the at acquisition journal: Dr

R

Cr R

Share capital (SCE) 250 000 Retained earnings (SCE) 345 871 Intangible asset (customer list) (SFP) 403 169 Intangible asset (Order backlog) (SFP) 45 000 Equipment 88 374 Deferred tax (Order backlog) (SFP) 12 600 Deferred tax (Other assets) (SFP) 137 632 Goodwill (SFP) (balancing) 345 689 Non-controlling interests (SFP/SCE) 200 000 Investment in Shisa Nyama (SFP) 1 127 871

The intangible asset (order backlog) will subsequently be amortised over its useful life (time to complete the order backlog) and the following journal will be processed after acquisition, when the backlog is completed: Dr

R

Cr R

Amortisation (P/L) 45 000 Accumulated amortisation (SFP) 45 000 Deferred tax (SFP) 12 600 Income tax expense (P/L) 12 600

C7. Amortisation of intangible asset (customer list)

Fair value on 1 March 20.14 [C5] 403 169 [1] Amortisation 20.15 (403 169 / 5) 80 634 [1] Deferred tax expense – 20.15 (80 634 x 28%) (22 578)


[2]

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C8. Deferred consideration


1. 2nd F C (clear all) 1. 2nd FC (clear all) 1. 2nd F MODE (clear all) 2. 0 PMT 2. 0 PMT 2. 0 PMT 3. 6,84%/72% 4. =9,5

I/YR

3. 6,84%/72% 4. =9,5

i

3. 6,84%/72% 4. =9,5

I/YR

[½]

5. 4 N 5. 4 n 5. 4 N [½] 6. 300 000 FV 6. 300 000 FV 6. 300 000 FV [½] 7. PV 208 672 7. Comp PV 208 672 7. Comp PV 208 672

8. 8. 8. Interest accrued for 20.15 (208 672 x 9,5%) 19 824 [½] [2]

C9. Income tax expense

Amalgamated Fast Foods Ltd (given) 664 249 [½] Shisa Nyama Ltd (given) 66 714 [½] Tax implication of elimination of intragroup profit (17 913 [C2] x 28%) (5 016) [½] Tax implication of reversal of order backlog (45 000 [C6] x 28%) (12 600) [½] Tax implication of depreciation on revalued equipment at acquisition

(25 250 [C3] x 28%)

(7 070)

[½] Tax implication of amortisation of intangible asset (80 634 [C7] x 28%) (22 578) [½]

683 699

[3] C10. Non-controlling interests

Revenue 1 487 761 Cost of sales (555 104) Other expenses (587 032) Finance costs (54 688) Income tax expense (66 714)

Profit of Shisa Nyama Ltd 224 223 [1] Elimination of unrealised intragroup profit [C2] (12 897) [½] Depreciation on the revalued equipment [C3] (18 180) [½] Amortisation of intangible asset (customer list) [C7] (58 056) [½] Reversal of order backlog (45 000 [C6] – 12 600 [C9]) (32 400) [½]

102 690

Non-controlling interests (102 690 x 15%) 15 404 [½]

[3½]

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C11.

Analysis of owners’ equity of Shisa Nyama Ltd (for completeness)

Total

Amalgamated Fast Foods Ltd (85%) NCI

At Since

At acquisition

Share capital (given) 250 000


Customer list (403 169 x 72%) 290 282

Intangible asset (order backlog) (45 000 x 72%) 32 400

Revaluation of equipment [(850 000 – 761 626) x 72%] 63 629

982 182 834 855 147 327

Equity represented by goodwill (balancing) 326 490 273 817 52 673

Consideration [C12] and NCI 1 308 672 1 108 672 200 000


Current year

Profit for the year [C10] 102 690 87 286 15 404

Dividend paid (given) (35 000) (29 750) (5 250)

1 376 362 57 536 210 154

C12.

Consideration transferred

Cash payment (250 000 – 35 620 (legal fees)) 214 380

Shares (500 x R800) 400 000 Deferred consideration [C8] 208 672 Contingent consideration (given) 285 620 1 108 672

COMMENT Transaction costs should be carefully analised as the accounting treatment for transaction costs are not all the same. Acquisition-related costs (finder’s fees, advisory, legal, valuation, professional fees, administration fees) should be expensed in profit or loss in the consolidated financial statements of the acquirer in accordance with IFRS 3.53. Share issue costs are not acquisition-related costs as defined in terms of IFRS 3. Share issue costs shall be accounted for as a deduction from equity in terms of IAS 32.35 in the separate and consolidated financial statements of the acquirer. In this question the accountant was unsure how to account for the acquisition in the separate accounting records of AFF and consequently only accounted for the cash amount paid and share issue costs.

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COMMENT Therefore, the accountant did the following: Dr

R

Cr R

J1 Investment in subsidiary (SFP) 300 000 Bank (SFP) 250 000 Bank (SFP) (Share issue cost paid) 50 000

The correct journal entries for the consideration paid in the separate accounting records of AFF Ltd should have been as follows: Dr

R

Cr R

J1 Investment in subsidiary (SFP) 1 108 672 Acquisition costs (P/L) 35 620 Bank (SFP) 250 000 Share capital (SCE) 400 000 Deferred consideration (SFP) 208 672 Contingent consideration (SFP) 285 620

J2 Share capital/Retained earnings (SCE) 50 000 Bank (SFP) 50 000

Therefore the correcting journal entry, relating to the share issue cost, in the separate accounting records of AFF Ltd would have been as follows: Dr

R

Cr R

J1 Share capital/Retained earnings (SCE) 50 000 Investment in subsidiary (SFP) 50 000

From the above it’s clear that the share issue costs will have no effect on the consideration paid in terms of IFRS 3.

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QUESTION 5 40 marks


Rich Dotcom Ltd operates in various industries and is listed on the JSE Limited. The company has several investments in other companies. You have recently been appointed as the Financial Manager: Group Reporting and has received the following consolidated trial balance of the group for the year ended 31 December 20.15 (you may assume that the amounts are correct, except where otherwise indicated in the information below):

R Debits

Intangible assets 400 000 Property, plant and equipment 2 000 000 Investment in RichDad Ltd 500 000 Financial assets 300 000 Inventory 250 000 Trade receivables 165 000 Cash and cash equivalents 654 000 Cost of sales 1 350 000 Other expenses 655 000 Income tax expense 256 000

6 530 000 Credits

Issued ordinary share capital

Rich Dotcom Ltd - 100 000 shares 750 000 RichDad Ltd - 10 000 shares 150 000 Retained earnings (1 January 20.15)

Rich Dotcom Ltd 1 600 000 RichDad Ltd 480 000 Long-term loan - Deferred tax 485 000 Trade payables 365 000 Revenue 2 250 000 Other income 450 000

6 530 000

Upon further inspection of the consolidated trial balance, you noticed that the only consolidation procedures performed by the previous Financial Manager were the combining of the like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its only subsidiary. You subsequently obtained the following information relating the investment in the subsidiary: Investment in RichDad Ltd Rich Dotcom Ltd acquired a 75% controlling shareholding in RichDad Ltd on 1 July 20.11. The retained earnings amounted to R300 000 at that date. All the assets and liabilities of RichDad Ltd were fairly valued at that date except for the following:

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• An office building with a carrying amount of R350 000 had a fair value of R500 000. The

remaining useful life and residual value remained unchanged at 20 years and Rnil respectively at that date. RichDad Ltd sold its office building on 31 December 20.14 for an amount of R300 000 to a property developer.

• RichDad Ltd owns a registered trademark which was designed during 20.10 at a cost of

R200 000. The trademark was correctly recognised as an intangible asset by RichDad Ltd. The original cost represents the fair value on 1 July 20.11. In order to manufacture the trademarked product, RichDad Ltd also documented the required technical expertise used which is unpatented. The fair value of the technical expertise was valued at R30 000 on 1 July 20.11. The trademark and technical expertise are both expected to have an indefinite useful life. The South African Revenue Service (SARS) does not allow any deductions against taxable income in respect of the technical expertise.

RichDad Ltd was also in negotiation with new clients regarding potential contracts worth R300 000 at the acquisition date. No additional assets, liabilities or contingent liabilities were identified at the acquisition date. The current year’s profit after tax for RichDad Ltd was R300 000. Intragroup transactions RichDad Ltd sold three of its products to Rich Dotcom Ltd on 1 January 20.15. The total sales amounted to R300 000. These products are classified as equipment as part of property, plant and equipment by Rich Dotcom Ltd. The useful life and residual value of the equipment was five years and Rnil respectively at that date. RichDad Ltd charges a gross profit percentage of 50% on cost price. Email from the Chief Executive Officer On your second day in the new position, you received the following email: Financial Manager: Group Reporting

From: Chief Executive Officer <[email protected]> Sent: 11 March 20.16 21:40 To: Financial Manager: Group Reporting Subject: Share option plan Attachments: Trust deed.docx Dear You There are two issues that require your urgent attention: Rich Dotcom Employee Share Trust Before your appointment, the board of directors of Rich Dotcom Ltd took a decision to set up the Rich Dotcom Employee Share Trust (RDEST) for the benefit of its employees. The employees of Rich Dotcom Ltd are entitled to a share option plan as part of their remuneration. The RDEST has been set up to operate the share option plan for the employees and is not a long-term employee benefit plan.

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Attached please find the trust deed for your perusal. The trust deed contains, inter alia, the following provisions: • All the elected trustees of RDEST must be employees of Rich Dotcom Ltd; • Rich Dotcom Ltd will provide the funding to RDEST and guarantee its obligations in order to

operate the share option plan; • The trust will buy Rich Dotcom Ltd’s shares; and • The trust will hold the shares for the duration of the vesting period in accordance with the share

option plan. Acquisition of SuperMom Ltd Rich Dotcom Ltd is in the process of acquiring a controlling shareholding in SuperMom Ltd. Their current Chief Executive Officer is a close friend of mine and she has brought the following to my attention: She was appointed six months ago by SuperMon Ltd on a three year contract. Included in her contract is a provision that if SuperMom Ltd is acquired by Rich Dotcom Ltd within the period of three years after her appointment, that she will be entitled to a once-off payment of R1 000 000 after the successful completion of the acquisition. Kind regards CEO Additional information 1. Investments in subsidiaries are accounted for at cost in accordance with IAS 27.10(a). 2. It is the accounting policy of Rich Dotcom Ltd to account for property, plant and equipment using

the cost model in accordance with IAS 16 Property, Plant and Equipment. 3. The Rich Dotcom Ltd Group provides depreciation on property, plant and equipment items using

the straight-line method over the asset’s remaining useful life. 4. There was no change in the issued ordinary share capital of any companies in the group since

1 July 20.11. 5. You may assume that all income tax related entries have been correctly accounted for in the

separate accounting records of Rich Dotcom Ltd. 6. Rich Dotcom Ltd has elected to measure the non-controlling interests of RichDad Ltd at its

proportionate share of the acquiree’s identifiable net assets at acquisition date. 7. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

Value Added Tax (VAT) and Dividend Tax.

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REQUIRED


Marks

(a) Provide the pro forma journal entries for the Rich Dotcom Ltd Group for the year ended 31 December 20.15. Journal entries relating to deferred taxation are also required.


(b) Discuss, with reasons, whether Rich Dotcom Ltd controls the Rich Dotcom

Employee Share Trust.

Communication skills: Logical flow and conclusion (c) Discuss, with reasons, how the payment to the Chief Executive Officer of

SuperMom Ltd will be treated at the acquisition date if Rich Dotcom Ltd successfully completes the acquisition.

25

1

9

1

4

Please note: • Show all your calculations. • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 5 - Suggested solution (a) Provide the pro forma journal entries for the Rich Dotcom Ltd Group for the year ended

31 December 20.15. Dr Cr R R J1 Share capital (SCE) (given) 150 000

(½)

Retained earnings (SCE) (given) 300 000

(½) Intangible asset (SFP) (given) 30 000

(½)

Office building (SFP) (500 000 - 350 000) 150 000

(1) Goodwill (SFP) (balancing) 64 040

(½)

Deferred tax (SFP) [(150 000 x 28%) + (30 000 x 28% x 80%)]

48 720 (1½) Non-controlling interests (SCE/SFP) [C1]

145 320 (1)

Investment in RichDad Ltd (SFP) (given)

500 000 (½) Elimination of at acquisition equity

J2 Deferred tax (SFP) (26 250 x 28%) 7 350

(1) Retained earnings (SCE) (balancing) 18 900

(½)

Accumulated depreciation (SFP) (150 000/20 x 3,5)

26 250 (1½) Depreciation on office building up to end of prior year


(1) Retained earnings (SCE) (balancing) 89 100

(½)

Accumulated depreciation (SFP) [J2] 26 250 (1) Office building (SFP) [J1]

150 000 (½)

Reversal of fair value adjustment on office building upon disposal

J4 Retained earnings (SCE) [(480 000 - 300 000 - 18 900 [J2] – 89 100 [J3]) x 25%]

18 000

(3) Non-controlling interests (SFP/SCE)

18 000 (½)

Non-controlling interests' share of since acquisition reserves

J5 Revenue (P/L) (given) 300 000

(½) Cost of sales (P/L) (balancing) OR (300 000 x 100/150)

200 000 (½)

Equipment (SFP) (300 000 x 50/150) OR (balancing)

100 000 (1½) Elimination of unrealised profit on the sale of equipment


(1) Income tax expense (P/L)

28 000 (½)

Tax implication of the depreciation on equipment

J7 Accumulated depreciation (SFP) (100 000/5) 20 000

(1½) Depreciation (P/L)

20 000 (½)

Realisation of unrealised profit on sale of equipment

J8 Income tax expense (P/L) (20 000 x 28%) 5 600

(1) Deferred tax (SFP)

5 600 (½)

Tax implication of the depreciation on the equipment

J9 Non-controlling interests (P/L) [(300 000 - 100 000 [J5] + 28 000 [J6] + 20 000 [J7] - 5 600 [J8]) x 25%]

60 600

(3½)

Non-controlling interests (SFP/SCE)

60 600 (½)

Non-controlling interests' share of current year's profit

Total (27) Maximum (25) Communication skills: Presentation and layout (1)

EXAM TECHNIQUE It is good exam technique to always provide journal narrations, even when it is not explicitly required.

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CALCULATIONS C1. Analysis of owners’ equity of RichDad Ltd

Total Rich Dotcom Ltd

(75%) NCI

At Since At acquisition Share capital (given) 150 000


Intangible asset (technical expertise) [30 000 x (1- (28% x 80%))]

23 280

Revaluation of office building [(500 000 – 350 000) x 72%]

108 000

581 280 435 960

145 320 Equity represented by goodwill (balancing)

64 040

64 040

-

Consideration and NCI 645 320 500 000

145 320


Retained earnings (480 000 – 300 000 -108 000)

72 000

54 000

18 000

Current year

Profit for the year (300 000 -100 000 [J5] + 28 000 [J6] + 20 000 [J7] – 5 600 [J8])

242 400

181 800

60 600

959 720

235 800 223 920

COMMENT Deferred tax on intangible asset (technical expertise) The tax base of an asset is any amount that would be deductible for tax against future economic benefits. The question states that SARS does not allow any deductions against taxable income in respect of the technical expertise. This will result in the tax base being zero which will give rise to a temporary difference. Deferred tax should thus be provided using the appropriate tax rate. The tax rate used will be based on the manner of recovery of the carrying amount of the intangible asset. In this question, the technical expertise has an indefinite useful life, it can thus only be recovered through sale and the CGT rate is used. Sale of office building Upon the sale of the office building, the subsidiary has correctly accounted for the sale in its separate records. However, remember that as a result of the IFRS 3 adjustment to fair value (R150 000), there is still an amount recognised in the consolidated records for the office building (the R150 000 less accumulated depreciation). This amount, including the tax consequences, must therefore be eliminated (J3). Intragroup transaction The intragroup transaction was “upstream”, the subsidiary selling to the parent. Therefore, any unrealised profit will also affect non-controlling interests which must be adjusted accordingly.

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(b) Discuss, with reasons, whether Rich Dotcom Ltd controls the Rich Dotcom Employee

Share Trust

Theory

An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee [IFRS 10.6]

An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, i.e. the activities that significantly affect the investee’s returns [IFRS 10.10]

Consideration of the following factors may assist in determining whether an entity controls an investee [IFRS 10.B3]:

Application

(a) The purpose and design of the investee;

RDEST was established by Rich Dotcom Ltd to operate a share option plan for the benefit of its employees and Rich Dotcom Ltd is therefore involved in the decisions of RDEST.

(1)

(b) What the relevant activities are and how decisions about those activities are made;

Rich Dotcom Ltd will provide the finances to RDEST to enable the trust to purchase the shares and hold it till the vesting dates. The trustees who operate the trust are all employees of RDEST.

(1)

(c) Whether the rights of the investor give it the current ability to direct the relevant activities;

An investor has power when it has the rights to appoint, reassign or remove members of an investee’s key management personnel who have the ability to direct the relevant activities [IFRS 10.B15(b)].

All the elected trustees of RDEST must be employees of Rich Dotcom Ltd and Rich Dotcom Ltd can therefore appoint, reassign or remove trustees and therefore have power over RDEST.

(1)

Rich Dotcom Ltd has no voting rights in RDEST and evidence of whether it has the practical ability to direct the relevant activities unilaterally must be considered.

(1)

Sometimes there will be indications that the investor has a special relationship with the investee, which suggests that the investor has more than a passive interest in the investee [IFRS 10.B19].

Rich Dotcom Ltd will provide the finances to RDEST to enable the trust to purchase the shares and will provide guarantees for its obligations. This indicates more than just a passive relationship and that it therefore has the practical ability to direct the relevant activities of RDEST.

(1)

(1) (d) Whether the investor is exposed, or has rights, to variable returns from its

involvement with the investee; and

RDEST is established to purchase the shares of Rich Dotcom Ltd and hold them during the vesting period of the share option plan. The Rich Dotcom Ltd’s shares that RDEST purchases and hold during the vesting period hedges Rich Dotcom Ltd’s exposure to changes in its share price by limiting the variability in the cost of the employee share scheme.

(1)

(1) Therefore, Rich Dotcom Ltd limits the exposure to variability of returns from RDEST

indicating that it has power over the RDEST. (1)

(e) Whether the investor has the ability to use its power over the investee to affect the amount of the investor’s returns.

Rich Dotcom Ltd established RDEST to operate a share option plan for the benefit of Rich Dotcom Ltd’s employees and therefore had the opportunity and incentive to obtain rights that result in Rich Dotcom Ltd having the ability to direct the relevant activities.

(1)

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Conclusion

Rich Dotcom Ltd therefore controls RDEST as it is exposed, or has rights, to variable returns from its involvement with the RDEST and has the ability to affect those returns through its power over the RDEST.

(1) Total (11)

Maximum (9) Communication skills: Logical flow and conclusion (1)

(c) Discuss, with reasons, how the payment to the Chief Executive Officer of SuperMom Ltd

will be treated at the acquisition date if Rich Dotcom Ltd successfully completes the acquisition

Theory The acquirer and the acquiree may have a pre-existing relationship or other arrangement before negotiations for the business combination began, or they may enter into an arrangement during the negotiations that is separate from the business combination. The acquirer shall identify any amounts that are not part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination, ie amounts that are not part of the exchange for the acquiree. [IFRS 3.51]

The acquirer should consider the reasons for the transaction, who initiated the transaction and the timing of the transaction, which are neither mutually exclusive nor individually conclusive, to determine whether a transaction is part of the exchange for the acquiree or whether the transaction is separate from the business combination [IFRS3.B50]

Application

The reasons for the transaction: SuperMom Ltd appointed their CEO on a three year contract to obtain her services and included the provision for the once-off payment if SuperMom Ltd is successfully acquired by another entity within that period.

(1)

Who initiated the transaction: SuperMom Ltd initiated the transaction by entering into a contract with their CEO.

(1)

The timing of the transaction: The contract with the CEO was entered into before the negotiations for the acquisition of SuperMom Ltd by Rich Dotcom Ltd began.

(1)

There is no evidence that the agreement was arranged primarily to provide benefits to Rich Dotcom Ltd or the Rich Dotcom Ltd Group.

(1)

Conclusion

Therefore, the liability to pay R1 000 000 to the CEO is included in the application of the acquisition method and a liability is recognised as part of the liabilities assumed by Rich Dotcom Ltd on the acquisition date.

(1)

Total (5)

Maximum (4)

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QUESTION 6 40 marks


This question consists of two independent parts. PART A 28 marks Chevy Ltd (Chevy) is a South African company listed on the JSE Limited. Chevy specialises in the restoration and sale of classic motor vehicles. All the companies in the Chevy Group have a February year end. Chevy acquired 70% of the ordinary share capital of Apache Ltd (Apache) on 30 June 20.15 for a cash consideration of R885 000. Apache’s retained earnings amounted to R1 085 000 on the date of acquisition. The fair value of the non-controlling interests on that date amounted to R365 000. Apache’s assets and liabilities were deemed to be fairly valued on the acquisition date and no additional assets, liabilities or contingent liabilities were identified. From 30 June 20.15, Chevy exercised control over Apache as per the definition of control in accordance with IFRS 10 Consolidated Financial Statements. Chevy acquired 65% of the ordinary share capital of Chevelle Ltd (Chevelle) on 30 April 20.16 for a cash consideration of R1 060 000. The fair value of the non-controlling interests on that date amounted to R570 000. The acquisition of Chevelle resulted in the recognition of goodwill in the consolidated financial statements of Chevy. From 30 April 20.16, Apache exercised control over Chevelle as per the definition of control in accordance with IFRS 10 Consolidated Financial Statements. Chevelle’s assets and liabilities were deemed to be fairly valued on 30 April 20.16, with the exception of the following: • Equipment was revalued with R134 000 more than the carrying amount. The remaining useful

life of the equipment on 30 April 20.16 was three years. The equipment is used in the production of income.

No additional assets, liabilities or contingent liabilities were identified on 30 April 20.16. The following intragroup transactions took place within the group during the year ended 28 February 20.17: • From 30 June 20.15 Apache has been selling inventory to Chevy at cost price plus 20%. Included

in the closing inventory of Chevy on 28 February 20.17 was inventory amounting to R132 500 (20.16: R87 400) that was purchased from Apache.

• During the 20.17 financial year, sales from Apache to Chevy amounted to R335 200. • Apache acquired land to the value of R700 000 on 1 August 20.16 for investment purposes. The

land is currently used by Chevy as a scrap yard. Based on the valuation performed on 28 February 20.17 the investment property’s value increased with R100 000.

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• Chevy sold office furniture to Chevelle on 1 November 20.16 for R14 000. The original cost price

of the furniture was R15 700. The furniture was originally purchased on 1 September 20.15 and had a useful life of five years on that date.

The separate trial balances of the various companies as at 28 February 20.17 are as follows: Chevy

Ltd R

Apache Ltd R

Chevelle Ltd R

Ordinary share capital (100 000 ordinary shares each) (100 000) (100 000) (100 000) Retained earnings (1 March 20.16) (7 522 300) (2 172 000) (1 273 820) Revaluation surplus (200 000) - - Gain on property valuation (other comprehensive income) (54 320) - - Deferred tax (276 800) (138 400) (20 000) Trade and other payables (110 000) (88 000) (66 000) Profit before tax (2 561 822) (1 152 200) (793 600) Land 4 000 400 - - Investment property - 800 000 - Equipment (carrying amount) 1 400 000 264 000 694 420 Office furniture (carrying amount) 967 360 22 000 31 000 Investment in Apache 885 000 - - Investment in Chevelle 1 060 000 - - Inventory 801 982 786 800 630 000 Trade and other receivables 450 000 260 000 320 000 Cash and cash equivalents 400 500 1 137 800 290 000 Income tax expense 760 000 320 000 238 000 Dividends paid (paid on 28 February 20.17) 100 000 60 000 50 000

Additional information 1. The Chevy Group apply the following accounting policies:

• Equipment and office furniture are accounted for according to the cost model in accordance with IAS 16 Property, Plant and Equipment.

• Land is accounted for according to the revaluation model in accordance with IAS 16 Property, Plant and Equipment.

• Depreciation on equipment and furniture items are provided on the straight-line method over the asset’s remaining useful life.

• Investment property is accounted for according to the fair value model in accordance with IAS 40 Investment Property.

• Non-controlling interests are measured at fair value at the acquisition date, for all acquisitions.

2. It is the accounting policy of Chevy and Apache to account for investments in subsidiaries at

cost in accordance with IAS 27.10(a) in its separate financial statements. 3. Chevelle’s income and expenses accrued evenly throughout the financial year. 4. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

Value Added Tax (VAT) and Dividend Tax. 5. There were no changes in the issued ordinary share capital of any of the companies in the group.

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PART B 12 marks Potato Ltd is a JSE Limited listed company that grows and distributes vegetables. On 1 January 20.17 Potato Ltd acquired the tomato division of ZZ4 Ltd. The main reason for this acquisition was so that Potato Ltd could get access to a supply contract between the tomato division and Veg & Fruit Ltd, a national greengrocer. The purchase consideration consisted of an immediate cash payment of R260 000 and an additional cash payment of R150 000 payable on 1 January 20.18. The tomato division constitutes a business and Potato Ltd obtained control over the business from 1 January 20.17 in terms of IFRS 10 Consolidated Financial Statements. The assets and liabilities of the tomato division on the acquisition date were as follows: Carrying amount

Dr/(Cr) R

Fair value Dr/(Cr)

R

Assets 380 000 400 000 Liabilities (110 000) (130 000)

The supply contract between the tomato division and Veg & Fruit Ltd had a fair value of R80 000 on 1 January 20.17 and the contract will expire on 1 March 2019. The tomato division did not recognise an asset in its accounting records in respect of the contract. Additional information 1. Assume a market related pre-tax interest rate of 12% per annum, compounded annually. 2. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore


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REQUIRED


Marks

PART A Prepare the consolidated statement of profit or loss and other comprehensive income of the Chevy Ltd Group for the year ended 28 February 20.17, starting with the profit before tax. Other comprehensive income should be presented net of tax.

27


PART B Discuss, with reference to amounts, how the purchase transaction of the tomato division should be accounted for on 1 January 20.17 in the separate accounting records of Potato Ltd. Please note: • Round off all amounts to the nearest Rand. • Show all your calculations. • Comparative figures are not required. • Notes to the consolidated statement of profit or loss and other comprehensive income

are not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

1

12

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QUESTION 6 - Suggested solution PART A CHEVY LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.17 R

Profit before tax [C1] 4 154 325 (12½) Income tax expense [C6] (1 242 905) (4½)

PROFIT FOR THE YEAR 2 911 420 Other comprehensive income: Items that will not be reclassified to profit or loss: Gains on property [54 320 + (100 000 – (100 000 x 28% x 80%))] 131 920 (1½)


Profit attributable to: Owners of the parent (balancing) 2 533 994 (½) Non-controlling interests (244 756 [C7] + 152 670 [C7]) 377 426 (6)

2 911 420

Total comprehensive income attributable to: Owners of the parent (balancing) 2 642 634 (½) Non-controlling interests [377 426 (above) + (77 600 x 30%)] 400 706 (1½)

3 043 340


COMMENT As the solution starts with Profit before tax, adjustments affecting only the statement of profit or loss and other comprehensive income are not required. An example is the elimination of the intragroup sales between Apache and Chevy amounting to R335 200. The pro forma journal entry required is Debit Revenue (P/L) and Credit cost of sales (P/L) of R335 200. However, the net effect on profit before tax is zero and this adjustment is therefore not required in [C1].

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CALCULATIONS C1. Profit before tax

Chevy Ltd 2 561 822 [½] Apache Ltd 1 152 200 [½] Chevelle Ltd (793 600 x 10/12) 661 333 [1] Realisation of unrealised intragroup profit for 20.16 [C2] or (20/120 x 87 400) 14 567 [2] Elimination of unrealised intragroup profit for 20.17 [C3] or (20/120 x 132 500) (22 083) [2] Depreciation on revalued equipment [C4] or (134 000/3 x 10/12) (37 222) [1] Elimination of intragroup gain on disposal of office furniture [C5] or (14 000 – (15 700 – (15 700/60 x 14))) (1 963) [2] Elimination of intragroup depreciation on office furniture [C5] or (1 963/46 x 4) 171 [1] Elimination of intragroup dividends received from Apache Ltd (60 000 x 70%) (42 000) [1] Elimination of intragroup dividends received from Chevelle Ltd (50 000 x 65%) (32 500) [1] Fair value adjustment on investment property (100 000) [½]

4 154 325

[12½]

COMMENT The land will be recognised as investment property in the separate financial statements of Apache Ltd, as it was acquired for investment purposes. The fair value adjustment and the deferred tax adjustment was thus recognised in profit or loss in Apache Ltd’s separate financial statements. Since the land is rented by Chevy Ltd (the parent), it now becomes owner-occupied property, plant and equipment in the consolidated financial statements (IAS 40.15). The fair value adjustment of R100 000 and deferred tax adjustment of R22 400 (refer to C6) recognised in profit or loss by Apache Ltd must thus be reversed in the consolidated financial statements. It is the group’s accounting policy to measure land in accordance with the revaluation model. The increase in fair value of R100 000 must thus be recognised in the consolidated financial statements in other comprehensive income, net of deferred tax (refer to C8).

C2. Unrealised profit in inventory – 20.16

Inventory - opening balance 1 March 20.16 87 400 Unrealised profit (20/120 x 87 400) 14 567 Deferred tax expense (14 567 x 28%) (4 079) Adjustment for 20.17 10 488

C3. Unrealised profit in inventory – 20.17

Inventory - closing balance 28 February 20.17 132 500 Unrealised profit (20/120 x 132 500) 22 083 Deferred tax expense (22 083 x 28%) (6 183) Adjustment for 20.17 15 900

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C4. Depreciation on revalued equipment

Remaining useful life 3 Revaluation at acquisition date 134 000 Additional depreciation for 20.17 (134 000/3 x 10/12) 37 222 Deferred tax expense (37 222 x 28%) (10 422) Adjustment for 20.17 26 800

C5. Intragroup gain on disposal of office furniture and depreciation

Cost price 15 700 Accumulated depreciation up to 1 November 20.16 (15 700/60 x 14) (3 663) Carrying amount on 1 November 20.16 12 037 Selling price (14 000) Unrealised profit on disposal of furniture (1 963) Deferred tax on gain (1 963 x 28%) 550 Depreciation on furniture (1 963/(60 – 14) x 4) (171) Deferred tax (171 x 28%) 48

C6. Income tax expense

Chevy Ltd (760 000) [½] Apache Ltd (320 000) [½] Chevelle Ltd (238 000 x 10/12) (198 333) [½] Tax implication of intragroup profit for 20.16 [C2] or (14 567 x 28%) (4 079) [½] Tax implication of intragroup profit for 20.17 [C3] or (22 083 x 28%) 6 183 [½] Tax implication of additional depreciation [C4] or (37 222 x 28%) 10 422 [½] Tax implication of gain on disposal of furniture [C5] or (1 963 x 28%) 550 [½] Tax implication of depreciation on furniture sold [C5] or (171 x 28%) (48) [½] Tax implication of fair value adjustment on investment property 22 400 [½]

(1 242 905) [4½]

C7. Non-controlling interests

Apache Ltd Profit before tax 1 152 200 [½] Income tax expense (320 000) [½] Profit after tax 832 200 After tax effect of realisation of intragroup profit 20.16 [C2] 10 488 [½] After tax effect of elimination of intragroup profit 20.17 [C3] (15 900) [½] After tax effect of fair value adjustment on investment property (100 000 – (100 000 x 28% x 80%)) (77 600) [1]

749 188 Profit or loss attributable to non-controlling interests (749 188 x 30%) 224 756 [½] Chevelle Ltd Profit before tax 793 600 [½] Income tax expense (238 000) [½] Profit for full year 555 600 Profit for 10 months (555 600 x 10/12) 463 000 [½] After tax effect of additional depreciation [C4] (26 800) [½]

436 200 Profit or loss attributable to non-controlling interests (436 200 x 35%) 152 670 [½] [6]

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C8. Analysis of owners' equity of Apache Ltd (for completeness)

Chevy Ltd 70%

Total At Since NCI

At acquisition Share capital 100 000 Retained earnings 1 085 000

1 185 000 829 500 355 500 Equity represented by goodwill (balancing) 65 000 55 500 9 500

Consideration and NCI 1 250 000 885 000 365 000

Since acquisition Beginning of the year

Retained earnings (2 172 000 – 1 085 000 – 10 488) 1 076 512 753 558 322 954

Current year Profit for the year [C7] 749 188 524 432 224 756 Other comprehensive income: Revaluation (100 000 – (100 000 x 28% x 80%)) 77 600 54 320 23 280

Dividends (60 000) (42 000) (18 000)

3 093 300 1 290 310 917 990

C9. Analysis of owners' equity of Chevelle Ltd (for completeness)

Chevy Ltd 65%

Total At Since NCI

At acquisition Share capital 100 000 Retained earnings 1 273 820 Profit for 2 months (463 000 [C7] x 2/12) 92 600

Revaluation of equipment 134 000 Deferred tax (37 520)

1 562 900 1 015 885 547 015 Equity represented by goodwill (balancing) 67 100 44 115 22 985

Consideration and NCI 1 630 000 1 060 000 570 000

Current year Profit for the year [C7] 436 200 283 530 152 670 Dividends (50 000) (32 500) (17 500)

2 016 200 251 030 705 170

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PART B Discuss how the purchase transaction of the tomato division should be accounted for

According to IFRS 3.3 an entity shall determine whether a transaction or other event is a business combination by applying the definition in IFRS 3, which requires that the asset acquired and liabilities assumed constitute a business.

The tomato division constitutes a business.

(1)

A business combination is defined in IFRS 3 as a transaction or other event in which an acquirer obtains control of one or more businesses (Appendix A).

On 1 January 20.17 Potato Ltd acquired the tomato division (business) and obtained control thereof.

(1)

Therefore the principles of IFRS 3 will be applied in accounting for the purchase transaction of the tomato division on 1 January 20.17 as the transaction meets the definition of a business combination.

(1)

According to IFRS 3.4 an entity shall account for each business combination by applying the acquisition method.

Applying the acquisition method requires: (a) identifying the acquirer; (b) determining the acquisition date; (c) recognising and measuring the identifiable assets acquired, the liabilities assumed and

any non-controlling interest in the acquiree; and (d) recognising and measuring goodwill or a gain from a bargain purchase.

Application of acquisition method Potato Ltd will apply the acquisition method to account for the transaction.

(1)

The acquirer will be Potato Ltd and the acquisition date will be 1 January 20.17.

(1)

The acquirer shall recognise identifiable assets acquired and the liabilities assumed if they meet the definitions of assets and liabilities in the Framework. The identifiable assets acquired and the liabilities assumed will be measured at their acquisition-date fair values.

Therefore the previously recognised assets will be recognised at the fair value of R400 000 and the liabilities at the fair value of R130 000.

(1)

No deferred tax will be recognised on the recognition of the previous assets and liabilities as the SARS will deem the tax base on initial recognition to be the same as the fair value of the assets and liabilities acquired.

(1)

The acquirer’s application of the recognition principle and conditions may result in recognising some assets and liabilities that the acquiree had not previously recognised as assets and liabilities in its financial statements (IFRS 3.13).

An intangible asset is identifiable if it meets either the separability criterion or the contractual-legal criterion (IFRS 3.B31).

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As the supply contract is a contract, it will be considered identifiable and should be recognised on acquisition date at fair value being R80 000 as it meets the contractual-legal criterion.

(1)

A deferred tax liability will be created at 28% of R80 000 (R22 400). The reason being that the supply contract was not acquired by means of a purchase transaction. The SARS will not recognise the supply contract and thus the base cost will be equal to Rnil.

(1)

The consideration transferred in a business combination shall be measured at fair value (IFRS 3.37)

The consideration consists of a cash payment of R260 000 and a deferred payment of R150 000. The deferred payment (current liability) will be discounted to a present value. Therefore the consideration will amount to R260 000 + R133 929 (R150 000/1,12 = R393 929).

(2)

The last step is to recognise goodwill or a gain on bargain purchase. Goodwill is calculated as the excess of the consideration transferred over the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed.

(1)

The goodwill recognised for the business combination of the tomato division will be R66 329. The amount is calculated as follows: R Consideration transferred: - Cash 260 000 - Deferred payment 133 929

393 929 Minus net identifiable assets acquired 327 600

- Previous assets 400 000 - Supply contract 80 000 - Deferred tax on supply contract (22 400)

- Previous liabilities (130 000)

Goodwill 66 329

(1)

Total Maximum

(13) (12)

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QUESTION 7 25 marks


PART A 21 marks Working Fire Ltd was established by Mrs Joan Canal in 19.70 and is the leading supplier of fireworks in South Africa. Working Fire Ltd and all its investments have a February year end. Working Fire Ltd has adapted successfully through the years to various changes in the environment. The new Explosives Act, which has not been promulgated in the Government Gazette, will have a significant impact on the fireworks and explosives industry once it is implemented. It is unsure when the act will be promulgated. The act will include strict requirements for explosives to adhere to the United Nations and the South African Bureau of Standards regulations in terms of classification, marking, transport and packaging. Suppliers will also have to obtain authorisation for explosives before these could be sold to end-users. Explosive Ltd The impact of the new act will also be significant for another joint arrangement of Working Fire Ltd, namely Explosive Ltd. Explosive Ltd was incorporated on 1 March 20.02 and specialises in on-site manufacturing of explosives. Working Fire Ltd acquired a 40% interest for an amount of R120 000 and exercises joint control over the relevant activities of Explosive Ltd in terms of the joint arrangement. Explosive Ltd is correctly classified as a joint venture. Working Fire Ltd is entitled to 40% of the net profit of the joint venture. Crackers Ltd Working Fire Ltd is the majority shareholder of Crackers Ltd, which was acquired on 1 July 20.12 when an 80% interest in the share capital and voting rights were acquired. On this date Working Fire Ltd obtained control of Crackers Ltd. Working Fire Ltd paid an amount of R500 000 for the investment in Crackers Ltd. The assets and liabilities of Crackers Ltd were deemed to be fairly valued at acquisition date. The following balances were extracted from the various separate trial balances as at 28 February 20.13:

Explosive Ltd

Dr/(Cr)

Crackers Ltd

Dr/(Cr)

R R

Revenue (4 120 000) (1 470 000) Cost of sales 2 974 000 585 000 Other income (467 000) (95 000) Administrative expenses 981 000 452 000 Income tax expense 167 480 139 920

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The following balances were extracted from the trial balance of Explosive Ltd as at 28 February 20.13:

R

Property, plant and equipment 2 299 000 Trade and other receivables 654 000 Inventory 520 520 Loan from Working Fire Ltd (non-current liability) (400 000) Deferred tax liability (212 000) Trade and other payables (584 000) Provisions (340 000)

The companies in the group had the following equity and reserve balances:

Explosive Ltd

Crackers Ltd

01/03/20.02 01/03/20.12 01/07/20.12

R R R

Share capital 350 000 350 000 150 000 Retained earnings - 1 426 000 489 000 Mark-to-market reserve - 522 000 56 000

350 000 2 298 000 695 000

Additional information 1. There was no movement in the mark-to-market reserve account of Crackers Ltd during the

current financial year. 2. Working Fire Ltd elected to measure non-controlling interests for the acquisition of Crackers Ltd

at the proportionate share of the net asset value. 3. On 31 October 20.12 Explosive Ltd created a provision for the future costs of an environmental

lawyer who would provide advice regarding the specific requirements of on-site manufacturing of explosives in terms of the new act. This provision was included in the administrative expenses of Explosive Ltd. The lawyer will only be appointed and remunerated once the new act is implemented. The provision amounted to R300 000 and was not remeasured at year end. The fees will not be deductible for income tax purposes.

4. The profit of Crackers Ltd accrued evenly during the year, with the exception of a legal expense

of R55 000 that related to the period after the acquisition by Working Fire Ltd. The legal expense is not deductible for income tax purposes. The retained earnings amount of R489 000 on 1 July 20.12 includes the profit for the period up to 1 July 20.12.

5. The following dividends were declared by each of the companies on 28 February 20.13:

R Working Fire Ltd 900 000 Explosive Ltd 150 000 Crackers Ltd 100 000

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6. It is the accounting policy of Working Fire Ltd to account for its investments in subsidiaries and

joint ventures at cost in accordance with IAS 27.10(a) in their separate financial statements. 7. There were no changes in the share capital of any of the entities during the year. 8. Assume an income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore the

effects of Dividend Tax and Value Added Tax (VAT). 9. Inventory is valued on the first-in-first-out basis. 10. No additional assets, liabilities or contingent liabilities were identified by Working Fire Ltd on the

relevant dates of acquisition of their investments. PART B 4 marks Working Fire Ltd is considering whether to invest in a new company, namely Fire Exports Ltd, which will assist Working Fire Ltd to export fireworks to neighbouring countries. Working Fire Ltd is able to purchase 10% of the share capital and voting rights of Fire Exports Ltd. On the date when Working Fire Ltd purchases a 10% interest, the company will also receive the option to acquire an additional 30% interest of one of the other shareholders, namely Cease Fire Ltd. The condition of the option is that it will only be exercisable on the date when the new Explosives Act is implemented.

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REQUIRED

YOU NOW HAVE 38 MINUTES TO ANSWER THIS QUESTION

Marks

PART A Prepare the pro forma consolidation journal entries for the consolidated financial statements of the Working Fire Ltd Group for the year ended 28 February 20.13. Journal entries related to deferred taxation are also required.


20

1

Please note: • Journal narrations are required. • Round off all amounts to the nearest Rand. • Your answer must comply with International Financial Reporting Standards (IFRS).

PART B Discuss whether Fire Exports Ltd is an associate of the Working Fire Ltd Group, assuming that Working Fire Ltd does acquire the 10% interest.

4

Please note: • Discussions regarding appropriate accounting treatment are not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 7 - Suggested solution (a) Journal entries

Fire Art Ltd Dr

R Cr R

Crackers Ltd J1 Share capital (SCE) (given) 150 000 (½)

Retained earnings (SCE) (given) 489 000 (½) Mark-to-market reserve (SCE) (given) 56 000 (½) Investment in Crackers Ltd (SFP) (given) 500 000 (½) Non-controlling interests (SCE) [C3] 139 000 (1½) Gain from bargain purchase (P/L) (balancing) 56 000 (½) Elimination of owner’s equity at acquisition

J2 Non-controlling interests (P/L) (240 387 [C3] x 20%) 48 077 (3½) Non-controlling interests (SCE) 48 077 (½) Allocation of profits to non-controlling interests

J3 Other income (dividends received) (P/L) (100 000 x 80%) 80 000 (1)

Non-controlling interests (SCE) 20 000 (½) Dividends paid (SCE) (given) 100 000 (½) Elimination of dividend paid by subsidiary

Explosive Ltd

J4 Investment in joint venture (SFP) [120 000 - (350 000 x 40%)] 20 000 (1½) Retained earnings (excess) (SCE) 20 000 (½) Recognition of excess at acquisition of investment in joint venture

J5 Investment in joint venture (SFP) (570 400 + 208 800) 779 200 (½) Retained earnings (SCE) (1 426 000 x 40%) 570 400 (1) Mark-to-market reserve (SCE) (522 000 x 40%) 208 800 (1) Recognition of equity of joint venture since acquisition until beginning of year

J6 Investment in joint venture (SFP) 305 808 (½) Share of profit of joint venture (P/L) [C2] 305 808 (3½) Recognition of share of other comprehensive income of joint venture

J7 Other income (P/L) (150 000 x 40%) 60 000 (1) Investment in joint venture (SFP) 60 000 (½)

Elimination of intragroup dividend

(20)


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PART B An associate is an entity over which the investor has significant influence [IAS 28.3].

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies [IAS 28.3].

If an entity holds, directly or indirectly, 20% or more of the voting power of the investee, it is presumed that the entity has significant influence, unless it can be clearly demonstrated that this is not the case [IAS 28.5].

Assuming that Working Fire Ltd acquired the 10% interest, the company does not have significant influence yet as it does not hold a 20% interest. (1)

The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether an entity has significant influence [IAS 28.7].

Potential voting rights are not currently exercisable or convertible when, for example, they cannot be exercised or converted until a future date or until the occurrence of a future event [IAS 28.7].

The option to acquire the 30% interest is dependant of the promulgation of the new Explosives Act of 2003. (1)

It is still unsure of when the Explosives Act of 2003 will be promulgated, therefore the option is not currently exercisable. (1)

The potential voting rights are thus not included in the assessment of significant influence. (1)

Fire Exports Ltd is not an associate of Working Fire Ltd. (1)

Total (5)

Maximum (4) CALCULATIONS C1. Profit of Crackers Ltd

Profit of Crackers Ltd attributable to Working Fire Ltd

Profit for the year (1 470 000 - 585 000 + 95 000 - 452 000 - 139 920)

388 080

[1]

4 months 8 months Total

Profit after tax excluding legal expense [(388 080 + 55 000) = 443 080 x 4/12]; [(388 080 + 55 000) = 443 080 x 8/12] 147 693 295 387 443 080 [1]

Legal expenses - incurred after acquisition - (55 000) (55 000) [½]

Profit for the year 147 693 240 387 388 080

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C2. Profit of Explosive Ltd

Explosive Ltd Profit for the year (4 120 000 - 2 974 000 + 467 000 - 981 000 - 167 480) 464 520 [2] Add back: Provision not allowed to be recognised (given - no current obligation as a result of a past event) 300 000 [½] Profit of Explosive Ltd for the year 764 520 40% interest attributable to Working Fire Ltd (764 520 x 40%) 305 808 [½]

[3] C3. Analysis of the owners' equity of Crackers Ltd

Total Working Fire Ltd

(80%) NCI

At Since

At acquisition

Share capital 150 000

Retained earnings 489 000

Mark-to-market reserve 56 000

695 000 556 000 139 000

Excess (56 000) (56 000) -

Consideration transferred and NCI 639 000 500 000 139 000 Current year

Profit for the year [C1] 240 387 192 309 48 077

Dividend declared (100 000)

(80 000) (20 000)

779 387

112 309 167 077

C4. Analysis of the owners’ equity of Explosive Ltd

Total Working Fire Ltd

(40%)

At Since

At acquisition

Share capital 350 000 350 000 140 000 Excess

(20 000)

Consideration 120 000 Since acquisition until beginning of year

Retained earnings 1 426 000

570 400


208 800 Current year

Profit for the year (464 520 [C2] + 300 000 [C2]) 764 520

305 808


(60 000)

2 912 520

1 025 008

EXAM TECHNIQUE Take note that the analysis provided in C3 and C4 did not have to be prepared in order to answer the question. These analyses have only been provided for completeness purposes. Students should therefore assess, prior to answering a question, whether the preparation of an analysis of owners’ equity is necessary, as this may result in ineffective time management.

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QUESTION 8 40 marks


This question consists of two independent parts. PART A 20 marks PlantWorld Ltd was incorporated in 20.5 and is listed on the JSE Limited. PlantWorld Ltd is one of the leading plant nurseries and lifestyle centres in South Africa and prides itself on being the number one rated nursery in customer service in Gauteng. Over the years the management of PlantWorld Ltd made several strategic investments in order to ensure the success of the company. All the companies in the group have a February year end. PlantWorld Ltd has the following investment: FlowerPower Ltd PlantWorld Ltd obtained 1 500 000 ordinary shares in FlowerPower Ltd on 1 September 20.11 for R2 100 000. FlowerPower Ltd specialises in providing florist services through an established online ordering system. The investment enabled PlantWorld Ltd to expand its services to include a variety of florist services and products. PlantWorld Ltd has been exercising significant influence over the financial and operating policy decisions of FlowerPower Ltd from that date. The equity balances of FlowerPower Ltd were as follows on 1 September 20.11: 01/09/20.11

R

Ordinary issued share capital (6 000 000 shares) 6 000 000 Retained earnings 3 000 000 Mark-to-market reserve 950 000

All the assets and liabilities of FlowerPower Ltd were deemed to be fairly valued on 1 September 20.11 except for land which had a carrying value of R1 250 000 and a fair value of R900 000. On 1 September 20.11 PlantWorld Ltd had a mark-to-market reserve balance of R1 980 000. There was a significant decline in the profit of FlowerPower Ltd for the year ended 28 February 20.14. It is estimated that any future dividends declared by FlowerPower Ltd will not exceed R1 290 000 per annum.

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Financial results for the year ended 28 February 20.14 The following balances were extracted from the trial balance of FlowerPower Ltd as at 28 February 20.14: R Debits Property, plant and equipment 7 945 000 Financial assets at fair value 1 266 103 Trade and other receivables 3 100 000 Inventory 2 950 000 Cash and cash equivalents 1 200 000 Cost of sales 14 750 000 Operating expenses 3 140 000 Finance costs 380 000 Income tax expense 855 000 Credits

Share capital (ordinary shares) 6 000 000 Retained earnings (01/03/20.13) 4 500 000 Trade and other payables 3 306 103 Provisions 790 000 Deferred tax liability 1 550 000 Revenue 17 560 000 Other income 850 000

The companies in the group had the following mark-to-market reserve balances at the respective dates: 01/03/20.13

R 28/02/20.14

R

PlantWorld Ltd 1 882 378 1 882 378 FlowerPower Ltd 1 200 000 1 030 000

The following related party disclosure note of FlowerPower Ltd was extracted from the company’s separate financial statements for the year ended 28 February 20.14: FlowerPower Ltd Notes for the year ended 28 February 20.14 21. Related parties Entities with significant influence over FlowerPower Ltd - PlantWorld Ltd Transactions with related parties other than key management personnel Purchase of goods from PlantWorld Ltd

20.14 R

6 500 000

20.13 R -

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No dividends were declared by FlowerPower Ltd for the year ended 28 February 20.14. Additional information 1. Assume an income tax rate of 28% and a capital gains tax inclusion rate of 80%. You may ignore

Dividend Tax and Value Added Tax (VAT). 2. Greenscapes Ltd was incorporated on 28 February 20.14 with an issued share capital of 100 000

ordinary shares. 3. It is the accounting policy of PlantWorld Ltd to account for investments in associates at cost in

accordance with IAS 27.10(a) in the company’s separate financial statements. 4. There has been no change in the share capital of the companies in the group since the

respective acquisition dates. 5. It is the policy of FlowerPower Ltd to keep 15% of stock on hand at year end. 6. PlantWorld Ltd sells inventory at a profit of 30% on cost. 7. A reasonable dividend return rate for an entity with a similar risk profile to that of

FlowerPower Ltd is 15%. PART B 20 marks Canvas Ltd is a retailer of art supplies and was established in 20.2 by Peter Aquarelle. During the years, Canvas Ltd has identified the need to expand their business by acquiring investments in other retailers of art supplies. On 1 March 20.5 Canvas Ltd acquired 120 000 ordinary shares of Watercolour Ltd, a retailer of paint for art projects, for an amount of R3 250 000. From this date, Canvas Ltd had control over Watercolour Ltd in accordance with IFRS 10 Consolidated Financial Statements. On 1 July 20.13, Canvas Ltd acquired shares in Sketches Ltd, a retailer of sketchbooks. The details of this transaction is provided in points 1 to 3 below. 1. Canvas Ltd’s investment in Sketches Ltd

Canvas Ltd acquired 75 000 shares in Sketches Ltd on 1 July 20.13 by transferring a cash amount of R322 000, together with equipment with a carrying amount of R50 000 and a fair value of R68 000 to Sketches Ltd. The equipment had a remaining useful life of four years with no residual value at that date. You may assume that the transaction did not lack commercial substance. From this date, Canvas Ltd exercised significant influence over the financial and operating policy decisions of Sketches Ltd. The relevant financial information of Sketches Ltd is presented in point 4.

2. Other information relating to the transactions All the assets and liabilities of Sketches Ltd were deemed to be fairly valued on 1 July 20.13. You may assume that no impairment losses arose on the investment in Sketches Ltd in the

separate records of Canvas Ltd, either at acquisition or subsequently.

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3. Financial information of Sketches Ltd The following information was extracted from the trial balance of Sketches Ltd:

01/07/20.13

R

Ordinary share capital 300 000 Retained earnings 1 300 000

6 months from

01/07/20.13 to

31/12/20.13

R

Profit after tax 257 000 Other comprehensive income, net of tax (revaluation surplus) 12 000

The following balances were extracted from the trial balance of Sketches Ltd for the year ended

31 December 20.14:

R Debits

Cost of sales 3 850 000 Other expenses 364 000 Finance costs 45 100 Income tax expense 73 100 Credits

Ordinary share capital

- 300 000 shares 300 000 Revenue 4 504 500 Other income 35 700

Sketches Ltd recorded an increase in the value of land of R46 000 in the current financial year

as a result of a revaluation. Sketches Ltd declared and paid a dividend amounting to R50 000 on 31 December 20.14. Additional information 1. It is the accounting policy of Canvas Ltd to measure investments in subsidiaries and investments

in associates at cost in accordance with IAS 27.10(a) in its separate financial statements. 2. All the companies in the group have a 31 December year end. 3. There were no changes in the ordinary share capital of Watercolour Ltd or Sketches Ltd during

the year. 4. It is the accounting policy of the Canvas Ltd Group to measure equipment in accordance with

the cost model. Depreciation is recognised in accordance with the straight-line method. 5. Assume an income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore the

effects of Dividend Tax and Value Added Tax (VAT).

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REQUIRED


Marks

PART A Prepare the pro forma consolidation journal entries to account for its investment in FlowerPower Ltd in the group financial statements of the PlantWorld Ltd Group for the year ended 28 February 20.14. Journal entries related to deferred taxation are also required. You may ignore the strategic agreement between PlantWorld Ltd and LawnDoctor Ltd.


Please note: • Round off all amounts to the nearest Rand. • Journal narrations are required. • Your answer must comply with International Financial Reporting Standards (IFRS).

19

1

PART B

(a) Provide the pro forma journal entries in respect of only the intragroup transactions that the Canvas Ltd Group should process for the year ended 31 December 20.14. Journal entries relating to deferred taxation are also required.


Please note: • Journal narrations are required. (b) Calculate the carrying amount of the line item “investment in associate” as it should

be disclosed in the consolidated statement of financial position of the Canvas Ltd Group as at 31 December 20.14.

Please note: • Comparative figures or notes to the consolidated financial statements are not

required.

10

1

9


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QUESTION 8 - Suggested solution PART A Pro forma consolidated journal entries for year ended 28 February 20.14 Dr

R Cr R

J1 Investment in associate (SFP) 319 600 (½) Retained earnings (Excess) (SCE)

[((6 000 000 + 3 000 000 + 950 000 – (1 250 000 – 900 000) + (350 000 x 28% x 80%)) x 25%) – 2 100 000] or [C5]

319 600

(3½) Recognition of excess at acquisition of investment in associate J2 Investment in associate (SFP) (balancing) 437 500 (½) Retained earnings (SCE)

[(4 500 000 – 3 000 000) x 25%]

375 000

(1½) Mark-to-market reserve (SCE)

[(1 200 000 – 950 000) x 25%]

62 500

(1½) Recognition of equity of associate since acquisition until

beginning of year

J3 Investment in associate (SFP) (balancing) 221 250 (½) Share of profit of associate (P/L) (715 000 [C1]) x 25%) 178 750 (2½) Share of other comprehensive income of associate

(OCI) [(1 030 000 – 1 200 000) x 25%]

42 500

(1½) Recognition of share of loss and other comprehensive income of

associate

J4 Revenue (P/L) [C2] 243 750 (1½) Cost of sales (P/L) [C2] 187 500 (1) Investment in associate (SFP) (balancing) 56 250 (½) Elimination of unrealised profit on intragroup inventory sales J5 Deferred tax (SFP) 15 750 (½) Income tax expense (P/L) (56 250 x 28%) 15 750 (1) Elimination of deferred tax on unrealised profit on intragroup sales J6 Impairment loss (P/L) [C4] 429 600 (3) Investment in associate (SFP) 429 600 (½) Recognition of impairment loss on associate Total

Maximum Communication skills: Presentation and layout

(20) (19) (1)

CALCULATIONS C1. Loss of associate

Revenue 17 560 000 [½] Cost of sales (14 750 000) [½] Other income 850 000 [½] Operating expenses (3 140 000) [½] Finance costs (380 000) [½] Income tax expense (855 000) [½] (715 000)

Maximum [2]

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C2. Intragroup sales – FlowerPower Ltd

Goods purchased 6 500 000 Closing stock (6 500 000 x 15%)

975 000 [½]

Revenue (975 000 x 25%) 243 750 [½] Cost of sales (243 750 x 100/130) (187 500) [½] Gross profit 56 250

[1½] C3. Analysis of owners’ equity of FlowerPower Ltd

Total

PlantWorld Ltd 25% At Since At acquisition Share capital 6 000 000 Retained earnings 3 000 000 Mark-to-market reserve 950 000 Land (1 250 000 – 900 000) (350 000) Deferred tax (350 000 x 28% x 80%) 78 400 9 678 400 2 419 600 Excess (319 600) Consideration transferred 2 100 000

Since acquisition Retained earnings (4 500 000 – 3 000 000) 1 500 000 375 000 Mark-to-market reserve (1 200 000 – 950 000)

250 000

62 500

Current year Profit for the year [C1] (715 000) (178 750) Mark-to-market reserve (1 030 000 – 1 200 000)

(170 000)

(42 500)

10 543 400 216 250

C4. Impairment loss – FlowerPower Ltd

Carrying value of investment (2 419 600 [C3] + 216 250 [C3] – 56 250 [C2])

2 579 600

[1]

Recoverable amount (1 290 000 x 25%/15%) (2 150 000) [1½] 429 600

[2½]

COMMENT The given information states that future dividends declared by FlowerPower Ltd will not exceed R1 290 0000 per annum. In the additional information section the dividend return rate for a similar risk profile entity was given as 15%. Thus the profit from which dividends are declared will be R1 290 000/0,15 = R8 600 000. The PlantWorld Ltd Group equity accounted FlowerPower Ltd at 25%. Their share will thus be R8 600 000 x 25% = R2 150 000. The investor did not recognise an impairment in its separate financial statements as the recoverable amount of R2 150 000 is higher than the cost of R2 100 000.

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PART B (a) Pro forma journal entries Dr Cr

R R J1 Retained earnings (SCE) (balancing) 2 835 (½)

Deferred tax (SFP) (3 937 x 28%) or [(4 500 x 28%) - (4 500 / 4 x 6/12 x 28%)] 1 102 (1) Investment in associate (SFP) [(68 000 - 50 000) x 25% = 4 500 - (4 500 / 4 x 6/12)] 3 937 (3½) Elimination of unrealised profit and depreciation on unrealised profit in prior year

J2 Investment in associate (SFP) (4 500 (J1) / 4) 1 125 (1½) Depreciation (P/L) 1 125 (½) Current year depreciation on unrealised profit

J3 Income tax expense (P/L) (1 125 x 28%) 315 (1) Deferred tax (SFP) 315 (½) Deferred tax on depreciation

J4 Other income (dividend received) (P/L) (50 000 x 25%) 12 500 (1) Investment in associate (SFP) 12 500 (½) Elimination of intragroup dividend (10)


COMMENT Please note that pro forma journals for intragroup transactions only were required. In terms of IAS 28.30, a contribution of a non-monetary asset to an associate in exchange for an equity interest in that entity shall be accounted for as an intragroup downstream transaction in accordance with IAS 28.28.

(b) Investment in associate held by Canvas Ltd

R

At acquisition Cost price (322 000 + 68 000) 390 000 (1) Excess (C1) 10 000 (2) Since acquisition until beginning of year Retained earnings (257 000 x 25%) 64 250 (½) Revaluation surplus (12 000 x 25%) 3 000 (½) Current year Profit for the year [(4 504 500 + 35 700 - 3 850 000 - 364 000 - 45 100 - 73 100) = 208 000 x 25%] 52 000 (2) Elimination of intragroup unrealised profit and prior year depreciation in equipment transferred [(a) (J1)] (3 937) (½) Current year depreciation on unrealised profit in equipment transferred [(a) (J2)] 1 125 (½) Other comprehensive income [(46 000 - (46 000 x 28% x 80%)) x 25%] 8 924 (1½) Dividend paid (given) (50 000 x 25%) (12 500) (½)

512 862

(9)

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CALCULATIONS C1. Excess in investment in associate held by Canvas Ltd Net asset value at acquisition: Share capital (given) 300 000 [½]

Retained earnings (given) 1 300 000 [½]

1 600 000

Share of net asset value acquired (1 600 000 x 25%) 400 000 [½]

Consideration transferred (322 000 + 68 000) (390 000) [½]

Excess 10 000

[2] C2. Analysis of Canvas Ltd's equity in Sketches Ltd

Total

Canvas Ltd (25%)

At Since

At acquisition

Share capital 300 000 75 000

Retained earnings 1 300 000 325 000

1 600 000 400 000

Excess (10 000)

Consideration transferred (322 000 + 68 000) 390 000


Retained earnings (given) 257 000 64 250

Revaluation surplus (given) 12 000 3 000

Current year

Profit for the year [(4 504 500 + 35 700 - 3 850 000 – 364 000 - 45 100 - 73 100)] 208 000 52 000

Other comprehensive income [46 000 - (46 000 x 28% x 80%)] 35 696 8 924

Dividend paid (given) (50 000) (12 500)

2 062 696 115 674

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QUESTION 9 40 marks


This question consists of two independent parts. PART A 37 marks Beauty Ltd (Beauty) was incorporated on 1 March 20.6. The company is listed on the JSE Limited and operates in the cosmetics sector. The success of the company is attributed to their aggressive expansion strategy, and the appointment of the new Chief Executive Officer, Mrs. Lotto. Beauty has the following investments: 1. Lipstick Ltd Beauty acquired 45 000 ordinary shares in Lipstick Ltd (Lipstick) on 1 September 20.15. Beauty

has been exercising significant influence over the financial and operating policy decisions of Lipstick from that date. Lipstick also operates in the cosmetic sector and has its principal place of business in the Northern Cape. The acquisition of Lipstick will enable Beauty to grow its product range by expanding into new markets.

The following consideration was paid by Beauty for the investment in Lipstick: • A cash amount of R423 235 was paid on 1 September 20.15, the signature date of the

agreement; and • Beauty issued 950 debentures with a face value of R120 each on 1 September 20.15.

Interest is payable annually in arrears at a nominal interest rate of 9,1% per annum. The debentures will be settled in cash on 31 August 20.20. A fair discount rate on similar debentures amounted to 11,5% per annum on the date of issue.

The following is an extract of the trial balance of Lipstick as at 1 September 20.15:

Notes R

Property, plant and equipment 1 2 900 000 Cash and cash equivalents 65 000 Share capital (100 000 ordinary shares) (100 000) Preference share capital (1 500 shares) 2 (634 380) Mark-to-market reserve (1 March 20.15) (180 000) Retained earnings (1 March 20.15) (550 100)

The assets and liabilities of Lipstick were fairly valued on 1 September 20.15 except for land

(refer to note 1).

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Notes 1. Land had a carrying amount of R1 425 000 and a fair value of R1 500 000 on

1 September 20.15. 2. The preference share capital was issued to outside investors at the incorporation of

Lipstick. These preference shares are non-redeemable, cumulative and were issued at a coupon rate of 8% per annum. The cumulative preference shares are correctly classified as an equity instrument in accordance with IAS 32 Financial Instruments: Presentation.

There were no preference dividends in arrears at 1 March 20.15. The profit after tax of Lipstick was as follows for the following periods:

Period R

1 March 20.15 – 31 August 20.15 467 200 1 September 20.15 – 28 February 20.16 642 500

1 March 20.15 – 28 February 20.16 1 109 700

Lipstick changed its accounting policy for land from the cost model to the revaluation model on

28 February 20.16. An independent sworn appraiser valued the land at R1 950 000 on 28 February 20.16.

The increase in the profit after tax of Lipstick for the last six months resulted in the shares of

Lipstick trading at R15 per share on 28 February 20.16. Beauty is the leading supplier of the Auto-vac machine. Beauty sells the Auto-vac machines at

a mark-up of 20% on the cost price. Lipstick purchased an Auto-vac machine from Beauty on 1 December 20.15 for R859 800. This machine will be used in the manufacturing process.

On 28 February 20.16, the current liabilities of Lipstick Ltd amounted to R1 100 000, with the

current assets amounting to R1 350 000. The non-current liabilities and non-current assets amounted to R1 560 800 and R4 241 630 respectively. Lipstick Ltd recorded total revenue of R9 500 000 during the current financial year.

Shimmer Ltd Shimmer Ltd (Shimmer) was incorporated on 1 March 20.5 and specialises in the manufacturing

of eye make-up. Beauty acquired a 55% interest for an amount of R350 000 at the incorporation of Shimmer and exercises joint control over the relevant activities of Shimmer in terms of a joint arrangement. Shimmer is correctly classified as a joint venture. Beauty is entitled to 55% of the profit for the year of the joint venture.

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The following balance were extracted from the separate trial balance of Shimmer Ltd as at

28 February 20.16:

Dr/(Cr)

R

Revenue (4 470 000) Cost of sales 3 324 000 Other income (582 000) Administrative expenses 1 237 000 Income tax expense 137 480 Property, plant and equipment 2 854 000 Inventory 733 620 Loan from Beauty (non-current liability) (500 000) Deferred tax liability (687 000)

Shimmer Ltd had the following equity and reserve balances:

Shimmer Ltd

01/03/20.5 01/03/20.15

R R Share capital 700 000 700 000 Retained earnings - 1 776 000 Mark-to-market reserve - 742 000

700 000 3 218 000

There were no movement in the mark-to-market reserves during the year. Safari Ltd The investment in Safari Ltd (Safari) was made on 1 January 20.5 for a cash consideration of

R250 000. The shareholders of Safari are as follows:

Shareholder Shares

Beauty 15 000 Other shareholders 85 000

Total 100 000

None of the other shareholders own more than 1 000 shares individually. Beauty’s shareholding has remained unchanged since the acquisition date. Each share entitles the shareholder to one vote at a shareholders’ meeting, in accordance with Safari’s Memorandum of Incorporation.

Beauty has the option to acquire an additional 10% of the ordinary share capital of Safari once they are operational in Russia. At this stage Safari cannot enter the market in Russia and there is no indication as to when the strict laws will be altered to allow foreign investments. The next election will be in 20.18 and Mr. Ladwig, the brother-in-law of one of the directors of Safari, will run for office. There are indications that he will be successful and one of his prime goals is to relax the laws regarding foreign investments.

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Additional information 1. The following ordinary dividends were declared by each of the companies on

31 January 20.16:

R Beauty 900 000 Shimmer 150 000

2. It is the accounting policy of Beauty to account for investments in subsidiaries and associates at

cost in accordance with IAS 27.10(a) in its separate financial statements. 3. There were no changes in the share capital of any of the entities during the year. 4. Assume an income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore the

effects of Dividend Tax and Value Added Tax (VAT). 5. Inventory is valued on a first-in-first-out basis. 6. It is the policy of the group to depreciate machinery over its useful life of 10 years on the straight-

line method. 7. All the companies in the group have a February year end. PART B 3 marks On 1 January 20.14 Life Ltd purchased a 30% interest in New Ltd and exercised significant influence over the financial and operating policy decisions from this date. Life Ltd paid a consideration of R80 000 for the investment and you may assume that it equalled 30% of the net asset value of New Ltd, fairly valued. No goodwill or excess arose at acquisition. Life Ltd also issued an unsecured loan of R20 000 to New Ltd on 1 January 20.14. The loan carries interest at 10% per annum, payable annually in arrears, and settlement of the loan is not expected in the next 24 months. New Ltd made a loss of R350 000 during the year. It is the accounting policy of Life Ltd to measure investments in associates in accordance with IAS 27.10(a) in its separate financial statements. Life Ltd did not provide guarantees for the liabilities of New Ltd.

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REQUIRED


Marks

PART A (a) Provide the pro forma consolidation journal entries to account for the investments

in the consolidated financial statements of the Beauty Ltd Group for the financial year ended 28 February 20.16. Journal entries relating to deferred taxation are also required.


Please note: • Journal narrations are required. (b) Prepare the investment in associate note to the consolidated financial statements

of the Beauty Ltd Group for the year ended 28 February 20.16.


(c) Discuss, with reasons, how the investment in Safari Ltd should be accounted for in the financial statements of the Beauty Ltd Group for the year ended 28 February 20.16.

22

1

10

1

3


PART B

Calculate the carrying amount of the line item “investment in associate” as it should be disclosed in the group statement of financial position in the group financial statements of Life Ltd Group as at 31 December 20.14.

3

Please note: • Round off all amounts to the nearest Rand. • Comparative figures and notes to the financial statements are not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 9 - Suggested solution PART A (a) Pro forma journal entries LIPSTICK LTD

Dr Cr

R

R

J1 Investment in Lipstick (SFP) (balancing) 434 846 (½)

Share of profit of associate (P/L) (289 125 [C2] – 11 419 [C2]) OR [(642 500 – 25 375) x 45%] 277 706 (1½)

Share of other comprehensive income of associate (OCI) (202 500 – 45 360) [C2] 157 140 (1½)

Share of profit and other comprehensive income of Lipstick

J2 Investment in Lipstick (SFP) [C2] 71 307 (4)

Share of profit of associate (P/L) 71 307 (½)

Recognition of excess at acquisition of Lipstick J3 Revenue (P/L) [C3] 386 910 (1)

Cost of sales (P/L) [C3] 322 425 (1)

Investment in Lipstick (SFP) [C3] OR (balancing) 64 485 (½)

Elimination of unrealised profit in closing PPE J4 Deferred tax (SFP) [C3] 18 056 (1)

Income tax expense (P/L) 18 056 (½)

Tax effect of unrealised profit J5

Investment in Lipstick (SFP) [C3] OR (64 485 (J4)/10 x 3/12) 1 612 (1½)

Cost of sales (depreciation) (P/L) [C3] 1 612 (½)

Realisation of intragroup profit J6 Income tax expense (P/L) [C3] 451 (1)

Deferred tax (SFP) 451 (½)

Tax effect on realisation of intragroup profit

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SHIMMER LTD Dr

R Cr R

J7 Investment in Shimmer Ltd (SFP)

[350 000 - (700 000 x 55%)] or [C8] 35 000 (1½) Retained earnings (excess) (SCE) 35 000 (½) Recognition of excess at acquisition of investment in joint venture

J8 Investment in Shimmer Ltd (SFP) (balancing) 1 384 900 (½) Retained earnings (SCE) (1 776 000 x 55%) 976 800 (1) Mark-to-market reserve (SCE) (742 000 x 55%) 408 100 (1) Recognition of equity of joint venture since acquisition until beginning of year

J9 Investment in Shimmer Ltd (SFP) 194 436 (½) Share of profit of joint venture (P/L) [C6] 194 436 (3) Recognition of share of profit of joint venture

J10 Other income (dividend received) (P/L) (150 000 x 55%) 82 500 (1) Investment in Shimmer Ltd (SFP) 82 500 (½)

Elimination of intragroup dividend

Total Maximum

(25) (22)

Communication skills: Presentation and layout (1) CALCULATIONS C1. Consideration paid

Cash (given) 423 235 [½] Debentures (table below) 104 014 [2]

Total 527 249 [2½]


• 2ndF C (Clear All) • 2ndF C.CE (Clear

All) • 2ndF MODE (Clear All)

• 5 N • 5 n • 5 N [½] • 10 374 (950 x 120 x 9,1%) PMT

• 10 374 PMT • 10 374 PMT [1]

• 114 000 FV • 114 000 FV • 114 000 FV [½] • 11,5% I/YR • 11,5% i • 11,5% I/Y [½]

• PV ⇒ (104 014) • COMP PV ⇒ (104 014) • COMP PV ⇒ (104 014)

Total Maximum

[2½] [2]

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C2. Analysis of the owners’ equity of Lipstick Ltd

Total

Beauty Ltd 45%

At Since

At acquisition Share capital (given) 100 000

[½]

Retained earnings (550 100 + 467 200 – 25 375 [C4]) 991 925

[1½]

Mark-to-market reserve (given) 180 000 [½] Revaluation surplus (1 500 000 – 1 425 000) 75 000 [½] Deferred tax (75 000 x 28% x 80%) (16 800) [½]

1 330 125 598 556 Excess (71 307) [3½]

Consideration transferred [C1] 527 249

Current year Revaluation surplus (525 000 – 75 000) 450 000 202 500 [½] Deferred tax (450 000 x 28% x 80%) (100 800) (45 360) [½] Profit after tax (given) 642 500 289 125 [½] Profit attributable to PSH [C4] (25 375) (11 419) [½]

2 296 450 434 846

COMMENT Preference share capital Students should note that the analysis of owners’ equity for preference share capital, and the analysis of owners’ equity for ordinary share capital should always be done separately. The investor might have acquired an interest in the ordinary share capital, but not in the preference share capital. The profit attributable to preference shareholders must thus be deducted from the total profit in the current year in order to show it separately in the analysis of owners’ equity for preference share capital. This will thus have an effect on the total share of profit of associate as the profit attributable to preference shareholders is deducted from the profit of the associate.

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C3. Intragroup transaction

100% 45% Revenue 859 800 386 910 [½] Profit on cost 20% Cost of sales (859 800 x 100/120) (716 500) (322 425) [1] Unrealised profit 143 300 64 485 [½] Tax at 28% 40 124 18 056 [½] Machine depreciated over 10 years, 3 months lapsed (1 December 20.15 – 28 February 20.16)

Revenue realised (859 800/10 x 3/12) 21 495 9 673 [½] Cost of sales realised (716 500/10 x 3/12) (17 913) (8 061) [½] Unrealised profit realised 3 582 1 612 [1] Tax at 28% 1 003 451 [½]

C4. Preference dividend

The 8% non-redeemable cumulative preference dividend should be provided as follows:

1 March 20.15 – 31 August 20.15 (634 380 x 8% x 6/12) 25 375 1 September 20.15 – 28 February 20.16 (634 380 x 8% x 6/12) 25 375 Total 50 750

C5. Total profit of Shimmer Ltd

Shimmer Ltd Profit for the year (4 470 000 – 3 324 000 + 582 000 – 1 237 000 - 137 480) 353 520 [2] Profit of Shimmer Ltd for the year 353 520 55% interest attributable to Beauty Ltd (353 520 x 55%) 194 436 [½]

[2½] C6. Analysis of the owners’ equity of Shimmer Ltd

Total Beauty Ltd

(55%)

At Since

At acquisition

Share capital 700 000 700 000 385 000 Excess

(35 000)

Consideration 350 000


Retained earnings 1 776 000 976 800


408 100

Current year

Profit for the year [C5] 353 520

194 436


(82 500)

3 421 520

1 496 836

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(b) BEAUTY LTD GROUP NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 28 FEBRUARY 20.16

3. Investment in associate

Name of investment in associate: Lipstick Ltd (½) Nature of the entity's relationship: Lipstick Ltd operates in the cosmetic sector

and will enable Beauty Ltd to grow its product range by expanding into new markets. (½)

Principal place of business: Northern Cape (½)

Proportion of ownership interest and voting rights held:

45% (½)

The investment in Lipstick Ltd was classified as an investment in associate, as 45% of the voting rights constitute significant influence.

(½)

The investment in associate is measured using the equity method.

(½)

The fair value of the investment in Lipstick Ltd amounted to R675 000 (45 000 x R15) on 28 February 20.16. (1)

Summarised financial information of Lipstick Ltd for the year ended 28 February 20.16: (½)

20.16

R

Current assets 1 350 000 (½) Non-current assets 4 241 630 (½) Current liabilities (1 100 000) (½) Non-current liabilities (1 560 800) (½) Revenue (9 500 000) (½) Profit after tax [1 109 700 – (634 380 x 8%)] (1 058 950) (1) Other comprehensive income [(1 950 000 – 1 425 000) – (525 000 x 28% x 80%)]

(407 400) (1½)

Total comprehensive income (1 466 350) (½) Reconciliation of the summarised information [IFRS 12.B14(b)]:

Net asset value of associate (1 350 000 + 4 241 630 – 1 100 000 – 1 560 800 – 634 380) OR (100 000 + 180 000 + 550 100 + 407 400 (RS) + 1 109 700 – 50 750)

2 296 450

(2½)

45% interest in the net asset value of associate (2 296 450 x 45%)

1 033 402 (½)

Unrealised profit included in PPE (64 485) (½) Realisation of unrealised profit 1 612 (½)

Carrying amount of investment in associate at 28 February 20.16 970 529



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(c) Investment in Safari Ltd Significant influence

• If an investor holds 20% or more of the voting power of an investee, it is presumed that the investor has significant influence (IAS 28.5).

• Beauty Ltd has 15% of the voting power of Safari Ltd and significant influence is therefore not presumed.

(1) Potential voting rights • However, the existence and effect of potential voting rights, including potential rights

held by other parties, should also be considered when assessing whether an entity has significant influence (IAS 28.7).

• All facts and circumstances that affect potential rights must be considered in the assessment, except the intention of management and the financial ability to exercise or convert those potential rights (IAS 28.8).

• Safari Ltd want to enter the market in Russia but at this stage it looks highly unlikely, although the indication is there that Mr Ladwig might win the next election.

(1)

Accounting treatment • Safari Ltd should not be accounted for as an investment in an associate.

(1) • The investment must be accounted for at fair value in accordance with IFRS 9 in the

separate accounting records of Beauty Ltd for the year ended 28 February 20.16.

(1) Total

Maximum (4) (3)

Communication skills: Logical flow and conclusion (1) PART B Investment in associate Cost price (given) 80 000 (½) Unsecured loan (settlement neither planned nor likely to occur in foreseeable future) [IAS 28.38] 20 000 (1) Share of loss of associate (350 000 x 30% = 105 000, limited to R100 000 total net investment) (100 000) (1½)

Investment in associate -

(3)

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QUESTION 10 40 marks


Iphepha SA Ltd is a company listed on the JSE Limited with a February year end. Iphepha SA Ltd owns several paper mills across South Africa. These paper mills manufacture paper from wood pulp and other specialised ingredients. Iphepha SA Ltd has various investments in subsidiaries as well as another investment that they acquired in the previous financial year. Imithi Ltd On 1 September 20.15, Iphepha SA Ltd acquired 30 000 ordinary shares in Imithi Ltd for a cash consideration of R80 000 as well as the transfer of machinery. At the date of acquisition, the machinery transferred to Imithi Ltd had a carrying amount of R22 500, a fair value of R30 000 and a remaining useful life of four years. You may assume that this transfer has commercial substance. From 1 September 20.15, Iphepha SA Ltd has been exercising significant influence over the financial and operating policy decisions of Imithi Ltd. The equity of Imithi Ltd consisted of the following at the acquisition date:

R

Ordinary share capital (100 000 shares) Retained earnings

100 000 275 200

375 200

All the assets and liabilities of Imithi Ltd were deemed to be fairly valued at the acquisition date and no additional assets or liabilities were identified. Iphepha SA Ltd has been purchasing wood pulp from Imithi Ltd since 1 September 20.15 at a mark-up of 20% on cost. Iphepha SA Ltd uses this wood pulp in the paper manufacturing process. The following information relates to these sale transactions: Year ended

28 February 20.17 R

Year ended 29 February 20.16

R

Included in Iphepha SA Ltd’s inventory on hand in respect of inventory purchased from Imithi Ltd

85 000

38 500

Sales from Imithi Ltd to Iphepha SA Ltd

280 000

130 000

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RecycleLab Ltd On 1 March 20.16, Iphepa SA Ltd acquired a 60% controlling interest in RecycleLab Ltd for a cash consideration. RecycleLab Ltd is a company that buys wood waste from timber companies, recycles it and sells it to furniture manufacturing companies. At the acquisition date, the fairly valued equity of RecycleLab Ltd consisted of ordinary share capital and retained earnings. You may assume that goodwill arose with the acquisition. All the assets and liabilities of RecycleLab Ltd were deemed to be fairly valued at the acquisition date and no additional assets, liabilities or contingent liabilities were identified. On 1 April 20.16, Iphepa SA Ltd entered into a joint arrangement with three other companies and acquired a 25% interest in the ordinary share capital of FineWoods Ltd for a cash consideration. Iphepa SA Ltd exercises joint control over the relevant activities of FineWoods Ltd in terms of the joint arrangement. FineWoods Ltd was correctly classified as a joint venture in accordance with IFRS 11 Joint Arrangements and is material to the group. You may assume that no goodwill or excess arose with this acquisition. All the assets and liabilities of FineWoods Ltd were deemed to be fairly valued at the acquisition date with the exception of equipment. On 1 April 20.16 the equipment of FineWoods Ltd had a carrying amount and fair value of R70 000 and R85 000 respectively. This equipment had a remaining useful life of four years on 1 April 20.16 and is depreciated on the straight-line method. No additional assets or liabilities were identified at the acquisition date. On 1 August 20.16, Iphepa SA Ltd sold equipment with a carrying amount of R120 800 to FineWoods Ltd for R140 000. The equipment is still included in the equipment of FineWoods Ltd on 28 February 20.17. This equipment had a remaining useful life of three years on 1 August 20.16 and is depreciated on the straight-line method. The separate trial balances of the various companies as at 28 February 20.17 are as follows: Imithi

Ltd

Dr/(Cr) R

RecycleLab Ltd

Dr/(Cr)

R

FineWoods Ltd

Dr/(Cr)

R

Property, plant and equipment 510 435 398 740 755 630 Trade receivables 158 750 87 750 220 150 Inventory 101 770 77 640 120 900 Cash and cash equivalents 20 500 10 220 35 700 Ordinary dividends (paid on 28 February 20.17)

50 000

20 000

25 000

Ordinary share capital - 100 000 shares - 150 000 shares - 150 000 shares - 50 000 shares

(100 000)

- - -

-

(150 000) - -

- -

(150 000) -

7% Preference share capital - - (240 000) Retained earnings (1 March 20.16) (350 410) (180 000) (270 350) Trade payables (130 005) (74 610) (200 810) Long-term liabilities (105 220) (98 890) (190 500) Loan from Iphepha SA Ltd (25 000) - - Profit for the year (130 820) (90 850) (105 720) - - -

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Additional information 1. It is the accounting policy of all the companies in the Iphepha SA Ltd Group to account for

investments in subsidiaries, investments in associates and investments in joint ventures at cost in accordance with IAS 27.10(a) in their separate financial statements.

2. The non-redeemable preference shares of FineWoods Ltd are cumulative and are correctly

classified as an equity instrument in accordance with IAS 32 Financial Instruments: Presentation. FineWoods Ltd paid preference dividends up until 29 February 20.16. Iphepa SA Ltd does not have an interest in the preference share capital of FineWoods Ltd.

3. Profits for all the companies accrued evenly throughout the year. 4. There were no changes in the issued ordinary or preference share capital of any of the

companies in the group. 5. The loan to Imithi Ltd amounting to R25 000 was granted by Iphepha SA Ltd on

1 February 20.16. There are no indications that the loan to Imithi Ltd will be repaid in the foreseeable future.

6. The net asset value of FineWoods Ltd on 28 February 20.17 amounted to R741 070. 7. It is the accounting policy of all the companies in the Iphepha SA Ltd Group to account for

property, plant and equipment in accordance with the cost model in terms of IAS 16 Property, Plant and Equipment.

8. Iphepa SA Ltd elected to measure non-controlling interests at the proportionate share of the

acquiree’s net identifiable assets at the acquisition date for all acquisitions. 9. Assume a normal income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore


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REQUIRED


Marks

(a) Provide the pro forma journal entries to account for the intragroup sale transaction of inventory between Iphepha SA Ltd and Imithi Ltd in the consolidated financial statements of the Iphepha SA Ltd Group for the year ended 28 February 20.17. Journals relating to deferred taxation and journal narrations are required.


(b) Prepare a reconciliation between the net asset value of FineWoods Ltd and the

carrying amount of the investment in FineWoods Ltd in the consolidated financial statements of the Iphepha SA Ltd Group for the year ended 28 February 20.17.

(c) Provide the pro forma journal entries to account for the investment in FineWoods Ltd

in the consolidated financial statements of the Iphepha SA Ltd Group for the year ended 28 February 20.17. Journals relating to deferred taxation are also required.

(d) Calculate the carrying amount of the investment in Imithi Ltd that should be disclosed

in the consolidated statement of financial position of the Iphepha SA Ltd Group as at 28 February 20.17.

(e) Discuss, with reasons, the difference in the accounting treatment of acquisition-

related costs between investments in associates and investments in subsidiaries. (f) Assume that Imithi Ltd made a loss amounting to R465 500 for the previous year

ended 29 February 20.16.

Discuss, with reasons and reference to calculations, how this loss of Imithi Ltd would have been treated in the consolidated financial statements of the Iphepha SA Ltd Group for the previous year ended 29 February 20.16.

Communication skills: Logical flow and conclusion Please note: • Round off all amounts to the nearest Rand. • Comparative figures are not required. • Your answer must comply with International Financial Reporting Standards (IFRS).

7

1

6

11 6

2

6

1

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QUESTION 10 - Suggested solution (a) Pro forma journals for the intragroup sale of inventory

Dr R

Cr R

J1 Retained earnings (SCE) (38 500 x 30% x 20/120) Share of profit of associate (P/L) Elimination of unrealised profit in opening inventory of Iphepha SA Ltd

1 925

1 925

(2) (½)

J2 Share of profit of associate (P/L) (1 925 x 28%) Retained earnings (SCE) Tax implication of unrealised profit in opening inventory

539 539

(1) (½)

J3 Share of profit of associate (P/L) (85 000 x 30% x 20/120) Inventory (SFP) Elimination of unrealised profit in closing inventory of Iphepha SA Ltd

4 250

4 250

(2) (½)

J4 Deferred tax (SFP) (4 250 x 28%) Share of profit of associate (P/L) Tax implication of unrealised profit in closing inventory

1 190 1 190

(1) (½)

Total Maximum

(8) (7)

Communication skills: Presentation and layout (narrations) (1) (b) Reconciliation between the net asset value of FineWoods Ltd to the investment in

FineWoods Ltd in the financial statements of the Iphepha SA Ltd Group [IFRS 12.B14(b)]

Dr/(Cr) R

Net assets of joint venture (741 070 (given) – 240 000 (preference shares))

501 070 (1)

25% interest in net asset value of joint venture (501 070 x 25%)

125 268

(½)

Unrealised profit on intragroup sales [(140 000 – 120 800) x 25%] (4 800) (1) Realisation of unrealised profit (4 800/3 x 7/12) 933 (1) Fair value adjustment on equipment at acquisition [(85 000 – 70 000) x 72% x 25%]

2 700

(1½)

Depreciation on fair value adjustment at acquisition (2 700/4 x 11/12) (619) (1) Preference dividends in arrears (240 000 x 7% x 25%) (4 200) (1)

Carrying amount of investment in FineWoods Ltd on 28 February 20.17 119 282


OR

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Dr/(Cr)

R

Net assets of joint venture (given) 741 070 (½) Reconciling items: Unrealised profit on intragroup sales (140 000 – 120 800) (19 200) (1) Realisation of unrealised profit (19 200/3 x 7/12) 3 733 (1) Fair value adjustment on equipment at acquisition [(85 000 – 70 000) x 72%]

10 800

(1½)

Depreciation on fair value adjustment at acquisition (10 800/4 x 11/12) (2 475) (1) Preference dividends in arrears (240 000 x 7%) (16 800) (1) Preference share capital (0% interest) (240 000) (½)

477 128

25% interest in net asset value of joint venture (477 128 x 25%) 119 282 (½)

Carrying amount of investment in FineWoods Ltd on 28 February 20.17 119 282


(c) Pro forma journals for investment in FineWoods Ltd in group financial statements of the

Iphepha SA Ltd Group

Dr R

Cr R

J1 Investment in FineWoods Ltd (SFP) Other income (P/L) [C4]

Share of profit of joint venture (P/L) [C4] Equity account joint venture

13 509 6 250

19 759

(½) (1½) (2½)

J2 Other income (P/L) [(140 000 - 120 800) x 25%] Investment in joint venture (SFP)

Elimination of unrealised profit

4 800 4 800

(2) (½)

J3 Deferred tax (SFP) (4 800 x 28%) Income tax expense (P/L)

Tax implication on elimination of unrealised profit

1 344

1 344

(1) (½)

J4 Investment in joint venture (SFP) (4 800/3 x 7/12) Depreciation (P/L)

Realisation of unrealised profit

933 933

(2) (½)

J5 Income tax expense (P/L) (933 x 28%) Deferred tax (SFP)

Tax implication on realisation of unrealised profits

261 261

(1) (½)

Total Maximum

(12½) (11)

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COMMENT The elimination of the unrealised profit on the intragroup sale of inventory is an adjustment in accordance with IAS 28 while applying the equity method in the group financial statements. It is therefore important to note that these elimination journals are therefore not recorded in the separate accounting records of either the investor or the associate. By eliminating the unrealised profit on inventory, the carrying amount of the investment in associate is reduced. However, the tax base of the investment in associate in the group financial statements will stay the same (the original cost paid by the investor which will be used for CGT purposes). This difference between the carrying amount and the tax base gives rise to deferred tax which is recognised in the group financial statements in the deferred tax line-item. If the associate is the seller, the carrying amount of inventory in the group is adjusted with the unrealised profit. As the tax base stays the same, the elimination gives rise to a temporary difference which is recognised in the group financial statements in the deferred tax line-item.

(d) Carrying amount of investment in Imithi Ltd to be disclosed in the consolidated statement

of financial position of the Iphepha SA Ltd Group as at 28 February 20.17

Dr/(Cr) R

Cost of investment (80 000 (cash) + 30 000 (machinery)) 110 000 (1) Excess at acquisition [(375 200 x 30%) – 110 000] 2 560 (1) Equity accounting of Imithi Ltd (156 030 x 30%)

156 030

46 809

(½)

Share of retained earnings (350 410 – 275 200) 75 210 (½) Profit for the year (given) 130 820 (½) Elimination of intragroup dividends (given) (50 000) (½) Unrealised profit on intragroup transfer of machinery – to beginning of year [[(30 000 - 22 500) x 30%] - (2 250/4 x 6/12)]

(1 969)

(2)

Realisation of unrealised profit – current year (2 250/4) 563 (½) Carrying amount of investment in Imithi Ltd on 28 February 20.17

157 963

Total (6½) Maximum (6)

(e) Different treatment of acquisition-related costs

Subsidiaries The acquirer shall account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received [IFRS 3.53]. The acquisition-related costs will thus not form part of the cost of the investment.

(1)

Associates The cost for an associate includes the purchase price and other costs directly attributable to the acquisition or issue of the asset such as professional fees for legal services, transfer taxes and other transaction costs [IAS 28.10 (E1 footnote)]. The acquisition-related costs will thus form part of the cost of the investment.

(1) (2)

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(f) Discussion regarding loss of associate

If an entity’s share of losses of an associate or a joint venture equals or exceeds its interest in the associate or joint venture, the entity discontinues recognising its share of further losses [IAS 28.38].

The interest in an associate or a joint venture is the carrying amount of the investment in the associate or joint venture determined using the equity method together with any long-term interests that, in substance, form part of the entity’s net investment in the associate or joint venture [IAS 28.38].

An item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, an extension of the entity’s investment in associate or joint venture [IAS 28.38].

As there are no indications that the loan from Iphepha SA Ltd to Imithi Ltd will be repaid in the foreseeable future, the loan forms part of the net investment in the associate.

(1)

The interest in the associate thus amounts to R135 591 (R110 000 + R25 000 + R2 560 – R1 969).

(1½)

The loss of Imithi Ltd attributable to Iphepha SA Ltd amounts to R69 825 (R465 500 x 6/12 x 30%). This loss is limited to the interest in Imithi Ltd of R135 591. The loss of R69 825 is less than the interest in Imithi Ltd and therefore the total loss of R69 825 will be recognised.

(2½)

Losses recognised using the equity method in excess of the entity’s investment in ordinary shares are applied to the other components of the entity’s interest in an associate or a joint venture in the reverse order of their seniority (i.e. priority in liquidation) [IAS 28.38].

The total loss of R69 825 will be applied to the investment in the ordinary shares. (1)

(6) Communication skills: Logical flow and layout (1)

CALCULATIONS C1. Analysis of owners’ equity of RecycleLab Ltd

Total Iphepha SA Ltd

(60%) NCI

At Since

At acquisition Share capital 150 000


330 000 198 000 132 000

Equity represented by goodwill 2 000 2 000 -


Current year Profit for the year 90 850 54 510 36 340

Dividends paid (20 000) (12 000) (8 000)

402 850 42 510 160 340

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C2. Pro forma journals for investment in RecycleLab Ltd in consolidated financial statements

of the Iphepha SA Ltd Group (for completeness purposes only)

Dr R

Cr R

J1 Ordinary share capital (SCE) Retained earnings (SCE) Goodwill (SFP)

Investment in RecycleLab Ltd (SFP) Non-controlling interests (SFP/SCE) [C1]

Elimination of at acquisition equity

150 000 180 000

2 000

200 000 132 000

J2 Non-controlling interests (P/L) [C1] Non-controlling interests (SFP)

Recognition of NCI’s interest in profit for the year

36 340 36 340

J3 Other income (P/L) [C1] Non-controlling interests (SFP/SCE)

Dividends paid (SCE) Elimination of intragroup dividends

12 000 8 000

20 000

C3. Total profit of joint venture (FineWoods Ltd)

Profit from 1/4/20.16 – 28/2/20.17 (105 720 x 11/12) (96 910) [1] Preference dividend (240 000 x 7% x 11/12) 15 400 [1] Elimination of intragroup dividends (given) 25 000 [½] (56 510)

Equity account FineWoods Ltd (56 510 x 25%) (14 128) [½] Depreciation on fair value adjustment at acquisition (from part (b)) 619 [½] Unrealised profit on intragroup sales [4 800 (from part (b)) x 72%] 3 456 [1] Realisation of unrealised profit [933 (from part (b)) x 72%] (672) [1] (10 725) [5½]

C4. Analysis of owners’ equity of FineWoods Ltd (ordinary share capital)

Total Iphepha SA Ltd

(25%)

At Since

At acquisition Ordinary share capital 150 000 Retained earnings 270 350 Profit (1/3/20.16 – 1/4/20.16) (105 720 x 1/12) 8 810 Preference dividends in arrears (240 000 x 7% x 1/12) (1 400) Equipment [(85 000 – 70 000) x 72%] 10 800

438 560 109 640 Goodwill/Excess (given) - Consideration 109 640 Current year Profit (1/4/20.16 – 28/2/20.17) (105 720 x 11/12) 96 910

Depreciation on equipment (10 800/4 x 11/12) (2 475) Preference dividends (240 000 x 7% x 11/12) (15 400) Total current year profit 79 035 19 759

Dividends paid (25 000) (6 250)

492 595 13 509

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C5. Analysis of owners’ equity of Imithi Ltd

Total

Iphepha SA Ltd (30%)

At Since

At acquisition Share capital 100 000 Retained earnings 275 200

375 200 112 560 Excess (2 560)

Consideration (80 000 + 30 000) 110 000 Since acquisition Retained earnings (350 410 – 275 200) 75 210 22 563 Current year Profit of Imithi Ltd 130 820 39 246

Dividends paid (50 000) (15 000)

531 230 46 809

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QUESTION 11 40 marks


This question consists of two independent parts. PART A 30 marks Mouth Watering Meats Ltd is a South African company that specialises in the processing and packaging of a variety of meat products. The company is listed on the JSE Limited. One of Mouth Watering Meats Ltd’s key suppliers filed for liquidation in 20.16 and as a result, the management of Mouth Watering Meats Ltd agreed to acquire strategic shareholdings in certain of its other key suppliers. These shareholdings will ensure stability and sustainability in the company’s procurement process. The details of these acquisitions are listed below: Boasting Beef Ltd Mouth Watering Meats Ltd acquired 45 000 ordinary shares in Boasting Beef Ltd on 1 May 20.17 for a share consideration of 10 000 ordinary shares and a cash consideration of R200 000. Boasting Beef Ltd is also listed on the JSE Limited and its main business is the sourcing and distribution of beef to an extensive retail client base. Mouth Watering Meats Ltd exercises significant influence over the financial and operating policy decisions of Boasting Beef Ltd from the acquisition date. The equity of Boasting Beef Ltd consisted of the following on 1 March 20.17:

R

Ordinary share capital (100 000 shares) Retained earnings

100 000 552 800

652 800

The equity of Boasting Beef Ltd consisted only of ordinary share capital and retained earnings at the acquisition date. All the assets and liabilities of Boasting Beef Ltd were deemed to be fairly valued at the acquisition date, except for the company’s warehouses which had a carrying amount of R590 000 and a fair value of R750 000 on 1 May 20.17. The warehouses had a remaining useful life of six years at the acquisition date. The aforementioned warehouses have been correctly classified as owner-occupied property by Boasting Beef Ltd. On 1 September 20.17, Mouth Watering Meats Ltd sold one of its machines used in its meat packaging process, to Boasting Beef Ltd for R145 000. The carrying amount of this machine was R120 000 and its remaining useful life was 4 years at the date of sale. This machine have been used in the beef packaging process of Boasting Beef Ltd from 1 September 20.17. Boasting Beef Ltd paid a management fee of R50 000 to Mouth Watering Meats Ltd during the 20.18 financial year.

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As part of the year end audit procedures performed by the external auditors of Boasting Beef Ltd, it was identified that financial assets acquired by the company on 22 June 20.17 for an amount of R300 000, had a fair value of R370 000 on 28 February 20.18. This fair value adjustment has not yet been recognised in the separate accounting records of Boasting Beef Ltd. Boasting Beef Ltd’s profit for the year ended 28 February 20.18 amounted to R551 700. Cheeky Chickens Ltd Mouth Watering Meats Ltd is the controlling shareholder of Cheeky Chickens Ltd, a company that specialises in the production of chicken livestock. This controlling interest was acquired on 1 January 20.17 when Mouth Watering Meats Ltd acquired 65% of the ordinary share capital of Cheeky Chickens Ltd for a cash consideration of R810 000. At the acquisition date, the fairly valued equity of Cheeky Chickens Ltd consisted only of ordinary share capital and retained earnings which amounted to R225 000 and R927 800 respectively. On 1 January 20.17, Cheeky Chickens Ltd had a non-cancellable order backlog for 60 ton chicken feed. Chicken feed is sold at R6 000 per ton at a profit mark-up of 20% on cost. This order backlog will be cleared in 2 months’ time (30 ton per month). All the assets and liabilities of Cheeky Chickens Ltd were deemed to be fairly valued and no additional assets, liabilities or contingent liabilities were identified at the acquisition date. From 12 June 20.17, Cheeky Chickens Ltd has been selling chicken feed to Boasting Beef Ltd on a monthly basis at a profit mark-up of 40% on cost. Boasting Beef Ltd then uses the purchased chicken feed to supplement its feed to newly born calves. Cheeky Chickens Ltd’s total sales to Boasting Beef Ltd for the 20.18 financial year amounted to R458 000. A total inventory value of R94 000 was still on hand in the records of Boasting Beef Ltd at 28 February 20.18. Cheeky Chickens Ltd’s profit for the current financial year amounted to R430 900 (20.17: R371 900). Additional information 1. All the companies in the Mouth Watering Meats Ltd Group have a 28 February year end. 2. The quoted closing share price for the ordinary shares of Mouth Watering Meats Ltd was

R12,20 per share on 1 May 20.17. 3. It is the accounting policy of Mouth Watering Meats Ltd to account for investments in subsidiaries

and investments in associates at cost in accordance with IAS 27.10(a) in its separate financial statements.

4. It is the accounting policy of all the companies in the Mouth Watering Meats Ltd Group to account

for all other investments in financial assets in accordance with IFRS 9 Financial Instruments. All the companies in the Mouth Watering Meats Ltd Group irrevocably elected to present subsequent changes in the fair value of these investments in other comprehensive income in a mark-to-market reserve.

5. Assume that the profits of each of the companies in the Mouth Watering Meats Ltd Group

accrued evenly throughout the respective years. 6. An appropriate pre-tax discount rate is 9% per annum, compounded monthly.

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7. There were no changes in the issued ordinary share capital of any of the companies in the group

during the past two years. 8. It is the accounting policy of all the companies in the Mouth Watering Meats Ltd Group to account

for property, plant and equipment in accordance with the cost model in terms of IAS 16 Property, Plant and Equipment and to provide depreciation by applying the straight-line method.

9. Mouth Watering Meats Ltd elected to measure non-controlling interests at the proportionate

share of the acquiree’s net identifiable assets at the acquisition date for all acquisitions. 10. Assume an income tax rate of 28% and a capital gains tax inclusion rate of 80%. Ignore

Value Added Tax (VAT) and Dividend Tax. PART B 10 marks Edcor Ltd is a company listed on the JSE Limited in the retail sector. Edcor Ltd intends to increase its market capitalisation and is in the process of acquiring a few companies that will help increase profits, which will increase share price and therefore increase its market capitalisation. Esquare Ltd Esquare Ltd is a small retail company started by three enterprising recently qualified students. The company’s business processes are expertly managed and therefore show great potential for scalability. Edcor Ltd is a party to a forward contract to acquire the majority of the shares in Esquare Ltd. One share equals one voting right. The forward contract's settlement date is in 25 days. Esquare Ltd has annual shareholder meetings at which decisions are made to direct the relevant activities. The next scheduled shareholders’ meeting is in nine months. However, shareholders that individually or collectively hold at least 10% of the voting rights can call a special meeting to change the existing policies over the relevant activities, but a requirement to give notice to the other shareholders means that such a meeting cannot be held for at least 30 days. Policies over the relevant activities can be changed only at special or scheduled shareholders' meetings. OneShop Ltd Edcor Ltd intends to acquire a 55% interest in OneShop Ltd. Edcor Ltd will have the right to restrict OneShop Ltd from undertaking activities that could significantly change the credit risk of OneShop Ltd to the detriment of Edcor Ltd. Another entity, Dido Ltd, will have existing rights that will provide them with the right to direct the relevant activities of OneShop Ltd. All the companies have a 28 February year end.

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REQUIRED


Marks

PART A Provide the pro forma consolidation journal entries of the Mouth Watering Meats Ltd Group for the year ended 28 February 20.18. Journal entries relating to deferred taxation are also required.


Please note: • The at acquisition elimination journal is not required. • Round off all amounts to the nearest Rand. • Journal narrations are required. • Show all your calculations. • Your answer must comply with International Financial Reporting Standards (IFRS). PART B (a) Discuss, with reasons, whether Edcor Ltd has power over Esquare Ltd. (b) Discuss, with reasons, whether Edcor Ltd will have control over OneShop Ltd.

Communication skills: Logical flow and conclusion Please note: • Your answer must comply with International Financial Reporting Standards (IFRS).

29

1

5 4

1

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QUESTION 11 - Suggested solution PART A Pro forma consolidation journal entries for the year ended 28 February 20.18 BOASTING BEEF LTD Dr

R

Cr R

J1 Investment in associate (SFP) [C1] Share of profit of associate (P/L) Recognition of excess at acquisition

64 978 64 978

(5) (½)

J2 Investment in associate (SFP) Share of profit of associate (P/L) [C1] Share of other comprehensive income of associate (OCI) [((370 000 – 300 000) x (1 – (28% x 80%))) x 45%] Recognition of share of profit and share of OCI of associate for the year

224 132 199 688

24 444

(½) (2)

(2)

J3 Other income (profit on sale of machinery) (P/L) [(145 000 – 120 000) x 45%] Investment in associate (SFP) Elimination of unrealised profit in machinery

11 250

11 250

(1½) (½)

J4 Deferred tax (SFP) (11 250 x 28%) Income tax expense (P/L) Tax effect of elimination of unrealised profit in machinery

3 150 3 150

(1) (½)

J5 Investment in associate (SFP) (11 250 / 4 x 6/12) Cost of sales (P/L) Realisation of intragroup profit on machinery

1 406 1 406

(1½) (½)

J6 Income tax expense (P/L) (1 406 x 28%) Deferred tax (SFP) Tax effect of realisation of intragroup profit on machinery

394 394

(1) (½)

CHEEKY CHICKENS LTD J7 Retained earnings (SCE)

Deferred tax (SFP) (59 332 x 28%) Accumulated amortisation (SFP) (59 332 [C3] x 2/2) Amortisation on intangible asset (order backlog) for previous year

42 719 16 613

59 332

(½) (1)

(2½)

J8 Retained earnings (SCE) [[(371 900 x 2/12) – 42 719 (J7)] x 35%] Non-controlling interests (SFP) Non-controlling interests’ share of since acquisition reserves

6 743 6 743

(2) (½)

J9 Revenue (P/L) (94 000 x 45%) Cost of sales (P/L) (94 000 x 100/140 x 45%) Investment in associate (SFP) (balancing) Elimination of unrealised profit in closing inventories of Boasting Beef Ltd

42 300 30 214 12 086

(1) (1½) (½)

J10 Deferred tax (SFP) [(42 300 – 30 214) x 28%] Income tax expense (P/L) Tax effect of elimination of unrealised profit in closing inventories

3 384 3 384

(1) (½)

J11 Non-controlling interests (P/L) [C2] Non-controlling interests (SFP) Non-controlling interests’ share of current year profit

147 769 147 769

(2½) (½)

Total (31) Maximum (29) Communication skills: Presentation and layout (1)

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EXAM TECHNIQUE Students must remember to classify their journals (i.e. SFP, OCI, SCE, SFP, P/L) in order to earn the available marks. The at acquisition elimination journal was not required. Students must read carefully to ensure they don’t waste valuable time by providing information that was not required.

PART B (a) Discuss whether Edcor Ltd has power over Esquare Ltd Definition of power An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, i.e. the activities that significantly affect the investee’s returns [IFRS 10.10]. OR To have power over an investee, an investor must have existing rights that gives it the current ability to direct relevant activities. For the purpose of assessing power, only substantive rights and rights that are not protective shall be considered (IFRS 10.B9).

Existing rights For a right to be substantive, the holder must have the practical ability to exercise that right [IFRS 10.B22].

When assessing control, an investor considers its potential voting rights as well as potential voting rights held by other parties to determine whether it has power [IFRS 10.B47].

The fact that it takes 25 days before Edcor Ltd can exercise its voting rights does not stop Edcor Ltd from having the current ability to direct the relevant activities from the moment Edcor Ltd acquires the forward contract.

(1)

(1)

Edcor Ltd's forward contract is a substantive right that gives them the current ability to direct the relevant activities because a special meeting cannot be held for at least 30 days, but Edcor Ltd can settle the forward contract in 25 days.

(1)

The existing shareholders are unable to change the existing policies over the relevant activities because a special meeting cannot be held for at least 30 days, at which point the forward contract will have been settled.

(1)

Conclusion An investor that holds more than half of the voting rights of an investee has power unless another entity has existing rights that provide that entity with the right to direct the relevant activities [IFRS 10.B35 - .B37].

Edcor Ltd will have the majority shares and one share equals one voting right. (1)

Edcor Ltd has power over Esquare Ltd because it holds substantive potential voting rights that give them the current ability to direct the relevant activities.

(1)


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(b) Discuss whether Edcor Ltd will have control over OneShop Ltd

Definition of control

An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee [IFRS 10.6].

Existing rights

For an investor that holds more than half of the voting rights of an investee, to have power over an investee, the investor's voting rights must be substantive [IFRS 10.B36].

Edcor Ltd will hold 55% of OneShop Ltd and thus have a majority of the voting rights, but Edcor Ltd's voting rights are not substantive.

(1) (1)

However, an investor that holds only protective rights does not have power over an investee, and consequently does not control the investee [IFRS 10.14].

Protective rights relate to fundamental changes to the activities of an investee [IFRS 10.B26].

Protective rights are designed to protect the interests of their holder without giving that party power over the investee to which those rights relate [IFRS 10.B27].

Conclusion

Edcor Ltd only has rights that restrict OneShop Ltd from undertaking activities that could change the credit risk of OneShop Ltd to the detriment (disadvantage) of Edcor Ltd. Although Edcor Ltd will hold the majority of the voting rights, they will only hold protective rights and thus do not have control over OneShop Ltd.

(1)

(2)

Total (5)

Maximum (4)

Communication skills: Logical flow and conclusion (1)

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CALCULATIONS C1. Analysis of owners’ equity of Boasting Beef Ltd

Total

Mouth Watering Meats Ltd

45%

[½]

At Since

At acquisition – 1 May 20.17

Share capital 100 000 [½]

Retained earnings (1 March 20.17) 552 800 [½]

Profit up to acquisition date (2 months) (551 700 x 2/12) 91 950 [1]

Revaluation surplus (750 000 – 590 000) 160 000 [½] Deferred tax (160 000 x 28%) (44 800) [½]

859 950 386 978

Excess (64 978)

Consideration [R200 000 + (10 000 x 12,20)] 322 000 [1]

[4½]

Since acquisition - current year

Profit since acquisition (10 months) (551 700 x 10/12) 459 750 [½]

Additional depreciation of revaluation [((160 000 – 44 800) / 6) x 10/12] (16 000) [1]

Total current year profit 443 750 199 688 [1½]

Current year OCI: Mark-to-market reserve [(370 000 – 300 000) x (1 – (28% x 80%))] 54 320 24 444

1 358 020 224 132

C2. Analysis of owners’ equity of Cheeky Chickens Ltd

Total

Mouth Watering Meats Ltd

65% NCI 35%

At Since

At acquisition – 1 January 20.17

Share capital 225 000


Intangible asset (order backlog) (59 332 [C3] x 72%) 42 719

1 195 519 777 087 418 432

Goodwill 32 913 32 913 -

Consideration and NCI 1 228 432 810 000 418 432

Since acquisition

Retained earnings (371 900 x 2/12) 61 983

Amortisation (42 719 x 2/2) (42 719)

Total retained earnings 19 264 12 522 6 742

Current year

Profit for the year (430 900 – 42 300 (J9) + 30 214 (J9) + 3 384 (J10)) 422 198 274 429 147 769

[2]

1 669 894 286 951 572 943

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C3. Order backlog at acquisition


1. 2nd F C (Clear All) 1. 2nd FC (Clear All) 1. 2ndF MODE (Clear All)

2. 12 2nd F PMT 2. - 2. -

3. 6 000 x 20/120 x 30 PMT 3. 6 000 x 20/120 x 30 PMT 3. 6 000 x 20/120 x 30 PMT [1]

4. 9 I/YR 4. 9/12 i 4. 9/12 I/Y [½]

5. 2 N 5. 2 n 5. 2 N [½]

6. PV = 59 332 6. 0 FV 6. 0 FV

7. Comp PV = 59 332 7. Comp PV = 59 332

[2]

COMMENT Order backlog The acquiree had an order backlog that, in accordance with IFRS 3.IE25, meets the contractual-legal criterion even if the purchase or sales orders can be cancelled. The order backlog therefore had to be recognised as an intangible asset.

SCHOOL OF ACCOUNTING SCIENCES - Unisa · TEST 1 ON TUTORIAL 102: 12 MARCH 2019 PERSONNEL AND...

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