March 2021 – KNEC STUDY MATERIALS, REVISION KITS AND PAST PAPERS

Test your understanding 1 – Cookie

Cookie, a company, prepares its financial statements in accordance with International Financial Reporting Standards. It has investments in two other companies, Biscuit and Cracker. The statements of financial position of all three companies as at 30 April 20X4 are presented below:

	Cookie	Biscuit	Cracker
Non-current assets	$m	$m	$m
Non-current assets
Property, plant and equipment	80	85	67
Investments	101	10	−
	–––––	–––––	–––––
Current assets	181	95	67
Current assets
Inventories	19	6	25
Trade receivables	17	13	33
Cash and cash equivalents	22	3	14
	–––––	–––––	–––––
Total assets	239	117	139
Equity and liabilities	–––––	–––––	–––––
Equity and liabilities
Share capital ($1)	21	10	20
Other components of equity	50	–	20
Retained earnings	105	79	43
	–––––	–––––	–––––
Total equity	176	89	83
Non-current liabilities	40	10	18
Current liabilities	23	18	38
	–––––	–––––	–––––
Total equity and liabilities	239	117	139
	–––––	–––––	–––––

The following notes are relevant to the preparation of the consolidated financial statements:

On 1 May 20X3, Cookie acquired 55% of the ordinary shares of Biscuit. Consideration was in the form of cash and shares. The cash consideration of $30 million has been recorded in the accounts of Cookie but no entries have been made for the 5 million shares issued. These had a fair value of $4.50 each on 1 May 20X3. The retained earnings of Biscuit at this date were $70 million.

The fair value of the net assets of Biscuit at the acquisition date was $95 million. The difference between the fair value and carrying amount of the net assets was due to a brand that was not recognised by Biscuit. This brand was estimated to have a remaining useful economic life of 5 years. The fair value of the non-controlling interest in Biscuit at acquisition was $45 million.

On 1 May 20X3, Cookie spent $56 million to acquire 70% of the ordinary shares of Cracker. On this date, Cracker had retained earnings of $30 million and other components of equity of $20 million. On 1 November 20X3, Cookie spent another $15 million in order to increase its holding to 90% of Cracker’s ordinary shares. Cookie elected to measure the non-controlling interest in Cracker using the share of net assets method.

During the year, Cookie sold goods to Biscuit for $4 million making a profit of $2 million. This sale was made on credit and the invoice has not yet been settled. One quarter of the goods remain in the inventory of Biscuit at the year end.

There has been no impairment in respect of the goodwill arising on the acquisition of Cracker. At the year end, it was estimated that the recoverable amount of the net assets of Biscuit was $107 million.

The investments held by Biscuit relate to equity shares that have been designated as fair value through profit and loss. They were purchased during the current year and are currently held at cost. At 30 April 20X4, these shares had a fair value of $15 million.

Included in the non-current liabilities of Cookie is a loan denominated in another currency, the Dinar (DN). The loan, for DN10 million, was received on 1 August 20X3 and correctly recorded at the spot rate. No other entries have been posted. The following exchange rates are relevant:

	DN:$1
1 August 20X3	2.3:1
30 April 20X4	2.6:1

Included in the property, plant and equipment of Cookie is an item of specialised plant which was constructed internally. Construction began on 1 May 20X3. The asset was recorded at a cost of $15 million and was attributed a useful economic life of five years. A breakdown of the cost is as follows:

	$m
Materials for construction	7.3
Directly attributable labour	2.9
Testing of machine	0.6
Training staff to use machine	0.5
Allocated general overheads	3.7
	–––––

15.0

–––––

The plant was available for use on 1 November 20X3 and was depreciated from this date.

During the year, Cookie started selling goods under warranty. No warranty provision has been accounted for. Cookie will repair goods under warranty for any manufacturing defects that become apparent within a year of purchase. If all items under warranty at 30 April 20X4 developed minor defects, then the total cost of repairs would be approximately $6 million. If all items under warranty developed major defects, then the total cost of repairs would be approximately $14 million. The directors of Cookie estimate that 7% of items under warranty will develop minor defects within the warranty period and that 4% of items under warranty will develop major defects within the warranty period.

Required:

Prepare the consolidated statement of financial position for the Cookie Group as at 30 April 20X4.

Test your understanding 2 – Pineapple

Pineapple is a public limited company which has investments in a number of other companies. The draft statements of profit or loss for the year ended 30 September 20X3 are presented below:

	Pineapple	Strawberry	Satsuma	Apricot
	$000	$000	$000	$000
Revenue	9,854	3,562	2,435	6,434
Cost of sales	(5,432)	(2,139)	(945)	(3,534)
	–––––––	–––––––	–––––––	–––––––
Gross profit	4,422	1,423	1,490	2,900
Administrative	(1,432)	(400)	(523)	(600)
expenses
Distribution	(402)	(324)	(237)	(254)
costs	–––––––	–––––––	–––––––	–––––––
Profit from	2,588	699	730	2,046
operations
Investment	386	15	34	135
income
Finance costs	(246)	–	(35)	–
	–––––––	–––––––	–––––––	–––––––
Profit before	2,728	714	729	2,181
taxation
Taxation	(486)	–	(161)	(432)
	–––––––	–––––––	–––––––	–––––––
Profit after tax	2,242	714	568	1,749
	–––––––	–––––––	–––––––	–––––––

Movements in the retained earnings of each company for the year ended 30 September 20X3 are presented below:

	Pineapple	Strawberry	Satsuma	Apricot
	$000	$000	$000	$000
1 October 20X2	5,645	1,325	2,342	3,243
Total	2,242	714	568	1,749
comprehensive
income for the
period
Dividends	–	(400)	–	–
	–––––––	–––––––	–––––––	–––––––
30 September	7,887	1,639	2,910	4,992
20X3	–––––––	–––––––	–––––––	–––––––

The following notes are relevant to the preparation of the group financial statements.

On 1 October 20X2, Pineapple purchased 80% of Strawberry’s 1 million $1 ordinary shares. It is the group’s policy to measure the non-controlling interest at fair value at the date of acquisition. At 1 October 20X2, the balance on Strawberry’s retained earnings was $1,325,000. The fair value of Strawberry’s net assets was deemed to be $4,000,000. The excess in the fair value of the net assets over their carrying amounts is due to a factory building with a remaining useful life at the acquisition date of 40 years.

Pineapple acquired 70% of Satsuma’s 2 million $1 ordinary shares several years ago for cash consideration of $4,900,000. At the acquisition date, retained earnings of Satsuma were $2,045,000 and the fair value of the non-controlling interest was $1,600,000. On 31 March 20X3, Pineapple sold its entire shareholding in Satsuma for $5,600,000. Goodwill arising on the acquisition of Satsuma was impaired by 40% in the year ended 30 September 20X2. Satsuma is geographically distinct from the rest of the Pineapple group and therefore the disposal should be presented as a discontinued operation.

On 30 June 20X3, Pineapple acquired 30% of the ordinary shares in Apricot. At 30 June 20X3, it was deemed that the fair value of a building owned by Apricot exceeded its carrying amount by $1,600,000. The remaining useful life of the building was 40 years at the acquisition date.

On 1 October 20X2, Pineapple sold goods to Strawberry for $400,000. All of these had been sold to third parties by 30 September 20X3. On 1 August 20X3, Apricot sold inventory to Pineapple making a profit of $100,000. By 30 September 20X3, one fifth of these goods have been sold to third parties by Pineapple.

Impairment testing on 30 September 20X3 revealed that goodwill arising of the acquisition of Strawberry was impaired by $300,000, and that the investment in Apricot was impaired by $50,000.

Goodwill impairments should be presented in administrative expenses.

On 1 October 20X2, Pineapple made an interest free loan of $1,500,000 to Blueberry, a key supplier, who was in financial difficulties. This loan is repayable on September 20X6. If the supplier had borrowed the money from a bank, they would have been charged annual interest of 12%. Pineapple has recorded the cash outflow and a corresponding financial asset at $1,500,000. No other accounting entries have been made, except to correctly record the required loss allowance.

On 30 June 20X3, Pineapple sold a new product to a customer for $500,000 in cash and recognised the revenue in full. The terms of the sale indicate that Pineapple must offer technical support to the customer over the next 24 months. Pineapple usually charges $3,000 per month for technical support.

Pineapple set up a defined contribution pension scheme on 1 October 20X2. Pineapple must make annual contributions into the scheme equivalent to 5% of employee salaries for that 12 month period. For the year ended 30 September 20X3, employee salaries were $900,000. Pineapple has paid $30,000 into the pension scheme in the current year and recognised this as an administrative expense.

Strawberry has recently returned to profitability after several years of making losses. Strawberry correctly recognised no deferred tax in the prior year financial statements in respect of tax adjusted losses due to high levels of uncertainty in forecasting future profits. At 30 September 20X3, the tax allowable losses of Strawberry are $500,000 and it is firmly believed that these will be relieved against Strawberry’s taxable profits in the next accounting period. No deferred tax entries have been posted in respect of these losses in the current year. Strawberry currently pays tax at 22% but, prior to the year end, the government announced that the tax rate will fall to 20% next year. All other deferred tax issues in the Pineapple group should be ignored.

Required:

Prepare the consolidated statement of profit or loss for the Pineapple Group for the year ended 30 September 20X3.

Test your understanding 3 – Vinyl

Vinyl has investments in CD and Tape. CD is located overseas and prepares its individual statements using the Mark (MK). The presentation currency of the Vinyl group is the dollar ($). The statements of financial position of Vinyl, CD and Tape as at 30 September 20X4 are presented below:

	Vinyl	CD	Tape
Non-current assets	$m	MKm	$m
Non-current assets
Property, plant and	350	290	160
equipment
Investment properties	10	–	–
Investments in subsidiaries	400	–	–
Financial assets	21	–	–
	–––––	–––––	–––––
Current assets	781	290	160
Current assets
Inventories	49	45	37
Trade receivables	76	46	49
Cash and cash equivalents	52	38	23
Total assets	–––––	–––––	–––––
Total assets	958	419	269
Equity and liabilities	–––––	–––––	–––––
Equity and liabilities
Equity capital	65	76	79
($1/MK1 shares)
Retained earnings	501	275	101
Other components of equity	50	–	6
	–––––	–––––	–––––
Non-current liabilities	616	351	186
Non-current liabilities
Loans	200	15	24
Defined benefit deficit	50	–	–
Current liabilities	92	53	59
Total equity and liabilities	–––––	–––––	–––––
Total equity and liabilities	958	419	269
	–––––	–––––	–––––

The following notes are relevant to the preparation of the consolidated financial statements:

Vinyl acquired 75% of the ordinary shares in CD on 1 October 20X3 for MK360 million. The fair value of the non-controlling interest at the acquisition date was MK90 million and the retained earnings of CD were MK210 million. There were no other components of equity. The fair value of the net assets of CD approximated their carrying amounts with the exception of a brand. This brand was not recognised by CD but Vinyl estimates that it had a fair value of MK10 million at the acquisition date. The brand was deemed to have an indefinite useful economic life.

Vinyl acquired 80% of the share capital of Tape on 1 October 20X0 for $100 million. At the acquisition date, the retained earnings of Tape were $19 million and other components of equity were $1 million. The non-controlling interest in Tape was measured using the share of net assets method. The fair value of the net assets of Tape at the acquisition date were $110 million. The excess of the fair value over the carrying amount of the net assets was attributable to non-depreciable land.

The goodwill of CD and Tape was tested for impairment at 30 September 20X4. There was no impairment relating to CD. The recoverable amount of the net assets of Tape was $201 million. There have been no impairments before this date.

It is the group’s policy to measure investment properties at fair value. At 30 September 20X4, Vinyl’s investment properties were valued at $14 million. This revaluation has not yet been accounted for.

The only entry posted in the year for Vinyl’s defined benefit pension scheme is the cash contributions paid into the scheme by Vinyl of $20 million. The following information relates to Vinyl’s pension scheme for the current financial year:

Discount rate at 1 October 20X3	5%
Current and past service costs	$22m
Pension benefits paid during the year	$5m
Present value of the obligation at 30	$179m
September 20X4	$120m
Fair value of the plan assets at 30	$120m
September 20X4

Included within Vinyl’s loan balance are the proceeds from the issue of convertible bonds on 30 September 20X4. On this date, Vinyl issued 500,000 $100 4% convertible bonds at par. Interest is payable annually in arrears. These bonds will be redeemed at par for cash on 30 September 20X7, or are convertible into 75,000 ordinary shares. The interest rate on similar debt without a conversion option is 9%.

The financial assets of Vinyl represent the amount paid on 1 October 20X3 to acquire redeemable preference shares in another company, which were classified to be measured at amortised cost. The effective rate of interest is 14.6%. Vinyl has received interest from these investments of $1.3 million, which has been recognised in profit or loss. Vinyl has not yet accounted for a loss allowance on these preference shares. It has calculated that the loss allowance required is $0.2 million.

The following exchange rates are relevant:

	MK to $1
1 October 20X3	1.2
30 September 20X4	1.7
Average rate for the year to 30 September	1.4
20X4

Required:

Prepare the consolidated statement of financial position for the Vinyl Group as at 30 September 20X4.

Test your understanding 4 – Frank

The following financial statements relate to the Frank Group:

Consolidated statement of financial position as at 30 September 20X4 (with comparatives)

	20X4	20X3
	$m	$m
Non-current assets
Property, plant and equipment	221	263
Goodwill	75	142
Investment in associates	204	103
Investment properties	82	60
	––––––	–––––
	582	568
Current assets
Inventories	256	201
Trade and other receivables	219	263
Cash and cash equivalents	103	42
	––––––	–––––
Total assets	1,160	1,074
	––––––	–––––

Equity and liabilities
Share capital	122	102
Retained earnings	64	24
Other components of equity	59	30
	–––––	–––––
	245	156
Non-controlling interest	104	87
	–––––	–––––
Non-current liabilities	349	243
Non-current liabilities
Loans	163	152
Deferred tax	44	33
Current liabilities
Trade and other payables	524	486
Income tax payable	23	12
Overdraft	57	148
Total equity and liabilities	–––––	–––––
Total equity and liabilities	1,160	1,074
	–––––	–––––

Consolidated statement of profit or loss and other comprehensive income for the year ended 30 September 20X4

	$m
Revenue	1,423
Cost of sales	(1,197)
	––––––
Gross profit	226
Operating expenses	(150)
	––––––
Profit from operations	76
Share of profit of associate	21
Profit on disposal of subsidiary	3
Finance cost	(12)
	––––––
Profit before tax	88
Income tax expense	(19)
	––––––
Profit for the period	69
	––––––

Other comprehensive income – items that will not be reclassified to
profit or loss
Gain on revaluation of property, plant and equipment	50
Income tax on items that will not be reclassified	(10)
	–––
Total comprehensive income	109
Profit attributable to:	–––
Profit attributable to:
Equity holders of the parent	43
Non-controlling interests	26
Profit for the period	–––
Profit for the period	69
Total comprehensive income attributable to:	–––
Total comprehensive income attributable to:
Equity holders of the parent	73
Non-controlling interests	36
Total comprehensive income for the period	–––
Total comprehensive income for the period	109
	–––

The following information is relevant to the Frank group:

Machinery with a carrying amount of $12m was disposed of for cash proceeds of $10m. Depreciation of $52m has been charged to operating expenses in the statement of profit or loss. As a result of a revaluation of Frank’s factories during the year, a transfer has been made within equity for excess depreciation of $1m. Included in trade and other payables at the reporting date is $2m (20X3: $nil) that relates to property, plant and equipment purchased during the reporting period.

Frank received a government grant of $3m in cash during the reporting period to help it fund the acquisition of a new piece of specialised machinery needed for its production process. The machinery was purchased during the year. Frank accounts for capital grants using the ‘netting off’ method.

Investment properties are accounted for at fair value. New investment properties were purchased during the period for $14m in cash.

During the reporting period, the Frank Group disposed of some of its shares in Chip. Frank held 90% of the ordinary shares in Chip before the disposal and 40% of the shares after the disposal (leaving it with significant influence). The Frank group received cash proceeds from the sale. The profit on disposal of $3m has been correctly calculated and credited to the statement of profit or loss. The fair value of the interest in Chip retained was $32m. Goodwill and the non-controlling interest at the disposal date were $40m and $4m respectively.

A breakdown of Chip’s net assets at the date of the share disposal is provided below:

	$m
Property, plant and equipment	81
Trade and other receivables	32
Cash and cash equivalents	6
Loans	(30)
Trade and other payables	(55)
	––––
Net assets at disposal date	34
	––––

During the period, $65m in cash was spent on investments in associates.

Finance costs include a $2m loss on the retranslation of a loan that was denominated in sterling (£). All other finance costs were paid in cash.

Required:

Prepare a consolidated statement of cash flows using the indirect method for the Frank group for the year ended 30 September 20X4 in accordance with IAS 7 Statement of Cash flows.

Note: the notes to the statement of cash flows are not required.

Test your understanding 5 – Sunny Days

Sunny Days is an entity that breeds and matures beef cattle for sale. It prepares its financial statements in accordance with International Financial Reporting Standards and has a year end of 30 September 20X4. The directors need help with a number of unresolved accounting issues that are detailed below.

In the financial statements for the year ended 30 September 20X3 Sunny Days reported biological assets of $1.8 million. Cattle with a carrying amount of $0.1 million died during the year ended 30 September 20X4 and Sunny Days sold cattle with a carrying amount of $0.4 million. During the current year, the company purchased new cattle and correctly recognised it at a value of $0.8 million. This was partly funded by an unconditional grant of $0.2 million from a local government agency.

Questions & Answers

Sunny Days does not have the information available to identify the principal market for its cattle. Details of the prices that Sunny Days could obtain for its entire herd at the two markets available to it at the reporting date are provided below:

	Market 1 Market 2
Estimated selling price ($m)	2.6	2.8
Cost of transporting cattle to market ($m)	0.1	0.4
Costs to sell (as % of selling price)	0.5%	0.5%

The farmland used by Sunny Days to rear its cattle was purchased for $3 million on 1 October 20X2 but was revalued to $3.2 million on 30 September 20X3. Due to declining property prices in the area, the land was deemed to have a fair value of $2.7 million as at 30 September 20X4.

(12 marks)

On 1 January 20X4, the government announced new legislation which made some of Sunny Days’ farming methods illegal. These laws became effective on 1 September 20X4. Due to short term cash flow difficulties, Sunny Days has not yet started to comply with the new legislation. It is estimated that the cost of compliance will be approximately $0.8 million. The government has said that fines for non-compliance are $0.1 million per month and will be strictly enforced.

The directors of Sunny Days wish to know how to account for the above costs as well as any resulting deferred tax impact. Fines are not a tax allowable expense. Sunny Days pays tax at a rate of 20%.

(5 marks)

Sunny Days enters into a contract with a supplier to use a specific retail unit (Unit 5A) for a period of five years. Unit 5A is part of a larger retail space owned by the supplier. Sunny Days will use the retail unit to sell farm produce to the general public.

During the five year period, the supplier can force Sunny Days to relocate to one of the other retail units. The terms of the contract state that the supplier would have to pay all of Sunny Day’s relocation costs, and make a payment to compensate for the inconvenience. The supplier would only benefit from moving Sunny Days if a larger retailer wished to move into Unit 5A and if they were willing to commit to using this space for more than five years. This is thought to be possible, but unlikely.

Sunny Days must open and operate Unit 5A during the hours when the larger retail space is open. However, Sunny Days can sell whatever products it wishes, at whatever prices it determines. The supplier will provide cleaning and security services.

Sunny Days will make fixed quarterly payments to the supplier. Sunny Days must also make an annual variable payment, calculated as a percentage of the revenue generated by Unit 5A.

The directors of Sunny Days require advice on whether this contract contains a lease.

(6 marks)

Required:

Discuss the accounting treatment of the above transactions in the financial statements of Sunny Days for the year ended 30 September 20X4.

Note: the mark allocation is shown against each of the three events above.

Professional marks will be awarded for the clarity and quality of presentation and discussion.

(2 marks)

(Total: 25 marks)

Test your understanding 6 – Coffee

Coffee is a company with a reporting date of 30 September 20X4. Its financial statements are prepared in accordance with International Financial Reporting Standards. There are a number of unresolved accounting issues, which are detailed below.

The financial controller of Coffee was appointed during the current reporting period. She is concerned that some of the payments made this year are significantly larger than the amounts that were provided and accrued for. The two largest discrepancies are detailed below:

– Legal experts had previously advised Coffee that it would probably be found not liable in a court case concerning breaches in employee health and safety legislation. As such, a contingent liability was disclosed in the financial statements for the period ended 30 September 20X3. However, on 1 July 20X4, Coffee was found liable and was ordered to pay damages of $2 million.

Questions & Answers

– In its financial statements for the year ended 30 September 20X3, Coffee provided for income tax payable of $3 million. However, in January 20X4, Coffee’s records were inspected by the tax authorities and a number of errors were discovered. The tax authorities recommended that Coffee improve its controls and training to prevent such mistakes from happening again. Coffee was not levied with any fines but the authorities deemed that the correct amount of tax payable on profits earned in the period ended 30 September 20X3 was $4 million. Coffee paid this in July 20X4.

Coffee requires advice as to the correct accounting treatment of these two events.

(6 marks)

Coffee makes a number of loans to its customers. The interest rate on these loans is at a market rate. Within the first 12 months, Coffee sells these loan assets to another company called Tea. Tea, which is a subsidiary of Coffee, holds the loans until maturity.

At the period end, Coffee holds loan assets that it has yet to sell to Tea. Coffee wishes to know the accounting treatment of these loan assets in both its individual and group financial statements.

(8 marks)

At the end of the reporting period, Coffee bought 200 kg of gold bullion for $4 million in cash. Gold bullion is traded on an active market and can be bought and sold instantly. The fair value of gold bullion changes erratically, and Coffee made the investment with the intention of trading it at a profit in the short-term.

Coffee is unsure whether the $4 million holding of gold bullion should be classified as cash and cash equivalents in its statement of cash flows.

(4 marks)

On 1 October 20X3, Coffee spent $2 million on acquiring a customer list that would provide benefits to the business for 18 months. Coffee has used its own knowledge and expertise to enhance the customer list, and believes that this enhanced list will bring it benefits indefinitely. The directors estimate that, at the reporting date, the original list has a fair value of approximately $1.5 million and that the enhanced list has a fair value of approximately $5 million.

Coffee requires advice as to the correct accounting treatment of the customer list.

(5 marks)

Required:

Discuss the correct accounting treatment of the above transactions for the year ended 30 September 20X4.

Note: the mark allocation is shown against each of the four events above.

Professional marks will be awarded for the clarity and quality of presentation and discussion.

(2 marks)

(Total: 25 marks)

Test your understanding 7 – Bath

Bath is a public limited company with a reporting date of 30 September 20X4. Its financial statements are prepared in accordance with International Financial Reporting Standards. There are a number of unresolved accounting issues, which are detailed below.

The directors of Bath have identified a number of operating segments. Details of these are provided below:

	Total	External	Total	Profit/
	revenue	revenue	assets	(loss)
	$m	$m	$m	$m
Delivery	304	281	215	(10)
services
Vehicle hire	217	96	94	62
Removal	51	46	173	14
services
Vehicle repairs	22	14	6	8
Road rescue	15	15	8	3
	–––––	–––––	–––––	–––––
	609	452	496	77
	–––––	–––––	–––––	–––––

The segments all earn different gross profit margins and, accordingly, Bath has concluded that they exhibit different economic characteristics.

Questions & Answers

Bath requires advice as to which of the segments are reportable in its operating segments disclosure note. For this purpose, information provided in parts (b), (c) and (d) should be ignored.

(6 marks)

Bath’s road rescue division was launched in the current financial year. Customers are charged an annual upfront fee. If the customer’s vehicle breaks down during the following 12 months, Bath will send one of its mechanics out to fix or recover it.

The finance director of Bath has noticed that the vast majority of the road rescue customers did not require any breakdown assistance during the year. As such, he is proposing to recognise revenue upon receipt of the annual fee.

(5 marks)

Bath purchased a new office building on 1 October 20W4 for $20 million and this was attributed a useful economic life of 50 years. On 30 September 20X4, the decision was made to sell the office building. At this date, the fair value was $17 million and costs to sell were estimated to be $0.1 million. The building was immediately marketed for sale at $17 million and it was expected that the sale would occur within 12 months.

In October 20X4, interest rates rose dramatically leading to a sharp decline in the property market. At 31 October 20X4, it was estimated that the fair value of the building was $13 million but Bath has not reduced the advertised sales price of the building.

Bath wishes to know the correct accounting treatment of the office building in the period ended 30 September 20X4.

(6 marks)

During the reporting period, Bath purchased an investment in the shares of Bristol for $16 million and made a designation to measure them at fair value through other comprehensive income. Bath received dividends of $3 million during the reporting period. At the reporting date, the quoted price of the shares was $20 million and the present value of the estimated dividends that Bath will receive over the next 5 years was $18 million.

Bath pays income tax at a rate of 25%. The tax base of the investment in shares is based on historical cost. Since there are no plans to sell the shares, Bath believes that it would be misleading to account for any related deferred tax effects.

Bath requires advice about the accounting treatment of the investment in the shares of Bristol for the period ended 30 September 20X4.

(6 marks)

Required:

Discuss the correct accounting treatment of the above transactions for the year ended 30 September 20X4.

Note: the mark allocation is shown against each of the four events above.

Professional marks will be awarded for the clarity and quality of presentation and discussion.

(2 marks)

(Total: 25 marks)

Test your understanding 8 – Arc

Arc owns 100% of the ordinary share capital of Bend and Curve. All ordinary shares of all three entities are listed on a recognised exchange. The group operates in the engineering industry, and are currently struggling to survive in challenging economic conditions. Curve has made losses for the last three years and its liquidity is poor. The view of the directors is that Curve needs some cash investment. The directors have decided to put forward a restructuring plan as at 30 June 20X1. Under this plan:

Bend is to purchase the whole of Arc’s investment in Curve. The purchase consideration is to be $105 million payable in cash to Arc and this amount will then be loaned on a long-term unsecured basis to Curve; and

Bend will purchase land and buildings with a carrying amount of $15 million from Curve for a total purchase consideration of $25 million. The land and buildings has a mortgage outstanding on it of $8 million. The total purchase consideration of $25 million comprises both ten million $1 nominal value non-voting shares issued by Bend to Curve and the $4 million mortgage liability which Bend will assume; and

Curve had also entered into a lease obligation on 1 July 20X0 for an asset with a useful economic life of six years. The present value of the lease payments at that date was $3 million, and the implicit rate of interest associated with the lease obligation was 10.2%. The lease required that annual payments in arrears of $700,000 must be

Questions & Answers

made. No entries had been made in respect of the lease in the draft financial statements of Curve; and

A dividend of $25 million will be paid from Bend to Arc to reduce the accumulated reserves of Bend.

The draft statements of financial position of Arc and its subsidiaries at 30

June 20X1 are summarised below:

	Arc	Bend	Curve
Non-current assets:	$m	$m	$m
Non-current assets:
Tangible non-current assets	500	200	55
Cost of investment in Bend	150
Cost of investment in Curve	95
Current assets	125	145	25
	–––––	–––––	–––––
	870	345	80
Equity and liabilities	–––––	–––––	–––––
Equity and liabilities
Ordinary share capital	100	100	35
Share premium			8
Retained earnings	720	230	5
	–––––	–––––	–––––
Non-current liabilities:	820	330	48
Non-current liabilities:
Long-term loan	5		12
Current liabilities:
Trade payables	45	15	20
	–––––	–––––	–––––
	870	345	80
	–––––	–––––	–––––

As a result of the restructuring, some of Bend’s employees will be made redundant. Based upon a detailed plan, the costs of redundancy will be spread over three years with $2.08 million being payable in one year’s time, $3.245 million payable in two years’ time and $53.375 million in three years’ time. The market yield of high quality corporate bonds is 4%. The directors of Arc consider that, based upon quantification of relevant and reliable data at 30 June 20X1, it will incur additional restructuring obligations amounting to $3 million.

Required:

Prepare the individual entity statements of financial position after the proposed restructuring plan.

(13 marks)

Discuss the key implications of the proposed plans, in particular whether the financial position of each company has been improved as a result of the reorganisation.

(5 marks)

Professional marks will be awarded in part (b) for clarity and expression of your discussion.

(2 marks)

(Total: 20 marks)

Test your understanding answers

Test your understanding 1 – Cookie

Consolidated statement of financial position for the Cookie Group as at 30 April 20X4

	$m
Property, plant and equipment ($80 + $85 + $67 – $4.2	228.2
(W9) + $0.4 (W9))
Goodwill ($1 + $7) (W3)	8.0
Other intangible assets ($15 – $3) (W2)	12.0
Investments ($10 + ($15 – $10))	15.0
	–––––
	263.2
Inventories ($19 + $6 + $25 – $0.5 (W7))	49.5
Trade receivables ($17 + $13 + $33 – $4 (W7))	59.0
Cash and cash equivalents ($22 + $3 + $14)	39.0
	–––––
Total assets	410.7
	–––––
Share capital ($21 + $5 (W3))	26.0
Other components of equity (W5)	67.8
Retained earnings (W5)	115.9
	––––––
	209.7
Non-controlling interest (W4)	57.6
	––––––
	267.3
Non-current liabilities ($40 + $10 + $18 – $0.5 (W8))	67.5
Current liabilities ($23 + $18 + $38 – $4 (W7) + $1 (W10))	76.0
	––––––
	410.7
	––––––

(W2) Net assets
	Acquisition	Reporting date
Biscuit	$m	$m
Biscuit
Share capital	10	10
Retained earnings	70	79
Investments ($15 – $10)	–	5
Brand (bal. fig)	15	15
Excess amortisation	–	(3)
(($15/5) × 1 year)	––––	––––
	––––	––––
	95	106
	––––	––––

	Acquisition	Reporting date
Cracker	$m	$m
Cracker
Share capital	20	20
Other components	20	20
Retained earnings	30	43
	––––	––––
	70	83
	––––	––––
(W3) Goodwill
Biscuit		$m
Cash consideration		30.0
Share consideration (5m × $4.5)		22.5
FV of NCI at acquisition		45.0
FV of net assets at acquisition (W2)		(95.0)
		––––––
Goodwill at acquisition		2.5
Impairment (W6)		(1.5)
		––––––
Goodwill at reporting date		1.0
		––––––

The share consideration has not been accounted for. In the above calculation, $22.5m is being debited to goodwill. Adjustments will need to be made to share capital for $5m (5m shares × $1 nominal) and to other components of equity for $17.5m (5m shares × ($4.5 – $1.0)).

Cracker	$m
Consideration	56.0
NCI at acquisition (30% × $70) (W2)	21.0
FV of net assets at acquisition (W2)	(70.0)
	–––––
Goodwill	7.0
	–––––

Remember that goodwill is calculated on the date control is achieved. It is not recalculated if further shares are purchased.

(W4) Non-controlling interest
	$m
Biscuit NCI at acquisition (W3)	45.0
45% of Biscuit’s post-acquisition net assets	4.95
(45% × ($106 – $95)) (W2)
Cracker NCI at acquisition (W3)	21.0
30% of Cracker’s post-acquisition net assets between 1 May	1.95
20X3 and 1 November 20X3
(30% × (($83 – $70) × 6/12)) (W2)	0.65
10% of Cracker’s post-acquisition net assets between 1	0.65
November 20X3 and 30 April 20X4
(10% × (($83 – $70) × 6/12)) (W2)
Goodwill impairment (W6)	(0.7)
Increase in ownership (W11)	(15.3)
	––––

57.6

––––

(W5) Group reserves

Retained earnings

100% Cookie

55% of Biscuit’s post acquisition profits

(55% × ($106 – $95)) (W2)

70% of Cracker’s post-acquisition retained earnings between

1 May 20X3 and 1 November 20X3

(70% × (($83 – $70) × 6/12)) (W2)

90% of Cracker’s post-acquisition retained earnings between

1 November 20X3 and 30 April 20X4

(90% × (($83 – $70) × 6/12)) (W2)

Goodwill impairment (W6)

PURP (W7)

Loan retranslation gain (W8)

PPE capital expenditure error (W9)

PPE depreciation error (W9)

Provision (W10)

105.0

6.05

4.55

5.85

(0.8)

(0.5)

0.5

(4.2)

0.4

(1.0)

––––

115.9

––––

Other components of equity
	$m
100% Cookie	50.0
Share issue (W3)	17.5
Increase in ownership (W11)	0.3
	––––
	67.8
	––––
(W6) Goodwill impairment – Biscuit
	$m
Year-end net assets (W2)	106.0
Goodwill (W3)	2.5
	––––
	108.5
Recoverable amount	(107.0)
	––––
Impairment	1.5
	––––

Under the full goodwill method, this impairment must be allocated between the group and the NCI based on their shareholdings.

Group share: 55% × $1.5m = $0.8m (W5)

NCI share: 45% × $1.5m = $0.7m (W4)

(W7) Intra-group trading

There has been trading between Cookie and Biscuit. The profit remaining in inventory of $0.5m ($2m × 25%) must be eliminated:

Dr Retained earnings (W5)	$0.5m
Cr Inventories	$0.5m

The invoice for the sales transaction remains outstanding. Therefore, the intra-group receivable and payable must be eliminated:

Dr Payables	$4.0m
Cr Receivables	$4.0m

(W8) Loan

The loan would have been initially recorded at $4.3m (DN10m/2.3).

As a monetary liability, it must be retranslated at the year end using the closing rate. This will result in a liability of $3.8m (DN10m/2.6).

The loan therefore needs to be reduced by $0.5m ($4.3m – $3.8m)

with a gain of $0.5m being recorded in profit or loss.

Dr Non-current liabilities	$0.5m
Cr Retained earnings (W5)	$0.5m

(W9) Plant

Per IAS 16, general overheads and training are not allowed to be included within the cost of property, plant and equipment. Therefore $4.2m ($3.7m + $0.5m) should be written off to profit or loss.

Dr Retained earnings (W5)	$4.2m
Cr PPE	$4.2m

As a result of the error above, the depreciation charge for the year will be incorrect.

The depreciation charged on this asset will have been $1.5m ($15m/5 years × 6/12). The depreciation that should have been charged is $1.1m (($15m – $4.2m)/5 years × 6/12). Depreciation must therefore be reduced by $0.4m.

The correcting entry is:
Dr PPE	$0.4m
Cr Retained earnings (W5)	$0.4m

(W10) Provision

An obligation exists for Cookie to repair units that develop defects and that are still under warranty. Per IAS 37, where a provision involves a large population of items, the expected value of the outflow should be determined.

The expected value of the cost of the repairs is:
($6m × 7%) + ($14m × 4%) = $1.0m
The entry for this is:
Dr Retained earnings (W5)	$1.0m
Cr Provisions	$1.0m

(W11) Increase in ownership

Cookie obtained control over Cracker on 1 May 20X3.

On 1 November 20X3, Cookie increases its holding of shares. Goodwill is not recalculated and no gain or loss arises. Instead, this is deemed to be a transaction within equity.

There will be a decrease in the NCI. The difference between the consideration paid and the decrease in the NCI is taken to other components of equity.

	$m
Decrease in NCI (W12)	15.3
Cash paid	(15.0)
	––––
Increase in shareholders’ equity	0.3
	––––

(W12) Decrease in NCI

The NCI in Cracker has decreased from 30% to 10%, a decline of two-thirds.

The NCI in Cracker before the share purchase was $22.95m ($21.0 m + $1.95m (W4)). The decrease in the NCI is therefore $15.3m (2/3 × $22.95m).

Test your understanding 2 – Pineapple

Consolidated statement of profit or loss for the year ended 30 September 20X3

	$000
Continuing operations
Revenue	12,953
($9,854 + $3,562 – $400 (intra. co) – $63 (W1))
Cost of sales	(7,213)
($5,432 + $2,139 – $400 (intra. co) + $42 (W2))
	––––––
Gross profit	5,740
Administrative expenses	(2,147)
($1,432 + $400 + $15 (W3) + $300 GW imp.)
Distribution costs	(726)
($402 + $324)
	––––––
Profit from operations	2,867
Share of profit of associates (W4)	54
Investment income	195
($386 + $15 – $320 (W5) + $114 (W6))
Finance costs	(793)
($246 + $547 (W6))
	––––––
Profit before taxation	2,323
Taxation	(386)
($486 – $100 (W7))
	––––––
Profit for the period from continuing operations	1,937

Discontinued operations
Profit for the period from discontinued operations (W8)	1,264
	––––––
Total profit for the period	3,201
	––––––
Profit attributable to:
Equity holders of Pineapple (bal. fig.)	3,021
Non-controlling interest (W10)	180
	––––––

3,201

––––––

Group structure

Revenue

A total price of $72,000 ($3,000 × 24) should be allocated to the performance obligation to provide technical support. This should be recognised as revenue over time.

Only 3 months of the service period have passed, therefore 21 months of service revenue must be removed from Pineapple’s statement of profit or loss.

This amounts to $63,000 (21 months × $3,000 per month).

(W2) Excess depreciation

The carrying amount of the net assets acquired is $2,325,000 ($1,000,000 + $1,325,000).

The excess of the fair value over the carrying amount is therefore $1,675,000 ($4,000,000 – $2,325,000).

The extra depreciation required is $42,000 ($1,675,000/40 years).

(W3) Pensions

Pineapple is obliged to pay $45,000 ($900,000 × 5%) in the current year. It has currently paid $30,000. An accrual is required for $15,000 ($45,000 – $30,000).

(W4) Share of profit of associate
	$000
P’s share of associate’s profit	131
($1,749 × 3/12 × 30%)
P’s share of excess depreciation	(3)
($1,600/40 years × 3/12 × 30%)
Impairment	(50)
PURP	(24)
($100 × 4/5 × 30%)
	––––––
Share of profit of associate	54
	––––––

(W5) Dividends

Strawberry paid a dividend in the year of $400,000 and therefore Pineapple would have received $320,000 ($400,000 × 80%). This should be removed from investment income.

(W6) Financial assets

The financial asset should have been initially recognised at its fair value of $953,000 ($1,500,000 × (1/1.12⁴)).

The asset must be written down by $547,000 ($1,500,000 – $953,000), which will be charged to profit or loss.

The financial asset is measured at amortised cost. Investment income should be recognised at $114,000 ($953,000 × 12%).

(W7) Deferred tax

Strawberry should recognise a deferred tax asset for $100,000

($500,000 × 20%) and should credit tax in profit or loss by the same amount.

(W8) Profit from discontinued operations
	$000
Profit to disposal date	284
($568 × 6/12)
Profit on disposal (W9)	980
	–––––

1,264

–––––

(W9) Profit on disposal of Satsuma

Proceeds from disposal

Carrying amount of subsidiary

Goodwill at disposal

Consideration

NCI at acquisition

FV of net assets at acquisition ($2,000 + $2,045)

Goodwill at acquisition

Impairment (40%)

Net assets at disposal

Share capital

Retained earnings b/fwd

Profit to disposal date (W8)

$000 $000 $000

5,600

4,900

1,600

(4,045)

––––––

2,455

(982)

––––––

1,473

2,000

2,342

284

––––––

4,626

NCI at disposal

NCI at acquisition

NCI share of post-acquisition net

assets

(30% × ($4,626 – $4,045))

NCI share of impairment

(30% × $982)

Carrying amount of sub at disposal

Profit on disposal

(W10) Non-controlling interest

1,600

174

(295)

––––––

(1,479)

––––––

(4,620)

––––––

980

––––––

	$000
NCI % of Strawberry’s profit	163
(20% × ($714 + $100 (W7))
NCI % of Satsuma’s profit to disposal	85
(30% × $284 (W8))
NCI % of Strawberry’s goodwill impairment	(60)
(20% × $300)
NCI % of Strawberry’s excess depreciation	(8)
(20% × $42 (W2))
	–––––

180

–––––

Test your understanding 3 – Vinyl

Consolidated statement of financial position for the Vinyl Group as at 30 September 20X4

	$m
Property, plant and equipment ($350 + MK290/1.7 +	691.6
$160 + $11 (W2))
Goodwill ($90.6 + $3.2 (W3))	93.8
Other intangible assets (MK10/1.7 (W2))	5.9
Investment properties ($10 + $4)	14.0
Financial assets ($21 + $3.1 – $1.3 – $0.2 (W11))	22.6
	–––––
	827.9
Inventories ($49 + MK45/1.7 + $37)	112.5
Trade receivables ($76 + MK46/1.7 + $49)	152.05
Cash and cash equivalents ($52 + MK38/1.7 + $23)	97.35
	–––––
Total assets	1,189.8
	–––––
Share capital	65.0
Other components of equity (W5)	76.8
Retained earnings (W5)	572.7
Translation reserve (W6)	(88.8)
	––––––
	625.7
Non-controlling interest (W4)	96.4
	––––––
Non-current liabilities	722.1
Non-current liabilities
Loans ($200 – $6.3 (W10) + MK15/1.7 + $24)	226.5
Defined benefit pension deficit (W9)	59.0
Current liabilities ($92 + MK53/1.7 + $59)	182.2
	––––––
	1,189.8
	––––––

Workings

(W1) Group structure

(W2) Net assets
	Acquisition	Reporting date
CD	MKm	MKm
CD
Share capital	76	76
Retained earnings	210	275
Brand (bal. fig)	10	10
	––––––	––––––
	296	361
	––––––	––––––

	Acquisition	Reporting date
Tape	$m	$m
Tape
Share capital	79	79
Other components	1	6
Retained earnings	19	101
Land (bal. fig.)	11	11
	––––––	––––––
	110	197
	––––––	––––––

(W3) Goodwill
CD			MKm
Consideration			360.0
FV of NCI at acquisition			90.0
FV of net assets at acquisition (W2)			(296.0)
			––––––
Goodwill			154.0
			––––––
	MKm	Exchange Rate	$m
Opening goodwill	154.0	1.2	128.3
Exchange loss	–	Bal fig.	(37.7)
	––––––		––––––
Closing goodwill	154.0	1.7	90.6
	––––––		––––––

The total exchange loss of $37.7m will be allocated to the group and

NCI based on their respective shareholdings:

Group: $37.7m × 75% = $28.3m

NCI: $37.7m × 25% = $9.4m

Tape	$m
Consideration	100.0
NCI at acquisition	22.0
(20% × $110 (W2))
FV of net assets at acquisition (W2)	(110.0)
	––––––
Goodwill at acquisition	12.0
Impairment (W7)	(8.8)
	––––––
Goodwill at reporting date	3.2
	––––––

	(W4) Non-controlling interest
		$m
	NCI in CD at acquisition	75.0
	(MK90/1.2 (W3))
	NCI % of CD’s post acquisition net assets	11.6
	25% × (MK361 – MK296 (W2)/1.4)
	NCI % of forex on CD’s goodwill (W3)	(9.4)
	NCI % of forex on CD’s opening net assets and profit (W8)	(20.2)
	NCI in Tape at acquisition (W3)	22.0
	NCI % of Tape’s post-acquisition net assets	17.4
	20% × ($197 – $110) (W2)	––––
		––––
		96.4
		––––
	(W5) Group reserves
	Retained earnings
		$m
	100% Vinyl	501.0
	Vinyl % of CD’s post-acquisition retained earnings	34.8
	75% × (MK361 – MK296 (W2)/1.4)	65.6
	Vinyl % of Tape’s post-acquisition retained earnings	65.6
	80% × (($197 – $110) – ($6 – $1))	(8.8)
	Goodwill impairment (W7)	(8.8)
	Investment property gain ($14 – $10)	4.0
	Net interest component (W9)	(3.5)
	Service cost (W9)	(22.0)
	Financial asset – effective interest (W11)	3.1
	Financial asset – interest received (W11)	(1.3)
	Loss allowance (W11)	(0.2)
		––––
		572.7
		––––

Other components of equity
	$m
100% Vinyl	50.0
Vinyl % of Tape’s post-acquisition other components of equity	4.0
80% × ($6 – $1) (W2)	16.5
Remeasurement gain (W9)	16.5
Convertible bond (W10)	6.3
	––––
	76.8
	––––
(W6) Translation reserve
	$m
Vinyl % of forex on CD’s goodwill (W3)	(28.3)
Vinyl % of forex on CD’s opening net assets and profit (W8)	(60.5)
	––––
	(88.8)
	––––
(W7) Goodwill impairment – Tape
	$m
Year-end net assets (W2)	197.0
Goodwill (W3)	12.0
Notional NCI ($12 × 20/80)	3.0
––––––
	212.0
Recoverable amount	(201.0)
––––––
Impairment	11.0
––––––

The impairment loss is allocated to the group based on shareholding.

The impairment loss attributable to the group is therefore $8.8m

($11m × 80%). The goodwill attributable to the NCI is not recognised

under the share of net assets method. Therefore the NCI share of the

impairment is not recognised.

(W8) Forex on opening net assets and profit
	MKm	Exchange Rate	$m
Opening net assets (W2)	296.0	1.2	246.7
Profit (W2)	65.0	1.4	46.4
Exchange loss	–	Bal fig.	(80.7)
	––––––		––––––
Closing net assets	361.0	1.7	212.4
	––––––		––––––

The forex loss is split between the group and the NCI based on their respective shareholdings:

Group: $80.7m × 75% = $60.5m

NCI: $80.7m × 25% = $20.2m

(W9) Pension
	$m
Net deficit b/fwd ($50 + $20)	70.0
Net interest component ($70 × 5%)	3.5
Cash contributions	(20.0)
Service cost	22.0
Benefits paid out	–
Remeasurement gain (bal. fig.)	(16.5)
	––––––
Net deficit c/fwd ($179 – $120)	59.0
	––––––

The cash contributions have already been accounted for. Therefore, the following adjustments are required:

Net interest
Dr profit or loss	$3.5m
Cr Net pension deficit	$3.5m
Service cost
Dr profit or loss	$22.0m
Cr Net pension deficit	$22.0m
Remeasurement gain
Dr Net pension deficit	$16.5m
Cr Other comprehensive income	$16.5m

(W10) Convertible bond

The convertible bond should have been split into a liability component and an equity component. The liability component is calculated as the present value of the repayments, discounted using the interest rate on a similar debt instrument without a conversion option. The equity component is the balance of the proceeds.

The repayments are interest of $2m (500,000 × $100 × 4%) per year, plus the repayment of $50m (500,000 × $100) on 30 September 20X7.

Date	Cash flow	Discount rate	Present value
	$m		$m
30/9/X5	2.0	1/1.09	1.8
30/9/X6	2.0	1/1.09²	1.7
30/9/X7	52.0	1/1.09³	40.2
			––––––
Liability			43.7
			––––––

The liability component is initially recognised at $43.7m so the equity component is recognised at $6.3m ($50m – $43.7).

The following adjustment is required:
Dr Loans	$6.3m
Cr Other components of equity	$6.3m

(W11) Financial assets

Interest should have been charged using the effective rate.

Investment income in profit or loss should be $3.1m ($21m × 14.6%). The interest received of $1.3m should be removed from profit or loss and deducted from the carrying amount of the financial asset.

The loss allowance will reduce the net carrying amount of financial assets and is charged to profit or loss.

	The entries required are:
	Effective interest
	Dr Financial asset	$3.1m
	Cr Profit or loss	$3.1m
	Interest received
	Dr Profit or loss	$1.3m
	Cr Financial asset	$1.3m
	Loss allowance
	Dr Profit or loss	$0.2m
	Cr Loss allowance	$0.2m

Test your understanding 4 – Frank

Consolidated statement of cash flows
	$m	$m
Cash flows from operating activities
Profit before tax	88
Finance cost	12
Profit on disposal of subsidiary	(3)
Share of profit of associates	(21)
Depreciation	52
Loss on disposal of PPE ($10 – $12)	2
Impairment of goodwill (W1)	27
Gain on investment properties (W2)	(8)
Increase in inventories	(55)
($256 – $201)
Reduction in receivables	12
($219 – $263 + $32)
Increase in payables	91
(($524 – $2 PPE accrual) – $486 + $55)
	–––––
Cash generated from operations	197
Interest paid ($12 – $2 forex loss)	(10)
Taxation paid (W3)	(7)
	–––––
Net cash from operating activities		180

Cash flows from investing activities
Purchase of PPE (W4)	(54)
Proceeds from disposal of PPE	10
Cash grant received	3
Purchase of investment properties	(14)
Dividends received from associate (W5)	17
Purchase of associates	(65)
Net cash impact of subsidiary disposal	35
(W6)
	–––––
Net cash from investing activities	(68)
Cash flows from financing activities
Proceeds from share issue ($122 – $102)	20
Proceeds from loan issue (W7)	39
Dividends paid (W8)	(4)
Dividends paid to NCI (W9)	(15)
	–––––

Net cash from financing activities

Increase in cash and cash equivalents

Opening cash and cash equivalents

($42 – $148)

Closing cash and cash equivalents

($103 – $57)

–––––

152

(106)

–––––

Workings
(W1) Goodwill
	$m
Bal b/fwd	142
Disposal of subsidiary	(40)
Impairment in year (bal. fig.)	(27)
	––––––
Bal c/fwd	75
	––––––

(W2) Investment properties
	$m
Bal b/fwd	60
Additions	14
Gain in P/L (bal. fig.)	8
	––––
Bal c/fwd	82
	––––
(W3) Taxation
	$m
Bal b/fwd ($33 + $12)	45
P/L	19
OCI	10
Cash paid (bal. fig)	(7)
	––––
Bal c/fwd ($44 + $23)	67
	––––
(W4) Property, plant and equipment
	$m
Bal b/fwd	263
Depreciation	(52)
Disposal of subsidiary	(81)
Disposal of PPE	(12)
Revaluation of PPE	50
Grant	(3)
Additions (bal. fig)	56
	––––
Bal c/fwd	221
	––––

Total PPE additions are $56m but $2m of this is included in payables and therefore has not been paid. This means that cash additions are $54m ($56m – $2m).

(W5) Associates
		$m
Bal b/fwd		103
Share of profit		21
Fair value of Chip retained		32
Additions		65
Dividends received (bal. fig)		(17)
		––––
Bal c/fwd		204
		––––
(W6) Disposal of subsidiary
	$m	$m
Cash proceeds (bal. fig.)		41
FV of interest retained		32
Goodwill at disposal	40
Net assets at disposal	34
NCI at disposal	(4)
CA of subsidiary at disposal	––––	(70)
CA of subsidiary at disposal		(70)
		––––
Profit on disposal (per P/L)		3
		––––

At the disposal date, the subsidiary had cash and cash equivalents of $6m. The net cash impact of the disposal is therefore $35m ($41m – $6m).

(W7) Loans
	$m
Bal b/fwd	152
Disposal of subsidiary	(30)
Foreign exchange loss	2
Proceeds from loan issue (bal. fig.)	39
	––––
Bal c/fwd	163
	––––

	(W8) Retained earnings
		$m
	Bal b/fwd	24
	Profit attributable to equity holders	43
	Reserve transfer	1
	Dividend paid (bal. fig.)	(4)
		––––
	Bal c/fwd	64
		––––
	(W9) Non-controlling interest
		$m
	Bal b/fwd	87
	Subsidiary disposal	(4)
	Total comprehensive income	36
	Dividend paid (bal. fig.)	(15)
		––––
	Bal c/fwd	104
		––––
	(W10) Other components of equity (for proof only)
		$m
	Bal b/fwd	30
	Group share of other comprehensive income	30
	($73 TCI share – $43 profit share)
	Reserve transfer	(1)
		––––
	Bal c/fwd	59
		––––

Test your understanding 5 – Sunny Days

Biological assets

Unconditional government grants related to biological assets are recognised in profit or loss when they become receivable. The government grant of $0.2 million will be recognised immediately in profit or loss because it was unconditional.

At the reporting date, biological assets are remeasured to fair value less costs to sell with gains or losses reported in profit or loss. Fair value is defined as the price that would be received from selling an asset in an orderly transaction amongst market participants at the measurement date. Fair value is determined by reference to the principal market or, in the absence of a principal market, the most advantageous market. The most advantageous market is the market which maximizes the net selling price that an entity will receive.

The principal market cannot be determined so the fair value of the biological assets at year end must be determined with reference to the most advantageous market. The net price received in market 1 is $2.49 million ($2.6m – $0.1m – ($2.6m × 0.5%)). The net price received in market 2 is $2.39 million ($2.8m – $0.4m – ($2.8m ×

0.5%)). Market 1 is the most advantageous market and should be used to determine fair value.

The fair value of the herd is therefore $2.5 million ($2.6m – $0.1m) and the fair value less costs to sell is $2.49 million (see calculation above). The herd should be recognized at $2.49 million at the reporting date and a gain of $0.39 million (W1) will be recorded in profit or loss.

Land

The land is an item of property, plant and equipment. Revaluation losses on property, plant and equipment are recorded in profit or loss unless a revaluation surplus exists for that specific asset.

The revaluation on 30 September 20X3 of $0.2 million ($3.2m – $3.0m) would have been recorded in other comprehensive income and held within a revaluation reserve in equity. The downwards revaluation in the current reporting period is $0.5 million ($3.2m – $2.7m). Of this, $0.2 million will be charged to other comprehensive income and the remaining $0.3 million will be charged to profit or loss.

(W1) Gain on revaluation of biological assets
	$m
Bfd	1.8
Additions	0.8
Death and disposal	(0.5)
Gain	0.39
	–––––
Cfd	2.49
	–––––

To recognise a provision, IAS 37 Provisions, Contingent Liabilities and Contingent Assets says that the following criteria must be satisfied:

– There must be a present obligation from a past event

– There must be a probable outflow of economic benefits

– The costs to settle the obligation must be capable of being estimated reliably.

No provision should be recognised for the $0.8 million costs of compliance because there is no obligation to pay (Sunny Days could simply change the nature of its business activities).

A provision should be made for the $0.1 million fine because there will be a probable outflow of resources from a past obligating event (breaking the law).

The fine is not an allowable expense for tax purposes and so the difference between accounting and tax treatments is not temporary. This means that no deferred tax balance is recognised.

A contract contains a lease if it ‘conveys the right to control the use of an identified asset for a period of time in exchange for consideration’ (IFRS 16, para 9).

To assess whether this is the case, IFRS 16 Leases requires entities to consider whether the customer has:

– the right to substantially all of the identified asset’s economic benefits, and

– the right to direct the identified asset’s use.

An asset – Unit 5A – is explicitly identified in the contract. Although Sunny Days can be relocated to a different unit, the supplier is unlikely to benefit from this. Therefore Sunny Days has the right to use an identified asset over the contract term.

Sunny Days has the right to substantially all of the economic benefits resulting from the use of the unit. This is because it has exclusive use of Unit 5A for five years, enabling it to make sales and to generate profits. The payments made to the supplier based on the revenue generated are a form of consideration that is transferred in exchange for the right to use the unit.

Sunny Days has the right to direct the use of the unit because it decides what products are sold, and the price at which they are sold. The restrictions on opening times outlined in the contract define the scope of a Sunny Day’s right of use, rather than preventing Sunny Days from directing use. The supplier’s provision of security and maintenance services have no impact on how Unit 5A is used.

Based on the above, it would seem that the contract between Sunny Days and its supplier contains a lease.

Test your understanding 6 – Coffee

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors says that a prior period error is a misstatement in prior year financial statements resulting from the misuse of information which should have been taken into account. Prior period errors are adjusted for retrospectively, by restating comparative amounts. Changes in accounting estimates are accounted for prospectively by including the impact in profit or loss in the current period and, where relevant, future periods.

The court case

This is not a prior period error because Coffee had based its accounting treatment on the best information available. The payment of $2 million will be expensed to profit or loss in the year ended 30 September 20X4.

Tax

The mistakes made in the financial statements for the year ended 30 September 20X3 should not have been made based on the information available to Coffee. This therefore satisfies the definition of a prior period error. In the financial statements for the year ended 30 September 20X3 the current tax expense and the income tax payable should both be increased by $1 million.

According to IFRS 9 Financial Instruments, an investment in debt should be held at amortised cost if it passes the ‘contractual cash flows characteristics’ test and if an entity’s business model is to hold the asset until maturity. The contractual cash flows characteristics test is passed if the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

If an entity’s business model is to both hold the assets to maturity and to sell the assets, and the asset passes the contractual cash flows characteristics test, then the debt instrument should be measured at fair value through other comprehensive income. All other investments in debt instruments should be measured at fair value through profit or loss.

Coffee’s individual financial statements

Coffee regularly sells the financial assets, and therefore does not hold them in order to collect the contractual cash flows. In Coffee’s individual financial statements, the financial assets should be measured at fair value at the reporting date with any gains or losses reported in profit or loss.

Consolidated financial statements

IFRS 10 Consolidated Financial Statements says that group accounts show the incomes, expenses, assets and liabilities of a parent and its subsidiaries as a single economic entity. Any profit or loss arising on the sale of the assets between Coffee and Tea must be eliminated when producing the consolidated financial statements.

Tea holds the financial assets until maturity. Therefore, the financial assets are held within the Coffee group in order to collect the contractual cash flows. In the consolidated financial statements of the Coffee group, the financial assets should be measured at amortised cost. Assuming that credit risk is low at the reporting date, a loss allowance must be created equal to 12-month expected credit losses.

The group could designate the financial assets to be measured at fair value through profit or loss if it reduces an accounting mismatch that arises from recognising gains or losses on different bases.

IAS 7 Statement of Cash Flows defines ‘cash equivalents’ as ‘short-term, highly liquid investments that are readily convertible to a known amount of cash and which are subject to an insignificant risk of a change in value’ (IAS 7, para 6).

The gold bullion is held for investment purposes, not for the purpose of meeting short-term cash commitments. There is also a substantial risk that the gold will go up or down in value and therefore it is not convertible to a known amount of cash. The gold bullion must therefore be excluded from cash and cash equivalents in the statement of cash flows. The money spent on the gold bullion would most likely be presented within cash flows from investing activities.

Purchased intangible assets are initially measured at cost. The customer list will therefore be initially recognised at its cost of $2 million.

Expenditure on internally generated intangible assets (except those arising from development activities) cannot be distinguished from the cost of developing the business as a whole. Such items are not recognised as intangible assets. The enhancement to the list is internally generated and consequently cannot be recognised.

Intangible assets can only be held under a revaluation model if an active market exists. The customer list is bespoke and so no active market will exist. Therefore, it cannot be held at fair value.

The customer list should be amortised over its estimated useful life of 18 months. This is the period over which the benefits of the $2 million expenditure will be realised. The amortisation expense in profit or loss in the current period is $1.3 million ($2m × 12/18) and the carrying amount of the intangible at the reporting date is $0.7 million ($2m – $1.3m).

Test your understanding 7 – Bath

According to IFRS 8 Operating Segments, an entity must report information about an operating segment if its:

– total revenue (internal and external) is 10% or more of the combined revenue of all segments

– reported profit or loss is more than 10% of the greater, in absolute amount, of (i) the combined reported profit of all operating segments that did not report a loss and (ii) the combined reported loss of all operating segments that reported a loss, or

– assets are 10% or more of the combined assets of all operating segments.

If total external revenue reported by operating segments is less than 75% of the entity’s total revenue, additional operating segments must be identified as reportable.

Revenue

All segments with total revenue of greater than $60.9 million (10% × $609m) must be reported.

Delivery Services and Vehicle Hire pass this test.

Reported profit or loss

The total profit of the profit making segments is $87 million ($62m + $14m + $8m + $3m). The total loss of the loss making segments is $10 million. 10% of the greater is therefore $8.7 million (10% × $87m). This means that segments with a profit or loss of greater than $8.7 million must be reported.

Delivery Services, Vehicle Hire and Removal Services pass this test.

Assets

All segments with total assets of greater than $49.6 million (10% × $496m) must be reported.

Delivery Services, Vehicle Hire and Removal Services pass this test.

75% test

Based on the above three tests, Delivery Services, Vehicle Hire and Removal Services are reportable. Together, their external revenue is $423 million ($281m + $96m + $46m). This amounts to 93.6% ($423m/$452m) of Bath’s external revenue. Therefore, no other segments need to be reported.

According to IFRS 15 Revenue from Contracts with Customers, an entity should recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer. Entities must decide at the inception of a contract whether a performance obligation is satisfied over time or at a point in time.

An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognises revenue over time, if one of the following criteria is met:

– ‘the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs

– the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced, or

– the entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date’ (IFRS 15, para 35).

The recovery service is consumed as time passes, since the service for a prior month cannot be re-performed again in the future. Revenue should therefore be recognised over time, rather than upfront.

An output method based on the time that has elapsed on the contract would probably provide the best estimate of the amount of revenue to recognise.

Per IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, an asset is classified as held for sale if it is available for immediate sale in its present condition and the sale is highly probable. To be highly probable, there must be an active plan to find a buyer, the asset must be being marketed at a price that is reasonable in relation to its fair value, and the sale should be expected within 12 months. An asset that is classified as held for sale should be measured at the lower of its carrying amount and fair value less costs to sell.

On 30 September 20X4 the sale appeared to be highly probable as the building was being marketed at its fair value. The carrying amount of the asset at 30 September 20X4 was $16 million ($20m × (40/50)). This is lower than the fair value less costs to sell of $16.9 million ($17m – $0.1m). Therefore, the asset should continue to be held at $16m.

The rise in interest rates occurs after the end of the reporting period. Therefore, the decline in the asset’s fair value does not represent conditions that existed at the reporting date. This is a non-adjusting event. The asset will remain classified as held for sale in the financial statements for the period ended 30 September 20X4. The decline in the asset’s value should, however, be described in a disclosure note.

In accordance with IFRS 9 Financial Instruments, financial assets measured at fair value through other comprehensive income are remeasured to fair value each reporting date with the gain or loss recorded in other comprehensive income (OCI).

IFRS 13 Fair Value Measurement defines fair value as the price received when selling an asset in an orderly transaction amongst market participants at the measurement date. When determining fair value, priority is given to level 1 inputs, which are quoted prices for identical assets in active markets. Management’s estimate of the dividends that will be received from the shares is a level 3 input to the fair value hierarchy. This should not be used to determine fair value because a level 1 input exists (a quoted price for an identical asset).

The shares should be revalued to $20 million and a gain of $4 million ($20m – $16m) recognised in OCI. The gain in OCI should be classified as an item that will not be recycled to profit or loss in future periods. The dividend received of $3 million is recognised in profit or loss.

According to IAS 12, deferred tax should be calculated on the difference between the carrying amount of a revalued asset and its tax base, even if there is no intention to dispose of the asset. The temporary difference of $4 million ($20m – $16m) will give rise to a deferred tax liability of $1 million ($4m × 25%). The gain on the investment was recognised in OCI and therefore the deferred tax charge will also be recognised in OCI.

Test your understanding 8 – Arc

(a) Arc – restatement

	Initial	AdjustsNotes		Final
Non-current assets:	$m	$m		$m
Non-current assets:	500			500
Tangible non-current assets	500			500
Cost of investment in Bend	150			150
Cost of investment in Curve	95	(95)	(1)
Loan to Curve		105(2)		105
Current assets	125	105(1)		150
		(105)	(2)
		25(3)
	–––––	–––––		–––––
	870	35		905
Equity and liabilities:	–––––	–––––		–––––
Equity and liabilities:	100			100
Ordinary share capital	100			100
Retained earnings	720	10(1)		755
		25(3)
	–––––	–––––		–––––
Non-current liabilities:	870	35		855
Non-current liabilities:	5			5
Long-term loan	5			5
Current liabilities:	45			45
Trade payables	45			45
	–––––	–––––		–––––
	870	35		905
	–––––	–––––		–––––

Notes:

Disposal of investment in Curve for $105m, resulting in a profit of $10m.

Long-term loan made to Curve.

Dividend due from Bend.

(a) Bend restatement
	Initial	AdjustsNotes		Final
Non-current assets:	$m	$m		$m
Non-current assets:	200	25(3)		225
Tangible non-current assets	200	25(3)		225
Cost of investment in Curve		105(1)		105
Current assets	145	(105)	(1)	15
		(25)	(2)
	–––––	–––––		–––––
	345	–		345
Equity and liabilities:	–––––	–––––		–––––
Equity and liabilities:	100	10(3)		110
Ordinary share capital	100	10(3)		110
Share premium		11(3)		11
Retained earnings	230	(25)	(2)	205
	–––––	–––––		–––––
Non-current liabilities:	330	(4)		326
Non-current liabilities:		4(3)		4
Long-term loan		4(3)		4
Current liabilities:	15			15
Trade payables	15			15
	–––––	–––––		–––––
	345	–		345
	–––––	–––––		–––––

Notes:

Purchase of investment in Curve for $105m.

Dividend due to Arc.

Purchase of land and buildings from Curve – comprising:

	$m
Non-voting shares of $1 each	10
Share premium (bal fig)	11
Mortgage liability taken over	4
	–––––
	25
	–––––

3 – Lease obligation as follows:

	Bal b/fwd	Int @ 10.2%	Cash paid	Bal c/fwd
	$000	$000	$000	$000
Y/end 30/06/X1	3,000	306	(700)	2,606
Y/end 30/06/X2	2,606	266	(700)	2,172

Current liability element = $2,606,000 – $2,172,000 = $434,000

(a) Curve – restatement

Non-current assets:

Tangible non-current assets

Lease assets

Cost of investment in Bend Current assets

Equity and liabilities:

Ordinary share capital

Share premium

Retained earnings

Non-current liabilities:

Long-term loan

Loan from Arc

Lease obligation

Initial	AdjustsNotes	Final
$m	$m	$m
55	(15.0)(2)	40.0
	3.0(3)	2.5
	(0.5)(3)
	21.0	21.0
25	105.0(1)	129.3
	(0.7)(3)
–––––	–––––	–––––
80	112.8	192.8
–––––	–––––	–––––
35		35.0
8		8.0
5	10.0(2)	14.2
	(0.5)(3)
	(0.3)(3)
–––––	–––––	–––––
48	9.2	57.2
12	(4.0)	8.0
	105.0(1)	105.0
	3.0(3)	2.2
	0.3(3)

(0.7)(3)

(0.4)(3)

Current liabilities:		(0.4)(3)	0.4
Lease obligation		(0.4)(3)	0.4
Trade payables	20		20.0
	–––––	–––––	–––––
	80	112.8	192.8
	–––––	–––––	–––––

Notes:

1	– Loan from Arc of $105m.
2	– Sale of land and buildings to Bend as follows:
		$m
	Disposal proceeds (Mort tfr at + shares at FV $21m)	25
	CV of land and buildings	15
		–––
	Profit on disposal	10
		–––

The plan has no impact on the group financial statements as all of the internal transactions will be eliminated on consolidation but does affect the individual accounts of the companies. The reconstruction only masks the problem facing Curve. It does not solve or alter the business risk currently being faced by the group.

A further issue is that such a reorganisation may result in further costs and expenses being incurred. Note that any proposed provision for restructuring must meet the requirements of IAS 37 Provisions, Contingent Liabilities and Contingent Assets before it can be included in the financial statements. A constructive obligation will arise if there is a detailed formal plan produced and a valid expectation in those affected that the plan will be carried out. This is normally crystallised at the point when there is communication by the company with those who are expected to be affected by the plan.

The transactions outlined in the plans are essentially under common control and must be viewed in this light. This plan overcomes the short-term cash flow problem of Curve and results in an increase in the accumulated reserves. The plan does show the financial statements of the individual entities in a better light except for the significant increase in long-term loans in Curve’s statement of financial position. The profit on the sale of the land from Curve to Bend will be eliminated on consolidation.

In the financial statements of Curve, the investment in Bend should be accounted for under IFRS 9. There is now cash available for Curve and this may make the plan attractive. However, the dividend from Bend to Arc will reduce the accumulated reserves of Bend but if paid in cash will reduce the current assets of Bend to a critical level.

The purchase consideration relating to Curve may be a transaction at an overvalue in order to secure the financial stability of the former entity. A range of values are possible which are current value, carrying amount or possibly at zero value depending on the purpose of the reorganisation. Another question which arises is whether the sale of Curve gives rise to a realised profit. Further, there may be a question as to whether Bend has effectively made a distribution. This may arise where the purchase consideration was well in excess of the fair value of Curve. An alternative to a cash purchase would be a share exchange. In this case, local legislation would need to be reviewed in order to determine the requirements for the setting up of any share premium account.

Posted on March 31, 2021March 31, 2021 by MJ — 1 Comment

UK GAAP

1 Purpose of chapter

The P2 UK paper

This chapter contains the additional syllabus content required for those who are sitting the P2 UK paper.

If you are sitting the P2 INT paper then you do not need to study this chapter.

2 UK GAAP

UK standards

Guidance about the accounting standards that UK companies should apply is found within FRS 100 Application of Financial Reporting Requirements. The rules are as follows:

Listed groups must prepare their accounts under IFRS.

– However, the companies within the group can take advantage of disclosure exemptions outlined in FRS 101 when preparing their individual (non-consolidated) financial statements.

Other UK companies will apply FRS 102 The Financial Reporting Standard Applicable in the UK and the Republic of Ireland unless:

– they voluntarily choose to apply IFRS, or

– they are a micro-entity and choose to apply FRS 105 The Financial Reporting Standard Applicable to the Micro-Entities Regime.

Purpose of chapter

The P2 UK paper

This chapter contains the additional syllabus content required for those who are sitting the P2 UK paper.

If you are sitting the P2 INT paper then you do not need to study this chapter.

2 UK GAAP

UK standards

Guidance about the accounting standards that UK companies should apply is found within FRS 100 Application of Financial Reporting Requirements. The rules are as follows:

Listed groups must prepare their accounts under IFRS.

– However, the companies within the group can take advantage of disclosure exemptions outlined in FRS 101 when preparing their individual (non-consolidated) financial statements.

Other UK companies will apply FRS 102 The Financial Reporting Standard Applicable in the UK and the Republic of Ireland unless:

– they voluntarily choose to apply IFRS, or

– they are a micro-entity and choose to apply FRS 105 The Financial Reporting Standard Applicable to the Micro-Entities Regime.

A small entity that applies FRS 102:

– does not have to show other comprehensive income

– does not have to produce a statement of cash flows

– is exempt from many of the disclosure requirements of FRS 102.

FRS 101

FRS 101 Reduced Disclosure Framework applies to the individual financial statements of subsidiaries and ultimate parent companies. It provides exemptions from disclosure requirements that will result in cost savings when producing individual financial statements. FRS 101 does not apply to consolidated financial statements.

To apply FRS 101, the shareholders of a qualifying entity must have been notified about its use and they must not object.

FRS 102

FRS 102 is a single standard that is organised by topic.

Although FRS 102 is based on IFRS for Small and Medium Entities (the SMEs Standard), there are differences. The differences that are examinable in the P2 UK syllabus are outlined later in this chapter.

FRS 105

The Financial Reporting Council has withdrawn the Financial Reporting Standard for Smaller Entities (FRSSE). Micro-entities can now choose to prepare their financial statements in accordance with FRS 105 The Financial Reporting Standard Applicable to the Micro-entities Regime.

An entity qualifies as a micro-entity if it satisfies two of the following three requirements:

Turnover of not more than £632,000 a year

Gross assets of not more than £316,000

An average number of employees of 10 or less.

FRS 105 is based on FRS 102 but with some amendments to satisfy legal requirements and to reflect the simpler nature of micro-entities. For example, FRS 105:

Prohibits accounting for deferred tax

Prohibits accounting for equity-settled share-based payments prior to the issue of the shares

Prohibits the revaluation model for property, plant and equipment, intangible assets and investment properties

Prohibits the capitalisation of borrowing costs

Prohibits the capitalisation of development expenditure as an intangible asset

Simplifies the rules around classifying a financial instrument as debt or equity

Removes the distinction between functional and presentation currencies.

There are very few disclosure requirements in FRS 105.

3 Examinable differences between International and UK standards

Examinable differences between FRS 102 and the SMEs Standard

Although FRS 102 is based on IFRS for Small and Medium Entities (the SMEs Standard), there are differences. Some of these differences are included in the UK P2 syllabus.

Financial statement presentation

To comply with Companies Act, FRS 102 allows a ‘true and fair over-ride’. If compliance with FRS 102 is inconsistent with the requirement to give a true and fair view, the directors must depart from FRS 102 to the extent necessary to give a true and fair view. Particulars of any such departure, the reasons for it and its effect are disclosed.

Statement of cash flows

Under FRS 102, small entities, mutual life assurance companies, pension funds and certain investment funds are not required to produce a statement of cash flows. This exemption does not exist under the SMEs Standard.

Consolidated and separate financial statements

Under the SMEs Standard, a parent need not present consolidated financial statements if the parent is itself a subsidiary, and its ultimate parent (or any intermediate parent) produces consolidated general purpose financial statements that comply with full IFRS and IAS Standards or the SMEs Standard.

FRS 102 makes some slight amendments to the above to comply with Companies Act. In particular, consolidated financial statements do not need to be produced if the parent, and group headed by it, qualifies as small. The requirements of Companies Act are dealt with in more detail later in this chapter.

Inventories

FRS 102 specifies that the cost of inventories acquired through a non-exchange transaction (such as a donation or legacy) should be measured at the fair value of the inventories at the acquisition date. The SMEs Standard does not mention this issue.

Investments in associates

FRS 102 explicitly clarifies that an investment in an associate cannot be equity accounted in the individual financial statements of a company that is a parent. Instead, the investment in associate can be held at cost or fair value.

Under FRS 102, the cost of an associate should include transaction costs. These are excluded from the cost of the associate under the SMEs Standard.

Investments in joint ventures

FRS 102 explicitly clarifies that an investment in a jointly controlled entity cannot be equity accounted in the individual financial statements of a company that is a parent. Instead, the investment can be held at cost or fair value.

Under FRS 102, the cost of a joint venture should include transaction costs. These are excluded from the cost of the joint venture under the SMEs Standard.

Intangible assets

Under FRS 102, an intangible asset arising from development activity can be recognised if certain criteria are met. These criteria are broadly the same as under IAS 38. According to the SMEs Standard, research and development expenditure is always written off to profit or loss.

Under FRS 102, intangible assets can be held under the cost model or the revaluation model. The SMEs Standard does not permit the revaluation model.

Business combinations and goodwill

According to FRS 102:

Negative goodwill (where the fair value of the net assets acquired exceeds the consideration) is recognised on the statement of financial position immediately below goodwill. It should be followed by a subtotal of the net amount of goodwill and the negative goodwill.

The subsequent treatment of negative goodwill is that any amount up to the fair value of non-monetary assets acquired is recognised in profit or loss in the periods in which the non-monetary assets are recovered. Any amount exceeding the fair value of non-monetary assets acquired must be recognised in profit or loss in the periods expected to be benefited.

Under the SMEs Standard negative goodwill is recognised immediately in profit or loss.

Government grants

Under FRS 102, two methods of recognising government grants are allowed:

The performance model

– If no conditions are attached to the grant, it is recognised as income immediately.

– If conditions are attached to the grant, it is only recognised as income when all conditions have been met.

The accruals model

– Grants are recognised as income on a systematic basis, either as costs are incurred (revenue grants) or over the asset’s useful life (capital grants).

Under the SMEs Standard only the performance model for recognising government grants is allowed.

Borrowing costs

Under FRS 102, an entity may capitalise borrowing costs that are directly attributable to the construction, acquisition or production of a qualifying asset. Under the SMEs Standard all borrowing costs are recognised as an expense in profit or loss.

Under FRS 102, the projected unit credit method must be used to estimate the defined benefit obligation.

In contrast, the SMEs Standard allows some simplified estimation techniques if an entity is not able, without undue cost or effort, to use the projected unit credit method to measure its obligation and cost under defined benefit plans. Entities are permitted to:

‘ignore estimated future salary increases

ignore future service of current employees

ignore possible in-service mortality of current employees between the reporting date and the date employees are expected to begin receiving post-employment benefits’ (SMEs Standard, para 28.19).

Related parties

FRS 102 permits an additional exemption from the disclosure of related party transactions than the SMEs Standard. FRS 102 states that disclosures need not be given of transactions entered into between two or more members of a group, provided that any subsidiary which is a party to the transaction is wholly owned by such a member.

Income tax

The income tax section of FRS 102 differs significantly from the SMEs Standard.

Profit or loss/statement of financial position:

– FRS 102 adopts a profit or loss approach to the recognition of deferred tax. Timing differences are defined as differences between taxable profits and total comprehensive income as stated in the financial statements that arise from the inclusion of income and expenses in tax assessments in periods different from those in which they are recognised in financial statements.

– FRS 102 makes an exception to this rule. It states that deferred tax should also be recognised based on the differences between the tax value and fair value of assets and liabilities acquired in a business combination.

– In contrast, the SMEs Standard conceptualises deferred tax through the statement of financial position. The standard states that deferred tax should be accounted for based on differences

‘between the amounts recognised for the entity’s assets and liabilities in the statement of financial position and the recognition of those assets and liabilities by the tax authorities’ (SMEs Standard, para 29.9).

Permanent differences:

– FRS 102 uses the concept of permanent differences. Permanent differences arise because certain types of income and expenses are non-taxable or disallowable, or because certain tax charges or allowances are greater or smaller than the corresponding income or expense in the financial statements. Deferred tax is not recognised on permanent differences.

– The SMEs Standard does not use the terminology ‘permanent difference’. Instead, it says that deferred tax assets and liabilities are recognised for ‘temporary differences’.

4 Companies Act

Examinable Companies Act requirements

The UK syllabus for P2 specifies that candidates must know the basic Companies Act requirements surrounding when single and group entity financial statements are required and when a subsidiary may be excluded from the group financial statements.

Single entity financial statements

A company is exempt from the requirement to prepare individual accounts for a financial year if:

it is itself a subsidiary undertaking

it has been dormant throughout the whole of that year, and

its parent undertaking is established under the law of an EEA State.

Group financial statements

A company subject to the small companies regime may prepare group accounts for the year.

If not subject to the small companies regime, a parent company must prepare group accounts for the year unless one of the following applies:

A company is exempt from the requirement to prepare group accounts if it is itself a wholly-owned subsidiary of a parent undertaking.

A parent company is exempt from the requirement to prepare group accounts if, under section 405 of Companies Act, all of its subsidiary undertakings could be excluded from consolidation.

Exclusion of a subsidiary from consolidation

Where a parent company prepares Companies Act group accounts, all the subsidiary undertakings of the company must be included in the consolidation, subject to the following exceptions:

A subsidiary undertaking may be excluded from consolidation if its inclusion is not material for the purpose of giving a true and fair view (but two or more undertakings may be excluded only if they are not material taken together).

A subsidiary undertaking may be excluded from consolidation where:

– severe long-term restrictions substantially hinder the exercise of the rights of the parent company over the assets or management of that undertaking

– the information necessary for the preparation of group accounts cannot be obtained without disproportionate expense or undue delay

– the interest of the parent company is held exclusively with a view to subsequent resale.

5 Question practice

UK focus question – Stream

Stream is a medium sized company which has invested in several smaller companies. The draft profit after tax in the consolidated statements for the year ended 31 December 20X1 is $5 million. However, advice is required about the following transactions:

During 20X1, Stream spent $500,000 on development activities. These activities are still ongoing as at 31 December 20X1. However, the Directors of Stream firmly believe that this development will lead to future economic benefits. Stream has adequate resources to complete the development. The cash spent to date has been recognised as an intangible asset.

On 1 January 20X1, Stream took out a $10 million 6% bank loan to finance the construction of a new head office building. Construction commenced on 1 January 20X1 and was still ongoing at the year end. Interest on the loan for the year has been charged as an expense.

If a choice of accounting treatment exists, the Directors of Stream wish to select the policy that will maximise reported assets.

Required:

Calculate the revised consolidated profit after tax for the year ended 31 December 20X1 assuming that Stream prepares its accounts using:

The SMEs Standard

FRS 102

Solution

	(a) SMEs Standard	(b) FRS 102
	$000	$000
Draft profit	5,000	5,000
Issue (i)	(500)	–
Issue (ii)	–	600
	–––––	–––––
Revised profit	4,500	5,600
	–––––	–––––

Explanations

According to the SMEs Standard, expenditure on development activity must be recognised as an expense. Therefore, if accounting under the SMEs Standard, the development asset currently recognised must be written off.

Expenditure on development can be capitalised under FRS 102 if relevant criteria are satisfied.

Borrowing costs must be expensed under the SMEs Standard.

According to FRS 102, borrowing costs can be included within the cost of a qualifying asset. Therefore, if Stream accounted under FRS 102, it would be able to reverse out the interest expense of $600,000 ($10m × 6%) and instead recognise it as part of the cost of its property, plant and equipment.

UK GAAP

UK focus question – Sofa

Sofa is a company that has a number of investments. Sofa exercises control over some of these investments and significant influence over others.

Required:

Advise the Directors of Sofa as to the key differences between the SMEs Standard and FRS 102 that would impact the consolidated financial statements of the Sofa group. Where possible, discuss the potential impact that these differences would have on profit.

Solution

Under the SMEs Standard, negative goodwill is recognised immediately in profit or loss. According to FRS 102, negative goodwill is recognised on the statement of financial position as a deduction against goodwill.

If a company acquires ‘negative goodwill’, the treatment under the SMEs Standard would lead to higher reported profits in the year of acquisition.

Under FRS 102, the cost of an associate should include transaction costs. These are excluded from the cost of the investment under the SMEs Standard and are instead written off to profit or loss.

Under the SMEs Standard, profits will be lower in the year when an associate is acquired than under FRS 102.

The lower carrying amount of the associate under the SMEs Standard may mean that impairments are less likely in the future.

UK focus question – FRS 105

You advise a client who is in the process of incorporating a new UK-based company. The company would qualify as a micro-entity and, as such, could apply FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime. Alternatively, it could apply FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland.

Required:

What factors should be considered when establishing whether the client should use FRS 105?

Solution

FRS 105 requires far fewer disclosures than FRS 102. This will reduce the time and cost burden of producing financial statements. However, consideration should be given to whether the users of the financial statements will find this lack of disclosure a hindrance to making economic decisions. This is unlikely in the case of such a small company.

FRS 105 does not permit property, plant and equipment, intangible assets or investment properties to be held at fair value. This will have a big impact on perception of the company’s financial position.

Accounting policy choices allowed in FRS 102 have been removed in FRS 105. For instance, borrowing costs and development costs must be expensed. Profits reported under FRS 105 may be lower than if FRS 102 was applied.

If the company is expected to grow quickly, it might be easier to simply apply FRS 102 from the outset. That way, it will avoid the burden of transitioning from FRS 105 to FRS 102 at a later date.

Posted on March 31, 2021March 31, 2021 by MJ — Leave a comment

Group statement of cash flows

Objective of statements of cash flows

IAS 7 Statement of Cash Flows provides guidance on the preparation of a statement of cash flows. The objective of a statement of cash flows is to provide information on an entity’s changes in cash and cash equivalents during the period.

The statement of financial position and statement of profit or loss are prepared on an accruals basis and do not show how the business has generated and used cash in the reporting period. The statement of profit or loss may show profits even though the company is suffering severe cash flow problems. A statement of cash flows is therefore important because it enables users of the financial statements to assess the liquidity, solvency and financial adaptability of the business.

Definitions

Cash consists of cash in hand and deposits repayable upon demand, less overdrafts. This includes cash held in a foreign currency.

Cash equivalents are ‘short-term, highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of changes in value’ (IAS 7, para 6).

Cash flows are ‘inflows and outflows of cash and cash equivalents’ (IAS 7, para 6).

2 Classification of cash flows

IAS 7 does not prescribe a specific format for the statement of cash flows, although it requires that cash flows are classified under one of three headings:

cash flows from operating activities, defined as the entity’s principal revenue earning activities and other activities that do not fall under the next two headings

cash flows from investing activities, defined as the acquisition and disposal of long-term assets and other investments (excluding cash equivalents)

cash flows from financing activities, defined as activities that change the size and composition of the entity’s equity and borrowings.

Proforma statement of cash flow per IAS 7
Cash flows from operating activities	$	$
Cash flows from operating activities	X
Profit before tax	X
Add: finance costs	X
Less: investment income	(X)
Less: income from associate	(X)
Adjust for non-cash items dealt with in arriving at
operating profit:
Add: depreciation	X
Less: gain on disposal of subsidiary	(X)
Add: loss on disposal of subsidiary	X
Add: loss on impairment charged to P/L	X
Add: loss on disposal of non-current assets	X
Add: increase in provisions	X
	––––
Changes in working capital:	X/(X)
Changes in working capital:
Increase in inventory	(X)
Increase in receivables	(X)
Decrease in payables	(X)
	––––
Cash generated/used from operations	X/(X)
Interest paid	(X)
Taxation paid	(X)
Net cash Inflow/(outflow) from operating	––––
Net cash Inflow/(outflow) from operating		X/(X)
activities

Cash flows from investing activities
Payments to purchase NCA	(X)
Receipts from NCA disposals	X
Net cash paid to acquire subsidiary	(X)
Net cash proceeds from subsidiary disposal	X
Cash paid to acquire associates	(X)
Dividend received from associate	X
Interest received	X
Net cash inflow/(outflow) from investing	––––
activities
	X/(X)
Cash flows from financing activities
Proceeds from share issue	X
Proceeds from loan or debenture issue	X
Cash repayment of loans or debentures	(X)
Lease liability repayments	(X)
Equity dividend paid by parent	(X)
Dividend paid to NCI	(X)
Net cash inflow/(outflow) from financing	––––
activities
	X/(X)
	––––
Increase/(decrease) in cash and equivalents	X/(X)
Cash and equivalents brought forward	X/(X)
	––––
Cash and equivalents carried forward	X/(X)
	––––

Classification of cash flows

Cash flows from operating activities

The key figure within cash flows from operating activities is ‘cash generated from operations’. There are two methods of calculating cash generated from operations:

The direct method shows operating cash receipts and payments, such as cash receipts from customers, cash payments to suppliers and cash payments to and on behalf of employees.

The indirect method (used in the proforma statement of cash flows presented earlier in the chapter) starts with profit before tax and adjusts it for non-cash charges and credits, deferrals or accruals of past or future operating cash receipts and payments, as well as for items that relate to investing and financing activities. The most frequently occurring adjustments required are:

– finance costs and investment incomes

– depreciation or amortisation charges in the year

– impairment charged to profit or loss in the year

– profit or loss on disposal of non-current assets

– change in inventories

– change in trade receivables

– change in trade payables.

IAS 7 permits either method, although encourages the use of the direct method. The methods differ only in respect of how the item ‘cash generated from operating activities’ is derived. A comparison between the direct and indirect method to arrive at cash generated from operations is shown below:

Direct method:	$m	Indirect method:	$m
Cash receipts from customers	15,424	Profit before tax	6,022
Cash payments to suppliers	(5,824)	Depreciation charges	899
Cash payments to and on behalf (2,200)		Increase in inventories	(194)
of employees
Other cash payments	(511)	Increase in receivables	(72)
		Increase in payables	234
	––––		––––
Cash generated from operations	6,889	Cash generated from	6,889
	––––	operations	––––
	––––		––––

The principal advantage of the direct method is that it discloses operating cash receipts and payments. Knowledge of the specific sources of cash receipts and the purposes for which cash payments have been made in past periods may be useful in assessing and predicting future cash flows.

Cash flows from investing activities

Cash flows to appear under this heading include:

cash paid for property, plant and equipment and other non-current assets

cash received on the sale of property, plant and equipment and other non-current assets

cash paid for investments in or loans to other entities (excluding movements on loans from financial institutions, which are shown under financing)

cash received for the sale of investments or the repayment of loans to other entities (again excluding loans from financial institutions).

Cash flows from financing activities

Financing cash flows mainly comprise receipts or repayments of principal from or to external providers of finance.

Financing cash inflows include:

receipts from issuing shares or other equity instruments

receipts from issuing debentures, loans, notes and bonds and from other long-term and short-term borrowings (other than overdrafts, which are normally included in cash and cash equivalents).

IAS 7 says that financing cash outflows include:

repayments of amounts borrowed (other than overdrafts)

the capital element of lease payments

payments to reacquire or redeem the entity’s shares.

Interest and dividends

IAS 7 allows interest and dividends, whether received or paid, to be classified under any of the three headings, provided the classification is consistent from period to period.

The practice adopted in this text is to classify:

interest received as a cash flow from investing activities

interest paid as a cash flow from operating activities

dividends received as a cash flow from investing activities

dividends paid as a cash flow from financing activities.

3 Cash and cash equivalents

The statement of cash flows reconciles cash and cash equivalents at the start of the reporting period to the end of the reporting period.

Cash equivalents are ‘short-term, highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of changes in value’ (IAS 7, para 6).

‘Cash equivalents’ are held in order to meet short-term cash commitments. They are not held for investment purposes.

IAS 7 does not define ‘readily convertible’ but notes that an investment would qualify as a cash equivalent if it had a short maturity of ‘three months or less from the date of acquisition’ (IAS 7, para 7).

Equity investments are generally excluded from being included in cash equivalents because there is a significant risk of a change in value. IAS 7 makes an exception for preference shares with a short period to maturity and a specified redemption date.

Test your understanding 1 – Cash and cash equivalents

The accountant for Minted, a company, is preparing a statement of cash flows. She would like advice about whether the following items can be included within ‘cash and cash equivalents’.

An overdraft of $100,000.

A balance of $500,000 held in a high-interest account. Minted must give 28 days’ notice in order to access this money, which is held with the intention of meeting working capital shortages.

An investment in the ordinary shares of Moolah. The shares are listed and therefore could be sold immediately. The shares have a fair value of $1m.

Required:

Advise the accountant of Minted whether the above items qualify as ‘cash and cash equivalents’.

Unusual items and non-cash transactions

Unusual cash flows

Where cash flows are unusual because of their size or incidence, sufficient disclosure should be given to explain their cause and nature.

For a cash flow to be unusual on the grounds of its size alone, it must be unusual in relation to cash flows of a similar nature.

Discontinued activities

Cash flows relating to discontinued activities are required by IFRS 5 to be shown separately, either on the face of the statement of cash flows or in a disclosure note.

Major non-cash transactions

Material transactions not resulting in movements of cash should be disclosed in the notes to the statement of cash flows if disclosure is necessary for an understanding of the underlying transactions.

4 Individual statements of cash flows

For your F3 and F7 exams, you will have learned how to prepare statements of cash flows for individual companies. It may be worthwhile taking some time to revise this knowledge using the following exercises.

Test your understanding 2 – Extracts

Calculate the required cash flows in each of the following scenarios:

(1)	20X1	20X0
	$	$
Property, plant and equipment (PPE)	250	100

During the year depreciation charged was $20, a revaluation surplus of $60 was recorded, and PPE with a carrying amount of $15 was disposed of. The carrying amount of assets recognised through lease agreements and classified as PPE was $30.

Required:

How much cash was spent on property, plant and equipment in the period?

(2)	20X1	20X0
	$	$
Deferred tax liability	100	50
Income tax liability	120	100

The income tax charge in the statement of profit or loss was $180.

Required:
How much tax was paid in the period?
(3)	20X1	20X0
	$	$
Retained earnings	300	200

The statement of profit or loss showed a profit for the period of $150.

Required:

How much was the cash dividend paid during the period?

Illustration – Single entity statements of cash flows

Below are the financial statements of Single for the year ended 30

September 20X2:

Statement of financial position as at 30 September 20X2 (including comparatives)

	20X2	20X1
Non-current assets	$m	$m
Non-current assets
Property, plant and equipment	90	60
Current assets	32	20
Inventories	32	20
Trade receivables	20	27
Cash and cash equivalents	8	12
	–––––	–––––
	150	119
	–––––	–––––

Equity and liabilities
Share capital ($1 shares)	30	5
Retained earnings	60	35
	–––––	–––––
Non-current liabilities:	90	40
Non-current liabilities:
Loans	10	29
Deferred tax	15	14
Current liabilities:
Trade payables	23	25
Tax payable	12	11
	––––––	––––––
	150	119
	––––––	––––––

Statement of profit or loss for the year ended 30 September 20X2

	$m
Revenue	450
Operating expenses	(401)
	––––––
Profit from operations	49
Finance cost	(3)
	––––––
Profit before tax	46
Tax	(12)
	––––––
Profit for the period	34
	––––––

Notes

Property, plant and equipment with a carrying amount of $9 million was disposed of for cash proceeds of $13 million. Depreciation for the year was $17 million.

Trade payables as at 30 September 20X2 includes accruals for interest payable of $4 million (20X1: $5 million).

Required:

Prepare the statement of cash flows for Single for the year ended 30 September 20X2.

Solution

Statement of cash flows
Cash flows from operating activities	$m	$m
Cash flows from operating activities
Profit before tax	46
Finance cost	3
Depreciation	17
Profit on disposal of PPE	(4)
($13 – $9)	(12)
Increase in inventories	(12)
($32 – $20)	7
Decrease in receivables	7
($20 – $27)	(1)
Decrease in payables	(1)
(($23 – $4) – ($25 – $5))	–––––
	–––––
	56
Interest paid (W1)	(4)
Tax paid (W2)	(10)
	–––––	42
		42
Cash flows from investing activities
Cash flows from investing activities
Proceeds from sale of PPE	13
Purchases of PPE (W3)	(56)
	–––––	(43)
Cash flows from financing activities		(43)
Cash flows from financing activities
Proceeds from shares ($30 – $5)	25
Repayment of loans ($10 – $29)	(19)
Dividends paid (W4)	(9)
	–––––	(3)
		(3)
		–––––
Decrease in cash and cash equivalents		(4)
Opening cash and cash equivalents		12
		–––––
Closing cash and cash equivalents		8
		–––––

	Workings
	(W1) Interest
		$m
	Balance b/fwd	5
	Profit or loss	3
	Cash paid (bal. fig.)	(4)
		–––––
	Balance c/fwd	4
		–––––
	(W2) Tax
		$m
	Balance b/fwd ($14 + $11)	25
	Profit or loss	12
	Cash paid (bal. fig.)	(10)
		–––––
	Balance c/fwd ($15 + $12)	27
		–––––
	(W3) PPE
		$m
	Balance b/fwd	60
	Depreciation	(17)
	Disposal	(9)
	Cash paid (bal. fig)	56
		–––––
	Balance c/fwd	90
		–––––
	(W4) Retained earnings
		$m
	Balance b/fwd	35
	Profit or loss	34
	Cash dividends paid (bal. fig.)	(9)
		–––––
	Balance c/fwd	60
		–––––

5 Preparation of a consolidated statement of cash flows

A consolidated statement of cash flows shows the cash flows between a group and third parties. It is prepared using the consolidated statement of financial position and the consolidated statement of profit or loss. This means that intra-group transactions have already been eliminated.

When producing a consolidated statement of cash flows, there are three extra elements that need to be considered:

acquisitions and disposals of subsidiaries

cash paid to non-controlling interests

Acquisitions and disposals of subsidiaries

Acquisitions

In the statement of cash flows we must record the actual cash flow for the purchase of the subsidiary net of any cash held by the subsidiary that is now controlled by the group.

The assets and liabilities of the acquired subsidiary must be included in any workings to calculate the cash movement for an item during the year.

Illustration – Acquisition of a subsidiary

Sparkling buys 70% of the equity shares of Still for $500,000 in cash. At the acquisition date, Still had cash and cash equivalents of $25,000.

Although Sparkling paid $500,000 for the shares, it also gained control of Still’s cash of $25,000. In the consolidated statement of cash flows, this would be presented as follows:

Cash flows from investing activities

$000

Acquisition of subsidiary, net of cash acquired (475)

($500,000 – $25,000)

Disposals

The statement of cash flows will show the cash received from the sale of the subsidiary, net of any cash held by the subsidiary that the group has lost control over.

The assets and liabilities of the disposed subsidiary must be included in any workings to calculate the cash movement for an item during the year.

Illustration – Disposal of a subsidiary

Sparkling owned 80% of the equity shares of Fizzy. During the period, these shares were sold for $800,000 in cash. At the disposal date, Fizzy had cash and cash equivalents of $70,000.

Although Sparkling received $800,000 for the shares, it lost control of Fizzy’s cash of $70,000. In the consolidated statement of cash flows, this would be presented as follows:

Cash flows from investing activities

$000

Disposal of subsidiary, net of cash disposed of 730 ($800,000 – $70,000)

Illustration 1 – Acquisitions and disposals

Extracts from a group statement of financial position are presented below:

	20X8	20X7
	$000	$000
Inventories	74,666	53,019
Trade receivables	58,246	62,043
Trade payables	93,678	86,247

During 20X8, Subsidiary A was acquired and all shares in Subsidiary B were disposed of.

Details of the working capital balances of these two subsidiaries are provided below:

	Working capital of	Working capital of
	Subsidiary A	Subsidiary B
	at acquisition	at disposal
	$000	$000
Inventories	4,500	6,800
Trade receivables	7,900	6,700
Trade payables	8,250	5,740

Required:

Calculate the movement in inventories, trade receivables and trade payables for inclusion in the .

Solution

The net assets of Subsidiary A are being consolidated at the end of the year, but they were not consolidated at the start of the year. Conversely, the net assets of Subsidiary B are not consolidated at the end of the year, but they were consolidated at the start of the year. The working capital balances brought forward and carried forward are therefore not directly comparable.

Comparability can be achieved by calculating the movement between the closing and opening figures and then:

Deducing the subsidiary’s balances at the acquisition date for a subsidiary acquired during the year.

Adding the subsidiary’s balances at the disposal date for a subsidiary disposed of during the year.

	Inventories	Trade	Trade
		receivables	payables
	$000	$000	$000
Bal c/fwd	74,666	58,246	93,678
Bal b/fwd	(53,019)	(62,043)	(86,247)
	–––––	–––––	–––––
	21,647	(3,797)	7,431
Less: Sub acquired in year	(4,500)	(7,900)	(8,250)
Add: Sub disposed in year	6,800	6,700	5,740
	–––––	–––––	–––––
Movement in the year	inc 23,947	dec (4,997)	inc 4,921
	–––––	–––––	–––––
Impact on cash flow	Outflow	Inflow	Inflow

Cash paid to non-controlling interests

When a subsidiary that is not wholly owned pays a dividend, some of that dividend is paid outside of the group to the non-controlling interest.

Dividends paid to non-controlling interests should be disclosed separately in the statement of cash flows.

To calculate the dividend paid, reconcile the non-controlling interest in the statement of financial position from the opening to the closing balance. You can use a T-account or a schedule to do this.

Illustration 2 – Cash paid to NCI

The following information has been extracted from the consolidated financial statements of WG, which has a year end of the 31 December:

	20X7	20X6
	$000	$000
Statement of financial position
Equity:
Non-controlling interest	780	690
Statement of profit or loss
Profit for the period attributable to the non-controlling	120	230
interest

During the year, WG bought a 70% shareholding in CC. WG uses the full goodwill method for all subsidiaries. The fair value of the non-controlling interest in CC at the acquisition date was $60,000.

During the year, WG disposed of its 60% holding in TT. At the acquisition date, the fair value of the NCI and the fair value of TT’s net assets were $35,000 and $70,000 respectively. The net assets of TT at the disposal date were $100,000.

Required:

What is the dividend paid to non-controlling interest in the year ended 31 December 20X7?

Solution

	$000
NCI b/fwd	690
NCI re sub acquired in year	60
NCI share of profit for the year	120
NCI derecognised due to subsidiary disposal (W1)	(47)
Cash dividend paid in year (bal. fig)	(43)
	–––––
NCI c/fwd	780
	–––––

(W1) NCI at date of TT disposal
	$000
FV of NCI at acquisition	35
NCI % of post-acquisition net assets	12
40% × ($100,000 – $70,000)

––––

Alternatively, a T account can be used:

Non-controlling interests

	$000		$000
NCI derecognised re	47	NCI Balance b/fwd	690
sub disposal (W1)
Dividends paid (bal fig)	43	NCI recognised re acq’n	60
		of sub
NCI Balance c/fwd	780	Share of profits in year	120
	–––––		–––––
	870		870
	–––––		–––––

Associates

An associate is a company over which an investor has significant influence. Associates are not part of the group and therefore cash flows between the group and the associate must be reported in the statement of cash flows.

Cash flows relating to associates that need to be separately reported within the statement of cash flows are as follows:

dividends received from an associate

loans made to associates

cash payments to acquire associates

cash receipts from the sale of associates.

These cash flows should be presented as cash flows from investing activities.

Remember, associates are accounted for using the equity method. This means that, in the consolidated statement of profit or loss, the group records its share of the associate’s profit for the year. This is a non-cash income and so must be deducted in the reconciliation between profit before tax and cash generated from operations.

Illustration 3 – Associates

The following information is from the consolidated financial statements of

Extract from consolidated statement of profit or loss for year ended 31 December 20X1

	$000
Profit from operations	734
Share of profit of associate	48
	–––––
Profit before tax	782
Tax	(304)
	–––––
Profit for the year	478
	–––––

Extracts from consolidated statement of financial position as at 31 December 20X1 (with comparatives)

	20X1	20X0
	$000	$000
Non-current assets
Investment in associate	466	456
Loan to associate	380	300

Required:

Calculate the relevant figures to be included in the for the year ended 31 December 20X1.

Solution

Extracts from statement of cash flows
	$000
Cash flows from operating activities
Profit before tax	782
Share of profit of associate	(48)
Investing activities
Dividend received from associate (W1)	38
Loan to associate (380 – 300)	(80)

(W1) Dividend received from associate

When dealing with the dividend from the associate, the process is the same as we have already seen with the non-controlling interest.

Set up a schedule or T account and include all the balances that relate to the associate. The balancing figure will be the cash dividend received from the associate.

	$000
Balance b/fwd	456
Share of profit of associate	48
Cash dividend received (bal fig)	(38)
	–––––
Balance c/fwd	466
	–––––

Instead of a schedule, a T-account could be used:

Associate

	$000		$000
	$000		$000
Balance b/fwd	456	Dividend received	38
		(bal fig)
Share of profit of associate	48	Balance c/fwd	466
	––––		––––
	504		504
	––––		––––

Test your understanding 3 – The Z group

The following information is from the consolidated financial statements of

Extract from consolidated statement of profit or loss for year ended 31 December 20X1

	$000
Profit from operations	900
Share of profit of associate	15
	–––––
Profit before tax	915
Tax	(200)
	–––––
Profit for the year	715
	–––––

Extracts from consolidated statement of financial position as at 31 December 20X1 (with comparatives)

20X1 20X0

	$000	$000
Non-current assets
Investment in associate	600	580

During the year, Z received dividends from associates of $5,000.

Required:

Based on the above information, prepare extracts showing relevant figures to be included in the for the year ended 31 December 20X1.

6 Question practice

Test your understanding 4 – Consolidated extracts

Calculate the required cash flows in each of the following scenarios:

(1)	20X1	20X0
	$	$
Non-controlling interest	840	440

The group statement of profit or loss and other comprehensive income reported total comprehensive income attributable to the non-controlling interest of $500.

Required:

How much was the cash dividend paid to the non-controlling interest?

(2)	20X1	20X0
	$	$
Non-controlling interest	850	500

The group statement of profit or loss and other comprehensive income reported total comprehensive income attributable to the non-controlling interest of $600.

Required:

How much was the cash dividend paid to the non-controlling interest?

(3)	20X1	20X0
	$	$
Investment in associate	500	200

The group statement of profit or loss reported ‘share of profit of associates’ of $750.

Required:

How much was the cash dividend received by the group?

(4)	20X1	20X0
	$	$
Investment in associate	3,200	600

The group statement of profit or loss reported ‘share of profit of associates’ of $4,000.

In addition, the associate revalued its non-current assets during the period. The group share of this gain is $500.

Required:

How much was the cash dividend received by the group?

(5)	20X1	20X0
	$	$
Property, plant and equipment	500	150
(PPE)

During the year depreciation charged was $50, and the group acquired a subsidiary which held PPE of $200 at the acquisition date.

Required:

How much cash was spent on property, plant and equipment in the period?

Test your understanding 5 – AH Group

Extracts from the consolidated financial statements of the AH Group for the year ended 30 June 20X5 are given below:

Consolidated statement of profit or loss for the year ended 30 June 20X5

	$000
Revenue	85,000
Cost of sales	(60,750)
	–––––––
Gross profit	24,250
Operating expenses	(5,650)
	–––––––
Profit from operations	18,600
Finance cost	(1,400)
	–––––––
Profit before disposal of property	17,200
Disposal of property (note 2)	1,250
	–––––––
Profit before tax	18,450
Tax	(6,250)
	–––––––
Profit for the period	12,200
	–––––––
Attributable to:
Non-controlling interest	405
Owners of the parent	11,795
	–––––––
	12,200
	–––––––

Note: There were no items of other comprehensive income.

Statement of financial position, with comparatives, at 30 June 20X5

		20X5		20X4
Non-current assets	$000	$000	$000	$000
Non-current assets
Property, plant and
equipment	50,600		44,050
Goodwill (note 3)	5,910		4,160
	––––––	56,510	––––––	48,210
Current assets		56,510		48,210
Current assets
Inventories	33,500		28,750
Trade receivables	27,130		26,300
Cash and cash equivalents	1,870		3,900
	––––––	62,500	––––––	58,950
		62,500		58,950
		–––––––		–––––––
		119,010		107,160
		–––––––		–––––––
Equity and liabilities	$000	$000	$000	$000
Equity shares	20,000		18,000
Share premium	12,000		10,000
Retained earnings	24,135		18,340
	––––––	56,135	––––––	46,340
		56,135		46,340
Non-controlling interest		3,875		1,920
		–––––––		–––––––
Total equity		60,010		48,260
Non-current liabilities
Interest-bearing borrowings		18,200		19,200
Current liabilities
Trade payables	33,340		32,810
Interest payables	1,360		1,440
Tax	6,100		5,450
	––––––	––––––

40,800	39,700
–––––––	–––––––
119,010	107,160
–––––––	–––––––

Notes:

Several years ago, AH acquired 80% of the issued equity shares of its subsidiary, BI. The NCI at the acquisition date was valued using the proportion of net assets method.

On 1 January 20X5, AH acquired 75% of the issued equity shares of CJ in exchange for a fresh issue of 2 million of its own $1 equity shares (issued at a premium of $1 each) and $2 million in cash. The net assets of CJ at the date of acquisition were assessed as having the following fair values:

	$000
Property, plant and equipment	4,200
Inventories	1,650
Trade receivables	1,300
Cash and cash equivalents	50
Trade payables	(1,950)
Tax	(250)
	–––––––
	5,000
	–––––––

Goodwill relating to the acquisition of entity CJ during the year was calculated on the full goodwill basis. On 1 January 20X5 when CJ was acquired, the fair value of the non-controlling interest was $1,750,000.

Any impairments of goodwill during the year have been accounted for within operating expenses.

During the year, AH disposed of property, plant and equipment for proceeds of $2,250,000. The carrying value of the asset at the date of disposal was $1,000,000. There were no other disposals of property, plant and equipment. Depreciation of $7,950,000 was charged to the consolidated statement of profit or loss in the year.

Required:

Prepare the consolidated statement of cash flows of the AH Group for the year ended 30 June 20X5 using the indirect method.

Test your understanding 6 – Pearl

Below are the consolidated financial statements of the Pearl Group for the year ended 30 September 20X2:

Consolidated statements of financial position
	20X2	20X1
	$000	$000
Non-current assets
Goodwill	1,930	1,850
Property, plant and equipment	2,545	1,625
Investment in associate	620	540
	––––––	–––––
	5,095	4,015
Current assets
Inventories	470	435
Trade receivables	390	330
Cash and cash equivalents	210	140
	––––––	–––––
	6,165	4,920
	––––––	–––––
Equity and liabilities
Share capital ($1 shares)	1,500	1,500
Retained earnings	1,755	1,085
Other reserves	750	525
	––––––	––––––
	4,005	3,110
Non-controlling interest	310	320
	––––––	––––––
Non-current liabilities:	4,315	3,430
Non-current liabilities:
Loans	500	300
Deferred tax	150	105
Current liabilities:
Trade payables	800	725
Tax payable	400	360
	––––––	––––––
	6,165	4,920
	––––––	––––––

Consolidated statement of profit or loss and other comprehensive income for the year ended 30 September 20X2

	$000
Revenue	2,090
Operating expenses	(1,155)
	––––––
Profit from operations	935
Gain on disposal of subsidiary	100
Finance cost	(35)
Share of profit of associate	115
	––––––
Profit before tax	1,115
Tax	(225)
	––––––
Profit for the period	890
Other comprehensive income	200
Other comprehensive income from associate	50
	––––––
Total comprehensive income	1,140
	––––––
Profit for the year attributable to:
Owners of the parent	795
Non-controlling interests	95
	––––––
	890
	––––––
Total comprehensive income for the year attributable to:
Owners of the parent	1,020
Non-controlling interests	120
	––––––
	1,140
	––––––

Consolidated statement of changes in equity
	Attributable	Attributable to
	to owners	the NCI
	of the
	parent
	$000	$000
Equity brought forward	3,110	320
Total comprehensive income	1,020	120
Acquisition of subsidiary	–	340
Disposal of subsidiary	–	(420)
Dividends	(125)	(50)
	–––––	–––––
Equity carried forward	4,005	310
	–––––	–––––

Depreciation of $385,000 was charged during the year. Plant with a carrying amount of $250,000 was sold for $275,000. The gain on disposal was recognised in operating costs. Certain properties were revalued during the year resulting in a revaluation gain of $200,000 being recognised.

During the year, Pearl acquired 80% of the equity share capital of Gem paying cash consideration of $1.5 million. The NCI holding was measured at its fair value of $340,000 at the date of acquisition. The fair value of Gem’s net assets at acquisition was made up as follows:

	$000
Property, plant and equipment	1,280
Inventories	150
Trade receivables	240
Cash and cash equivalents	80
Trade payables	(220)
Tax payable	(40)
	––––––
	1,490
	––––––

During the year, Pearl disposed of its 60% equity shareholding in Stone for cash proceeds of $850,000. The subsidiary has been acquired several years ago for cash consideration of $600,000. The NCI holding was measured at its fair value of $320,000 at acquisition and the fair value of Stone’s net assets were $730,000. Goodwill had not suffered any impairment. At the date of disposal, the net assets of Stone had carrying values in the consolidated statement of financial position as follows:

	$000
Property, plant and equipment	725
Inventories	165
Trade receivables	120
Cash and cash equivalents	50
Trade payables	(80)
	––––––
	980
	––––––

Required:

Prepare the consolidated statement of cash flows for the Pearl group for the year ended 30 September 20X2.

7 Foreign exchange and cash flow statements

Exchange gains and losses

The values of assets and liabilities denominated in an overseas currency will increase or decrease partly due to movements in exchange rates. These movements must be factored into your workings in order to determine the actual cash payments and receipts during the year.

Dealing with foreign exchange issues

The loan balances of the Grey group as at 31 December 20X1 and 31

December 20X0 are presented below:

	20X1	20X0
	$m	$m
Loans	60	20

One of the subsidiaries of the Grey group prepares its financial statements in sterling (£). The exchange loss on the translation of the loans of this subsidiary was $10 million.

Remember that an exchange loss increases the value of a liability. This is not a cash flow. Therefore, the exchange loss must be factored into the cash flow workings as follows:

	$m
Bal b/fwd	20
Exchange loss	10
Cash received (bal. fig.)	30
	–––––
Bal c/fwd	60
	–––––

The cash received from new loans in the year is $30 million. This will be shown as an inflow within cash flows from financing activities.

Illustration – Cash flows and foreign exchange

A group had the following working capital as at 31 December 20X1 and 20X0:

	20X1	20X0
	$	$
Inventories	100	200
Trade receivables	300	200
Trade payables	500	200
During the period ended 31 December 20X1, the group acquired a
subsidiary with the following working capital.
Inventories		50
Trade receivables		200
Trade payables		40

During this period the group disposed of a subsidiary with the following working capital.

Inventories	25
Trade receivables	45
Trade payables	20

During this period the group experienced the following exchange rate differences.

Inventories	11	Gain
Trade receivables	21	Gain
Trade payables	31	Loss

Required:

Calculate the movements in inventories, trade receivables and trade payables as they would appear in the indirect reconciliation between profit before tax and cash generated from operations for the period ended 31 December 20X1.

Solution

	Inventories	Trade	Trade
		receivables	payables
	$000	$000	$000
Bal c/fwd	100	300	500
Bal b/fwd	(200)	(200)	(200)
	–––––	–––––	–––––
	(100)	100	300
Less: Sub acquired in year	(50)	(200)	(40)
Add: Sub disposed in year	25	45	20
Adjustment for forex	(11)	(21)	(31)
	–––––	–––––	–––––
Movement in the year	dec (136)	dec (76)	inc 249
	–––––	–––––	–––––
Impact on cash flow	Inflow	Inflow	Inflow

Be careful with foreign exchange gains and losses:

Assets are increased by a foreign exchange gain

Liabilities are increased by a foreign exchange loss.

Overseas cash balances

If cash balances are partly denominated in a foreign currency, the effect of exchange rate movements must be reported in the statement of cash flows in order to reconcile the cash balances at the beginning and end of the period.

According to IAS 7, this reconciling item is presented separately from cash flows from operating, investing and financing activities.

Illustration – Overseas subsidiary

B Group recognised a gain of $160,000 on the translation of the financial statements of a 75% owned foreign subsidiary for the year ended 31 December 20X7. This gain is found to be made up as follows

	$
Gain on opening net assets:
Non-current assets	90,000
Inventories	30,000
Receivables	50,000
Payables	(40,000)
Cash	30,000
	–––––––
	160,000
	–––––––

The overseas subsidiary made no profit or loss in the year. No goodwill arose on acquisition.

B Group recognised a loss of $70,000 on retranslating the parent entity’s foreign currency loan. This loss has been recorded in the statement of profit or loss.

Consolidated statements of financial position as at 31 December

	20X7	20X6
	$000	$000
Non-current assets	2,100	1,700
Inventories	650	480
Receivables	990	800
Cash	500	160
	––––––	––––––
	4,240	3,140
	––––––	––––––
Share capital	1,000	1,000
Group reserves	1,600	770
	––––––	––––––
	2,600	1,770
Non-controlling interest	520	370
	––––––	––––––
Equity	3,120	2,140
Long-term loan	250	180
Payables	870	820
	––––––	––––––
	4,240	3,140
	––––––	––––––

There were no non-current asset disposals during the year.

Consolidated statement of profit or loss for the year ended 31 December 20X7

	$000
Profit before tax (after depreciation of $220,000)	2,100
Tax	(650)
	––––––
Group profit for the year	1,450
	––––––
Profit attributable to:
Owners of the parent	1,190
Non-controlling interest	260
	––––––
Net profit for the period	1,450
	––––––

Note: The dividend paid by the parent company of the B group during the year was $480,000.

Prepare a statement of cash flows for the year ended 31 December 20X7.

Solution

Statement of cash flows for the year ended 31 December 20X7

Cash flows from operating activities	$000
	$000
Profit before tax	2,100
Forex loss on loan	70
Depreciation charges	220
Increase in inventory (650 – 480 – 30)	(140)
Increase in receivables (990 – 800 – 50)	(140)
Increase in payables (870 – 820 – 40)	10
	–––––
Cash generated from operations	2,120
Income taxes paid	(650)
	–––––
Net cash from operating activities	1,470
	–––––
Cash flows from investing activities
Purchase of non-current assets (W1)	(530)
	––––– –––––
	(530)
Cash flows from financing activities
Dividends paid to non-controlling interests (W2)	(150)
Dividends paid	(480)
	–––––
	(630)
Exchange gain on cash	30
	–––––
Increase in cash and cash equivalents	340
Cash and cash equivalents at 1 Jan 20X7	160
	–––––
Cash and cash equivalents at 31 Dec 20X7	500
	–––––

Note: There have been no proceeds from loans during the year. The loan balance has increased by $70,000 ($250,000 – $180,000) as a result of the foreign exchange loss.

Workings
(W1) Non-current assets
	$000
Bal b/fwd	1,700
Exchange gain	90
Depreciation	(220)
Additions (bal. fig.)	530
	––––––
Bal c/fwd	2,100
	––––––
(W2) Non-controlling interest
	$000
Bal b/fwd	370
Total comprehensive income*	300
Dividend paid (bal. fig.)	(150)
	––––––
Bal c/fwd	520
	––––––

This is the NCI share of the subsidiary’s profit after tax ($260,000) as well as the NCI share of the foreign exchange gain (25% × $160,000)

Test your understanding 7 – Boardres

Set out below is a summary of the accounts of Boardres, a public limited company, for the year ended 31 December 20X7.

Consolidated statement of profit or loss and other comprehensive income for the year ended 31 December 20X7

	$000
Revenue	44,754
Cost of sales and other expenses	(39,613)
	––––––
Profit from operations	5,141
Income from associates	30
Finance cost	(305)
	––––––
Profit before tax	4,866
Tax:	(2,038)
	–––––
Profit for the period	2,828
Other comprehensive income: Items that may be reclassified to
profit or loss in future periods
Total exchange difference on retranslation of foreign operations	302
(note 5)
	–––––
Total comprehensive income	3,130
	–––––
Profit for the year attributable to:
Owners of the parent	2,805
Non-controlling interests	23
	–––––
	2,828
	–––––
Total comprehensive income for the year attributable to:
Owners of the parent (2,805 + 302)	3,107
Non-controlling interests	23
	––––––

3,130

––––––

Summary of changes in equity attributable to the owners of the parent for the year

			$000
Equity b/f			14,164
Profit for year			2,805
Dividends paid			(445)
Exchange differences			302
			–––––
Equity c/f			16,826
			–––––
Consolidated statements of financial position at 31 December
		20X7	20X6
Non-current assets	Note	$000	$000
Non-current assets
Goodwill		500	–
Property, plant and equipment	(1)	11,157	8,985
Investment in associate		300	280
		––––––	–––––
Current assets		11,957	9,265
Current assets		9,749	7,624
Inventories		9,749	7,624
Receivables		5,354	4,420
Short-term investments	(2)	1,543	741
Cash		1,013	394
		––––––	–––––
		29,616	22,444
		––––––	–––––
Equity share capital		1,997	1,997
Share premium		5,808	5,808
Retained earnings		9,021	6,359
		––––––	––––––
		16,826	14,164
Non-controlling interest		170	17
		––––––	––––––
Total equity		16,996	14,181
Non-current liabilities
Loans		2,102	1,682
Provisions	(4)	1,290	935
Current liabilities	(3)	9,228	5,646
		––––––	––––––
		29,616	22,444
		––––––	––––––

Notes to the accounts

Property, plant and equipment

Property, plant and equipment movements include the following:

	$000
Carrying amount of disposals	305
Proceeds from disposals	854
Depreciation charge for the year	907

Short-term investments

The short-term investments are readily convertible into cash and there is an insignificant risk that their value will change.

Current liabilities

		20X7	20X6
		$000	$000
Bank overdrafts		1,228	91
Trade payables		4,278	2,989
Tax		3,722	2,566
	––––––		––––––
		9,228	5,646
	––––––		––––––
(4) Provisions
	Legal	Deferred	Total
	provision	taxation
	$000	$000	$000
At 31 December 20X6	246	689	935
Exchange rate adjustment	29	–	29
Increase in provision	460	–	460
Decrease in provision	–	(134)	(134)
	––––––	––––––	––––––
At 31 December 20X7	735	555	1,290
	––––––	––––––	––––––

Liberated

During the year, the company acquired 82% of the issued equity capital of Liberated for a cash consideration of $1,268,000. The fair values of the assets of Liberated were as follows:

	$000
Property, plant and equipment	208
Inventories	612
Trade receivables	500
Cash in hand	232
Trade payables	(407)
Debenture loans	(312)
	–––––
	833
	–––––

Exchange gains

The net exchange gain on translating the financial statements of a wholly-owned subsidiary has been recorded in other comprehensive income and is held within retained earnings. The gain comprises differences on the retranslation of the following:

	$000
Property, plant and equipment	138
Legal provision	(29)
Inventories	116
Trade receivables	286
Trade payables	(209)
	––––
Net exchange gain	302
	––––

(7) Non-controlling interest

The non-controlling interest is valued using the proportion of net assets method.

Required:

Prepare a statement of cash flows for the year ended 31 December 20X7.

8 Evaluation of statements of cash flows

Usefulness and limitations

Usefulness of the statement of cash flows

A statement of cash flows can provide information that is not available from the statement of financial position or statement of profit or loss and other comprehensive income.

It may assist users of financial statements in making judgements on the amount, timing and degree of certainty of future cash flows.

It gives an indication of the relationship between profitability and cash generating ability, and thus of the quality of the profit earned.

Analysts and other users of financial information often, formally or informally, develop models to assess and compare the present value of the future cash flow of entities. Historical cash flow information could be useful to check the accuracy of past assessments.

A statement of cash flow in conjunction with a statement of financial position provides information on liquidity, solvency and adaptability. The statement of financial position is often used to obtain information on liquidity, but the information is incomplete for this purpose as the statement of financial position is drawn up at a particular point in time.

Cash flows cannot easily be manipulated and are not affected by judgement or by accounting policies.

Limitations of the statement of cash flows

Statements of cash flows should normally be used in conjunction with statements of profit and loss and other comprehensive income and statements of financial position when making an assessment of future cash flows.

Statements of cash flows are based on historical information and therefore do not provide complete information for assessing future cash flows.

There is some scope to ‘window dress’ cash flows. For example, a business may delay paying suppliers until after the period-end, or it may sell assets before the period-end and then immediately repurchase them at the start of the next period.

Cash flow is necessary for survival in the short term, but in order to survive in the long term a business must be profitable. It is often necessary to sacrifice cash flow in the short term in order to generate profits in the long term (e.g. by investment in non-current assets). A substantial cash balance is not a sign of good management if the cash could be invested elsewhere to generate profit.

Neither cash flow nor profit provides a complete picture of an entity’s performance when looked at in isolation.

9 Other issues

Criticisms of IAS 7

The following criticisms have been made of IAS 7 Statement of Cash Flows

Direct and indirect method

Allowing entities to choose between using the direct or indirect method limits comparability.

Many users of the financial statements will not understand the adjustments made to profit when cash generated from operations is presented under the indirect method.

Lack of guidance and disagreements

There is insufficient guidance in IAS 7 as to how to classify cash flows.

This can create the following problems:

IAS 7 allows dividends and interest paid to be presented as cash flows from either operating or financing activities. This limits comparability between companies.

Entities may classify cash flows related to the same transaction in different ways (a loan repayment might be split between interest paid within operating activities and the repayment of the principal in financing activities). This could hinder user understanding.

There are disagreements about the presentation of payments related to leases. Some argue that they should be classified as a financing activity, whereas others argue that they are a form of investment activity.

Expenditure on research is classified as an operating activity. Some argue that they should be included within investing activities, because it relates to items that are intended to generate future income and cash flows.

Disclosures

Current cash flow disclosures are deemed to be inadequate. In particular, there is a lack of disclosure about restrictions on an entity’s ability to use their cash and cash equivalents (particularly if located overseas) and whether other sources of finance would be more economical.

Test your understanding 1 – Cash and cash equivalents

To qualify as a cash equivalent, an item must be readily convertible to cash and have an insignificant risk of a change in value. Furthermore, it should be held for the purpose of meeting short-term cash commitments.

Bank overdrafts are an integral part of most company’s cash management. They are therefore generally treated as a component of cash.

The balance of $500,000 in a high interest account is readily available (only 28 days’ notice is required to access it). This money is also held to meet short-term needs. Assuming that there is not a significant penalty for accessing this money, it should be included within cash equivalents.

The shares are not a cash equivalent. Shares are investments rather than a way of meeting short-term cash requirements. Moreover, there is a significant risk that the value of the shares will change. Any cash spent on shares in the period should be shown within cash flows from investing activities.

Test your understanding 2 – Extracts

(1) Property, plant and equipment
	$
	$
Bal b/fwd	100
Revaluation	60
Leases	30
Depreciation	(20)
Disposals	(15)
Additions (bal. fig.)	95
	––––––
Bal c/fwd	250
	––––––

	(2) Tax
		$
	Bal b/fwd (50 + 100)	150
	Profit or loss charge	180
	Tax paid (bal. fig.)	(110)
		––––––
	Bal c/fwd (100 + 120)	220
		––––––
	(3) Retained earnings
		$
	Bal b/fwd	200
	Profit or loss	150
	Dividend paid (bal. fig.)	(50)
		––––––
	Bal c/fwd	300
		––––––

Test your understanding 3 – The Z group

Extracts from statement of cash flows
	$000
Cash flows from operating activities
Profit before tax	915
Share of profit of associate	(15)
Cash flows from investing activities
Dividend received from associate	5
Cash paid to acquire associates (W1)	(10)
(W1) Associate
(W1) Associate
	$000
Balance b/fwd	580
Share of profit of associate	15
Cash dividend received	(5)
Cash spent on investments in associates (bal. fig)	10
	–––––
Balance c/fwd	600
	–––––

Test your understanding 4 – Consolidated extracts

(1) Non-controlling interest
	$
	$
Bal b/fwd	440
Total comprehensive income	500
Dividend paid (bal. fig.)	(100)
	––––––
Bal c/fwd	840
	––––––
(2) Non-controlling interest
	$
Bal b/fwd	500
Total comprehensive income	600
Dividend paid (bal. fig.)	(250)
	––––––
Bal c/fwd	850
	––––––
(3) Associate
	$
Bal b/fwd	200
Profit or loss	750
Dividend received (bal. fig.)	(450)
	––––––
Bal c/fwd	500
	––––––
(4) Associate
	$
Bal b/fwd	600
Profit or loss	4,000
Revaluation	500
Dividend received (bal. fig.)	(1,900)
	––––––
Bal c/fwd	3,200
	––––––

Property, plant and equipment

	$
Bal b/fwd	150
New subsidiary	200
Depreciation	(50)
Additions (bal. fig.)	200
	––––––
Bal c/fwd	500
	––––––

Test your understanding 5 – AH Group

Consolidated statement of cash flows for the year ended 30 June 20X5

	$000	$000
Cash flows from operating activities
Profit before tax	18,450
Less: profit on disposal of property	(1,250)
(2,250 – 1,000)
Add: finance cost	1,400
Adjustment for non-cash items dealt with in
arriving at operating profit:
Depreciation	7,950
Decrease in trade receivables	470
(27,130 – 26,300 – 1,300)
Increase in inventories	(3,100)
(33,500 – 28,750 – 1,650)
Decrease in trade payables	(1,420)
(33,340 – 32,810 – 1,950)
Goodwill impaired (W5)	1,000
	––––––
Cash generated from operations	23,500
Interest paid (W1)	(1,480)
Income taxes paid (W2)	(5,850)
Net cash from operating activities	––––––	16,170
Net cash from operating activities		16,170

Cash flows from investing activities
Acquisition of subsidiary net	(1,950)
of cash acquired (2,000 – 50)
Purchase of property, plant, and	(11,300)
equipment (W3)
Proceeds from sale of property	2,250
	––––––
Net cash used in investing activities	(11,000)
Cash flows from financing activities
Repayment of long-term	(1,000)
borrowings
(18,200 – 19,200)
Dividend paid by parent (W7)	(6,000)
Dividends paid to NCI (W6)	(200)
	–––––
Net cash used in financing activities	(7,200)
	––––––
Net decrease in cash and cash equivalents	(2,030)
Cash and cash equivalents at 1 July 20X4	3,900
	––––––
Cash and cash equivalents at 30 June 20X5	1,870
	––––––
(W1) Interest paid
	$000
Bal b/fwd	1,440
Profit or loss	1,400
Interest paid (bal. fig.)	(1,480)
	––––––
Bal c/fwd	1,360
	––––––
(W2) Income taxes paid
	$000
Bal b/fwd	5,450
Profit or loss	6,250
New subsidiary	250
Tax paid (bal. fig.)	(5,850)
	––––––
Bal c/fwd	6,100
	––––––

	(W3) Property, plant and equipment
		$000
	Bal b/fwd	44,050
	New subsidiary	4,200
	Depreciation	(7,950)
	Disposals	(1,000)
	Additions (bal. fig.)	11,300
		––––––
	Bal c/fwd	50,600
		––––––
	(W4) Goodwill arising on acquisition of subsidiary
		$000
	Fair value of shares issued (2m × $2)	4,000
	Cash consideration	2,000
		–––––
		6,000
	Fair value of NCI at acquisition	1,750
		–––––
		7,750
	Fair value of net assets at acquisition	(5,000)
		–––––
	Goodwill at acquisition	2,750
	(W5) Goodwill	–––––
	(W5) Goodwill	$000
		$000
	Bal b/fwd	4,160
	Goodwill on sub acquired (W4)	2,750
	Impairment in year (bal. fig.)	(1,000)
		––––––
	Bal c/fwd	5,910
		––––––
	(W6) Non-controlling interest
		$000
	Bal b/fwd	1,920
	NCI arising on subsidiary acquired	1,750
	Profit or loss	405
	Dividend paid (bal. fig.)	(200)
		––––––
	Bal c/fwd	3,875
		––––––

	(W7) Retained earnings
		$000
	Bal b/fwd	18,340
	Profit or loss	11,795
	Dividend paid (bal. fig.)	(6,000)
		––––––
	Bal c/fwd	24,135
		––––––

Test your understanding 6 – Pearl

Consolidated statement of cash flows
	$000	$000
Cash flows from operating activities
Profit before tax	1,115
Finance cost	35
Profit on sale of subsidiary	(100)
Income from associates	(115)
Depreciation	385
Impairment (W1)	80
Gain on disposal of PPE ($275 – $250)	(25)
Increase in inventories	(50)
($470 – $435 – $150 + $165)
Decrease in receivables	60
($390 – $330 – $240 + $120)
Decrease in payables	(65)
($800 – $725 – $220 + $80)
	–––––
	1,320
Interest paid	(35)
Tax paid (W4)	(180)
	–––––

1,105

Cash flows from investing activities
Proceeds from sale of PPE	275
Purchases of PPE (W5)	(800)
Dividends received from associate (W6)	85
Acquisition of subsidiary ($1,500 – $80)	(1,420)
Disposal of subsidiary ($850 – $50)	800
	–––––

(1,060)

Cash flows from financing activities

Proceeds from loans ($500 – $300)	200
Dividends paid to shareholders of the	(125)
parent (per CSOCIE)
Dividends paid to NCI (per CSOCIE)	(50)
	–––––

Increase in cash and cash equivalents Opening cash and cash equivalents

Closing cash and cash equivalents

–––––

140

–––––

210

–––––

Workings
(W1) Goodwill
	$000
Balance b/f	1,850
Acquisition of subsidiary (W2)	350
Disposal of subsidiary (W3)	(190)
Impairment (bal fig)	(80)
	––––––
Balance c/f	1,930
	––––––
(W2) Goodwill on acquisition of subsidiary
	$000
Cost of investment	1,500
Fair value of NCI at acquisition	340
Fair value of net assets at acquisition	(1,490)
	––––––

350

––––––

	(W3) Goodwill at disposal date
		$000
	Cost of investment	600
	Fair value of NCI at acquisition	320
	Fair value of net assets at acquisition	(730)
		––––––
		190
		––––––
	(W4) Tax
		$000
	Balance b/f ($360 + $105)	465
	Acquisition of subsidiary	40
	Disposal of subsidiary	–
	Profit or loss	225
	Cash paid (bal. fig.)	(180)
		––––––
	Balance c/f ($400 + $150)	550
		––––––
	(W5) PPE
		$000
	Balance b/f	1,625
	Depreciation	(385)
	Revaluation gain	200
	Disposal of plant	(250)
	Acquisition of subsidiary	1,280
	Disposal of subsidiary	(725)
	Cash paid (bal. fig)	800
		––––––
	Balance c/f	2,545
		––––––
	(W6) Dividend from associate
		$000
	Balance b/f	540
	Share of profit of associate	115
	OCI from associate	50
	Dividend received (bal. fig)	(85)
		––––––
	Balance c/f	620
		––––––

Test your understanding 7 – Boardres

Statement of cash flows for the year ended 31 December 20X7

	$000	$000
Cash flows from operating activities
Profit before tax	4,866
Finance cost	305
Income from associates	(30)
Depreciation	907
Goodwill (W7)	85
Profit on disposal of PPE (W1)	(549)
Increase in legal provision	460
	–––––
	6,044
Change in working capital
Increase in inventory
(9,749 – 7,624 – 612 acq – 116 ex diff)	(1,397)
Increase in receivables
(5,354 – 4,420 – 500 acq – 286 ex diff)	(148)
Increase in payables
(4,278 – 2,989 – 407 acq – 209 ex diff)	673
	–––––
	5,172
Interest paid	(305)
Tax paid (W2)	(1,016)
	–––––
Cash flows from investing activities
Purchase of non-current assets (W3)	(3,038)
Proceeds on disposal	854
Cash consideration paid on acquisition
of subsidiary, net of cash acquired
(1,268 – 232)	(1,036)
Dividend received from associate (W4)	10
	–––––

(3,210)

Cash flows from financing activities
Dividends paid	(445)
Dividends paid to NCI (W6)	(20)
Proceeds from debt issue (W5)	108
	–––––
	(357)
	–––––
Change in cash and cash equivalents	284
Opening cash and cash equivalents
(394 + 741 – 91)	1,044
	–––––
Closing cash and cash equivalents
(1,013 + 1,543 – 1,228)	1,328
	–––––

Workings
(W1) Profit on disposal of property, plant and equipment
	$000
Sales proceeds	854
Carrying amount	(305)
	–––––
Profit on disposal	549
	–––––
(W2) Tax paid
	$000
Bal b/fwd (2,566 + 689)	3,255
Profit or loss	2,038
Tax paid (bal. fig.)	(1,016)
	––––––
Bal c/fwd (3,722 + 555)	4,277
	––––––

	(W3) Property, plant and equipment
		$000
	Bal b/fwd	8,985
	Exchange gain	138
	Acquisition of subsidiary	208
	Depreciation	(907)
	Disposal	(305)
	Additions (bal. fig.)	3,038
		––––––
	Bal c/fwd	11,157
		––––––
	(W4) Dividends from associates
		$000
	Bal b/fwd	280
	Profit or loss	30
	Dividend received (bal. fig.)	(10)
		––––––
	Bal c/fwd	300
		––––––
	(W5) Debentures
		$000
	Bal b/fwd	1,682
	Acquisition of subsidiary	312
	Cash received (bal. fig.)	108
		––––––
	Bal c/fwd	2,102
		––––––
	(W6) Non-controlling interest
		$000
	Bal b/fwd	17
	Total comprehensive income	23
	Acquisition of subsidiary (18% × 833)	150
	Dividend paid (bal. fig.)	(20)
		––––––
	Bal c/fwd	170
		––––––

	(W7) Goodwill
		$000
	Cost of investment	1,268
	NCI at acquisition (18% × 833)	150
		–––––
		1,418
	FV of net assets at acquisition	(833)
		–––––
	Goodwill at acquisition	585
		–––––
		$000
	Goodwill b/fwd	nil
	Goodwill acquired (above)	585
	Goodwill impairment (bal. fig)	(85)
		–––––
	Goodwill c/fwd	500
		–––––

Posted on March 31, 2021March 31, 2021 by MJ — Leave a comment

Group re-organisations

Definition of a group reorganisation

A group reorganisation (or restructuring) is any of the following:

the transfer of shares in a subsidiary from one group entity to another

the addition of a new parent entity to a group

the transfer of shares in one or more subsidiaries of a group to a new entity that is not a group entity but whose shareholders are the same as those of the group’s parent

the combination into a group of two or more companies that before the combination had the same shareholders

the acquisition of the shares of another entity that itself then issues sufficient shares so that the acquired entity has control of the combined entity.

Reasons for a reorganisation

There are a number of reasons why a group may wish to reorganise.

These include the following.

A group may wish to list on a public stock exchange. This is usually facilitated by creating a new holding company and keeping the business of the group in subsidiary entities.

The ownership of subsidiaries may be transferred from one group company to another. This is often the case if the group wishes to sell a subsidiary, but retain its trade.

The group may decide to transfer the assets and trades of a number of subsidiaries into one entity. This is called divisionalisation and is undertaken in order to simplify the group structure and save costs.

The details of divisionalisation are not examinable at P2.

There may be corporate tax advantages to reorganising a group structure, particularly if one or more subsidiaries within the group is loss-making.

The group may split into two or more parts; each part is still owned by the same shareholders but is not related to the other parts. This is a demerger and is often done to enhance shareholder value. By splitting the group, the value of each part is realised whereas previously the stock market may have undervalued the group as a whole. The details of demergers are not examinable at P2.

An unlisted entity may purchase a listed entity with the aim of achieving a stock exchange listing itself. This is called a reverse acquisition.

Types of group reorganisation

There are a number of ways of effecting a group reorganisation. The type of reorganisation will depend on what the group is trying to achieve.

New holding company

A group might set up a new holding entity for an existing group in order to improve co-ordination within the group or as a vehicle for flotation.

H becomes the new holding entity of S.

Usually, H issues shares to the shareholders of S in exchange for shares of S, but occasionally the shareholders of S may subscribe for shares in H and H may pay cash for S.

IFRS 3 excludes from its scope any business combination involving entities or businesses under ‘common control’, which is where the same parties control all of the combining entities/businesses both before and after the business combination.

As there is no mandatory guidance in accounting for these items, the acquisition method should certainly be used in examination questions.

Change of ownership of an entity within a group

This occurs when the internal structure of the group changes, for example, a parent may transfer the ownership of a subsidiary to another of its subsidiaries.

The key thing to remember is that the reorganisation of the entities within the group should not affect the group accounts, as shareholdings are transferred from one company to another and no assets will leave the group.

The individual accounts of the group companies will need to be adjusted for the effect of the transfer.

The following are types of reorganisation:

Subsidiary moved up

This can be achieved in one of two ways.

S transfers its investment in T to H as a dividend in specie. If this is done then S must have sufficient distributable profits to pay the dividend.

H purchases the investment in T from S for cash. In practice the purchase price often equals the fair value of the net assets acquired, so that no gain or loss arises on the transaction.

Usually, it will be the carrying value of T that is used as the basis for the transfer of the investment, but there are no legal rules confirming this.

A share-for-share exchange cannot be used as in many jurisdictions it is illegal for a subsidiary to hold shares in the parent company.

Subsidiary moved down

This reorganisation may be carried out where there are tax advantages in establishing a ‘sub-group’, or where two or more subsidiaries are linked geographically.

This can be carried out either by:

a share-for-share exchange (S issues shares to H in return for the shares in T)

a cash transaction (S pays cash to H).

Subsidiary moved along

This is carried out by T paying cash (or other assets) to S. The consideration would not normally be in the form of shares because a typical reason for such a reconstruction would be to allow S to be managed as a separate part of the group or even disposed of completely. This could not be achieved effectively were S to have a shareholding in T.

If the purpose of the reorganisation is to allow S to leave the group, the purchase price paid by T should not be less than the fair value of the investment in U, otherwise S may be deemed to be receiving financial assistance for the purchase of its own shares, which is illegal in many jurisdictions.

Reverse acquisitions

Definition

A reverse acquisition occurs when an entity obtains ownership of the shares of another entity, which in turn issues sufficient shares so that the acquired entity has control of the combined entity.

Reverse acquisitions are a method of allowing unlisted companies to obtain a stock exchange quotation by taking over a smaller listed company.

For example, a private company arranges to be acquired by a listed company. This is effected by the public entity issuing shares to the private company so that the private company’s shareholders end up controlling the listed entity. Legally, the public entity is the parent, but the substance of the transaction is that the private entity has acquired the listed entity.

Assessment of group reorganisations

Previous examination questions testing group reorganisations have provided a scenario with a group considering a number of reorganisation options. The questions have then asked for an evaluation and recommendation of a particular proposal.

In order to do this, you will need to consider the following:

the impact of the proposal on the individual accounts of the group entities

the impact of the proposal on the group accounts

the purpose of the reorganisation

whether there is any impairment of any of the group’s assets

whether any impairment loss should be recognised in relation to the investment in subsidiaries in the parent company accounts.

Group reorganisations and separate financial statements

IAS 27 Separate Financial Statements details the accounting treatment of investments in subsidiaries, associates and joint ventures when separate (non-consolidated) financial statements are produced.

In separate financial statements, investments in subsidiaries, associates and joint ventures can be measured:

at cost

in accordance with IFRS 9 Financial Instruments

using the equity method.

A parent may reorganise the structure of its group by establishing a new entity as its parent. In this case, as long as certain criteria are met, the

new parent records the cost of the original parent in its separate financial statements as the carrying amount of ‘its share of the equity items shown in the separate financial statements of the original parent at the date of the reorganisation’ (IAS 27, para 13). The criteria that must

be met are as follows:

‘The new parent obtains control of the original parent by issuing equity instruments in exchange for existing equity instruments of the original parent

The assets and liabilities of the new group and the original group are the same immediately before and after the reorganisation

The owners of the original parent before the reorganisation have the same absolute and relative interests in the net assets of the original group and the new group immediately before and after the reorganisation’ (IAS 27, para 13).

The above rule also applies when an entity that is not a parent establishes a new entity as its parent.

1 Chapter summary

Posted on March 31, 2021March 31, 2021 by MJ — Leave a comment

Group accounting – foreign currency

Key definitions

Foreign currency transactions in the individual financial statements of a company were covered earlier in this text.

Below is a reminder of some key definitions:

The functional currency is the currency of the ‘primary economic environment where the entity operates’ (IAS 21, para 8). In most cases

this will be the local currency.

The presentation currency is the ‘currency in which the entity presents its financial statements’ (IAS 21, para 8).

2 Consolidation of a foreign operation

The functional currency used by a subsidiary to prepare its own individual accounting records and financial statements may differ from the presentation currency used for the group financial statements. Therefore, prior to adding together the assets, liabilities, incomes and expenses of the parent and subsidiary, the financial statements of an overseas subsidiary must be translated.

Translating the subsidiary’s financial statements

The rules for translating an overseas subsidiary into the presentation currency of the group are as follows:

Incomes, expenses and other comprehensive income are translated at the rate in place at the date of each transaction. The average rate for the year may be used as an approximation.

Assets and liabilities are translated at the closing rate.

Illustration 1 – Dragon

This example runs through the chapter and is used to illustrate the basic steps involved in consolidating an overseas subsidiary.

Dragon bought 90% of the ordinary shares of Tattoo for DN180 million on 31 December 20X0. The retained earnings of Tattoo at this date were DN65 million. The fair value of the non-controlling interest at the acquisition date was DN14 million.

The financial statements of Dragon and Tattoo for the year ended 31

December 20X1 are presented below:

Statements of profit or loss for year ended 31 December 20X1

	Dragon	Tattoo
	$m	DNm
Revenue	1,200	600
Costs	(1,000)	(450)
	––––––	––––––
Profit	200	150
	––––––	––––––
Statements of financial position as at 31 December 20X1
	Dragon	Tattoo
	$m	DNm
Property, plant and equipment	290	270
Investments	60	–
Current assets	150	130
	––––––	––––––
	500	400
	––––––	––––––

Share capital	10	5
Retained earnings	290	215
Liabilities	200	180
	––––––	––––––
	500	400
	––––––	––––––

There has been no intra-group trading. Goodwill arising on the acquisition of Tattoo is not impaired. The presentation currency of the consolidated financial statements is the dollar ($).

Exchange rates are as follows:
	DN to $
31 December 20X0	3.0
31 December 20X1	2.0
Average for year to 31 December 20X1	2.6

Required:

For inclusion in the consolidated statement of profit or loss and other comprehensive income for the year ended 31 December 20X1, calculate:

Revenue

Costs

For inclusion in the consolidated statement of financial position as at 31 December 20X1, calculate:

Property, plant and equipment

Investments

Current assets

Share capital

Liabilities

Solution

	$m
Revenue ($1,200 + (DN600/2.6))	1,430.8
Costs ($1,000 + (DN450/2.6))	(1,173.1)
PPE ($290 + (DN270/2))	425.0
Investments (eliminated on consolidation)	–
Current assets ($150 + (DN130/2))	215.0
Share capital (Dragon only)	10.0
Liabilities ($200 + (DN180/2))	290.0

Remember, the incomes and expenses of an overseas subsidiary are translated at the average rate. The assets and liabilities are translated at the closing rate.

Translating goodwill

Goodwill should be calculated in the functional currency of the subsidiary.

According to IAS 21, goodwill should be treated like other assets of the subsidiary and therefore translated at the reporting date using the closing rate.

As with all consolidated statement of financial position questions, it may be helpful to produce a table showing the subsidiary’s net assets (at fair value) at both the year end and acquisition date (‘Working 2’). This should be completed in the functional currency of the subsidiary.

Illustration 2 – Goodwill

Required:

Using the information in illustration 1, calculate goodwill for inclusion in the consolidated statement of financial position for the Dragon group as at 31 December 20X1.

Solution

Goodwill calculation

	DNm
Consideration	180
NCI at acquisition	14
Net assets at acquisition (W)	(70)
	––––
	124
Goodwill impairments	–
	––––
	124
	––––

Goodwill is translated at the closing rate to give a value of $62m (DN124/2).

(W) Net assets of Tattoo

	Acquisition date Reporting date Post-acquisition
	DNm	DNm	DNm
Share capital	5	5
Retained earnings	65	215
	––––––	––––––	––––––
	70	220	150
	––––––	––––––	––––––

Exchange differences

The process of translating an overseas subsidiary gives rise to exchange gains and losses. These gains and losses arise for the following reasons:

Goodwill: Goodwill is retranslated each year-end at the closing rate. It will therefore increase or decrease in value simply because of exchange rate movements.

Opening net assets: At the end of the prior year, the net assets of the subsidiary were translated at the prior year closing rate. This year, those same net assets are translated at this year’s closing rate. Therefore, opening net assets will have increased or decreased simply because of exchange rate movements.

Profit: The incomes and expenses (and, therefore, the profit) of the overseas subsidiary are translated at the average rate. However, making a profit increases the subsidiary’s assets which are translated at the closing rate. This disparity creates an exchange gain or loss.

Current year exchange gains or losses on the translation of an overseas subsidiary and its goodwill are recorded in other comprehensive income.

Goodwill translation

The proforma for calculating the current year gain or loss on the retranslation of goodwill is as follows:

	DN	Exchange Rate	$
Opening goodwill	X	Opening rate	X
Impairment loss in year	(X)	Average rate	(X)
Exchange gain/(loss)	–	Bal fig.	X/(X)
	––––––		––––––
Closing goodwill	X	Closing rate	X
	––––––		––––––

If the subsidiary was purchased part-way through the current year, then substitute ‘opening goodwill’ for ‘goodwill at acquisition’. This would then be translated at the rate of exchange on the acquisition date.

It is important to pay attention to the method of goodwill calculation:

If the full goodwill method has been used, gain and losses will need to be apportioned between the group and the non-controlling interest.

If the proportionate goodwill method has been used, then all of the exchange gain or loss on goodwill is attributable to the group.

Illustration 3 – Translating goodwill

Required:

Using the information in illustration 1, calculate the exchange gain or loss arising on the translation of the goodwill that will be credited/charged through other comprehensive income in the year ended 31 December 20X1.

Who is this gain or loss attributable to?

Solution

	DNm	Exchange Rate	$m
Opening goodwill	124.0	3.0	41.3
Impairment loss in year	–	2.6	–
Exchange gain	–	Bal fig.	20.7
	––––––		––––––
Closing goodwill	124.0	2.0	62.0
	––––––		––––––

The total translation gain of $20.7m will be credited to other comprehensive income.

This is then allocated to the group and NCI based on their respective shareholdings:

Group: $20.7m × 90% = $18.6m

NCI: $20.7m × 10% = $2.1m

Opening net assets and profit

The exchange gains or losses arising on the translation of opening net assets and profit for the year are generally calculated together.

The proforma for calculating the current year exchange gain or loss on the translation of the opening net assets and profit is as follows:

	DN	Exchange Rate	$
Opening net assets	X	Opening rate	X
Profit/(loss) for the year	X/(X)	Average rate	X/(X)
Exchange gain/(loss)	–	Bal fig.	X/(X)
	––––––		––––––
Closing net assets	X	Closing rate	X
	––––––		––––––

If the subsidiary was purchased part-way through the current year, then substitute ‘opening net assets’ and ‘opening rate’ for ‘acquisition net assets’ and ‘acquisition rate’.

The gain or loss on translation of the opening net assets and profit is apportioned between the group and non-controlling interest based on their respective shareholdings.

Illustration 4 – Opening net assets and profit

Required:

Using the information in illustration 1, calculate the exchange gain or loss arising on the translation of the opening net assets and profit of Tattoo that will be credited/charged through other comprehensive income in the year ended 31 December 20X1.

Who are these gains or losses attributable to?

Solution

	DNm	Exchange Rate	$m
Opening net assets*	70	3.0	23.3
Profit/(loss) for the year*	150	2.6	57.7
Exchange gain/(loss)	–	Bal fig.	29.0
	––––––		––––––
Closing net assets*	220	2.0	110.0
	––––––		––––––

*These figures are taken from the net assets working, which can be found in the solution to illustration 2.

The total translation gain of $29.0m will be credited to other comprehensive income.

This is then allocated to the group and NCI based on their respective shareholdings:

Group: 29.0 × 90% = $26.1m

NCI: 29.0 × 10% = $2.9m

Exchange differences on the statement of financial position

Exchange gains and losses arising from the translation of goodwill and the subsidiary’s opening net assets and profit which are attributable to the group are normally held in a translation reserve, a separate component within equity.

Illustration 5 – Reserves

Required:

Using the information in illustration 1, calculate the non-controlling interest, retained earnings and the translation reserve for inclusion in the consolidated statement of financial position as at 31 December 20X1.

Solution

Non-controlling interest

	$m
NCI at acquisition (DN14/3 opening rate)	4.7
NCI % of Tattoo’s post-acquisition profits	5.7
(10% × (DN150/2.6 average rate))
NCI % of goodwill translation (illustration 3)	2.1
NCI % of net assets and profit translation (illustration 4)	2.9
	––––––
	15.4
	––––––
Retained earnings
	$m
100% of Dragon	290.0
90% of Tattoo’s post-acquisition profits	51.9
(90% × (DN150/2.6))	––––––
	––––––
	341.9
	––––––
Translation reserve
	$m
Group share of goodwill forex (illustration 3)	18.6
Group share of net assets and profit forex (illustration 4)	26.1
	––––––

44.7

––––––

Illustration 6 – Completing the financial statements

Required:

Using the information in illustration 1, complete the consolidated statement of financial position and the statement of profit or loss and other comprehensive income for the Tattoo group for the year ended 31 December 20X1.

Solution

Statement of profit or loss and other comprehensive income for year ended 31 December 20X1

	$m
Revenue (illustration 1)	1,430.8
Costs (illustration 1)	(1,173.1)
	–––––––
Profit for the year	257.7
Other comprehensive income –
items that may be classified to profit or loss in future periods
Exchange differences on translation of foreign subsidiary	49.7
($20.7 (illustration 3) + $29.0 (illustration 4))	–––––––
	–––––––
Total comprehensive income for the year	307.4
Profit attributable to:	–––––––
Profit attributable to:
Owners of Dragon (bal. fig.)	251.9
Non-controlling interest	5.8
(10% × (DN150/2.6 avg. rate))	–––––––
	–––––––
Profit for the year	257.7
	–––––––
Total comprehensive income attributable to:
Owners of Dragon (bal. fig.)	296.6
Non-controlling interest	10.8
($5.8 (profit) + $2.1 (illustration 3) + $2.9 (illustration 4))	–––––––
	–––––––
Total comprehensive income for the year	307.4
	–––––––

	Statement of financial position as at 31 December 20X1
		$m
	Property, plant and equipment (illustration 1)	425.0
	Goodwill (illustration 2)	62.0
	Current assets (illustration 1)	215.0
		––––––
		702.0
		––––––
	Share capital (illustration 1)	10.0
	Retained earnings (illustration 5)	341.9
	Translation reserve (illustration 5)	44.7
		––––––
		396.6
	Non-controlling interest (illustration 5)	15.4
		––––––
		412.0
	Liabilities (illustration 1)	290.0
		––––––
		702.0
		––––––

Test your understanding 1 – Parent and Overseas

Parent is an entity that owns 80% of the equity shares of Overseas, a foreign entity that has the Shilling as its functional currency. The subsidiary was acquired at the start of the current accounting period on 1 January 20X7 when its retained earnings were 6,000 Shillings.

At that date the fair value of the net assets of the subsidiary was 20,000 Shillings. This included a fair value adjustment in respect of land of 4,000 Shillings that the subsidiary has not incorporated into its accounting records and still owns.

Goodwill, which is unimpaired at the reporting date, is to be accounted for using the full goodwill method. At the date of acquisition, the non-controlling interest in Overseas had a fair value of 5,000 Shillings.

Statements of financial position:	Parent	Overseas
	Parent	Overseas
	$	Shillings
Investment (20,999 shillings)	3,818
Assets	9,500	40,000
	–––––––	–––––––
	13,318	40,000
Equity and liabilities	–––––––	–––––––
Equity and liabilities
Equity capital	5,000	10,000
Retained earnings	6,000	8,200
Liabilities	2,318	21,800
	–––––––	–––––––
	13,318	40,000
	–––––––	–––––––
Statement of profit or loss for the year:	Parent	Overseas
	Parent	Overseas
	$	Shillings
Revenue	8,000	5,200
Costs	(2,500)	(2,600)
	––––––	–––––––
Profit before tax	5,500	2,600
Tax	(2,000)	(400)
	––––––	–––––––
Profit for the year	3,500	2,200
	––––––	–––––––

Neither entity recognised any other comprehensive income in their individual financial statements during the reporting period.

Relevant exchange rates (Shillings to $1) are:
Date	Shillings: $1
1 January 20X7	5.5
31 December 20X7	5.0
Average for year to 31 December 20X7	5.2

Required:

Prepare the consolidated statement of financial position at 31 December 20X7, together with a consolidated statement of profit or loss and other comprehensive income for the year ended 31 December 20X7.

Test your understanding 2 – Saint and Albans

On the 1 July 20X1 Saint acquired 60% of Albans, whose functional currency is Ds. The presentation currency of the Saint group is the dollar ($). The financial statements of both entities are as follows.

Statements of financial position as at 30 June 20X2
	Saint	Albans
Assets	$	D
Investment in Albans	5,000	–
Loan to Albans	1,400	–
Property, plant and equipment	10,000	15,400
Inventories	5,000	4,000
Receivables	4,000	500
Cash and cash equivalents	1,600	560
	––––––	––––––
	27,000	20,460
	––––––	––––––
Equity and liabilities	$	D
Equity capital ($1/D1)	10,000	1,000
Share premium	3,000	500
Retained earnings	4,000	12,500
Non-current liabilities	5,000	5,460
Current liabilities	5,000	1,000
	–––––––	–––––––
	27,000	20,460
	–––––––	–––––––
Statements of profit or loss for the year ended 30 June 20X2
	Saint	Albans
	$	D
Revenue	50,000	60,000
Cost of sales	(20,000)	(30,000)
	–––––––	––––––
Gross profit	30,000	30,000
Distribution and Administration expenses	(20,000)	(12,000)
	–––––––	–––––––
Profit before tax	10,000	18,000
Tax	(8,000)	(6,000)
	–––––––	–––––––
Profit for the year	2,000	12,000
	–––––––	–––––––

Note: There were no items of other comprehensive income within the individual financial statements of either entity.

The following information is applicable.

Saint purchased the shares in Albans for D10,000 on the first day of the accounting period. At the date of acquisition the retained earnings of Albans were D500 and there was an upward fair value adjustment of D1,000. The fair value adjustment is attributable to plant with a remaining five-year life as at the date of acquisition. This plant remains held by Albans and has not been revalued.

Just before the year-end Saint acquired some goods from a third party at a cost of $800, which it sold to Albans for cash at a mark up of 50%. At the reporting date all these goods remain in the inventories of Albans.

On 1 June X2 Saint lent Albans $1,400. The liability is recorded at the historic rate within the non-current liabilities of Albans.

No dividends have been paid.

Goodwill is to be accounted using the full goodwill method. An impairment review was performed and goodwill had reduced in value by 10% at 30 June 20X2. Impairment is to be charged to cost of sales. The fair value of the non-controlling interest at the date of acquisition was D5,000.

On 1 July 20X1, Saint received a government grant for $4,000. This grant was provided as a contribution towards the costs of training employees over the next two years. Saint has reduced its administrative expenses by the full $4,000.

On 30 June 20X2, Saint sold $2,000 of receivables to a factor for $1,500. Saint must reimburse the factor with any amounts not collected by 31 December 20X2. Saint has credited the proceeds received against receivables.

(viii)Exchange rates are as follows:
	D: $1
1 July 20X1	2.00
Average rate	3.00
1 June 20X2	3.90
30 June 20X2	4.00

Required:

Prepare the group statement of financial position as at 30 June 20X2 and the group statement of profit or loss and other comprehensive income for the year ended 30 June 20X2.

3 Disposals

On the disposal of a foreign subsidiary, the cumulative exchange differences recognised as other comprehensive income and accumulated in a separate component of equity become realised.

IAS 21 requires that these exchanges differences are recycled (i.e. reclassified) on the disposal of the subsidiary as part of the profit/loss on disposal.

Test your understanding 3 – LUMS Group

The LUMS group has sold its entire 100% holding in an overseas subsidiary for proceeds of $50,000. The net assets at the date of disposal were $20,000 and the carrying value of goodwill at that date was $10,000. The cumulative balance on the group foreign currency reserve is a gain of $5,000.

Required:

Calculate the gain arising on the disposal of the foreign subsidiary in the consolidated statement of profit or loss.

4 Other issues

Shortcomings in IAS 21

In relation to IAS 21, the following criticisms have been made:

Lack of theoretical underpinning

It is not clear why foreign exchange gains and losses on monetary items are recorded in profit or loss, yet foreign exchange gains and losses arising on consolidation of a foreign operation are reported in other comprehensive income (OCI).

It is argued that recording foreign exchange gains or losses on monetary items in profit or loss increases the volatility of reported profits. As such, it has been suggested that foreign exchange gains or losses should be recorded in OCI if there is a high chance of reversal.

Long-term items

It is argued that retranslating long-term monetary items using the closing rate does not reflect economic substance. This is because a current exchange rate is being used to translate amounts that will be repaid in the future.

Foreign exchange gains and losses on long-term items are highly likely to reverse prior to repayment/receipt, suggesting that such gains and losses are unrealised. This provides further weight to the argument that foreign exchange gains and losses on at least some monetary items should be recorded in OCI.

The average rate

IAS 21 does not stipulate how to determine the average exchange rate in the reporting period. This increases the potential for entities to manipulate their net assets or total comprehensive income.

The use of different average rates will limit comparability between reporting entities.

Monetary/non-monetary

The distinction between monetary and non-monetary items can be ambiguous and would benefit from further clarification.

Foreign operations

IAS 21 uses a restrictive definition of a ‘foreign operation’ – a subsidiary, associate, joint venture or branch whose activities are based in a country or currency other than that of the reporting entity. It is argued that IAS 21 should instead use a definition of a foreign operation that is based on substance, rather than legal form.

Test your understanding 1 – Parent and Overseas

Group statement of financial position

Note: The assets and liabilities of Overseas have been translated at the closing rate.

	$
Goodwill (W3)	1,200
Assets ($9,500 + ((Sh40,000 + Sh4,000 FVA)/5.0))	18,300
	––––––
	19,500
	––––––
Equity and liabilities	$
Equity capital	5,000
Retained earnings (W5)	6,338
Translation reserve (W6)	392
	––––––
	11,730
Non-controlling interest (W4)	1,092
	––––––
Total equity	12,822
Liabilities ($2,318 + (Sh21,800/5.0))	6,678
	––––––

19,500

––––––

Group statement of profit or loss and other comprehensive income for the year

Note: The income and expenses for Overseas have been translated at the average rate.

	$
Revenue ($8,000 + (Sh5,200/5.2))	9,000
Costs ($2,500 + (Sh2,600/5.2))	(3,000)
	–––––
Profit before tax	6,000
Tax ($2,000 + (Sh400/5.2))	(2,077)
	–––––
Profit for the year	3,923

Other comprehensive income
Items that may be reclassified to profit or loss in future periods
Exchange differences on translation of foreign subsidiary	490
($109 (W3) + $381 (W6))	–––––
	–––––
Total comprehensive income for the year	4,413
Profit for the year attributable to:	–––––
Profit for the year attributable to:
Owners of Parent (bal. fig.)	3,838
Non-controlling interest (20% × (Sh2,200/5.2))	85
	–––––
	3,923
Total comprehensive income attributable to:	–––––
Total comprehensive income attributable to:
Owners of Parent (bal. fig.)	4,230
Non-controlling interest $85 (profit) + $22(W3) + $76(W7)	183
	–––––

4,413

–––––

Workings

(W1) Group structure

80%

NCI = 20% for complete year

(W2) Net assets of subsidiary in functional currency

	Acq’n date	Rep date
	Shillings	Shillings	Shillings
Share capital	10,000	10,000
Retained earnings	6,000	8,200
Fair value adjustment – land	4,000	4,000
	–––––	–––––	–––––
	20,000	22,200	2,200
	–––––	–––––	–––––

(W3) Goodwill calculation and forex

Calculation of goodwill
Full goodwill:		Shillings
Cost of investment			20,999
($3,818 × 5.5)
FV of NCI at acquisition				5,000
			––––––
			25,999
FV of NA at acquisition (W2)			(20,000)
			––––––
Full goodwill at acquisition				5,999
			––––––
Translate at closing rate			$1,200
(Sh5,999/5)			––––––
Goodwill forex			––––––
Goodwill forex	Shillings	Exchange		$
	Shillings	Exchange		$
		rate		1,091
Goodwill at acquisition	5,999	5.5		1,091
Impairment	–			–
Exchange gain		bal. fig		109
	––––			––––
Closing goodwill	5,999	5.0		1,200
	––––			––––
The exchange gain on the retranslation of goodwill is allocated
between the group and NCI based upon their respective
shareholdings:
Group: 80% × $109 = $87 (W7)
NCI: 20% × $109 = $22 (W4)
(W4) Non-controlling interest
				$
NCI fair value at acquisition (Sh5,000/5.5 op. rate)				909
NCI share of post-acquisition profit (20% × (Sh2,200 (W2)/5.2				85
avg rate))				22
NCI share of exchange gain on retranslation of goodwill (W3)				22
NCI share of exchange gain on retranslation of net assets (W7)				76
				––––

1,092

––––

(W5) Retained earnings
	$
Parent	6,000
Group share of post-acquisition profit	338
(80% × (2,200(W2)/5.2 avg. rate))
	–––––
	6,338
	–––––
(W6) Translation reserve
	$
Group share of goodwill forex (W3)	87
Group share of net assets and profit forex (W7)	305
	–––––
	392
	–––––
(W7) Forex on net assets and profit

Net assets at acquisition (W2)

Retained profit for the year (W2)

Exchange gain

Shillings	Rate	$
20,000	5.5	3,636
2,200	5.2	423
bal fig		381

––––– ––––

Closing net assets 22,200 5.0 4,440

––––– ––––

Note that the total exchange gain on retranslation of the opening net assets and profit must be allocated between the group and NCI based upon their respective shareholdings as follows:

Group: 80% × $381 = $305 (W6)

NCI: 20% × $381 = $76 (W4)

Test your understanding 2 – Saint and Albans

Saint Group

Note: The assets and liabilities of Albans have been translated at the closing rate.

Group statement of financial position at 30 June 20X2
	$
Goodwill (W3)	2,700
Loan to Albans ($1,400 – $1,400 interco)	Nil
Property, plant and equipment	14,050
($10,000 + D14,500/4 + D1,000 (W2)/4 – D200 (W2)/4)
Inventories ($5,000 + D4,000/4 – $400 (W8))	5,600
Receivables ($4,000 + D500/4 + $1,500 (W10))	5,625
Cash and cash equivalents ($1,600 + D560/4)	1,740
	–––––
	29,715
	–––––
	$
Equity capital	10,000
Share premium	3,000
Retained earnings (W5)	3,692
Translation reserve (W7)	(2,773)
	–––––
	13,919
Non-controlling interest (W4)	2,046
	–––––
Total equity	15,965
Non-current liabilities ($5,000 + D5,460/4 + D140/4 – $1,400	5,000
interco)
Current liabilities ($5,000 + D1,000/4 + $2,000 (W9) + $1,500	8,750
(W10))

–––––

29,715

–––––

Note: The income and expenses of Albans have been translated at the average rate for the year.

Group statement of profit or loss and other comprehensive income for the year ended 30 June 20X2

	$
Revenue ($50,000 + D60,000/3 – $1,200 interco)	68,800
Cost of sales	(29,667)
($20,000 + D30,000/3 + D200/3 (W2) + $400 (W3) + $400
(W8) – $1,200 interco)	–––––
	–––––
Gross profit	39,133
Admin expenses ($20,000 + D12,000/3 + D140/3 (W2) +	(26,047)
$2,000 (W9))	–––––
Profit before tax	13,086
Tax ($8,000 + D6,000/3)	(10,000)
	–––––
Profit for the year:	3,086
Other comprehensive income – items that may be reclassified
to profit or loss in future periods:
Exchange loss on translation of foreign subsidiary	(4,622)
(($2,900) (W3) + ($1,722) (W6))	–––––
	–––––
Total comprehensive income for the year	(1,536)
Profit for the year:	–––––
Profit for the year:
Attributable to Group (bal fig.)	1,691
Attributable to NCI	1,395
((40% × (D11,660 (W2)/3 avg. rate)) – $160 GW impairment
(W3))	–––––
	–––––
	3,086
	–––––
Total comprehensive income for the year:	$
Attributable to Group (bal fig.)	(1,082)
Attributable to NCI	(454)
($1,395 profit – $1,160 (W3) – $689 (W6))	–––––
	–––––

(1,536)

–––––

Workings

(W1) Group structure

60%

NCI = 40% for complete year

(W2) Net assets of subsidiary in functional currency

	At acquisition Rep date Post-acq’n
	D	D	D
Equity capital	1,000	1,000
Share premium	500	500
Retained earnings	500	12,500
Fair value adjustment – plant	1,000	1,000
FVA – dep’n on plant (1/5)		(200)
Exchange loss on loan*		(140)
	–––––	–––––	–––––
Post acquisition movement	3,000	14,660	11,660
	–––––	–––––	–––––

*Exchange loss on loan received by Albans

The loan was initially recorded at D5,460 ($1,400 × 3.9)

The loan needs to be retranslated using the closing rate to D5,600 ($1,400 × 4.0)

There is therefore an exchange loss of D140 (D5,600 – D5,460).

Dr Profit or loss/retained earnings (W2)	D140
Cr Non-current liabilities	D140

(W3) Goodwill
Goodwill calculation
			D
Cost to parent ($5,000 × 2.0)			10,000
FV of NCI at acquisition			5,000
			–––––
			15,000
FV of NA at acquisition (W2)			(3,000)
			–––––
Full goodwill at acquisition			12,000
Impairment – 10%			(1,200)
			–––––
Unimpaired goodwill at reporting date			10,800
			–––––
Exchange gain (loss) on retranslation of goodwill
	D	Rate	$
Goodwill at acquisition	12,000	2.0	6,000
Impairment	(1,200)	3.0	(400)
Exchange gain (loss)		Bal fig	(2,900)
	–––––		–––––
Goodwill at reporting	10,800	4.0	2,700
date	–––––		–––––
	–––––		–––––

The impairment loss on the goodwill is allocated between the group and NCI based on their respective shareholdings:

Group: 60% × $400 = $240 (W5)

NCI: 40% × $400 = $160 (W4)

The exchange loss on retranslation of goodwill is allocated between the group and NCI based on their respective shareholdings:

Group: 60% × $2900 = $1,740 (W7)

NCI: 40% × $2900 = $1,160 (W4)

(W4) Non-controlling interest
			$
FV at acquisition per question (D5,000/2)			2,500
NCI % of post-acquisition profit			1,555
40% × (D11,660/3 avg rate) (W2)
NCI % of goodwill impairment (W3)			(160)
NCI % of retranslation loss on goodwill (W3)			(1,160)
NCI % of retranslation loss on net assets (W6)			(689)
			–––––
			2,046
			–––––
(W5) Group retained earnings
			$
Parent retained earnings			4,000
Government grant (W9)			(2,000)
Group share of goodwill impairment (W3)			(240)
Group share of post-acq’n profit			2,332
60% × (D11,660/3 avg. rate) (W2)
PURP (W8)			(400)
			–––––
			3,692
(W6) Exchange differences on retranslation of net assets			–––––

	D	Rate	$
Acquisition net assets	3,000	2.0	1,500
Profit for year	11,660	3.0	3,887
Exchange gain/(loss)		bal fig	(1,722)
	–––––		–––––
Closing net assets	14,660	4.0	(3,665)
	–––––		–––––

The exchange loss is allocated between the group and NCI based upon respective shareholdings:

Group: 60% × $1,722 = $1,033 (W7)

NCI: 40% × $1,722 = $689 (W4)

(W7) Translation reserve

Group share of forex on net assets and profit (W6) (1,033)

Group share of forex on goodwill (W3) (1,740)

–––––

(2,773)

–––––

(W8) PURP

The profit on the intra-group sale is $400 ((50/100) × $800).

All of these items remain in group inventory. Therefore the adjustment required is:

Dr Cost of sales/retained earnings	$400
Cr Inventories	$400

(W9) Government grant

This is a revenue grant. It should be recognised in profit or loss on a systematic basis. The grant is intended to cover training costs over a two year period and so it should be recognised in profit or loss over two years.

Saint should increase its expenses by $2,000 (1/2 × $4,000) and record the balance as deferred income on the SFP.

Dr Administrative expenses/retained earnings	$2,000
Cr Current liabilities	$2,000

(W10) Receivables factoring

The risks and rewards of ownership have not transferred from Saint to the factor so the receivable should not be derecognised. The proceeds received should instead be shown as a liability.

The correcting entry is:
Dr Receivables	$1,500
Cr Liabilities	$1,500

Test your understanding 3 – LUMS Group

	$
Proceeds	50,000
Net assets recorded prior to disposal:
Net assets	20,000
Goodwill	10,000
	––––––
	(30,000)
Recycling of forex gains to P/L	5,000
	––––––
	25,000
	––––––

Posted on March 31, 2021March 31, 2021 by MJ — Leave a comment

Change in a group structure

Acquisition of a subsidiary

There are two acquisition scenarios that need to be considered in more detail:

mid-year acquisitions

step acquisitions.

Mid-year acquisitions

A parent entity consolidates a subsidiary from the date that it achieves control. If this happens partway through the reporting period then it will be necessary to pro-rate the results of the subsidiary so that only the post-acquisition incomes and expenses are consolidated into the group statement of profit or loss.

Illustration 1 – Tudor – mid-year acquisition of a subsidiary

On 1 July 20X4 Tudor purchased 1,600,000 of the 2,000,000 $1 equity shares of Windsor for $10,280,000. On the same date it also acquired 1,000,000 of Windsor’s $1 10% loan notes. At the date of acquisition the retained earnings of Windsor were $6,150,000.

The statements of profit or loss for each entity for the year ended 31 March 20X5 were as follows.

	Tudor	Windsor
	$000	$000
Revenue	60,000	24,000
Cost of sales	(42,000)	(20,000)
	–––––––	–––––––
Gross profit	18,000	4,000
Distribution costs	(2,500)	(50)
Administrative expenses	(3,500)	(150)
	–––––––	–––––––
Profit from operations	12,000	3,800
Investment income	75	–
Finance costs	–	(200)
	–––––––	–––––––
Profit before tax	12,075	3,600
Tax	(3,000)	(600)
	–––––––	–––––––
Profit for the year	9,075	3,000
Retained earnings bfd	–––––––	–––––––
Retained earnings bfd	16,525	5,400

There were no items of other comprehensive income in the year.

The following information is relevant:

The fair values of Windsor’s net assets at the date of acquisition were equal to their carrying values with the exception of plant and equipment, which had a carrying value of $2,000,000 but a fair value of $5,200,000. The remaining useful life of this plant and equipment was four years at the date of acquisition. Depreciation is charged to cost of sales and is time apportioned on a monthly basis.

During the post-acquisition period Tudor sold goods to Windsor for $12 million. The goods had originally cost $9 million. During the remaining months of the year Windsor sold $10 million (at cost to Windsor) of these goods to third parties for $13 million.

Incomes and expenses accrued evenly throughout the year.

Tudor has a policy of valuing non-controlling interests using the full goodwill method. The fair value of non-controlling interest at the date of acquisition was $2,520,000.

The recoverable amount of the net assets of Windsor at the reporting date was $14,150,000. Any goodwill impairment should be charged to administrative expenses.

Required:

Prepare a consolidated statement of profit or loss for Tudor group for the year ended 31 March 20X5.

Solution

Tudor group statement of profit or loss for the year ended 31 March 20X5

	$000
Revenue ($60,000 + (9/12 × $24,000) – $12,000)	66,000
Cost of sales	(46,100)
($42,000 + (9/12 × $20,000) – $12,000 + $600 (W6) + $500
(W5))	––––––
	––––––
Gross profit	19.900
Distribution costs ($2,500 + (9/12 × $50))	(2,538)
Administrative expenses	(3,912)
($3,500 + (9/12 × $150) + $300 (W3))	––––––
	––––––
Profit from operations	13,450
Investment income ($75 – $75)	–
Finance costs ((9/12 × $200) – $75)	(75)
	––––––
Profit before tax	13,375
Tax ($3,000 + (9/12 × $600))	(3,450)
	––––––
Profit after tax for the year	9,925
Profit attributable to:	––––––
Profit attributable to:
Owners of the parent (bal. fig)	9,655
Non-controlling interest (W7)	270
	––––––

9,925

––––––

There were no items of other comprehensive income in the year.

(W1) Group structure – Tudor owns 80% of Windsor

– the acquisition took place three months into the year

– nine months is post-acquisition

(W2) Goodwill impairment
	$000
Net assets of the subsidiary (W3)	13,000
Goodwill (W4)	1,450
	––––––
	14,450
Recoverable amount	(14,150)
	––––––
Impairment	300
	––––––

The impairment will be allocated against goodwill and charged to the statement of profit or loss.

Goodwill has been calculated using the fair value method so the impairment needs to be factored in when calculating the profit attributable to the NCI (W7).

(W3) Net assets	Acq’n	Rep.
	Acq’n	Rep.
	date	date
	$000	$000
Equity capital	2,000	2,000
Retained earnings	6,150	8,400
(Rep date = $5,400 bfd + $3,000)	3,200
Fair value adjustment – PPE ($5.2m –	3,200	3,200
$2.0m)
Depreciation on FVA (W6)	–	(600)
	––––––	––––––
	11,350	13,000
	––––––	––––––

(W4) Goodwill
	$000
Consideration	10,280
FV of NCI at acquisition	2,520
	–––––––
	12,800
FV of net assets at acquisition (W3)	(11,350)
	–––––––
Goodwill pre-impairment review (W2)	1,450
	–––––––

(W5) PURP

$2 million ($12m – $10m) of the $12 million intra-group sale remains in inventory.

The profit that remains in inventory is $500,000 (($12m – $9m) × 2/12).

(W6) Excess depreciation

Per W3, there has been a fair value uplift in respect of PPE of $3,200,000.

This uplift will be depreciated over the four year remaining life.

The depreciation charge in respect of this uplift in the current year statement of profit or loss is $600,000 (($3,200,000/4 years) × 9/12).

(W7) Profit attributable to the NCI
	$000	$000
Profit of Windsor (9/12 × $3,000)	2,250
Excess depreciation (W6)	(600)
Goodwill impairment (W2)	(300)
	–––––
× 20%	1,350	–––––
× 20%		–––––
Profit attributable to the NCI		270
		–––––

Step acquisitions

A step acquisition occurs when the parent company acquires control over the subsidiary in stages. This is achieved by buying blocks of shares at different times. Acquisition accounting is only applied at the date when control is achieved.

Any pre-existing equity interest in an entity is accounted for according to:

– IFRS 9 in the case of simple investments

– IAS 28 in the case of associates and joint ventures

– IFRS 11 in the case of joint arrangements other than joint ventures

At the date when the equity interest is increased and control is achieved:

(1) re-measure the previously held equity interest to fair value

(2) recognise any resulting gain or loss in profit or loss for the year

(3) calculate goodwill and the non-controlling interest on either a partial or full basis.

For the purposes of the goodwill calculation, the consideration will be the fair value of the previously held equity interest plus the fair value of the consideration transferred for the most recent purchase of shares at the acquisition date. You may wish to use the following proforma:

	$
Fair value of previously held interest	X
Fair value of consideration for additional interest	X
NCI at acquisition	X
	–––
	X
Less: FV of net assets at acquisition	(X)
	–––
Goodwill at acquisition	X
	–––

If there has been re-measurement of any previously held equity interest that was recognised in other comprehensive income, any changes in value recognised in earlier years are now reclassified to retained earnings.

Purchasing further shares in a subsidiary after control has been acquired (for example taking the group interest from 60% to 75%) is regarded as a transaction between equity holders. Goodwill is not recalculated. This situation is dealt with separately within this chapter.

Illustration 2 – Ayre, Fleur and Byrne

Ayre has owned 90% of the ordinary shares of Fleur for many years. Ayre also has a 10% investment in the shares of Byrne, which was held in the consolidated statement of financial position as at 31 December 20X6 at $24,000 in accordance with IFRS 9. On 30 June 20X7, Ayre acquired a further 50% of Byrne’s equity shares at a cost of $160,000.

The draft statements of profit or loss for the three companies for the year ended 31 December 20X7 are presented below:

Statements of profit or loss for the year ended 31 December 20X7

	Ayre	Fleur	Byrne
	$000	$000	$000
Revenue	500	300	200
Cost of sales	(300)	(70)	(120)
	–––––	–––––	–––––
Gross profit	200	230	80
Operating costs	(60)	(80)	(60)
	–––––	–––––	–––––
Profit from operations	140	150	20
Income tax	(28)	(30)	(4)
	–––––	–––––	–––––
Profit for the period	112	120	16
	–––––	–––––	–––––

The non-controlling interest is calculated using the fair value method. On 30 June 20X7, fair values were as follows:

Byrne’s identifiable net assets – $200,000

The non-controlling interest in Byrne – $100,000

The original 10% investment in Byrne – $26,000

Required:

Prepare the consolidated statement of profit or loss for the Ayre Group for the year ended 31 December 20X7 and calculate the goodwill arising on the acquisition of Byrne.

Solution

Group statement of profit or loss for the year ended 31 December 20X7

	$000
Revenue ($500 + $300 + (6/12 × $200))	900
Cost of sales ($300 + $70 + (6/12 × $120))	(430)
	–––––
Gross profit	470
Operating costs ($60 + $80 + (6/12 × $60))	(170)
	–––––
Profit from operations	300
Profit on derecognition of equity investment (W1)	2
	–––––
	302
Income tax ($28 + $30 + (6/12 × $4))	(60)
	–––––
Profit for the period	242
	–––––
Profit attributable to:
Equity holders of the parent (bal. fig)	226.8
Non-controlling interest (W2)	15.2
	–––––
Profit for the period	242
	–––––
Goodwill calculation
	$000
FV of previously held interest	26
FV of consideration for additional interest	160
NCI at acquisition date	100
	–––––
	286
FV of net assets at acquisition	(200)
	–––––
Goodwill	86
	–––––

(W1) Group Structure

This is a step acquisition. The previous investment in shares must be revalued to fair value with the gain on revaluation recorded in the statement of profit or loss.

Dr Investment ($26,000 – $24,000)	2,000
Cr Profit or loss	2,000

The investment, now held at $26,000, is included in the calculation of goodwill.

Ayre had control over Byrne for 6/12 of the current year. Therefore 6/12 of the incomes and expenses of Byrne are consolidated in full.

(W2) Profit attributable to the NCI
	$000	$000
Profit of Fleur in consolidated profit or loss	120
× 10%	––––	12
× 10%		12
Profit of Byrne in consolidated profit or loss	8
(6/12 × $16)	––––
× 40%		3.2
		––––
Profit attributable to NCI		15.2
		––––

Test your understanding 1 – Major and Tom

The statements of financial position of two entities, Major and Tom, as at 31 December 20X6 are as follows:

	Major	Tom
	$000	$000
Investment	160
Sundry assets	350	250
	–––––	–––––
	510	250
	–––––	–––––
Equity share capital	200	100
Retained earnings	250	122
Liabilities	60	28
	–––––	–––––
	510	250
	–––––	–––––

Major acquired 40% of Tom on 31 December 20X1 for $90,000. At this time, the retained earnings of Tom stood at $76,000. A further 20% of shares in Tom was acquired by Major three years later for $70,000. On this date, the fair value of the existing holding in Tom was $105,000. Tom’s retained earnings were $100,000 on the second acquisition date. The NCI should be valued using the proportion of net assets method.

Required:

Prepare the consolidated statement of financial position for the Major group as at 31 December 20X6.

2 Disposal scenarios

During the year, one entity may sell some or all of its shares in another entity causing a loss of control.

Possible situations include:

the disposal of all the shares held in the subsidiary

the disposal of part of the shareholding, leaving a residual holding after the sale, which is regarded as an associate

the disposal of part of the shareholding, leaving a residual holding after the sale, which is regarded as a trade investment.

The accounting treatment of all of these situations is very similar.

Disposals in the individual financial statements

In all of the above scenarios, the profit on disposal in the investing entity’s individual financial statements is calculated as follows:

	$
Sales proceeds	X
Carrying amount (usually cost) of shares sold	(X)
	–––
Profit/(loss) on disposal	X/(X)
	–––

The profit or loss may need to be reported as an exceptional item. If so, it must be disclosed separately on the face of the parent’s statement of profit or loss for the year.

There may be tax to pay on this gain, depending on the tax laws in place in the parent’s jurisdiction. This would result in an increase to the parent company’s tax expense in the statement of profit or loss.

Disposals in the consolidated financial statements

If the sale of shares causes control over a subsidiary to be lost, then the treatment in the consolidated financial statements is as follows:

Consolidate the incomes and expenses of the subsidiary up until the disposal date

On disposal of the subsidiary, derecognise its assets, liabilities, goodwill and non-controlling interest and calculate a profit or loss on disposal

Recognise any remaining investment in the shares of the former subsidiary at fair value and subsequently account for this under the relevant accounting standard

– A holding of 20–50% of the shares would probably mean that the remaining investment is an associate, which should be accounted for using the equity method

– A holding of less than 20% of the shares would probably mean that the remaining investment should be accounted for under IFRS 9 Financial Instruments.

Where control of a subsidiary has been lost, the following template should be used for the calculation of the profit or loss on disposal:

	$	$
Disposal proceeds		X
Fair value of retained interest		X
		–––
Less interest in subsidiary disposed of:		X
Less interest in subsidiary disposed of:
Net assets of subsidiary at disposal date	X
Goodwill at disposal date	X
Less: Carrying amount of NCI at disposal date	(X)
	–––	(X)
		(X)
		–––
Profit/(loss) to the group		X/(X)
		–––

Illustration 3 – Rock

Rock has held a 70% investment in Dog for two years. Goodwill has been calculated using the full goodwill method. There have been no goodwill impairments to date.

Rock disposes of all of its shares in Dog. The following information has been provided:

	$
Cost of investment	2,000
Dog – Fair value of net assets at acquisition	1,900
Dog – Fair value of the non-controlling interest at acquisition	800
Sales proceeds	3,000
Dog – Net assets at disposal	2,400

Required:

Calculate the profit or loss on disposal in:

Rock’s individual financial statements

the consolidated financial statements.

Solution

Rock’s individual financial statements

		$
Sales proceeds		3,000
Cost of shares sold		(2,000)
		––––––
Profit on disposal		1,000
		––––––
(b) Consolidated financial statements
	$	$
Sales proceeds		3,000
Interest in subsidiary disposed of:
Net assets at disposal	2,400
Goodwill at disposal (W1)	900
Carrying amount of NCI at disposal (W2)	(950)
	–––––	(2,350)
		(2,350)
		–––––
Profit on disposal		650
		–––––
(W1) Goodwill
		$
Consideration		2,000
FV of NCI at acquisition		800
		––––––
		2,800
FV of net assets at acquisition		(1,900)
		––––––
Goodwill		900
		––––––
(W2) NCI at disposal date
		$
NCI at acquisition		800
NCI % of post acquisition net assets		150
(30% × ($2,400 – $1,900))		–––––
		–––––

950

–––––

Illustration 4 – Thomas and Percy

Thomas disposed of a 25% holding in Percy on 30 June 20X6 for $125,000. A 70% holding in Percy had been acquired five years prior to this. Thomas uses the full goodwill method. Goodwill was impaired and written off in full prior to the year of disposal.

Details of Percy are as follows:	$
	$
Net assets at disposal date	340,000
Fair value of a 45% holding at 30 June 20X6	245,000

The carrying value of the NCI is $80,000 at the disposal date.

Required:

What is the profit or loss on disposal for inclusion in the consolidated statement of profit or loss for the year ended 31 December 20X6?

Solution

The group’s holding in Percy has reduced from 70% to 45%. Control over Percy has been lost and a profit or loss on disposal must be calculated.

The profit on disposal to be included in the consolidated statement of profit or loss is calculated as follows:

	$	$
Proceeds		125,000
FV of retained interest		245,000
		–––––––
Net assets recognised at disposal	340,000	370,000
Net assets recognised at disposal	340,000
Goodwill at disposal	–
Less: NCI at disposal date	(80,000)
	–––––––	(260,000)
		(260,000)
		–––––––
Profit on disposal		110,000
		–––––––

On 30 June 20X6, the remaining investment in Percy will be recognised at its fair value of $245,000. From that date, it will be accounted for using the equity method in the consolidated financial statements.

Test your understanding 2 – Padstow

Padstow purchased 80% of the shares in St Merryn four years ago for $100,000. On 30 June it sold all of these shares for $250,000. The net assets of St Merryn at the acquisition date were $69,000 and at the disposal date were $88,000. Fifty per cent of the goodwill arising on acquisition had been written off in an earlier year. The fair value of the non-controlling interest in St Merryn at the date of acquisition was $15,000. It is group policy to account for goodwill using the full goodwill method.

Tax is charged at 30%.

Required:

Calculate the profit or loss arising to the parent entity on the disposal of the shares.

Calculate the profit or loss arising to the group on the disposal of the shares.

Test your understanding 3 – Hague

Hague has held a 60% investment in Maude for several years, using the full goodwill method to value the non-controlling interest. Half of the goodwill has been impaired prior to the date of disposal of shares by Hague. Details are as follows:

	$000
Cost of investment	6,000
Maude – Fair value of net assets at acquisition	2,000
Maude – Fair value of a 40% investment at acquisition date	1,000
Maude – Net assets at disposal	3,000
Maude – Fair value of a 25% investment at disposal date	3,500

Required:

Assuming a full disposal of the holding and proceeds of $10 million, calculate the profit or loss arising:

in Hague’s individual financial statements

in the consolidated financial statements.

Tax is 25%.

Assuming a disposal of a 35% holding and proceeds of $5 million:

calculate the profit or loss arising in the consolidated financial statements

explain how the residual shareholding will be accounted for.

Ignore tax.

Presentation of disposed subsidiary in the consolidated financial statements

There are two ways of presenting the results of the disposed subsidiary:

Time-apportionment line-by-line

In the consolidated statement of profit or loss, the income and expenses of the subsidiary are consolidated up to the date of disposal. The traditional way is to time apportion each line of the disposed subsidiary’s results.

The profit or loss on disposal of the subsidiary would be presented as an exceptional item.

Discontinued operation

If the subsidiary qualifies as a discontinued operation in accordance with IFRS 5 then its results are aggregated into a single line on the face of the consolidated statement of profit or loss. This is presented immediately after profit for the period from continuing operations.

This single figure comprises:

– the profit or loss of the subsidiary up to the disposal date

– the profit or loss on the disposal of the subsidiary.

Test your understanding 4 – Kathmandu

The statements of profit or loss and extracts from the statements of changes in equity for the year ended 31 December 20X9 are as follows:

Statements of profit or loss for the year ended 31 December 20X9

	Kathmandu	Nepal
	group
	$	$
Revenue	553,000	450,000
Operating costs	(450,000)	(400,000)
	–––––––	–––––––
Operating profits	103,000	50,000
Investment income	8,000	–
	–––––––	–––––––
Profit before tax	111,000	50,000
Tax	(40,000)	(14,000)
	–––––––	–––––––
Profit for the period	71,000	36,000
	–––––––	–––––––
Extracts from SOCIE for year ended 31 December 20X9
	Kathmandu	Nepal
	group
	$	$
Retained earnings b/f	100,000	80,000
Profit for the period	71,000	36,000
Dividend paid	(25,000)	(10,000)
	––––––	––––––
Retained earnings c/f	146,000	106,000
	––––––	––––––

There were no items of other comprehensive income during the year.

Additional information

The accounts of the Kathmandu group do not include the results of Nepal.

On 1 January 20X5 Kathmandu acquired 70% of the shares of Nepal for $100,000 when the fair value of Nepal’s net assets was $110,000. Nepal has equity capital of $50,000. At that date, the fair value of the non-controlling interest was $40,000. It is group policy to measure the NCI at fair value at the date of acquisition.

Nepal paid its 20X9 dividend in cash on 31 March 20X9.

Goodwill has not been impaired.

Required:

Prepare the group statement of profit or loss for the year ended 31 December 20X9 for the Kathmandu group on the basis that Kathmandu plc sold its holding in Nepal on 1 July 20X9 for $200,000. This disposal is not yet recognised in any way in Kathmandu group’s statement of profit or loss. Assume that Nepal does not represent a discontinued operation per IFRS 5.

Explain and illustrate how the presentation of the group statement of profit or loss would differ from part (a) if Nepal represented a discontinued activity per IFRS 5.

Prepare the group statement of profit or loss for the year ended 31 December 20X9 for the Kathmandu group on the basis that Kathmandu sold half of its holding in Nepal on 1 July 20X9 for $100,000 This disposal is not yet recognised in any way in Kathmandu group’s statement of profit or loss. The residual holding of 35% has a fair value of $100,000 and leaves the Kathmandu group with significant influence over Nepal.

3 Control to control scenarios

In this chapter, we have looked at:

share purchases that have led to control over another company being obtained

share sales that have led to control over another company being lost.

However, some share purchases will simply increase an entity’s holding in an already existing subsidiary (e.g. increasing a holding from 80% to 85%). Similarly, some share sales will not cause an entity to lose control over a subsidiary (e.g. decreasing a holding from 80% to 75%).

These ‘control to control’ scenarios will now be considered in more detail.

Increasing a shareholding in a subsidiary (e.g. 80% to 85%)

When a parent company increases its shareholding in a subsidiary, this is not treated as an acquisition in the group financial statements. For example, if the parent holds 80% of the shares in a subsidiary and buys 5% more then the relationship remains one of a parent and subsidiary. However, the NCI holding has decreased from 20% to 15%.

The accounting treatment of the above situation is as follows:

The NCI within equity decreases

The difference between the consideration paid for the extra shares and the decrease in the NCI is accounted for within equity (normally, in ‘other components of equity’).

Note that no profit or loss arises on the purchase of the additional shares.

Goodwill is not recalculated.

The following proforma will help to calculate the adjustments required to NCI and other components of equity:

Cash paid X Cr

Decrease in NCI (X) Dr

––––

Decrease/(increase) to other components of equity X/(X) Dr/Cr (bal. entry)

––––

The decrease in NCI will represent the proportionate reduction in the carrying amount of the NCI at the date of the group’s additional purchase of shares

For example, if the NCI shareholding reduces from 30% to 20%, then the carrying amount of the NCI must be reduced by one-third.

Test your understanding 5 – Gordon and Mandy

Gordon has owned 80% of Mandy for many years.

Gordon is considering acquiring more shares in Mandy. The NCI of Mandy currently has a carrying amount of $20,000, with the net assets and goodwill having a carrying amount of $125,000 and $25,000 respectively.

Gordon is considering the following two scenarios:

Gordon could buy 20% of the Mandy shares leaving no NCI for $25,000, or

Gordon could buy 5% of the Mandy shares for $4,000 leaving a 15% NCI.

Required:

Calculate the adjustments required to NCI and other components of equity.

Sale of shares without losing control (e.g. 80% to 75%)

From the perspective of the group accounts, a sale of shares which results in the parent retaining control over the subsidiary is simply a transaction between shareholders. If the parent company holds 80% of the shares of a subsidiary but then sells a 5% holding, a relationship of control still exists. As such, the subsidiary will still be consolidated in the group financial statements. However, the NCI has risen from 20% to 25%.

The accounting treatment of the above situation is as follows:

The NCI within equity is increased

The difference between the proceeds received and the increase in the non-controlling interest is accounted within equity (normally, in ‘other components of equity’).

Note that no profit or loss arises on the sale of the shares. Goodwill is not recalculated.

The following proforma will help to calculate the adjustments required to NCI and other components of equity:

	$
Cash proceeds received	X	Dr
Increase in NCI	(X)	Cr
	–––
Increase/(Decrease) to other components of	X/	Cr/Dr (bal.
equity	(X)	entry)
	–––

The increase in the NCI will be the share of the net assets (always) and goodwill (fair value method only) of the subsidiary at the date of disposal which the parent has effectively sold to the NCI.

For example, if the NCI shareholding increases from 20% to 30%, then the carrying amount of the NCI must be increased by 10% of the subsidiary’s net assets and, if using the fair value method, goodwill.

Illustration 5 – No loss of control – Juno

Until 30 September 20X7, Juno held 90% of Hera. On that date it sold a 10% interest in the equity capital for $15,000. At the date of the share disposal, the carrying amount of net assets and goodwill of Juno were $100,000 and $20,000 respectively. At acquisition, the NCI was valued at fair value.

Required:

How should the sale of shares be accounted for in the Juno Group’s financial statements?

Solution

	$
Cash proceeds	15,000	Dr
Increase in NCI: 10% × ($100,000 + $20,000)	(12,000)	Cr
	––––––
Increase in other components of equity (bal. fig)	3,000	Cr
	––––––

There is no gain or loss to the group as there has been no loss of control. Note that, depending upon the terms of the share disposal, there could be either an increase or decrease in equity.

Test your understanding 6 – David and Goliath

David has owned 90% of Goliath for many years and is considering selling part of its holding, whilst retaining control of Goliath.

At the date of considering disposal of part of the shareholding in Goliath, the NCI has a carrying amount of $7,200 and the net assets and goodwill have a carrying amount of $70,000 and $20,000 respectively. The NCI was valued at fair value at the acquisition date.

David could sell 5% of the Goliath shares for $5,000 leaving it holding 85% and increasing the NCI to 15%, or

David could sell 25% of the Goliath shares for $20,000 leaving it holding 65% and increasing the NCI to 35%.

Required:

How would these share sales be accounted for in the consolidated financial statements of the David group?

Test your understanding 7 – Pepsi

Statements of financial position for three entities at the reporting date are as follows:

	Pepsi	Sprite	Tango
	$000	$000	$000
Assets	1,000	800	500
Investment in Sprite	326	–	–
Investment in Tango	165	–	–
	–––––	–––––	–––––
Total assets	1,491	800	500
Equity	–––––	–––––	–––––
Equity
Ordinary share capital ($1)	500	200	100
Retained earnings	391	100	200
	–––––	–––––	–––––
	891	300	300
Liabilities	600	500	200
	–––––	–––––	–––––
Total equity and liabilities	1,491	800	500
	–––––	–––––	–––––

Pepsi acquired 80% of Sprite when Sprite’s retained earnings were $25,000, paying cash consideration of $300,000. It is group policy to measure NCI at fair value at the date of acquisition. The fair value of the NCI holding in Sprite at acquisition was $65,000.

At the reporting date, Pepsi purchased an additional 8% of Sprite’s equity shares for cash consideration of $26,000. This amount has been debited to Pepsi’s investment in Sprite.

Pepsi acquired 75% of Tango when Tango’s retained earnings were $60,000, paying cash consideration of $200,000. The fair value of the NCI holding in Tango at the date of acquisition was $50,000.

At the reporting date, Pepsi sold 10% of the equity shares of Tango for $35,000. The cash proceeds have been credited to Pepsi’s investment in Tango.

Required:

Prepare the consolidated statement of financial position of the Pepsi group.

4 Subsidiaries acquired exclusively with a view to resale

Subsidiaries acquired exclusively with a view to subsequent

A subsidiary acquired exclusively with a view to resale is not exempt from consolidation. However, if it meets the ‘held for sale’ criteria in IFRS 5 Non-current Assets Held for Sale and Discontinued Operations:

it is presented in the financial statements as a disposal group classified as held for sale. This is achieved by amalgamating all its assets into one line item and all its liabilities into another

it is measured, both on acquisition and at subsequent reporting dates, at fair value less costs to sell. (IFRS 5 sets down a special rule for such subsidiaries, requiring the deduction of costs to sell. Normally, it requires acquired assets and liabilities to be measured at fair value).

The ‘held for sale’ criteria in IFRS 5 include the requirements that:

the subsidiary is available for immediate sale

the sale is highly probable

it is likely to be disposed of within one year of the date of its acquisition.

A newly acquired subsidiary which meets these held for sale criteria automatically meets the criteria for being presented as a discontinued operation.

Illustration: IFRS 5

David acquires Rose on 1 March 20X7. Rose is a holding entity with two wholly-owned subsidiaries, Mickey and Jackie. Jackie is acquired exclusively with a view to resale and meets the criteria for classification as held for sale. David’s year-end is 30 September.

On 1 March 20X7 the following information is relevant:

the identifiable liabilities of Jackie have a fair value of $40m

the acquired assets of Jackie have a fair value of $180m

the expected costs of selling Jackie are $5m.

On 30 September 20X7, the assets of Jackie have a fair value of $170m.

The liabilities have a fair value of $35m and the selling costs remain at $5m.

Discuss how Jackie will be treated in the David Group financial statements on acquisition and at 30 September 20X7.

Solution

On acquisition the assets and liabilities of Jackie are measured at fair value less costs to sell in accordance with IFRS 5:

	$m
Assets	180
Less selling costs	(5)
	––––
	175
Liabilities	(40)
	––––
Fair value less costs to sell	135
	––––

At the reporting date, the assets and liabilities of Jackie are remeasured to update the fair value less costs to sell.

	$m
Assets	170
Less selling costs	(5)
	––––
	165
Liabilities	(35)
	––––
Fair value less costs to sell	130
	––––

The fair value less costs to sell has decreased from $135m on 1 March to $130m on 30 September. This $5m reduction in fair value must be presented in the consolidated statement of profit or loss as part of the single line item entitled ‘discontinued operations’. Also included in this line is the post-tax profit or loss earned/incurred by Jackie in the March – September 20X7 period.

The assets and liabilities of Jackie must be disclosed separately on the face of the statement of financial position. Jackie’s assets will appear below the subtotal for the David group’s current assets:

Non-current assets classified as held for sale 165

Jackie’s liabilities will appear below the subtotal for the David group’s current liabilities:

	$m
Liabilities directly associated with non-current assets	35
classified as held for sale
No other disclosure is required.

Test your understanding 1 – Major and Tom

Consolidated statement of financial position for Major as at 31 December 20X6

	$
Goodwill (W3)	55,000
Sundry assets ($350,000 + $250,000)	600,000
	–––––––
	655,000
	–––––––
Equity and liabilities	$
Equity share capital	200,000
Retained earnings (W5)	278,200
Non-controlling interest (W4)	88,800
Liabilities ($60,000 + $28,000)	88,000
	–––––––
	655,000
	–––––––

Tom becomes a subsidiary of Major from December 20X4.

The previously held investment must be revalued to fair value with the gain or loss recorded in the statement of profit or loss.

Dr Investment
($105,000 – $90,000)	15,000
Cr Profit or loss	15,000

(W2) Net assets
At Acquisition		At Reporting
	20X4	date
	$	$
Share capital	100,000	100,000
Retained earnings	100,000	122,000
	–––––––	–––––––
	200,000	222,000
	–––––––	–––––––
(W3) Goodwill
		$
Fair value of previously held interest		105,000
Fair value of consideration for additional interest		70,000
		–––––––
		175,000
NCI at acquisition (40% × $200,000)		80,000
Less: FV of net assets at acquisition (W2)		(200,000)
		–––––––
		55,000
		–––––––
(W4) Non-controlling interest
		$
NCI at acquisition date		80,000
NCI % of post-acquisition net assets		8,800
(40% × $22,000 (W2))		–––––––
		–––––––
		88,800
		–––––––
(W5) Group Retained earnings
		$
Major		250,000
Gain on revaluation of investment (W1)		15,000
Tom (60% × $22,000 (W2))		13,200
		–––––––
		278,200
		–––––––

Test your understanding 2 – Padstow

(a) Profit to Padstow
	$000
Sales proceeds	250
Cost of shares sold	(100)
	–––––
Profit on disposal	150
	–––––
The tax due on the profit on disposal is:
($150,000 × 30%)	45

The profit on disposal will be disclosed as an exceptional item in the statement of profit or loss.

The tax on the gain will be charged to the statement of profit or loss as part of the year’s current tax charge.

(b) Consolidated accounts
	$000	$000
Sales proceeds		250
Net assets at disposal date	88.0
Goodwill at disposal date (W1)	23.0
Less: NCI at disposal date (W2)	(14.2)
	–––––	(96.8)
		–––––
Profit on disposal		153.2
		–––––

The tax of $45,000 that arose on the disposal in the parent’s financial statements will be consolidated into the group financial statements.

	(W1) Goodwill	$000
		$000
	Consideration	100.0
	NCI at acquisition	15.0
		––––
		115.0
	FV of net assets at acquisition	(69.0)
		––––
	Goodwill at acquisition	46.0
	Impairment ($46 × 50%)	(23.0)
		––––
	Goodwill at disposal date	23.0
		––––
	(W2) NCI at disposal date
		$000
	NCI at acquisition	15.0
	NCI % of post-acq’n net assets movement	3.8
	(20% × ($88.0 – $69.0))
	NCI % of impairment (20% × $23.0 (W1))	(4.6)
		––––
		14.2
		––––

Test your understanding 3 – Hague

Full disposal

Profit in Hague’s individual financial statements

	$000
Sale proceeds	10,000
Cost of shares	(6,000)
	––––––
Profit on disposal	4,000
Tax charge on disposal:	––––––
Tax charge on disposal:
(25% × $4,000)	(1,000)

Profit in consolidated financial statements

	$000	$000
Sale proceeds		10,000
FV of retained interest		nil
CV of subsidiary at disposal:
Net assets at disposal:	3,000
Goodwill at disposal (W1)	2,500
Less: NCI at disposal date (W2)	(400)	(5,100)
	–––––	(5,100)
		–––––
Profit on disposal		4,900
(W1) Goodwill		–––––
(W1) Goodwill		$000
		$000
Consideration		6,000
NCI at acquisition		1,000
		––––––
		7,000
FV of NA at acquisition (given)		(2,000)
		––––––
Goodwill at acquisition		5,000
Impaired (50%)		(2,500)
		––––––
Goodwill at disposal		2,500
		––––––
(W2) NCI at disposal date
		$000
NCI at acquisition		1,000
NCI share of post-acquisition net assets		400
(40% × ($3,000 – $2,000))
Less: NCI share of goodwill impairment		(1,000)
(40% × $2,500) (W1)
		––––––
		400
		––––––

Disposal of a 35% shareholding

Profit in consolidated financial statements

	$000	$000
Disposal proceeds		5,000
FV of retained interest		3,500
		–––––
CV of subsidiary at disposal date:		8,500
CV of subsidiary at disposal date:
Net assets at disposal	3,000
Goodwill at disposal (W1)	2,500
Less: NCI at disposal date (W2)	(400)	(5,100)
	–––––	(5,100)
		–––––
Profit on disposal		3,400
		–––––

After the date of disposal, the residual holding will be accounted for using the equity method in the consolidated financial statements:

– The statement of profit or loss will show the group’s share of the current year profit earned by the associate from the date significant influence was obtained.

– The statement of financial position will show the carrying value of the investment in the associate. This will be the fair value of the retained shareholding at the disposal date plus the group’s share of the increase in reserves from this date.

Test your understanding 4 – Kathmandu

Consolidated statement of profit or loss – full disposal

	$
Revenue ($553,000 + (6/12 × $450,000))	778,000
Operating costs ($450,000 + (6/12 × $400,000))	(650,000)
	–––––––
Operating profit	128,000
Investment income ($8,000 – ($10,000 × 70%))	1,000
Profit on disposal (W1)	80,400
	–––––––
Profit before tax	209,400
Tax ($40,000 + (6/12 × $14,000))	(47,000)
	–––––––
Profit for the period	162,400
Attributable to:	–––––––
Attributable to:
Equity holders of Kathmandu (bal. fig)	157,000
Non-controlling interest (W5)	5,400
	–––––––
	162,400
	–––––––

There were no items of other comprehensive income during the year.

Group statement of profit or loss – discontinued operations presentation

	$
Revenue	553,000
Operating costs	(450,000)
	––––––––
Operating profit	103,000
Investment income	1,000
($8,000 – (70% × $10,000))	––––––––
	––––––––
Profit before tax	104,000
Tax	(40,000)
	––––––––
Profit for the period from continuing	64,000
operations
Profit from discontinued operations	98,400
(($36,000 × 6/12)+ $80,400 (W1))	––––––––
	––––––––
	162,400
Attributable to:	––––––––
Attributable to:
Equity holders of Kathmandu (bal. fig)	157,000
Non-controlling interest (W5)	5,400
	––––––––
	162,400
	––––––––

There were no items of other comprehensive income during the year.

Notice that the post-tax results of the subsidiary up to the date of disposal are presented as a one-line entry in the group statement of profit or loss. There is no line-by-line consolidation of results when this method of presentation is adopted.

Consolidated statement of profit or loss – partial disposal

	$
Revenue ($553,000 + (6/12 × $450,000)	778,000
Operating costs ($450,000 + (6/12 × $400,000))	(650,000)
	–––––––
Operating profit	128,000
Investment income ($8,000 – (70% × $10,000)	1,000
Income from associate (35% × $36,000 × 6/12)	6,300
Profit on disposal (W6)	80,400
	–––––––
Profit before tax	215,700
Tax ($40,000 + (6/12 × $14,000))	(47,000)
	–––––––
Profit for the period	168,700
	–––––––

There were no items of other comprehensive income during the year.

Attributable to:
Equity holders of Kathmandu (bal. fig)		163,300
Non-controlling interest (W5)		5,400
		5,400
		–––––––
		168,700
		–––––––
(W1) Profit on full disposal (part a)
	$	$
Proceeds		200,000
Interest in subsidiary disposed of:
Net assets at disposal (W2)	138,000
Goodwill at disposal (W3)	30,000
NCI at date of disposal (W4)	(48,400)
	––––––	(119,600)
		(119,600)
		–––––––
Profit on disposal		80,400
		–––––––

(W2) Net assets of Nepal at disposal
		$
Share capital		50,000
Retained earnings b/f		80,000
Profit up to disposal date (6/12 × $36,000)		18,000
Dividend paid prior to disposal		(10,000)
		–––––––
Net assets at disposal		138,000
		–––––––
(W3) Goodwill		$
		$
Consideration		100,000
FV of NCI at date of acquisition		40,000
		–––––––
		140,000
FV of net assets at date of acquisition		(110,000)
		–––––––
Goodwill		30,000
		–––––––
(W4) NCI at disposal date
FV of NCI at date of acquisition		40,000
NCI share of post-acquisition net assets		8,400
(30% × ($138,000 (W2) – $110,000)		–––––––
		–––––––
		48,400
		–––––––
(W5) Profit attributable to NCI
	$	$
Profit of Nepal (6/12 × $36,000)	18,000
	––––––
× 30%	18,000	––––––
		––––––
Profit attributable to NCI		5,400
		––––––

(W6) Profit on part disposal (part c)
	$	$
Proceeds		100,000
FV of retained interest (per question)		100,000
		–––––––
		200,000
Net assets at disposal (W2)	138,000
Unimpaired goodwill at disposal date (W3)	30,000
	–––––––
	168,000
NCI at date of disposal (W4)	(48,400)
	–––––––	(119,600)
		(119,600)
		–––––––
Profit on disposal		80,400
		–––––––

Test your understanding 5 – Gordon and Mandy

(i) Purchase of 20% of Mandy shares
	$
	$
Cash paid	25,000 Cr
Decrease in NCI ((20%/20%) × 20,000)	(20,000) Dr
	––––––
Decrease in other components of equity	5.000 Dr
	––––––
(ii) Purchase of 5% of Mandy shares
	$
Cash paid	4,000	Cr
Decrease in NCI ((5%/20%) × 20,000)	(5,000)	Dr
	––––––
Increase in other components of equity	(1,000)	Cr
	––––––

Test your understanding 6 – David and Goliath

(i) Sale of 5% of Goliath shares

	$
Cash proceeds	5,000	Dr
Increase in NCI	(4,500)	Cr
(5% × ($70,000 + $20,000)	–––––
	–––––
Increase in other components of equity	500	Cr
	–––––
(ii) Sale of 25% of Goliath shares
	$
Cash proceeds	20,000	Dr
Increase in NCI	(22,500)	Cr
(25% × ($70,000 + $20,000)
	––––––
Decrease in other components of	(2,500)	Dr
equity	––––––
	––––––

Note that in both situations, Goliath remains a subsidiary of David after the sale of shares. There is no gain or loss to the group – the difference arising is taken to equity. Goliath would continue to be consolidated within the David Group like any other subsidiary. There is no change to the carrying value of goodwill. The only impact will be the calculation of NCI share of retained earnings for the year – this would need to be time-apportioned based upon the NCI percentage pre- and post-disposal during the year.

Test your understanding 7 – Pepsi

Consolidated statement of financial position

	$000
Assets ($1,000 + $800 + $500)	2,300
Goodwill ($140 + $90) (W3)	230
	–––––
Total assets	2,530
Equity	–––––
Equity
Ordinary share capital ($1)	500
Retained earnings (W5)	556
Other components of equity ($6 – $4) (W6, W7)	2
	–––––
	1,058
Non-controlling interests ($48 + $124) (W4)	172
	–––––
	1,230
Liabilities ($600 + $500 + $200)	1,300
	–––––
Total equity and liabilities	2,530
	–––––

Workings

(W1) Group structure

Pepsi

Sprite		Tango
Initial holding:	80%	Initial holding	75%
Acquisition:	8%	Disposal	(10%)
	––––		––––
Reporting date	88%	Reporting date	65%
	––––		––––

(W2) Net Assets of subsidiaries
Sprite	Acquisition date	Reporting date
	$000	$000
Share capital	200	200
Retained earnings	25	100
	––––	––––
	225	300
	––––	––––

Tango	Acquisition date	Reporting date
	$000	$000
Share capital	100	100
Retained earnings	60	200
	––––	––––
	160	300
	––––	––––
(W3) Goodwill
Sprite		$000
Consideration		300
FV of NCI at acquisition		65
Fair value of net assets at acquisition (W2)		(225)
		––––
		140
Tango		––––
Tango		$000
Consideration		200
FV of NCI at acquisition		50
Fair value of net assets at acquisition (W2)		(160)
		––––
		90
		––––

	(W4) Non-controlling interest
	Sprite	$000
	NCI at acquisition (W3)	65
	NCI% × post acquisition net assets	15
	(20% × $75 (W2))	––––
		––––
	NCI before control to control adjustment	80
	Decrease in NCI (W6)	(32)
		––––
		48
	Tango	––––
	Tango	$000
	NCI at acquisition (W3)	50
	NCI% × post acquisition net assets	35
	(25% × $140 (W2))	––––
		––––
	NCI before control to control adjustment	85
	Increase in NCI (W7)	39
		––––
		124
		––––
	(W5) Retained earnings
		$000
	Pepsi’s retained earnings	391
	Pepsi’s % of Sprite’s post acquisition retained earnings	60
	(80% × $75 (W2))
	Pepsi’s % of Tango’s post acquisition retained earnings	105
	(75% × $140 (W2))	––––
		––––
		556
		––––

(W6) Control to control adjustment – Sprite
	$000
Cash paid	26	Cr
Decrease in NCI (8/20 × $80 (W4))	(32)	Dr
	––––
Increase to other components of equity	(6)	Cr
	––––
(W7) Control to control adjustment – Tango
	$000
Cash received	35	Dr
Increase in NCI (10% × ($300 (W2) + $90 (W3))	(39)	Cr
	––––
Decrease to other components of equity	(4)	Dr
	––––

Posted on March 31, 2021March 31, 2021 by MJ — 1 Comment

Complex groups

Complex group structures

Complex group structures exist where a subsidiary of a parent entity owns a shareholding in another entity which makes that other entity also a subsidiary of the parent entity.

Complex structures can be classified under two headings:

Vertical groups

Mixed groups.

2 Vertical groups

Definition

A vertical group arises where a subsidiary of the parent entity holds shares in a further entity such that control is achieved. The parent entity therefore controls both the subsidiary entity and, in turn, its subsidiary (often referred to as a sub-subsidiary entity).

Look at the following two situations:

In both situations, H controls S, and S controls T. H is therefore able to exert control over T by virtue of its ability to control S. All three companies form a vertical group.

Both companies that are controlled by the parent are consolidated.

The basic techniques of consolidation are the same as seen previously, with some changes to the goodwill, NCI and group reserves calculations.

Approach to a question

When establishing the group structure, follow these steps:

Control – which entities does the parent control directly or indirectly?

Percentages – what are the effective ownership percentages for consolidation?

Dates – when did the parent achieve control over the subsidiary and the sub-subsidiary?

Illustration 1 – Vertical group structure

Control

H controls S and S controls T. Therefore, H can indirectly control T.

Effective consolidation percentage

S will be consolidated with H owning 90% and the NCI owning 10%.

T will be consolidated with H owning 72% (90% × 80%) and the NCI owning 28% (100% – 72%).

These effective ownership percentages will be used in standard workings (W4) and (W5).

Dates

S will be consolidated from 31 December 20X0.

When H acquires control of S, it also acquires indirect control over T.

Therefore H will consolidate T from 31 December 20X0.

Illustration 2 – Vertical group structure

Control

H controls S and S controls T. Therefore, H can indirectly control T.

Effective consolidation percentage

S will be consolidated with H owning 70% and the NCI owning 30%.

T will be consolidated with H owning 42% (70% × 60%) and the NCI owning 58% (100% – 42%).

The effective ownership percentages will be used in standard workings (W4) and (W5).

Do not be put off by the fact that the effective group interest in T is less than 50%, and that the effective non-controlling interest in T is more than 50%.

Dates

S will be consolidated from 31 December 20X1.

However, S did not gain control of T until 30 April 20X2 meaning that H does not indirectly control T until this date. Therefore, T is consolidated into the H group from 30 April 20X2.

Indirect holding adjustment

Accounting for a sub-subsidiary requires an indirect holding adjustment.

Goodwill in the sub-subsidiary is calculated from the perspective of the ultimate parent company. Therefore, the cost of the investment in the sub-subsidiary should be the parent’s share of the amount paid by its subsidiary.

– The NCI’s share of the cost of the investment in the sub-subsidiary must be eliminated from the goodwill calculation.

The value of the non-controlling interest in the subsidiary includes the NCI’s share of the cost of the investment in the sub-subsidiary.

– The NCI’s share of the cost of the investment in the sub-subsidiary must be eliminated from the NCI calculation.

Illustration 3 – Indirect holding adjustment

On 31 December 20X1, A purchased 90% of the equity shares in B for $150,000 and B purchased 80% of the equity shares in C for $100,000.

At this date, the fair value of the net assets of B and C were $144,000 and $90,000 respectively. The fair value of the non-controlling interest in B and C was $17,000 and $15,000 respectively.

Required:

Calculate goodwill and the non-controlling interest for inclusion in the consolidated statement of financial position as at 31 December 20X1.

Solution

Goodwill
	B	C
	$	$
Consideration	150,000	100,000
Indirect holding adjustment (10% × $100,000)		(10,000)
Add: FV of non-controlling interest at acquisition	17,000	15,000
	––––––	––––––
	167,000	105,000
Less: Net assets at acquisition	(144,000) (90,000)
Goodwill at acquisition	––––––	––––––
Goodwill at acquisition	23,000	15,000
	––––––	––––––
Non-controlling interest
		$
B: NCI at acquisition (W3)		17,000
B: Indirect holding adjustment (W3)		(10,000)
C: NCI at acquisition (W3)		15,000
		––––––
Non-controlling interest		22,000
		––––––

Note: In subsequent years, the NCI will be adjusted for its share of the post-acquisition net asset movement of each subsidiary.

The NCI % in B is 10% (100% – 90%).

The NCI % in C is 28% (100% – (90% × 80%))

Illustration 4 – Vertical group 1

The draft statements of financial position of David, Colin and John, as at 31 December 20X4, are as follows:

	D	C	J
	$000	$000	$000
Sundry assets	280	180	130
Shares in subsidiary	120	80
	––––	––––	––––
	400	260	130
	––––	––––	––––
Equity capital ($1 shares)	200	100	50
Retained earnings	100	60	30
Liabilities	100	100	50
	––––	––––	––––
	400	260	130
	––––	––––	––––

The following information is also available:

David acquired 75,000 $1 shares in Colin on 1 January 20X4 when the retained earnings of Colin amounted to $40,000. At that date, the fair value of the non-controlling interest in Colin was valued at $38,000.

Colin acquired 40,000 $1 shares in John on 30 June 20X4 when the retained earnings of John amounted to $25,000. The retained earnings of John had been $20,000 on the date of David’s acquisition of Colin. On 30 June 20X4, the fair value of the non-controlling interest in John (both direct and indirect), based upon effective shareholdings, was $31,000.

Goodwill has suffered no impairment. It is group policy to use the full goodwill method.

Required:

Produce the consolidated statement of financial position of the David group as at 31 December 20X4.

Solution

Statement of financial position for the David group at 31 December 20X4

	$000
Goodwill ($18 + $16) (W3)	34
Sundry assets ($280 + $180 + $130)	590
	––––
	624
Equity and liabilities:	––––
Equity and liabilities:
Equity capital	200
Retained earnings (W5)	118
	––––
Non-controlling interest (W4)	318
Non-controlling interest (W4)	56
	––––
Total equity	374
Liabilities ($100 + $100 + $50)	250
	––––

624

––––

(W1) Group structure

Control

David controls Colin and Colin controls John. Therefore, David can indirectly control John.

Effective consolidation percentage

Colin will be consolidated with David owning 75% and the NCI owning 25%.

John will be consolidated with David owning 60% (75% × 80%) and the NCI owning 40% (100% – 60%).

The effective ownership percentages will be used in standard workings (W4) and (W5).

Dates

Colin will be consolidated from 1 Jan 20X4.

However, Colin did not gain control of John until 30 June X4. Therefore, David does not indirectly control John until this date. As such, John is consolidated from 30 June 20X4.

(W2) Net assets

The acquisition date will be the date on which David (the parent company) gained control over each entity:

– Colin: 1 January 20X4

– John: 30 June 20X4

This means that the information given regarding John’s retained earnings at 1 January 20X4 is irrelevant in this context.

Net assets of subsidiaries

	Colin		John
	At acq’n At rep date		At acq’n At rep date
Equity capital	$000	$000	$000	$000
Equity capital	100	100	50	50
Retained earnings	40	60	25	30
	––––	––––	––––	––––
	140	160	75	80
	––––	––––	––––	––––

(W3) Goodwill

A separate goodwill calculation is required for each subsidiary.

For the sub-subsidiary, goodwill is calculated from the perspective of the ultimate parent entity (David) rather than the immediate parent (Colin). Therefore, the effective cost of John is only David’s share of the amount that Colin paid for John, i.e. $80,000 × 75% = $60,000.

	Colin	John
	$000	$000
Cost of investment in subsidiary	120	80
Indirect holding adjustment (25% × $80,000)	–	(20)
Fair value of NCI	38	31
	––––	––––
	158	91
FV of net assets (W2)	(140)	(75)
	––––	––––
	18	16
	––––	––––
(W4) Non-controlling interest
		$000
Colin: NCI at acquisition (W3)		38
Colin: NCI share of post-acq’n net assets (25% × $20,000 (W2))		5
Less: Indirect holding adjustment (25% × 80,000)		(20)
John: NCI at acquisition (W3)		31
John NCI share of post acq’n net assets (40% × $5,000 (W2))		2
		––––
		56
		––––
(W5) Group retained earnings
		$000
David		100
Colin: 75% × $20,000 (W2)		15
John: 60% × $5,000 (W2)		3
		––––

118

––––

Note that only the group’s effective share (60%) is taken of John’s post-acquisition retained earnings.

Illustration 5 – Vertical group 2

The draft statements of financial position of Daniel, Craig and James as at 31 December 20X4 are as follows:

	D	C	J
	$000	$000	$000
Sundry assets	180	80	80
Shares in subsidiary	120	80
	–––	–––	–––
	300	160	80
	–––	–––	–––
Equity capital	200	100	50
Retained earnings	100	60	30
	–––	–––	–––
	300	160	80
	–––	–––	–––

Craig acquired 40,000 $1 shares in James on 1 January 20X4 when the retained earnings of James amounted to $25,000.

Daniel acquired 75,000 $1 shares in Craig on 30 June 20X4 when the retained earnings of Craig amounted to $40,000 and those of James amounted to $30,000.

It is group policy to value the non-controlling interest using the proportion of net assets method.

Required:

Produce the consolidated statement of financial position of the Daniel group at 31 December 20X4.

Solution

Consolidated statement of financial position of the Daniel group at 31 December 20X4

Assets:	$000
Goodwill ($15 + $12) (W3)	27
Sundry assets ($180 + $80 + $80)	340
	–––––
	367
Equity and liabilities:	–––––
Equity and liabilities:
Equity capital	200
Retained earnings (W5)	115
Non-controlling interest (W4)	52
	–––––

367

–––––

(W1) Group structure

Control

Daniel controls Craig and Craig controls James. Therefore, Daniel can indirectly control James.

Effective consolidation percentage

Craig will be consolidated with Daniel owning 75% and the NCI owning 25%.

James will be consolidated with Daniel owning 60% (75% × 80%)

and the NCI owning 40% (100% – 60%).

The effective ownership percentages will be used in standard workings (W4) and (W5). They will also be used in (W3) to calculate goodwill, as the group policy is to use the proportion of net assets method.

Dates

Craig will be consolidated from 30 June 20X4.

When Daniel acquires control of Craig, it also acquires indirect control over James. Therefore Daniel will consolidate James from 30 June 20X4.

(W2) Net assets
		Craig	James
Acq’n date		Rep date	Acq’n date	Rep date
Share capital	$000	$000	$000	$000
Share capital	100	100	50	50
Retained	40	60	30	30
earnings	———	———	———	———
	———	———	———	———
	140	160	80	80
	———	———	———	———
(W3) Goodwill
			Craig	James
			$000	$000
Cost of investment			120	80
Indirect holding adjustment			–	(20)
(25% × $80,000)
NCI at acquisition:			35	32
Craig: 25% × $140,000 (W2)
James: 40% × $80,000 (W2)			———	———
			———	———
			155	92
FV of NA at acquisition (W2)			(140)	(80)
			———	———
Goodwill			15	12
			———	———

	(W4) Non-controlling interest
		$000
	Craig: NCI at acquisition (W3)	35
	Craig: NCI % post-acq’n net assets	5
	(25% × ($160,000 – $140,000)) (W2)
	Less: indirect holding adjustment (W3)	(20)
	James: NCI at acquisition (W3)	32
	James: NCI % post-acq’n net assets	–
	(40% × ($80,000 – $80,000)) (W2)
		——
		52
		——
	(W5) Group retained earnings
		$000
	Daniel	100
	Craig: 75% × ($60,000 – $40,000) (W2)	15
	James: 60% × ($30,000 – $30,000) (W2)	–
		––––
		115
		––––

Test your understanding 1 – H, S & T

The following are the statements of financial position at 31 December 20X7 for H group companies:

	H	S	T
	$	$	$
75% of the shares in S	65,000	–	–
60% of the shares in T	–	55,000	–
Sundry assets	280,000	133,000	100,000
	–––––––	–––––––	–––––––
	345,000	188,000	100,000
	–––––––	–––––––	–––––––
Equity share capital ($1 shares)	100,000	60,000	50,000
Retained earnings	45,000	28,000	25,000
Liabilities	200,000	100,000	25,000
	–––––––	–––––––	–––––––
	345,000	188,000	100,000
	–––––––	–––––––	–––––––

All the shareholdings were acquired on 1 January 20X1 when the retained earnings of S were $10,000 and those of T were $8,000. At that date, the fair value of the non-controlling interest in S was $20,000. The fair value of the total non-controlling interest (direct and indirect) in T was $50,000. It is group policy to value the non-controlling interest using the full goodwill method.

At the reporting date, the recoverable amount of the net assets of S were $93,000. It was deemed that goodwill arising on the acquisition of T was not impaired.

Required:

Prepare the consolidated statement of financial position for the H group at 31 December 20X7.

Test your understanding 2 – Grape, Vine and Wine

The statements of financial position of three entities at 30 June 20X6 were as follows:

	Grape	Vine	Wine
	$000	$000	$000
Investment	110	60	–
Sundry assets	350	200	120
	––––	––––	––––
	460	260	120
	––––	––––	––––
Equity share capital	100	50	10
Retained earnings	210	110	70
Liabilities	150	100	40
	––––	––––	––––
	460	260	120
	––––	––––	––––

Grape purchased 40,000 of the 50,000 $1 shares in Vine on 1 July 20X5, when the retained earnings of that entity were $80,000. At that time, Vine held 7,500 of the 10,000 $1 shares in Wine. These had been purchased on 1 January 20X5 when Wine’s retained earnings were $65,000. On 1 July 20X5, Wine’s retained earnings were $67,000.

At 1 July 20X5, the fair value of the non-controlling interest in Vine was $27,000, and that of Wine (both direct and indirect) was $31,500. It is group policy to value the non-controlling interest using the full goodwill method.

The equity share capital of Grape includes $20,000 received from the issue of 20,000 class B shares on 30 June 20X6. These shares entitle the holders to fixed annual dividends. The holders of these B shares can also demand the repayment of their capital from 30 June 20X9.

Included in the liabilities of Grape are $100,000 proceeds from the issue of a loan on 1 July 20X5. There are no annual interest payments and Grape therefore believes that no further accounting entries are required until the repayment date. The loan is repayable on 30 June 20X8 at a premium of 100%. The effective rate of interest on the loan is 26.0%.

Required:

Prepare the consolidated statement of financial position for the Grape group at 30 June 20X6.

3 Mixed (D-shaped) groups

Definition

In a mixed group situation the parent entity has a direct controlling interest in at least one subsidiary. In addition, the parent entity and the subsidiary together hold a controlling interest in a further entity.

For example:

H has 60% of the shares of S. S is therefore a subsidiary of H.

H has a 30% direct holding in T. H also controls S, who has a 30% holding in T. H therefore controls T through its direct and indirect holdings. This means that T is part of H’s group and must be consolidated.

Accounting for a mixed group is similar to accounting for a vertical group.

Approach to a question

Follow the same steps as with a vertical group when establishing group structure:

Control

Percentages of ownership

Dates of acquisition

Illustration 6 – Mixed group structure

P acquired a 70% interest in S on 1 April 20X4, and acquired a 25% interest in Q on the same date.

S acquired a 40% interest in Q on 1 April 20X4.

Control

P controls S. This makes S a subsidiary of P.

P is able to direct 25% + 40% = 65% of the voting rights of Q. Q is a sub-subsidiary of P.

Effective consolidation percentage

S will be consolidated with P owning 70% and the NCI owning 30%.

P’s effective interest in Q is calculated as follows:
Direct	25%
Indirect (70% × 40%)	28%
P’s effective interest in Q	––––
P’s effective interest in Q	53%
	––––

The NCI interest in Q is therefore 47% (100% – 53%).

Dates

The date of acquisition for S and Q is 1 April 20X4.

Illustration 7 – Mixed group structure

H acquired a 60% interest in S on 1 January 20X6, and acquired a 30% interest in T on the same date.

S acquired a 30% interest in T on 1 July 20X4.

Control

H controls S. This makes S a subsidiary of H.

H is able to direct 30% + 30% = 60% of the voting rights of T. T is a sub-subsidiary of H.

Effective consolidation percentage

S will be consolidated with H owning 60% and the NCI owning 40%.

H’s effective interest in T is calculated as follows:
Direct	30%
Indirect (60% × 30%)	18%
H’s effective interest in T	––––
H’s effective interest in T	48%
	––––

The NCI interest in T is therefore 52% (100% – 48%).

Dates

The date of acquisition for S and T is 1 January 20X6.

Further detail on mixed groups

Note that the definition of a mixed group does not include the situation where the parent and an associate together hold a controlling interest in a further entity.

E.g.

H owns 35% of S, S owns 40% of W and H owns 40% of W.

This is not a mixed group situation. Neither S nor W is a member of the H group, although S and W may both be ‘associates’ of H.

H’s interest in W might be calculated as before as (35% × 40%) + 40% = 54%. Although H has an arithmetic interest in W that is more than 50%, it does not have parent entity control of W, as it does not control S’s 40% stake in W.

Consolidation

All consolidation workings are the same as those used in vertical group situations, with the exception of goodwill.

The goodwill calculation for the sub-subsidiary differs slightly from a vertical group. The cost of the sub-subsidiary must include the following:

the cost of the parent’s holding (the direct holding)

the cost of the subsidiary’s holding (the indirect holding)

the indirect holding adjustment.

Illustration 8 – H, S, C

The statements of financial position of H, S and C as at 31 December 20X5 were as follows:

	H	S	C
	$	$	$
75% of shares in S	72,000	–	–
40% of shares in C	25,000	–	–
30% of shares in C	–	20,000	–
Sundry assets	125,000	120,000	78,000
	–––––––	–––––––	–––––––
	222,000	140,000	78,000
	–––––––	–––––––	–––––––
Equity share capital ($1 shares)	120,000	60,000	40,000
Retained earnings	95,000	75,000	35,000
Liabilities	7,000	5,000	3,000
	–––––––	–––––––	–––––––
	222,000	140,000	78,000
	–––––––	–––––––	–––––––

All shares were acquired on 31 December 20X2 when the retained earnings of S amounted to $30,000 and those of C amounted to $10,000.

It is group accounting policy to value the non-controlling interest on a proportionate basis.

Required:

Prepare the statement of financial position for the H group as at 31 December 20X5.

Solution

Group statement of financial position for H group as at 31 December 20X5

	$
Goodwill ($4,500 + $8.750) (W3)	13,250
Sundry assets ($125,000 + $120,000 + $78,000)	323,000
	––––––––
	336,250
	––––––––
Equity and liabilities:	$
Equity share capital	120,000
Retained earnings (W5)	144,375
Non-controlling interest (W4)	56,875
	––––––––
Total equity	321,250
Liabilities ($7,000 + $5,000 + $3,000)	15,000
	––––––––
	336,250
	––––––––

(W1) Group structure

H’s interest in S in 75%. The NCI interest in S is 25%.
H’s effective interest in C:
Direct	40.0%
Indirect (75% × 30%)	22.5%
	–––––
	62.5%
	–––––

The NCI interest in C is 37.5% (100% – 62.5%).

(W2) Net assets
S’s net assets	At acq’n	At rep date
	$	$
Equity capital	60,000	60,000
Retained earnings	30,000	75,000
	––––––	––––––
	90,000	135,000
C’s net assets	––––––	––––––
C’s net assets
	$	$
Equity capital	40,000	40,000
Retained earnings	10,000	35,000
	––––––	––––––
	50,000	75,000
(W3) Goodwill	––––––	––––––
(W3) Goodwill
Goodwill arising on acquisition of S
		$
Cost of H’s investment		72,000
NCI at acquisition (25% × $90,000 (W2))		22,500
		––––––
		94,500
Less: FV of net assets at acquisition (W2)		(90,000)
		––––––
Goodwill		4,500
Goodwill arising on acquisition of C		––––––
Goodwill arising on acquisition of C
		$
Cost of H’s investment		25,000
Cost of S’s investment		20,000
Indirect holding adjustment (25% × $20,000)		(5,000)
NCI at acquisition (37.5% × $50,000 (W2))		18,750
		––––––
		58,750
Less: FV of net assets at acquisition (W2)		(50,000)
		––––––
Goodwill		8,750
		––––––

	(W4) Non-controlling interest	$
		$
	S – NCI at acquisition (W3)	22,500
	S – NCI % of post acquisition net assets	11,250
	(25% × $45,000 (W2))
	Indirect holding adjustment (W3)	(5,000)
	C – NCI at acquisition (W3)	18,750
	C – NCI % of post acquisition net assets	9,375
	(37.5% × $25,000 (W2))	–––––
		–––––
		56,875
	(W5) Retained earnings	–––––
	(W5) Retained earnings	$
		$
	100% of H’s retained earnings	95,000
	Group share of S’s post acquisition retained earnings	33,750
	(75% × $45,000 (W2))
	Group share of C’s post acquisition retained earnings	15,625
	(62.5% × $25,000 (W2))	––––––
		––––––
		144,375
		––––––

Test your understanding 3 – T, S & R

The following are the summarised statements of financial position of T, S and R as at 31 December 20X4.

	T	S	R
	$	$	$
Non-current assets	140,000	61,000	170,000
Investments	200,000	65,000	–
Current assets	30,000	28,000	15,000
	–––––––	–––––––	–––––––
	370,000	154,000	185,000
	–––––––	–––––––	–––––––
Equity shares of $1 each	200,000	80,000	100,000
Retained earnings	150,000	60,000	80,000
Other components of equity	10,000	8,000	–
Liabilities	10,000	6,000	5,000
	–––––––	–––––––	–––––––
	370,000	154,000	185,000
	–––––––	–––––––	–––––––

On 1 January 20X3 S acquired 35,000 ordinary shares in R at a cost of $65,000 when the retained earnings of R amounted to $40,000.

On 1 January 20X4 T acquired 64,000 shares in S at a cost of $120,000 and 40,000 shares in R at a cost of $80,000. On this date, the retained earnings of S and R amounted to $50,000 and $60,000 respectively. S also had other components of equity of $3,000. The fair value of the NCI in S on 1 January 20X4 was $27,000. The fair value of the NCI (direct and indirect) in R was $56,000. The non-controlling interest is measured using the full goodwill method. At the reporting date, goodwill has not been impaired.

On 1 January 20X4, T entered into a lease agreement. T is the lessor and is leasing a machine to a third party for two years. The machine has a useful economic life of ten years. No receipt was due during 20X4 so no accounting entries have been posted. T is due a receipt of $10,000 on 31 December 20X5.

On 1 January 20X4, T granted 100 share appreciation rights (SARs) to 60 managers. These entitle the holders to a cash bonus based on the share price of T. The SARs vest if the managers are still employed by T at 31 December 20X7. Five managers left during 20X4 and it is expected that another 15 will leave prior to 31 December 20X7. The fair value of each SAR was $10 on 1 January 20X4 and $14 on 31 December 20X4.

Required:

Prepare the consolidated statement of financial position of the T group as at 31 December 20X4.

Test your understanding 1 – H, S & T

Consolidated statement of financial position as at 31 December 20X7

	$
Goodwill ($5,000 + $33,250) (W3)	38,250
Sundry net assets ($280,000 + $133,000 + $100,000)	513,000
	–––––––
	551,250
	–––––––
Equity and liabilities
Equity share capital	100,000
Retained earnings (W5)	58,650
NCI (W4)	67,600
Liabilities ($200,000 + $100,000 + $25,000)	325,000
	–––––––
	551,250
	–––––––

S:		%
S:	Group share	75
	NCI	25
T:	Group share (75% × 60%)	45
	NCI (100% – 45%)	55

(W2) Net assets
		S	T
	acq’n	rep date	acq’n rep date
Equity capital	$	$	$	$
Equity capital	60,000	60,000	50,000	50,000
Retained earnings	10,000	28,000	8,000	25,000
	––––––	––––––	––––––	––––––
	70,000	88,000	58,000	75,000
	––––––	––––––	––––––	––––––
(W3) Goodwill
			S	T
			$	$
Consideration paid			65,000	55,000
FV of NCI			20,000	50,000
Indirect Holding Adjustment (25% × $55,000)			– (13,750)
			––––––	––––––
			85,000	91,250
FV of NA at acquisition			(70,000) (58,000)
			––––––	––––––
Goodwill at acquisition			15,000	33,250
Impairment (W5)			(10,000)	–
			––––––	––––––
Goodwill at reporting date			5,000	33,250
			––––––	––––––
(W4) Non-controlling interest
				$
S – FV at date of acquisition				20,000
S – NCI % of post-acq’n net assets (25% × $18,000 (W2))				4,500
Indirect Holding Adjustment (W3)				(13,750)
T – FV at date of acquisition				50,000
T – NCI % of post-acq’n net assets (55% × $17,000 (W2))				9,350
NCI % of S’s goodwill impairment (25% × $10,000 (W3))				(2,500)
				––––––
				67,600
				––––––

	(W5) Consolidated retained earnings
		$
	Retained earnings of H	45,000
	Group % of post-acquisition retained earnings:
	S – (75% × $18,000 (W2))	13,500
	T – (45% × $17,000 (W2))	7,650
	H’s % of S’s goodwill impairment (75% × $10,000 (W3))	(7,500)
		–––––––
		58,650
		–––––––
	(W6) Goodwill impairment
		$
	Goodwill in S before impairment review (W3)	15,000
	Net assets of S at reporting date (W2)	88,000
		–––––––
		103,000
	Recoverable amount	(93,000)
		–––––––
	Goodwill impairment	10,000
		–––––––

Test your understanding 2 – Grape, Vine and Wine

Consolidated statement of financial position as at 30 June 20X6

	$
Goodwill ($7,000 + $2,500 (W3))	9,500
Sundry assets ($350,000 + $200,000 + $120,000)	670,000
	––––––
	679,500
	––––––
Equity and liabilities	$
Equity share capital ($100,000 – $20,000 (W6))	80,000
Retained earnings (W5)	209,800
Non-controlling interest (W4)	53,700
Liabilities ($150,000 + $100,000 + $40,000 + $20,000 (W6)	336,000
+ $26,000 (W7))
	––––––
	679,500
	––––––

(W1) Group structure

Effective consolidation percentage

Vine will be consolidated with Grape owning 80% and the NCI owning 20%.

Wine will be consolidated with Grape owning 60% (80% × 75%) and the NCI owning 40% (100% – 60%).

The effective ownership percentages will be used in standard workings (W4) and (W5).

Dates

Grape gained control over Vine and Wine on 1 July 20X5.

(W2) Net assets
		Vine		Wine
	acq’n	rep. date	acq’n	rep. date
	$	$	$	$
Equity capital	50,000	50,000	10,000	10,000
Retained earnings	80,000	110,000	67,000	70,000
	–––––––	–––––––	––––––	––––––
	130,000	160,000	77,000	80,000
	–––––––	–––––––	––––––	––––––

The acquisition date for both entities is the date they joined the Grape group, i.e. 1 July 20X5.

(W3) Goodwill
	Vine	Wine
	$	$
Consideration paid	110,000	60,000
Indirect holding adjustment		(12,000)
(20% × $60,000)
FV of NCI at acquisition	27,000	31,500
	–––––––	––––––
	137,000	79,500
FV of net assets at acquisition (W2)	(130,000)	(77,000)
	–––––––	––––––
Goodwill	7,000	2,500
	–––––––	––––––
(W4) Non-controlling interest
		$
V – NCI at acquisition (W3)		27,000
V – NCI share of post acq’n net assets		6,000
(20% × $30,000 (W2))
Indirect holding adjustment (W3)		(12,000)
W – NCI at acquisition (W3)		31,500
W – NCI share of post acq’n net assets		1,200
(40% × $3,000 (W2))
		––––––
		53,700
		––––––
(W5) Consolidated retained earnings
		$
Retained earnings of Grape		210,000
Interest on liability (W7)		(26,000)
Group share of post-acquisition retained earnings
V (80% × $30,000 (W2))		24,000
W (60% × $3,000 (W2))		1,800
		–––––––
		209,800
		–––––––

(W6) Shares

A financial liability exists if there is an obligation to deliver cash.

The class B shares are a financial liability and must be reclassified:

Dr Equity share capital	$20,000
Cr Liabilities	$20,000

(W7) Loan

The loan will be measured at amortised cost. A finance cost must be charged using the effective rate. The finance cost for the year is $26,000 ($100,000 × 26%).

Dr Finance costs/retained earnings (W5)	$26,000
Cr Liabilities	$26,000

Test your understanding 3 – T, S & R

T consolidated statement of financial position as at 31 December 20X4

	$
Goodwill ($14,000 + $28,000 (W3))	42,000
Non-current assets ($140,000 + $61,000 + $170,000)	371,000
Current assets	78,000
($30,000 + $28,000 + $15,000 + $5,000 (W6))	–––––––
	–––––––
	491,000
	–––––––
	$
Equity share capital	200,000
Retained earnings (W5)	162,600
Other components of equity (W5)	14,000
	–––––––
	376,600
Non-controlling interest (W4)	79,400
Liabilities	35,000
($10,000 + $6,000 + $5,000 + $14,000 (W7))

–––––––

491,000

–––––––

(W1) Group structure

T has an 80% holding in S. The NCI holding is 20%.
T’s effective holding in R is calculated as follows:
Direct		40%
Indirect (80% × 35%)		28%
		––––
		68%
		––––
The NCI holding in R is 32% (100% – 68%).
T’s acquisition date for both entities is 1 January 20X4.
(W2) Net assets
S’s Net assets	At acq’n	At rep date
	$	$
Equity share capital	80,000	80,000
Retained earnings	50,000	60,000
Other components of	3,000	8,000
equity	–––––––	–––––––
	133,000	148,000
	–––––––	–––––––
R’s Net assets
	$	$
Equity share capital	100,000	100,000
Retained earnings	60,000	80,000
	–––––––	–––––––
	160,000	180,000
	–––––––	–––––––

(W3) Goodwill
Goodwill arising on the acquisition of S
	$
Consideration paid	120,000
FV of NCI	27,000
	–––––––
	147,000
FV of net assets at acquisition (W2)	(133,000)
	–––––––
Goodwill	14,000
	–––––––
Goodwill arising on the acquisition of R
	$
Cost of T’s investment	80,000
Cost of S’s investment	65,000
Indirect holding adjustment (20% × 65,000)	(13,000)
Fair value of NCI at acquisition	56,000
	–––––––
	188,000
FV of net assets at acquisition (W2)	(160,000)
	–––––––
Goodwill	28,000
	–––––––
(W4) Non-controlling interest
	$
S – FV of NCI at acquisition	27,000
NCI share of S’s post acquisition net assets	3,000
(20% × ($148,000 – $133,000) (W2))
Indirect holding adjustment (W3)	(13,000)
R – FV of NCI at acquisition	56,000
NCI share of R’s post acquisition net assets	6,400

(32% × ($180,000 – $160,000) (W2))

––––––

79,400

––––––

(W5) Group retained earnings
	$
100% of T’s retained earnings	150,000
Operating lease (W6)	5,000
Share-based payment (W7)	(14,000)
Group share of S’s post acquisition retained earnings	8,000
(80% × ($60,000 – $50,000) (W2))
Group share of R’s post acquisition retained earnings	13,600
(68% × ($80,000 – $60,000) (W2))
	–––––––
	162,600
	–––––––
Other components of equity
	$
100% of T’s other components of equity	10,000
Group share of S’s post acquisition other components	4,000
(80% × ($8,000 – $3,000) (W2))
Group share of R’s post acquisition other components	–
(68% × nil (W2))
	–––––––
	14,000
	–––––––

(W6) Operating lease

The lease term is much shorter than the useful life of the asset so it appears to be an operating lease. The total lease receipts should be recognised as income in the statement of profit or loss on a straight line basis.

The annual operating lease income is $5,000 ($10,000/2 years).

The adjusting entry is:
Dr Current assets	$5,000
Cr Profit or loss/Retained earnings (W5)	$5,000

(W7) Share-based payments

This is a cash-settled share-based payment scheme.

The expense should be spread across the vesting period. The expense to be recognised is based on the fair value of the scheme at the period end and the number of SARs that are expected to vest.

(60 employees – 5 – 15) × 100 × $14 × 1/4 = $14,000
The adjusting entry is:
Dr Profit or loss/Retained earnings (W5)	$14,000
Cr Liabilities	$14,000

Posted on March 31, 2021March 31, 2021 by MJ — 1 Comment

Group accounting – basic groups

Overview of interests in other entities

The following diagram presents an overview of the varying types of interests in other entities, together with identification of applicable reporting standards.

The standards referred to in the diagram above cover a range of group accounting issues:

IFRS 10 Consolidated Financial Statements

IFRS 11 Joint Arrangements

IFRS 12 Disclosure of Interests in Other Entities

IAS 28 Investments in Associates and Joint Ventures

These standards, as well as IFRS 3 Business Combinations, are covered in this chapter. IFRS 9 Financial Instruments was dealt with earlier in the publication.

Group accounting – basic groups

2 Definitions

IFRS 10 Consolidated Financial Statements says that an entity that is a parent is required to prepare consolidated financial statements. The standard provides the following definitions:

A parent is an entity that controls another entity.

A subsidiary is an entity that is controlled.

An investor controls an investee when:

the investor has power over the investee, and

the investor is exposed, or has rights, to variable returns from its involvement with the investee, and

the investor has the ability to affect those returns through its power over the investee.

Consolidated financial statements present the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries as if they were a single economic entity.

3 Revision from F7: Consolidation techniques

Consolidated statement of financial position

Producing a consolidated statement of financial position involves five standard workings. These will help you to understand the structure of the group and to calculate goodwill, the non-controlling interest and group reserves.

The first step in any examination question should be to determine the group structure.

(W1) Group structure

This working is useful to decide the status of any investments. If one entity is controlled by another entity then it is a subsidiary and must be consolidated.

In numerical exam questions, control is normally presumed to exist if one company owns more than half of the voting capital of another entity.

Once the group structure has been determined, set up a proforma statement of financial position.

Group statement of financial position as at the reporting date

	$000
Goodwill (W3)	X
Assets (P + S)	X
	–––
Total assets	X
	–––
Equity capital (Parent’s only)	X
Retained earnings (W5)	X
Other components of equity (W5)	X
Non-controlling interest (W4)	X
	–––
Total equity	X
Liabilities (P + S)	X
	–––
Total equity and liabilities	X
	–––
You will need to do the following:

– Eliminate the carrying amount of the parent’s investments in its subsidiaries (these will be replaced by goodwill)

– Add together the assets and liabilities of the parent and its subsidiaries in full

– Include only the parent’s balances within share capital and share premium

– Set up and complete standard workings 2 – 5 to calculate goodwill, the non-controlling interest and group reserves.

(W2) Net assets of each subsidiary

This working sets out the fair value of the subsidiary’s identifiable net assets at acquisition date and at the reporting date.

	At acquisition At reporting date
	$000	$000
Equity capital	X	X
Share premium	X	X
Other components of equity	X	X
Retained earnings	X	X
Goodwill in the accounts of the sub.	(X)	(X)
Fair value adjustments (FVA)	X	X
Post acq’n dep’n/amort. on FVA		(X)
PURP if the sub is the seller		(X)
	–––––––––	–––––––––
	X	X
	(to W3)
	–––––––––	–––––––––

Remember to update the face of the statement of financial position for adjustments made to the net assets at the reporting date (such as fair value uplifts and provisions for unrealised profits (PURPS)).

The fair value of the subsidiary’s net assets at the acquisition date are used in the calculation of goodwill.

The movement in the subsidiary’s net assets since acquisition is used to calculate the non-controlling interest and group reserves.

(W3) Goodwill
	$000
Fair value of purchase consideration	X
NCI at acquisition**	X
	–––
Less: fair value of identifiable net assets at acquisition	X
Less: fair value of identifiable net assets at acquisition
(per net assets working)	(X)
	–––
Goodwill at acquisition	X
Less: impairment to date	(X)
	–––
Goodwill to consolidated SFP	X
	–––

**if full goodwill method adopted, NCI value = FV of NCI at date of acquisition. This will normally be given in a question.

**if proportionate goodwill method adopted, NCI value = NCI % of the fair value of the net assets at acquisition (per W2).

(W4) Non-controlling interest
	$000
NCI value at acquisition (W3)	X
NCI % of post-acquisition movement in net assets (W2)	X
Less: NCI % of goodwill impairment (fair value method only)	(X)
	–––
NCI to consolidated SFP	X
	–––
(W5) Group reserves
Retained earnings
	$000
Parent’s retained earnings (100%)	X
For each subsidiary: group share of post-acquisition
retained earnings (W2)	X
Add: gain on bargain purchase (W3)	X
Less: goodwill impairment** (W3)	(X)
Less: PURP if the parent was the seller	(X)
	–––
Retained earnings to consolidated SFP	X
	–––

If the NCI was valued at fair value at the acquisition date, then only the parent’s share of the goodwill impairment is deducted from retained earnings.

Other components of equity
	$000
Parent’s other components of equity (100%)	X
For each subsidiary: group share of post-acquisition
other components of equity (W2)	X
	–––
Other components of equity to consolidated SFP	X
	–––

Consolidated statement of profit or loss and other comprehensive income

Step 1: Group structure

This working is useful to decide the status of any investments. If one entity is controlled by another entity then it is a subsidiary and must be consolidated.

In numerical exam questions, control is normally presumed to exist if one company owns more than half of the voting capital of another entity.

Step 2: Pro-forma

Once the group structure has been determined, set up a proforma statement of profit or loss and other comprehensive income.

Remember to leave space at the bottom to show the profit and total comprehensive income (TCI) attributable to the owners of the parent company and the profit and TCI attributable to the non-controlling interest.

Group statement of profit or loss and other comprehensive income for the year ended 30 June 20X8

	$000
Revenue (P + S)	X
Cost of sales (P + S)	(X)
	––––
Gross profit	X
Operating costs (P + S)	(X)
	––––
Profit from operations	X
Investment income (P + S)	X
Finance costs (P + S)	(X)
	––––
Profit before tax	X
Income tax (P + S)	(X)
	––––
Profit for the period	X
Other comprehensive income (P + S)	X
	––––
Total comprehensive income	X
	––––

Profit attributable to:
Equity holders of the parent (bal. fig)	X
Non-controlling interest (Step 4)	X
	––––
Profit for the period	X
	––––
Total comprehensive income attributable to:
Equity holders of the parent (bal. fig)	X
Non-controlling interest (Step 4)	X
	––––
Total comprehensive income for the period	X
	––––

Step 3: Complete the pro-forma

Add together the parent and subsidiary’s incomes and expenses and items of other comprehensive income on a line-by-line basis.

If the subsidiary has been acquired mid-year, make sure that you pro-rate the results of the subsidiary so that only post-acquisition incomes, expenses and other comprehensive income are consolidated.

Ensure that you eliminate intra-group incomes and expenses, unrealised profits on intra-group transactions, as well as any dividends received from the subsidiary.

Step 4: Calculate the profit/TCI attributable to the non-controlling interest

Remember, profit for the year and TCI for the year must be split between the group and the non-controlling interest. The following proforma will help you to calculate the profit and TCI attributable to the non-controlling interest.

	Profit	TCI
	$000	$000
Profit/TCI of the subsidiary for the year	X	X
(pro-rated for mid-year acquisition)
PURP (if S is the seller)	(X)	(X)
Excess depreciation/amortisation	(X)	(X)
Goodwill impairment (under FV model only)	(X)	(X)
	–––	–––
×NCI%	X	X
	–––	–––
Profit/TCI attributable to the NCI	X	X
	–––	–––

Associates

Definitions

An associate is defined as ‘an entity over which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor’ (IAS 28, para 3).

Significant influence is the power to participate in, but not control, the financial and operating policy decisions of an entity. IAS 28 states that:

Significant influence is usually evidenced by representation on the board of directors, which allows the investing entity to participate in policy decisions.

A holding between 20% and 50% of the voting power is presumed to give significant influence, unless it can be clearly demonstrated that this is not the case.

It is presumed that a holding of less than 20% does not give significant influence, unless such influence can be clearly demonstrated.

Accounting for associates

Associates are not consolidated because the parent does not have control. Instead they are accounted for using the equity method.

Statement of financial position

IAS 28 requires that the carrying amount of the associate is determined as follows:

	$000
Cost	X
Add: P% of increase in reserves	X
Less: impairment losses	(X)
Less: P% of unrealised profits if P is the seller	(X)
Less: P% of excess depreciation on fair value adjustments	(X)
	–––
Investment in associate	X
	–––
The investment in the associate is shown in the non-current assets
section of the consolidated statement of financial position.

Statement of profit or loss and other comprehensive income

For an associate, a single line item is presented in the statement of profit or loss below operating profit. This is made up as follows:

	$000
P% of associate’s profit after tax	X
Less: Current year impairment loss	(X)
Less: P% of unrealised profits if associate is the seller	(X)
Less: P% of excess depreciation on fair value adjustments	(X)
Share of profit of associate	–––
Share of profit of associate	X
	–––

Within consolidated other comprehensive income, the group should present its share of the associate’s other comprehensive income (if applicable).

Adjustments

Dividends received from the associate must be removed from the consolidated statement of profit or loss.

Transactions and balances between the associate and the parent company are not eliminated from the consolidated financial statements because the associate is not a part of the group.

The group share of any unrealised profit arising on transactions between the group and the associate must be eliminated.

If the associate is the seller:

– Dr Share of the associate’s profit (P/L)/Retained earnings (SFP)

– Cr Inventories (SFP)

If the associate is the purchaser:

– Dr Cost of sales (P/L)/Retained earnings (SFP)

– Cr Investment in the associate (SFP)

General points and disclosures

IAS 28 notes the following:

The financial statements used to equity account for the associate should be drawn up to the investor’s reporting date. If this is not possible, then the difference in reporting dates should be less than three months.

The associate’s accounting policies should be harmonised with those of its investor.

The investor should disclose its share of the associate’s contingencies.

A list and description of significant associates should be disclosed. This will note the ownership interests and voting interests for each associate.

Note that the equity method is not used in the following situations:

the investment is classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations

the investor is itself a subsidiary, its owners do not object to the equity method not being applied and its debt and equity securities are not publicly traded. In this case, the investor’s parent must present consolidated financial statements that do use the equity method.

Illustration 1 – Consolidated statement of financial position

Summarised financial statements for three entities for the year ended 30

June 20X8 are as follows:

Statements of financial position

	Borough	High	Street
Assets	$	$	$
Property, plant and	100,000	80,000	60,000
equipment
Investments	121,000	–	–
Inventories	22,000	30,000	15,000
Receivables	70,000	10,000	2,000
Cash and cash equivalents	47,000	25,000	3,000
	–––––––	–––––––	–––––––
	360,000	145,000	80,000
	–––––––	–––––––	–––––––

Equity and liabilities
Equity capital ($1 shares)	100,000	75,000	35,000
Retained earnings	200,000	50,000	40,000
Other components of equity	10,000	5,000	–
Liabilities	50,000	15,000	5,000
	–––––––	–––––––	–––––––
	360,000	145,000	80,000
	–––––––	–––––––	–––––––

On 1 July 20X7, Borough purchased 45,000 shares in High for $100,000. At that date, High had retained earnings of $30,000 and no other components of equity. High’s net assets had a fair value of $120,000 and the fair value of the non-controlling interest was $55,000. It is group policy to value the non-controlling interest at acquisition at fair value.

The excess of the fair value of High’s net assets over their carrying amounts at the acquisition date relates to property, plant and equipment. This had a remaining estimated useful life of five years at the acquisition date. Goodwill has been subject to an impairment review and it was determined to be impaired by $7,000.

On 1 July 20X7, Borough purchased 10,500 equity shares in Street for $21,000. At that date, Street had retained earnings of $25,000 and no other components of equity.

During the year Borough sold goods too High for $10,000 at a margin of 50%. By the reporting date, High had only sold 80% of these goods. Included in the receivables of Borough and the liabilities of High are intra-group balances of $5,000.

On 5 July 20X8, Borough received notification that an employee was claiming damages against them as a result of a work-place accident that took place on 30 April 20X8. Lawyers have advised that there is a 60% chance that Borough will lose the case and will be required to pay damages of $30,000.

Required:

Prepare the consolidated statement of financial position as at 30 June 20X8.

Solution

Borough Group statement of financial position as at 30 June 20X8

Non Current Assets	$
Goodwill (W3)	28,000
Property, plant and equipment	192,000
($100,000 + $80,000 + $15,000 (W2) – $3,000 (W2))
Investment in Associate (W7)	25,500
Current Assets
Inventories ($22,000 + $30,000 – $1,000 (W6))	51,000
Receivables ($70,000 + $10,000 – $5,000 inter.co)	75,000
Cash and cash equivalents ($47,000 + $25,000)	72,000
	–––––––
	443,500
	–––––––
Equity capital	100,000
Retained earnings (W5)	179,500
Other components of equity (W5)	13,000
Non-controlling interest (W4)	61,000
	–––––––
Total equity	353,500
Liabilities	90,000

($50,000 + $15,000 – $5,000 inter.co + $30,000 (W8))

–––––––

443,500

–––––––

(W1) Group structure

Borough is the parent

High is a 60% subsidiary (45/75)

Street is a 30% associate (10.5/35)

Both acquisitions took place a year ago

(W2) Net assets of High
	Acq	Rep date
	$	$
Equity capital	75,000	75,000
Other components of equity	–	5,000
Retained earnings	30,000	50,000
Fair value adjustment (FVA)	15,000*	15,000
Depreciation on FVA ($15,000/5)	–	(3,000)
	––––––	––––––
*bal fig	120,000	142,000
	––––––	––––––
(W3) Goodwill
		$
Consideration		100,000
FV of NCI at acquisition		55,000
		–––––––
		155,000
FV of net assets at acquisition (W2)		(120,000)
		–––––––
Goodwill at acquisition		35,000
Impairment		(7,000)
		–––––––
Goodwill at the reporting date		28,000
		–––––––
(W4) Non-controlling interest
		$
Fair value of NCI at acquisition (given)		55,000
NCI % of post-acquisition net assets		8,800
(40% × ($142,000 – $120,000) (W2))
NCI share of goodwill impairment		(2,800)
(40% × $7,000)		–––––––
		–––––––

61,000

–––––––

(W5) Group reserves
Group retained earnings
	$
Parent	200,000
Provision (W8)	(30,000)
Share of post-acquisition retained earnings:
High: 60% × (($50,000 – $3,000) – $30,000) (W2)	10,200
Street: 30% × ($40,000 – $25,000)	4,500
Group share of goodwill impairment	(4,200)
(60% × $7,000)
PURP (W6)	(1,000)
	–––––––
	179,500
	–––––––
Other components of equity
	$
Parent	10,000
Share of post-acquisition other components of equity:
High: 60% × ($5,000 – $nil) (W2)	3,000
	–––––––

13,000

–––––––

(W6) Provision for unrealised profit

The profit on the intra-group sale was $5,000 (50% × $10,000).

The unrealised profit still in inventory is $1,000 (20% × $5,000).

The parent was the seller, so retained earnings is adjusted in (W5)

Dr Retained earnings	$1,000
Cr Inventories	$1,000
(W7) Investment in the associate	$
	$
Cost	21,000
Share of increase in retained earnings	4,500
(30% × ($40,000 – $25,000))	–––––––
	25,500
	–––––––

(W8) Provision

The obligating event, the accident, happened during the reporting period. This means that there is an obligation from a past event, and a probable outflow of resources that can be measured reliably. A provision is therefore required for the best estimate of the amount payable, which is $30,000. This is charged to the statement of profit or loss so will reduce retained earnings in (W5).

Dr Retained earnings	$30,000
Cr Provisions	$30,000

Illustration 2 – Consolidated statement of profit or loss

H has owned 80% of the ordinary shares of S and 30% of the ordinary shares of A for many years. The information below is required to prepare the consolidated statement of profit or loss for the year ended 30 June 20X8.

Statements of profit or loss for the year ended 30 June 20X8

	H	S	A
	$	$	$
Revenue	500,000	200,000	100,000
Cost of sales	(100,000)	(80,000)	(40,000)
	–––––––	–––––––	–––––––
Gross profit	400,000	120,000	60,000
Distribution costs	(160,000)	(20,000)	(10,000)
Administrative expenses	(140,000)	(40,000)	(10,000)
	–––––––	–––––––	–––––––
Profit from operations	100,000	60,000	40,000
Tax	(23,000)	(21,000)	(14,000)
	–––––––	–––––––	–––––––
Profit after tax	77,000	39,000	26,000
	–––––––	–––––––	–––––––

Note: There were no items of other comprehensive income in the year.

At the date of acquisition, the fair value of S’s plant and machinery, which at that time had a remaining useful life of ten years, exceeded the book value by $10,000.

During the year S sold goods to H for $10,000 at a margin of 25%. By the year-end H had sold 60% of these goods.

The group accounting policy is to measure non-controlling interests using the proportion of net assets method. The current year goodwill impairment loss was $1,200, and this should be charged to administrative expenses.

By 30 June 20X8 the investment in A had been impaired by $450, of which the current year loss was $150.

On 1 January 20X8, H signed a contract to provide a customer with support services for the following twelve months. H received the full fee of $30,000 in advance and recognised this as revenue.

Required:

Prepare the consolidated statement of profit or loss for the year ended 30 June 20X8.

Solution

Group statement of profit or loss for the year ended 30 June 20X8

	$
Revenue	675,000
($500,000 + $200,000 – $10,000 (W3) – $15,000 (W4))
Cost of sales	(172,000)
($100,000 + $80,000 + $1,000 (W2) – $10,000 (W3) +
$1,000 (W3))
	–––––––
Gross profit	503,000
Distribution costs ($160,000 + $20,000)	(180,000)
Administrative expenses	(181,200)
($140,000 + $40,000 + $1,200 GW imp)
	–––––––

Profit from operations	141,800
Share of profit of associate	7,650
((30% × $26,000) – $150 impairment)
	–––––––
Profit before tax	149,450
Tax ($23,000 + $21,000)	(44,000)
	–––––––
Profit for the period	105,450
	–––––––

Attributable to:
Equity holders of the parent (bal. fig)	98,050
Non-controlling interest (W5)	7,400
	–––––––
Profit for the period	105,450
	–––––––

Workings

(W1) Group structure

(W2) Excess depreciation
$10,000/10 years = $1,000.
The adjusting entry is:
Dr Cost of sales	$1,000
Cr PPE	$1,000
(W3) Intra-group trading
The $10,000 trading between S and H must be eliminated:
Dr Revenue	$10,000
Cr Cost of sales	$10,000

The profit on the sale was $2,500 (25% × $10,000). Of this, $1,000 ($2,500 × 40%) remains within the inventories of the group. The PURP adjustment is therefore:

Dr Cost of sales	$1,000
Cr Inventories	$1,000

(W4) Revenue

The performance obligation is satisfied over time. Based on the passage of time, the contract is 50% (6/12) complete so only 50% of the revenue should be recognised by the reporting date. Therefore $15,000 ($30,000 × 50%) should be removed from revenue and held as a liability on the SFP.

Dr Revenue		$15,000
Cr Contract liability		$15,000
(W5) Profit attributable to NCI
	$	$
S’s profit for the year	39,000
PURP (W3)	(1,000)
Excess depreciation (W2)	(1,000)
	––––––
× 20%	37,000	––––––
× 20%		––––––
Profit attributable to NCI		7,400
		––––––

Note: If the parent had sold goods to the subsidiary then the PURP adjustment would not be included when calculating the profit attributable to the NCI.

Goodwill has been calculated using the share of net assets method.

Therefore, none of the impairment loss is attributable to the NCI.

Illustration 3 – Associates

Paint has several investments in subsidiary companies. On 1 July 20X1, it acquires 30% of the ordinary shares of Animate for $2m. This holding gives Paint significant influence over Animate.

At the acquisition date, the fair value of Animate’s net assets approximate to their carrying values with the exception of a building. This building, with a remaining useful life of 10 years, had a carrying value of $1m but a fair value of $1.8m.

Between 1 July 20X1 and 31 December 20X1, Animate sold goods to Paint for $1 million making a profit of $100,000. All of these goods remain in the inventory of Paint. This sale was made on credit and the invoice has not yet been settled.

Animate made a profit after tax of $800,000 for the year ended 31 December 20X1. At 31 December 20X1, the directors of Paint believe that the investment in the associate needs impairing by $50,000.

Required:

Prepare extracts from the consolidated statement of financial position and the consolidated statement of profit or loss showing the treatment of the associate for the year ended 31 December 20X1.

Solution

Consolidated statement of financial position	$
Investment in associate (W1)	2,058,000
Consolidated statement of profit or loss
Share of profit of associate (W2)	28,000

Note: No adjustment is required for receivables and payables held between Paint and Animate.

(W1) Investment in associate	$
	$
Cost	2,000,000
Share of post-acquisition profit	120,000
(30% × $800,000 × 6/12)
Share of excess depreciation	(12,000)
(30% × (($1.8m – $1m)/10 years) × 6/12)
Impairment	(50,000)
	––––––––
Investment in associate	2,058,000
	––––––––

The inventory is held within the group so the parent’s share of the PURP is credited against inventory rather than the investment in the associate.

	(W2) Share of associate’s profit	$
		$
	P’s share of A’s profit after tax	120,000
	(30% × $800,000 × 6/12)	(50,000)
	Impairment	(50,000)
	P’s share of excess depreciation	(12,000)
	(30% × (($1.8m – $1m)/10 years) × 6/12)	(30,000)
	P’s share of PURP	(30,000)
	(30% × $100,000)	––––––––
		––––––––
	Share of profit of associate	28,000
		––––––––

4 Control

Consolidated statements are produced if one entity controls another entity. It is often presumed that control exists if a company owns more than 50% of the ordinary shares of another company. However, in section B of the P2 exam, the examiner may test the definition of control in more detail.

According to IFRS 10, an investor controls an investee when:

the investor has power over the investee, and

the investor is exposed, or has rights, to variable returns from its involvement with the investee, and

the investor has the ability to affect those returns through its power over the investee.

IFRS 10 identifies a range of circumstances that may need to be considered when determining whether or not an investor has power over an investee, such as:

exercise of the majority of voting rights in an investee

contractual arrangements between the investor and other parties

holding less than 50% of the voting shares, with all other equity interests held by a numerically large, dispersed and unconnected group

holding potential voting rights (such as convertible loans) that are currently capable of being exercised

the nature of the investor’s relationship with other parties that may enable that investor to exercise control over an investee.

It is therefore possible to own less than 50% of the ordinary shares of another entity and to still exercise control over it.

Application of IFRS 10 control definition

An investor has 48 per cent of the voting rights of another entity. The remaining 52 per cent of the voting rights are held by thousands of other shareholders, none of whom individually hold more than 1 per cent of the voting rights. These other shareholders have no relationship with one another.

Due to the size of its holding and the relative size of the other shareholdings, the investor believes that it controls the investee.

Test your understanding 1 – Control

Parsley has a 40% holding in the ordinary shares of Oregano. Another investor has a 10% shareholding in Oregano whilst the remaining voting rights are held by thousands of shareholders, none of whom individually hold more than 1 per cent of the voting rights. Parsley also holds debt instruments that, as at 30 April 20X4, are convertible into ordinary shares of Oregano at a price of $4 per share. At 30 April 20X4, the shares of Oregano trade at $3.80 per share. If the debt was converted into ordinary shares, Parsley would hold 60% of the voting rights in Oregano. Parsley and Oregano undertake similar activities and would benefit from synergies.

Required:

Discuss how Parsley’s investment in the ordinary shares of Oregano should be treated in the consolidated financial statements for the year ended 30 April 20X4.

Exemptions from consolidation

Intermediate parent companies

An intermediate parent entity is an entity which has a subsidiary but is also itself a subsidiary of another entity. For example:

IFRS 10 permits a parent entity not to present group financial statements provided all of the following conditions apply:

it is a wholly-owned, or partially-owned subsidiary where owners of the non-controlling interest do not object to the non-preparation

its debt or equity instruments are not currently traded in a domestic or foreign market

it is not in the process of having any of its debt or equity instruments traded on a domestic or foreign market

the ultimate parent entity produces consolidated financial statements that comply with IFRS Standards and which are available to the public.

If this is the case, IAS 27 Separate Financial Statements requires that the following disclosures are made:

the fact that consolidated financial statements have not been presented

a list of significant investments (subsidiaries, joint ventures and associates) including percentage shareholdings, principal place of business and country of incorporation

the bases on which those investments listed above have been accounted for in its separate financial statements.

Investment entities

An investment entity is defined by IFRS 10 as an entity that:

obtains funds from investors and provides them with investment management services, and

invests those funds to earn returns from capital appreciation, investment income, or both, and

measures the performance of its investments on a fair value basis.

Investment entities do not consolidate an investment over which they have control. Instead, the investment is measured at fair value at each reporting date with gains and losses recorded in profit or loss.

Invalid reasons to exclude a subsidiary from consolidation

In addition to the valid reasons to exclude a subsidiary from consolidation considered earlier, directors of the parent entity may seek to exclude a subsidiary from group accounts for several invalid reasons, including:

Long-term restrictions on the ability to transfer funds to the parent. This exclusion from consolidation is not permitted as it may still be possible to control a subsidiary in such circumstances.

The subsidiary undertakes different activities and/or operates in different locations, thus being distinctive from other members of the group. This is not a valid reason for exclusion from consolidation.

Indeed it could be argued that inclusion within the group accounts of such a subsidiary will enhance the relevance and reliability of the information contained within the group accounts.

The subsidiary has made losses or has significant liabilities which the directors would prefer to exclude from the group accounts to improve the overall reported financial performance and position of the group. This could be motivated, for example, by determination of directors’ remuneration based upon group financial performance. This is not a valid reason for exclusion from consolidation.

The directors may seek to disguise the true ownership of the subsidiary, perhaps to avoid disclosure of particular activities or events, or to avoid disclosure of ownership of assets. This could be motivated, for example, by seeking to avoid disclosure of potential conflicts of interest which may be perceived adversely by users of financial statements.

The directors may seek to exclude a subsidiary from consolidation in order for the group to disguise its true size and extent. This could be motivated, for example, by trying to avoid legal and regulatory compliance requirements applicable to the group or individual subsidiaries. This is not a valid reason for exclusion from consolidation.

5 The acquisition method

IFRS 3 applies to business combinations. A business combination is where an acquirer obtains control of a business.

IFRS 3 defines a business as ‘an integrated set of activities and assets that is capable of being conducted and managed to provide a return in the form of dividends, lower costs, or other economic benefits’ benefits’ (IFRS 13, Appendix A). Therefore:

if the assets acquired are not a business, the transaction should be accounted for as the purchase of an asset

if the assets acquired do constitute a business, the transaction is accounted for by applying the acquisition method outlined in IFRS 3.

The acquisition method has the following requirements:

Identifying the acquirer

Determining the acquisition date

Recognising and measuring the subsidiary’s identifiable assets and liabilities

Recognising goodwill (or a gain from a bargain purchase) and any non-controlling interest.

Although you will be aware of many of these requirements from your previous studies, as well as from the illustrations earlier in this chapter, you are expected to have a more detailed knowledge of each of these elements for the P2 exam.

Identifying the acquirer

The acquirer is the entity that has assumed control over another entity.

In a business combination, it is normally clear which entity has assumed control.

The acquirer

Lyra pays $1 million to obtain 60% of the ordinary shares of Pan.

Lyra is the acquiring company.

However, sometimes it is not clear as to which entity is the acquirer. For these cases, IFRS 3 provides guidance:

The acquirer is normally the entity that has transferred cash or other assets within the business combination

If the business combination has not involved the transfer of cash or other assets, the acquirer is usually the entity that issues its equity interests.

Other factors to consider are as follows:

The acquirer is usually the entity whose (former) management dominates the combined entity

The acquirer is usually the entity whose owners have the largest portion of voting rights in the combined entity

The acquirer is normally the bigger entity.

Test your understanding 2 – Identifying the acquirer

Abacus and Calculator are two public limited companies. The fair values of the net assets of these two companies are $100 million and $60 million respectively.

On 31 October 20X1, Abacus incorporates a new company, Phone, in order to effect the combination of Abacus and Calculator. Phone issues its shares to the shareholders of Abacus and Calculator in return for their equity interests.

After this, Phone is 60% owned by the former shareholders of Abacus and 40% owned by the former shareholders of Calculator. On the board of Phone are 4 of the former directors of Abacus and 2 of the former directors of Calculator.

Required:

With regards to the above business combination, identify the acquirer.

The acquisition date

The acquisition date is the date on which the acquirer obtains control over the acquiree. This will be the date at which goodwill must be calculated and from which the incomes and expenses of the acquiree will be consolidated.

Identifiable assets and liabilities

The acquirer must measure the identifiable assets acquired and the liabilities assumed at their fair values at the acquisition date.

Remember, when completing a consolidated statement of financial position, these fair value uplifts are adjusted in the net assets table (W2).

Goodwill in the subsidiary’s individual financial statements is not an identifiable asset because it cannot be separately disposed of.

Fair value of the identifiable net assets of the acquiree

Identifiable assets

IFRS 3 says that an asset is identifiable if:

It is capable of disposal separately from the business owning it, or

It arises from contractual or other legal rights, regardless of whether those rights can be sold separately.

The identifiable assets and liabilities of the subsidiary should be recognised at fair value where:

they meet the definitions of assets and liabilities in the Conceptual Framework for Financial Reporting, and

they are exchanged as part of the business combination rather than a separate transaction.

Items that are not identifiable or do not meet the definitions of assets or liabilities are subsumed into the calculation of purchased goodwill.

Contingent liabilities

Contingent liabilities that are present obligations arising from past events and that can be measured reliably are recognised at fair value at the acquisition date. This is true even where an economic outflow is not probable. The fair value will incorporate the probability of an economic outflow.

Provisions

A provision for future operating losses cannot be created as this is a post-acquisition item. Similarly, restructuring costs are only recognised to the extent that a liability actually exists at the date of acquisition.

Fair value – exceptions

There are some exceptions to the requirement to measure the subsidiary’s net assets at fair value when accounting for business combinations. Assets and liabilities falling within the scope of the following standards should be valued according to those standards:

IAS 12 Income Taxes

IAS 19

IFRS 2 Share-based Payment

IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

Test your understanding 3 – Fair value of identifiable net assets

P purchased 60% of the shares of S on 1 January 20X1. At the acquisition date, S had share capital of $10,000 and retained earnings of $190,000.

The property, plant and equipment of S includes land with a carrying value of $10,000 but a fair value of $50,000.

Included within the intangible assets of S is goodwill of $20,000 which arose on the purchase of the trade and assets of a sole-trader business. S has an internally generated brand that is not recognised (in accordance with IAS 38). The directors of P believe that this brand has a fair value of $150,000.

In accordance with IAS 37, the financial statements of S disclose the fact that a customer has initiated legal proceedings against them. If the customer wins, which lawyers have advised is unlikely, estimated damages would be $1m. The fair value of this contingent liability has been assessed as $100,000 at the acquisition date.

The directors of P wish to close one of the divisions of S. They estimate that this will cost $200,000 in redundancy payments.

Required:

What is the fair value of S’s identifiable net assets at the acquisition date?

Goodwill

Goodwill should be recognised on a business combination. This is calculated as the difference between:

The aggregate of the fair value of the consideration transferred and the non-controlling interest in the acquiree at the acquisition date, and

The fair value of the acquiree’s identifiable net assets and liabilities.

Purchase consideration

When calculating goodwill (W3), purchase consideration transferred to acquire control of the subsidiary must be measured at fair value.

When determining the fair value of the consideration transferred, remember that:

Contingent consideration is included even if payment is not deemed probable. Its fair value will incorporate the probability of payment occurring.

Acquisition costs are excluded from the calculation of purchase consideration.

– Legal and professional fees are expensed to profit or loss as incurred

– Debt or equity issue costs are accounted for in accordance with IFRS 9 Financial Instruments.

Contingent consideration

IFRS 3 says that contingent consideration is an obligation of the acquirer to transfer additional assets or equity interests if specified future events occur or conditions are met.

In an examination question the acquisition date fair value of any contingent consideration (or details of how to calculate it) would be given.

The payment of contingent consideration may be in the form of equity or a liability (issuing a debt instrument or cash) and should be recorded as such under the rules of IAS 32 Financial Instruments: Presentation (or other applicable standard).

Changes in the fair value of any contingent consideration after the acquisition date are dealt with in IFRS 3.

Changes due to additional information obtained after the acquisition date that affects the facts or circumstances as they existed at the acquisition date are accounted for retrospectively. This means that the liability (and goodwill) are remeasured. This further information must have been obtained within twelve months of the acquisition date.

Changes due to events after the acquisition date (for example, meeting an earnings target which triggers a higher payment than was provided for at acquisition) are treated as follows:

– Contingent consideration classified as equity shall not be remeasured. Its subsequent settlement shall be accounted for within equity (e.g. Cr share capital/share premium Dr retained earnings).

– Contingent consideration classified as an asset or a liability shall be remeasured at fair value with the movement recognised in profit or loss.

Note: Although contingent consideration is usually a liability, it may be an asset if the acquirer has the right to a return of some of the consideration transferred if certain conditions are met.

Test your understanding 4 – Purchase consideration

Following on from TYU 3, the purchase consideration transferred by P in exchange for the shares in S was as follows:

Cash paid of $300,000

Cash to be paid in one year’s time of $200,000

10,000 shares in P. These had a nominal value of $1 and a fair value at 1 January 20X1 of $3 each

$250,000 to be paid in one year’s time if S makes a profit before tax of more than $2m. There is a 50% chance of this happening. The fair value of this contingent consideration can be measured as the present value of the expected value.

Legal fees associated with the acquisition were $10,000.

Where required, a discount rate of 10% should be used.

Required:

Per IFRS 3, what is the fair value of the consideration transferred to acquire control of S?

Goodwill and the non-controlling interest

The calculation of goodwill will depend on the method chosen to value the non-controlling interest at the acquisition date.

IFRS 3 provides a choice in valuing the non-controlling interest at acquisition:

EITHER: OR:

Method 1 – The proportionate

share of net assets method

NCI % × Fair value of the net

assets of the subsidiary at the

acquisition date

Method 2 – The fair value method

Fair value of NCI at date of acquisition. This is usually given in the question.

If the NCI is valued at acquisition as their proportionate share of the acquisition net assets, then only the acquirer’s goodwill will be calculated.

Where an exam question requires the use of this method, it will state that ‘it is group policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary’s identifiable net assets’.

If the NCI is valued at acquisition at fair value, then goodwill attributable to both the acquirer and the NCI will be calculated. This is known as the ‘full goodwill method’.

Where an exam question requires the use of this method, it will state that ‘it is group policy to value the non-controlling interest using the full goodwill method’ or that ‘the non-controlling interest is measured at fair value’.

Test your understanding 5 – Goodwill

Following on from ‘Test your understandings’ 3 and 4, the fair value of the non-controlling interest at the acquisition date is $160,000.

Required:

Calculate the goodwill arising on the acquisition of S if the non-controlling interest at the acquisition date is valued at:

fair value

its proportion of the fair value of the subsidiary’s identifiable net assets.

Non-controlling interest – choice of method

The method used to measure the NCI should be decided on a transaction by transaction basis. This means that, within the same group, the NCI in some subsidiaries may have been measured at fair value at acquisition, whilst the NCI in other subsidiaries may have been measured at acquisition using the proportionate basis.

Measurement period

During the measurement period, IFRS 3 requires the acquirer in a business combination to retrospectively adjust the provisional amounts recognised at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date.

This would result in goodwill arising on acquisition being recalculated.

The measurement period ends no later than twelve months after the acquisition date.

Measurement period illustration

P bought 100% of the shares of S on 31 December 20X1 for $60,000. On the acquisition date, it was estimated that the fair value of S’s net assets were $40,000.

For the year ended 31 December 20X1, P would consolidate S’s net assets of $40,000 and would also show goodwill of $20,000 ($60,000 – $40,000).

However, P receives further information on 30 June 20X2 which indicates that the fair value of S’s net assets at the acquisition date was actually $50,000. This information was determined within the measurement period and so is retrospectively adjusted for.

Therefore, the financial statements for the year ended 31 December 20X1 will be adjusted. P will now consolidate S’s net assets of $50,000 and will show goodwill of $10,000 ($60,000 – $50,000).

Bargain purchases

If the share of net assets acquired exceeds the consideration given, then a gain on bargain purchase (‘negative goodwill’) arises on acquisition. The accounting treatment for this is as follows:

IFRS 3 says that negative goodwill is rare and therefore it may mean that an error has been made in determining the fair values of the consideration and the net assets acquired. The figures must be reviewed for errors.

If no errors have been made, the negative goodwill is credited immediately to profit or loss.

6 Impairment of goodwill

IAS 36 Impairment of Assets requires that goodwill is tested for impairment annually.

Goodwill does not generate independent cash inflows. Therefore, it is tested for impairment as part of a cash generating unit.

A cash generating unit is the ‘smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets’ (IAS 36, para 6).

For exam purposes, a subsidiary is normally designated as a cash generating unit.

Accounting for an impairment

An impairment loss is the amount by which the carrying amount of an asset or a cash generating unit exceeds its recoverable amount.

Recoverable amount is the higher of fair value less costs to sell and value in use.

Impairment losses on a subsidiary will firstly be allocated against goodwill and then against other assets on a pro-rata basis.

Accounting for an impairment with a non-controlling interest

Full method of valuing NCI

Goodwill calculated under the fair value method represents full goodwill. It can therefore be added together with the other net assets of the subsidiary and compared to the recoverable amount of the subsidiary’s net assets on a like for like basis.

Any impairment of goodwill is allocated between the group and the NCI based upon their respective shareholdings.

Proportionate method of valuing NCI

If the NCI is valued at acquisition at its share of the subsidiary’s net assets then only the goodwill attributable to the group is calculated. This means that the NCI share of goodwill is not reflected in the group accounts. As such, any comparison between the carrying amount of the subsidiary (including goodwill) and the recoverable amount of its net assets will not be on a like-for-like basis.

In order to address this problem, goodwill must be grossed up to include goodwill attributable to the NCI prior to conducting the impairment review. This grossed up goodwill is known as total notional goodwill.

As only the parent’s share of the goodwill is recognised in the group accounts, only the parent’s share of the goodwill impairment loss should be recognised.

Illustration 4 – Impairment of goodwill

A owns 80% of B. At 31 October 20X6 the carrying amount of B’s net assets is $60 million, excluding goodwill of $8 million that arose on the original acquisition.

The recoverable amount of the net assets of B is $64 million.

Calculate the impairment loss if:

the NCI at acquisition was measured at fair value

the NCI at acquisition was measured at its proportion of the fair value of the subsidiary’s identifiable net assets.

Solution

Full goodwill method

	$m
Goodwill	8
Net assets	60
	––––
Carrying amount	68
Recoverable amount	64
	––––
Impairment	4
	––––

The impairment loss will be allocated against goodwill, reducing it from $8m to $4m.

The $4m impairment expense will be charged to profit or loss. Of this, $3.2m ($4m × 80%) is attributable to the group and $0.8m ($4m × 20%) is attributable to the NCI.

(b) Proportionate method
	$m	$m
Goodwill	8
Unrecognised NCI (20/80 × $8m)	2
Total notional goodwill	––––	10
Total notional goodwill		10
Net assets		60
		––––
Carrying amount		70
Recoverable amount		64
		––––
Impairment		6
		––––

The impairment loss is allocated against the total notional goodwill.

Only the group’s share of goodwill has been recognised in the financial statements and so only the group’s share (80%) of the impairment is recognised. The impairment charged to profit or loss is therefore $4.8m and goodwill will be reduced to $3.2m ($8m – $4.8m).

Test your understanding 6 – Happy

On 1 January 20X5, Lucky group purchased 80% of Happy for $500,000. The fair value of the identifiable net assets of Happy at the date of acquisition amounted to $590,000.

The carrying amount of Happy’s net assets at 31 December is $520,000 (excluding goodwill). Happy is a cash-generating unit.

At 31 December 20X5 the recoverable amount of Happy’s net assets is $530,000.

Required:

Calculate the impairment loss and explain how this would be dealt with in the financial statements of the Lucky group. if:

the NCI at acquisition was measured at its fair value of $130,000.

the NCI at acquisition was measured at its share of the fair value of Happy’s identifiable net assets.

Impact on the financial statements

If goodwill is calculated using the fair value method (i.e. the non-controlling interest is valued at fair value at the acquisition date), then goodwill and the non-controlling interest will be higher than if the proportionate method was used. Although this will reduce the return on capital employed, it will also strengthen the gearing ratio.

The higher asset value reported when using the fair value method may lead to higher impairment losses being charged to profit or loss.

Test your understanding 7 – Pauline

On 1 April 20X7 Pauline acquired the following non-current investments:

6 million equity shares in Sonia by an exchange of two shares in Pauline for every four shares in Sonia plus $1.25 per acquired Sonia share in cash. The market price of each Pauline share at the date of acquisition was $6 and the market price of each Sonia share at the date of acquisition was $3.25.

30% of the equity shares of Arthur at a cost of $7.50 per share in cash.

Only the cash consideration of the above investments has been recorded by Pauline. In addition $1,000,000 of professional costs relating to the acquisition of Sonia is included in the cost of the investment.

The summarised draft statements of financial position of the three companies at 31 March 20X8 are presented below:

	Pauline	Sonia	Arthur
	$000	$000	$000
Assets
Non-current assets
Property, plant and	36,800	20,800	36,000
equipment
Investments in Sonia and	26,500	–	–
Arthur
Financial assets	13,000	–	–
	––––––	––––––	––––––
	76,300	20,800	36,000

Current assets
Inventories	13,800	12,400	7,200
Trade receivables	6,400	3,000	4,800
	––––––	––––––	––––––
Total assets	96,500	36,200	48,000
	––––––	––––––	––––––
Equity and liabilities
Equity shares of $1 each	20,000	8,000	8,000
Retained earnings
– at 31 March 20X7	32,000	12,000	22,000
– for year ended 31	18,500	5,800	10,000
March 20X8	––––––	––––––	––––––
	––––––	––––––	––––––
Non-current liabilities	70,500	25,800	40,000
Non-current liabilities
7% Loan notes	10,000	2,000	2,000
Current liabilities
Trade payables	16,000	8,400	6,000
	––––––	––––––	––––––
	96,500	36,200	48,000
	––––––	––––––	––––––

The following information is relevant to the preparation of the consolidated statement of financial position:

At the date of acquisition Sonia had an internally generated brand name. The directors of Pauline estimate that this brand name has a fair value of $2 million, an indefinite life and has not suffered any impairment.

On 1 April 20X7, Pauline sold an item of plant to Sonia at its agreed fair value of $5 million. Its carrying amount prior to the sale was $4 million. The estimated remaining life of the plant at the date of sale was five years.

During the year ended 31 March 20X8 Sonia sold goods to Pauline for $5.4 million. Sonia had marked up these goods by 50% on cost. Pauline had a third of the goods still in its inventory at 31 March 20X8. There were no intra-group payables or receivables at 31 March 20X8.

Pauline has a policy of valuing non-controlling interests at fair value at the date of acquisition. For this purpose the share price of Sonia at this date should be used. Impairment tests on 31 March 20X8 concluded that the recoverable amount of the net assets of Sonia were $34 million.

The financial assets in Pauline’s statement of financial position are classified as fair value through profit or loss. In the draft financial statements, they are held at their fair value as at 1 April 20X7. They have a fair value of $18 million as at 31 March 20X8.

Required:

Prepare the consolidated statement of financial position for the Pauline group as at 31 March 20X8.

7 IFRS 11 – Joint arrangements

IFRS 11 Joint Arrangements adopts the definition of control as included in IFRS 10 (see earlier within this chapter) as a basis for determining whether there is joint control.

Joint arrangements are defined ‘as arrangements where two or more parties have joint control’ (IFRS 11, Appendix A). This will only apply if the

relevant activities require unanimous consent of those who collectively control the arrangement.

Joint arrangements may take the form of either:

joint operations

joint ventures.

The key distinction between the two forms is based upon the parties’ rights and obligations under the joint arrangement.

IFRS 11 Joint arrangements

Joint operations

Joint operations are defined as joint arrangements whereby ‘the parties that have joint control have rights to the assets and obligations for the liabilities’ (IFRS 11, Appendix A). Normally, there will not be a

separate entity established to conduct joint operations.

Example of a joint operation

A and B decide to enter into a joint operation to produce a new product. A undertakes one manufacturing process and B undertakes the other. A and B have agreed that decisions regarding the joint operation will be made unanimously and that each will bear their own expenses and take an agreed share of the sales revenue from the product.

Joint ventures

Joint ventures are defined as joint arrangements whereby ‘the parties have joint control of the arrangement and have rights to the net assets of the arrangement’ (IFRS 11, Appendix A). This will normally

be established in the form of a separate entity to conduct the joint venture activities.

Example of a joint venture

A and B decide to set up a separate entity, C, to enter into a joint venture. A will own 55% of the equity capital of C, with B owning the remaining 45%. A and B have agreed that decision-making regarding the joint venture will be unanimous. Neither party will have direct right to the assets, or direct obligation for the liabilities of the joint venture; instead, they will have an interest in the net assets of entity C set up for the joint venture.

Accounting for joint arrangements

Joint operations

If the joint operation meets the definition of a ‘business’ then the principles in IFRS 3 Business Combinations apply when an interest in a joint operation is acquired:

Acquisition costs are expensed to profit or loss as incurred

The identifiable assets and liabilities of the joint operation are measured at fair value

The excess of the consideration transferred over the fair value of the net assets acquired is recognised as goodwill.

At the reporting date, the individual financial statements of each joint operator will recognise:

its share of assets held jointly

its share of liabilities incurred jointly

its share of revenue from the joint operation

its share of expenses from the joint operation.

The joint operator’s share of the income, expenses, assets and liabilities of the joint operation are included in its individual financial statements and so they will automatically flow through to the consolidated financial statements.

Joint ventures

In the individual financial statements, an investment in a joint venture can be accounted for:

at cost

in accordance with IFRS 9 Financial Instruments, or

by using the equity method.

In the consolidated financial statements, the interest in the joint venture entity will be accounted for using the equity method. The treatment of a joint venture in the consolidated financial statements is therefore identical to the treatment of an associate.

Test your understanding 8 – A, B, C and D

A, B and C establish a new entity, which is called D. A has 50 per cent of the voting rights in the new entity, B has 30 per cent and C has 20 per cent. The contractual arrangement between A, B and C specifies that at least 75 per cent of the voting rights are required to make decisions about the activities of entity D.

Required:

How should A account for its investment in D in its consolidated financial statements?

Illustration 5 – Joint operation – Blast

Blast has a 30% share in a joint operation. The assets, liabilities, revenues and costs of the joint operation are apportioned on the basis of shareholdings. The following information relates to the joint arrangement activity for the year ended 30 November 20X2:

The manufacturing facility cost $30m to construct and was completed on 1 December 20X1 and is to be dismantled at the end of its estimated useful life of 10 years. The present value of this dismantling cost to the joint arrangement at 1 December 20X1, using a discount rate of 8%, was $3m.

During the year ended 30 November 20X2, the joint operation entered into the following transactions:

– goods with a production cost of $36m were sold for $50m

– other operating costs incurred amounted to $1m

– administration expenses incurred amounted to $2m.

Blast has only accounted for its share of the cost of the manufacturing facility, amounting to $9m. The revenue and costs are receivable and payable by the two other joint operation partners who will settle amounts outstanding with Blast after each reporting date.

Required:

Show how Blast will account for the joint operation within its financial statements for the year ended 30 November 20X2.

Solution – Blast

Profit or loss impact:	$m
Revenue ($50m × 30%)	15.000
Cost of sales ($36m × 30%)	(10.800)
Operating costs ($1m × 30%)	(0.300)
Depreciation (($30m + 3m) × 1/10 × 30%)	(0.990)
Administration expenses ($2m × 30%)	(0.600)
Finance cost ($3m × 8% × 30%)	(0.072)
	–––––
Share of net profit re joint operation (include in retained	2.238
earnings within SOFP)	–––––
	–––––

Statement of financial position impact:	$m
Property, plant and equipment (amount paid = share of cost)	9.000
Dismantling cost ($3m × 30%)	0.900
Depreciation ($33m × 1/10 × 30%)	(0.990)
	–––––
	8.910
	–––––
Trade receivables (i.e. share of revenue due)	15.000

Month: March 2021

ACCA P2 : CORPORATE REPORTING NOTES

Questions & Answers

UK GAAP

Group statement of cash flows

Group re-organisations

Group accounting – foreign currency

Change in a group structure

Complex groups

Group accounting – basic groups